When to Own Stocks and When to Own Gold

Abstract

This article shows that dynamic investment portfolio asset allocation based on secular market cycles outperforms a buy-and-hold portfolio of equities and outperforms a buy-and-hold portfolio of gold over long periods. An objective definition of secular market enables identification of an appropriate ex-ante risk-on or risk-off posture for a portfolio. The author constructs an objective measure, which is termed a “secular market indicator (SMI),” using a modified Shiller Cyclically-Adjusted Price Earnings (CAPE) ratio with gold as a reference point. This SMI has slightly greater predictive power than Shiller's CAPE Ratio in that it provides a consistent threshold signal for secular macroeconomic reversals. Finally, the author uses the SMI to create a simple decision rule to shift asset allocation between equity and gold depending on the secular market cycle. The resulting portfolio outperforms an all-equity portfolio and an all-gold portfolio over holding periods of 10+ years about 70% of the time and produces superior risk-adjusted performance about 80% of the time.