Sep 042015

Blogger John Koning recently posted on the negative skewness (or as he says: bulls walk up the stairs, bears jump out the window) of the stock market. He notes that “there are plenty of famous meltdowns in stocks, including 1914, 1929, 1987, and 2008, but almost no famous melt ups”. To demonstrate this, he produces a chart of 22,013 trading days since 1928 grouped by the daily return and showing the percentage of days that were negative.

The chart below replicates Koning’s figures but I have also included gold and silver London Fixes since 1968 for comparison, which is the longest data set I have.


In a rising market we should see percentages below 50 reflecting more up than down days. For the S&P Koning notes that 51.9% of daily changes over 2% were negative, that is, “there are more extreme negative results than extreme positive results”. He lists some of the academic theories to explain this but the only one the could apply to precious metals is volatility feedback:

“When important news arrives, this signals that market volatility has increased. If the news is good, investor jubilation will be partially offset by an increase in wariness over volatility, the final change in share price being smaller than it would otherwise have been. When the news is bad, disappointment will be reinforced by this wariness, amplifying the decline.”

It is interesting that gold doesn’t exhibit negative skewness like the S&P but silver demonstrates an unusual skew negative on small returns but no so much for the extremes, a case of bears walking down stairs.

However, because the groups in Koning’s chart compress the data quite and bit and there wasn’t a globally free market in gold until 1975, I think it is better to look at a time period starting from the 1976 bottom (after the excitement of gold becoming legal again had washed out). To get a better handle on the skewness, I have broken up the daily returns into 0.25% increments, and the chart below shows the distribution for gold.


Note that gold has a long tail with a lot of concentration in the sub 1% returns. Converting that data into Koning’s “percentage which are negative” results in the chart below.


Generally this shows little skewing, keeping in mind that the larger percentages for the groups over 3% are based on a very small number of days (less than 30) so a difference of a few days can result in large percentage variances. For silver, below, the distribution is a lot more fatter.


This reflect silver’s higher volatility and while not a statistically normal distribution it doesn’t to my eye show excessive tail skewness. When plotted as percentage negative we again see the skew negative on the small returns but with some big positive skews for daily returns above 2.5%.


Looking at these results I don’t think they support the volatility feedback theory. The best explanation I can come up with is that gold and silver react strongly to positive news (ie everyone is pretty clear what is bad economic news and good for gold and silver), hence we see more 55-60% skew to positive large daily returns. However, in general prices grind down as people slowly get out of the fear trade, due to everyone having a different assessment of when the bad news/event that triggers the price spike is no longer a risk.

Sep 032015

Back in July I said that “an investment in AUD gold may represent a reasonable bet” given that “the general consensus on the Australian dollar is that it will continue to weaken due to a poor economic outlook with commodity prices falling”.

Today, Australian media are reporting that the AUD/USD exchange rate will reach 0.60 by end of 2016. First is Deutsche Bank chief economist Adam Boyton quoted as saying that the dollar will keep falling to US60¢ by the end of 2016 and he “wouldn’t be surprised if the Australian dollar is printed with a ‘five’ handle in the next three years”. That article also says “Suncorp senior economist Darryl Conroy is also expecting the dollar to fall towards US50¢”. The Sydney Morning Herald was quoting AMP chief economist Shane Oliver as saying “he expects the dollar to reach US68¢ by the end of the year and slide to US60¢ throughout 2016”.

If the Australian exchange rate does fall to USD 0.60, then that puts a strong floor under the Australian gold price. The following conservative USD gold prices at that exchange rate equate to:

USD 800 = AUD 1,333
USD 1,000 = AUD 1,667
USD 1,200 = AUD 2,000

The chart below puts those moves into context.


USD 800 is the most pessimistic forecast of the mainstream gold analysts, and would represent an 18% fall in AUD terms from today at an 0.60 exchange rate. This is not an unrealistic scenario, as the effect of changes in the Australian exchange rate on the AUD gold price, if driven primarily by USD strength, will be counteracted by a fall in the USD gold price.

While the USD 800/FX 0.60 combination results in a big loss, it does need to be weighed up against the upside. I have spoken to some Australian investors who are expecting the Australian economy to fall into a recession and are thus expecting the exchange rate to weaken and house prices to fall, but for the USD gold price to rise at the same time on the back of weak Chinese and global economies. In that scenario, a conservative USD 1,500 gold price at 0.60 is AUD 2,500 per ounce. These investors are expecting a 40% reduction in average Australian house prices, which would bring to house price/gold ratio down to levels it has reached in previous recessions, as shown in the chart below.


As discussed earlier this week, their plan is to switch out of gold and into other hard assets. Ultimately it comes down to whether you think that the Australian dollar’s fall is going to be driven more by factors unique to Australia’s economy and thus the USD gold price will not necessarily fall at the same time, resulting in a surging AUD gold price.

Sep 022015

Reuters reported last week that “South Africa’s mining industry, unions and the government have committed to a broad plan to stem job losses, including boosting platinum by promoting the metal as a central bank reserve asset”. This is apparently an idea put forward by the World Platinum Investment Council in late 2014.

The idea got me thinking about the role of platinum and palladium in a precious metal portfolio. Generally I shy away from recommending them due to their lower liquidity compared to gold and silver and more volatile and industrial nature. As a theoretical exercise I thought I would extend the work done in this and this post to include platinum and palladium.

In those previous posts I was only dealing with two metals, which with 1% incremental changes only involves 101 different percentage allocations to run through. With four metals and a 5% increment, I was looking at over 1,771 different portfolios (assuming my macro was working correctly!)

Also, because I only had pricing data for the platinum group metals from mid 1990, I have just run the simulation from July 1990 to July 2015 with $100 being bought each month (total cash invested $30,000). The result in the chart below.


Across the X axis are each of the 1771 different percentage combinations of the four metals, sorted roughly by the resulting end portfolio value/return. The colours show the general weightings of each metal.

In general terms, the worst performing portfolios are those with a lot of platinum and the best those with more palladium. Gold takes a big role but is somewhat interchangeable with silver within a particular allocation to gold/silver.

I think the result is skewed by a higher average monthly return on palladium (0.86% per month) compared to platinum (0.38%). I would also note that palladium returns have a low correlation of  0.31 to gold and 0.42 to silver, coupled with higher volatility, probably giving better diversification benefits than platinum, which has a higher correlation to gold and silver (0.559 and 0.561 respectively).

Using a single 25 year time period with a flat $100 monthly investment also skews the result towards the performance of the four metal during the 1990s. For the record, the best performing portfolio combination was 30% gold and 70% palladium at $90,046 and the worst 100% platinum at $49,449.

I would be careful reading to much into this brief analysis, but it does indicate that there is some role for platinum and palladium in a precious metal portfolio (unless you are Australian, because palladium attracts a 10% Goods and Services Tax).