Maxwell Gold

Director Investment Strategy

Investment Insights October 2017

Market Reality May Benefit Real Assets

Summary

Risks of an aging bull market and record low volatility may Exhibit 2: Low correlations to US financial assets.
spur investors to diversify into real assets for protection. S&P 500 Barclays US Aggregate

Rising inflationary pressures may benefit real assets. Precious Metals

Real assets remain cheap relative to financial assets. Commodities

Real assets, hard assets, tangible assets. The investment industry is

MLPs
full of terms for this asset class. Regardless of the terminology,
however, real assets are simply investments that provide a store of
REITs
value linked to a physical asset such as gold, oil, or real estate. This
distinction from traditional investment vehicles may result in two
0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0
key benefits: 1) providing diversification from financial assets such Correlation
as stocks and bonds; 2) hedging against rising inflation. Given the Source: Bloomberg, ETF Securities. Data from =01/01/96 to 09/30/17.
current reality of the market, particularly in the US, the benefits of
real assets may begin to shine again. (REITs) exhibited the highest correlation with stocks. Commodities
and master limited partnerships (MLPs) offer the lowest
Long Rally, Low Volatility correlations to US bond with precious metals having the highest
The current US equity bull market, the second longest rally in correlation. Given elevated valuations among financial assets and
market history, is now approaching its 9th year. In response, on-going geopolitical, monetary policy, and fiscal policy risks,
investors are beginning to question how much longer this nearly investors may shift to real assets.
uninterrupted run can last. Compounding concerns is record low
market volatility across both stocks and bonds, a possible sign of
Inflationary Pressures Build
complacency by market participants (see Exhibit 1). Despite recent sluggish figures in the consumer price index (CPI),
US inflation remains elevated. In fact, traditional measurements
Exhibit 1: Volatility measures hit record lows this year. may not fully capture inflationary pressures currently building.
70 300
Input costs to producers continue to rise with higher wage costs
S&P 500 Volatility Index (VIX), lhs
60 from a tightening labor market and higher commodity prices
250
1-Month Treasury Volatility Index
(MOVE), rhs
raising. Furthermore, inflation has picked up year to date in the
50
200 form of a weaker US dollar which is inherently inflationary by
Index Level

Index Level

40
150 Exhibit 3: Markets indicators point to rising inflation.
30 US Inflation Expectations (lhs) US Dollar (inverted, rhs)
100 2.10 0.012
20
US 1 0 Y ear Breakeven Rate (%)

2.00
US Dollar Index (inverted)

10 50 1.90
1.80
0 0
1.70
1990 1993 1996 1999 2002 2005 2008 2011 2014 2017 0.011
Source: Bloomberg, ETF Securities. Data from 1/1/90 to 10/20/17 1.60
1.50

Real assets exhibit a low correlation to both US stocks and bonds 1.40
1.30
historically, and may provide downside protection against a spike
1.20 0.010
in volatility in financial assets (see Exhibit 2). Among commonly
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Jun-17
Dec-15

Dec-16
Jan-16

Jan-17
Sep-16

Sep-17
Oct-15

Oct-16

Oct-17
Jul-16

Jul-17
Nov-15

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Apr-17

utilized liquid real assets, precious metals provide the lowest

correlation to equities while real estate investment trusts Source: Bloomberg, ETF Securities. Chart data from 10/20/15 to 10/20/17.

1
Past performance is no guarantee of future results.
lowering spending power. Market expectations for inflation have
also risen in recent years. After recalibrating at the onset of 2017
and expectations have resumed upward in the second of this year
(see Exhibit 3).
An environment of elevated and rising inflationary pressures may
benefit real assets compared to financial assets. Real assets have a
high sensitivity (or beta) to inflation and typically perform well
when inflation increases. Among liquid real assets, commodities
have the highest beta to monthly moves in the US consumer price
index (CPI) followed by MLPs. An equal weighted mix of real assets
results in a beta to US inflation more than 5 times that of stocks
(see Exhibit 4). Stocks have a slight positive beta to inflation while
bonds generally exhibit the opposite relationship. This makes sense
given that inflation eats away at the nominal value of bond
coupons.
Exhibit 4: Real assets more sensitive to inflation moves.
5.00
4.00
Beta to US Inflation
Real assets may present an attractive relative valuation for
investors dealing with stretched valuations in addition to a source
of diversification achieved by their low equity betas.
Whats Real and Whats Not?
The term real assets is a broad category with a varying membership
list. The moniker can be applied to common investments such as
commodities and real estate to more exotic investments like
mineral rights and collectibles (ie: art, wine, stamps). Investors can
access real assets through liquid vehicles, illiquid funds, or through
direct ownership as well as through public or private offerings.
While many financial investments share the diversification and
inflation-hedging benefits of real assets they should not be
classified as a real asset. Real assets provide an inherent hedge
against financial markets because their value is linked to a physical
asset or property and not to a financial or paper claim on wealth as
4 .4 is the case for most stocks, bonds, cash, and currencies.
Bitcoin, a Real Asset? A Bit Farfetched.

