Since the onset of the global financial crisis that started in 2008 many of the rules of thumb have gone out the window. This has caused professional and retail investors a great amount of head scratching and headaches. The biggest problem with a breakdown of rules of thumb is that far too many investors rely on them and when they breakdown they do not know where to turn.
Correlation and your allocation
For the past quarter century or more the single biggest driver of investment advice has been modern portfolio theory (MPT). One of the significant points of MPT (in an overly simplistic explanation) is that if you diversify your portfolio between things that move independent of one another you can lower the overall risk of your portfolio. That is great when everything is working correctly which is not very often. While MPT is correct in that diversification is good the financial services industry has used it as an excuse to be lazy. The financial services industry twisted MPT into supporting the idea of buying and holding a diversified portfolio as “the” investment strategy. The problem is that every once in a while the stars line up and diversification gets blown out of the water like in 2001-2002 and 2008-2009. The current situation with gold and the dollar is a fine example of a rule of thumb that has broken down.
Gold dollar relationship
Historically the relationship of the U.S. dollar and gold is inverse of one another. Until the crisis hit in 2008 the dollar had been on a multi year slide versus foreign currencies all the while gold was rising. Throughout the crisis the dollar and gold had held their opposite relationship until now. In the last few months the dollar and gold have been rising in tandem. How can this be? Simple, the second largest economy on the planet (Europe) is in terrible trouble and the rest of the world is still in denial about the U.S. debt problem. The result is assets leaving Europe coming to the supposed safe haven of the U.S. dollar and even smarter investors seeing that the printing presses printing money in the U.S. and now Europe will devalue both currencies leaving one true safe haven – Gold. So, in the short-term the crisis in Europe is driving the U.S. dollar and gold. This will not last forever and the long-term winner will likely be gold.
Below you can see the last few months (the onset of the real concern over Greece) the dollar and gold have been both moving up.
Chart courtesy of StockCharts.com
Disclosure Statement: ETFGPS is a blog that Navigates The World of ETFs. Sustainable Investment Strategies LLC is a Registered Investment Adviser in the State of Maryland, and does hold positions in ticker GLD and UUP at the time of writing. Investors who are interested in money management services may visit theSustainable Investment Strategies LLC web site