Friday, February 05, 2021
US Banks Vs. US Gold A Long Term Strategy To Counter Rising Yields
By Century Financial in 'Investment Insights'
*This performance is only observed with historical backtests and not traded by the company.
Risks & Assumptions
The Benchmark 10-year treasury yields have surged to 1.15% nearing its recent high of 1.187%. If the benchmark rate surpasses that milestone, it would sit at the highest level since mid-March.
What’s driving Treasury yields?
The anticipation of larger government borrowing to fund the prospective $1.9 trillion US fiscal stimulus pushed the benchmark 10-year treasury yields to near 10-month high touched in January. Governments across the world have unleased massive stimulus to revive their economies which were adversely impacted by the Covid-19 crisis. Higher fiscal spending would even mean higher issuance of long-term bonds and this has been contributing to rise in US yields. Overall, yields across the globe are likely to rise as investors have been piling on bets that Covid-19 vaccine rollouts and ample fiscal aid would spur the economic recovery.
Strategy to counter rising yields
One sector which can benefit from higher yields is financial services as banks and financial service companies benefit from higher yields through higher net interest margin. On the other hand, rising yields should weigh on the non-yielding gold and hurt the profits of gold miners. Technically, gold prices have given a break below the key $1800 level and could be headed for more losses.
Pair Strategy which takes long position on CMC US Banks Share Basket and short position on CMC US Gold Share basket could be a good one to play this trend.
However, it is important to note that Trading pairs is not a risk-free strategy. The difficulty comes when prices of the two securities move contrary to the positions taken resulting in losses. Thus, it is important to adhere to strict risk management rules when dealing with such adverse situations.
The table below displays the historical performance of CMC US Banks Share Basket and the CMC US Gold Share basket. As can be seen in the year 2013, when the talks of tapering had just begun, US banks outperformed US gold miners by 88%. Between the period 2012-2015 when 10-year treasury yields rose from 1.87% to 2.26%, US banks outperformed US gold miners by over 150%.
Historical performance of US Banks vs US Gold |
|||
Year ending | US banks | US gold | Long US Banks Short US Gold |
12/31/2008 | -38% | -10% | -28% |
12/30/2009 | 5% | 36% | -30% |
12/31/2010 | 22% | 38% | -16% |
12/30/2011 | -22% | -10% | -13% |
12/31/2012 | 30% | 1% | 29% |
12/31/2013 | 38% | -50% | 88% |
12/31/2014 | 7% | -13% | 20% |
12/31/2015 | -1% | -21% | 20% |
12/30/2016 | 31% | 74% | -43% |
12/29/2017 | 16% | 12% | 3% |
12/31/2018 | -20% | -11% | -9% |
12/31/2019 | 32% | 54% | -22% |
12/31/2020 | -10% | 27% | -37% |
Note:
The strategy has been back-tested on the current constituent weights and hence the results are subject to backfill bias and selection bias.
Individual stocks in the basket are subject to both weightage recalculation & recomposition risk. As a result, certain stocks may be added or removed from the basket at the discretion of platform provider without any advance notification. This may be specific to any individual stock or due to any sector specific event. Consequently, share basket performance may significantly deviate from the one specified above / below
Besides, as seen in the chart, Financial Select Sector SPDR Fund (XLF) and Vaneck Vectors Gold Miners Etf (GDX) ratio has bounced off the five year low and is expected to rally further.
XLF vx GDX ratio chart
Risks & Assumptions
Data Source: Bloomberg
Arun Leslie John
Chief Market Analyst
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