2 .7 2 .8
3.00
2 .2
2.00 1 .5 The recent popularity of Bitcoin and other cryptocurrencies has
1.00 0.5 thrown them into the same classification as real assets and other
- stores of value including gold and reserve currencies. Bitcoin,
(1.00)
however, fails to meet the three major functions of money (medium
-0.6
(2.00)
of exchange, unit of account, and store of value) that other reserve
currencies such as the US Dollar, Euro, and Japanese Yen provide.
(Equal Weight)

Commodities
MLPs
US Stocks
US Bonds

REITs

Precious
Metals

Real Assets

Additionally, Bitcoins limited track-record and high volatility

should certainly bring caution to those classifying it as a store of
Source: Bloomberg, ETF Securities. Data from 12/31/95 to 09/30/17. value. Since 2010, Bitcoins annualized daily volatility has been 15
times more volatile than the US dollar, 7 times more volatile than
A Bargain in an Expensive Market? the price of gold, and 3 times more volatile than the price of oil. In
fact, Bitcoins volatility more closely resembles the VIX Index than
Real assets may benefit from two of the major investment hurdles
any other real asset or currency.
investors are currently dealing with: diversification and inflation
hedging. Given the strong run up in valuations across financial Exhibit 6: Bitcoins volatility is 7 times that of gold.
assets, however, real assets now appear to be relatively cheap,
140%
particularly against US equities. This may spur investors to 1 2 0%
120% 1 11%
evaluate the asset class from a third lens and may provide a
Annualized Daily V olatility

100%
tailwind from new investment demand. 80%
60%
Exhibit 5: Real assets are cheap relative to equities.
Equity Current Price Av erage Price Relativ e 40% 29% 33%
22%
1 6 % 1 7%
Beta to S&P 500 to S&P 500 Discount 20% 7% 9% 9% 1 4% 1 4%
0%
Precious Metals 0.1 1 0.026 0.033 -21 %
VIX Index
Gold
Euro

MLPs

Copper

Bitcoin
US Dollar

Japanese Yen

S&P 500

REITs

Silver

Oil

Com m odities 0.29 0.1 34 0.1 94 -31 %

REITs 0.43 0.267 0.31 3 -1 5%

Source: Bloom berg, ETF Securities. Data from 07/19/10 to 10/25/17.
MLPs 0.37 0.1 1 2 0.1 59 -29%
Source: Bloomberg, ETF Securities. Data from 12/31/95 to 9/30/17.

As outlined in Exhibit 5, real assets are currently priced at steep

discounts compared to their average price ratio to the S&P 500.
This is a reflection of the financial asset inflation driven by
quantitative easing programs by global central banks as well as
lower commodity prices and tepid inflation in recent years.

2
Past performance is no guarantee of future results.
Important Risks

The statements and opinions expressed are those of the author and are as of the date of this report. All information is historical and not indicative of
future results and subject to change. Reader should not assume that an investment in any securities and/or precious metals mentioned was or would
be profitable in the future. This information is not a recommendation to buy or sell. Past performance does not guarantee future results.

The S&P 500 Index is a capitalization-weighted index of 500 stocks selected by the Standard & Poors Index Committee designed to represent the
performance of the leading industries in the U.S. economy. The Barclays US Aggregate Bond Index is a broad-based flagship benchmark that
measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. Real Estate Investment Trust (REIT) is a type of security
that invests in real estate through property or mortgages and often trades on major exchanges like a stock. A master limited partnership (MLP) is a
type of business venture that exists in the form of a publicly traded limited partnership. The Chicago Board Options Exchange (CBOE) S&P 500
Volatility Index (VIX) shows the market's expectation of 30-day volatility. Merrill Option Volatility Estimate (MOVE) Index is a yield curve weighted
index of the normalized implied volatility on 1-month Treasury options. The Consumer Price Index (CPI) is a measure that examines the weighted
average of prices of a basket of consumer goods and services; headline includes all categories while core excludes food and energy. Correlation is a
measure of fluctuation between two variables. Standard deviation (volatility) is a measure of the dispersion of a set of data from its mean. Beta is a
measure of the volatility, or systematic risk, of a security or a portfolio, in comparison to the market as a whole. Bitcoin is a type of cryptocurrency,
which is a digital or virtual currency that uses cryptography for security.

Diversification does not eliminate the risk of experiencing investment losses.

Maxwell Gold is a registered representative of ALPS Distributors, Inc.

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