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Decimal Digest
22 Aug 2011


A Tale of Two Assets

Since the last few weeks, Gold has been showing stellar price performance, on the back of heightened questioning of the credit quality of sovereigns in the developed world.

Many analysts term the price performance of Gold as a combination of fear trade and love trade - Fear trade, representing all pervasive fear surrounding the sovereign credit quality; and Love trade - representing continual buying of Gold in India, and now in China, as a perennial store of wealth.

However, one can have a different take on this matter. Let’s look at the chart below:

The red line in the chart represents a hypothetical bond portfolio performance, where, at the start of every year, new 30 year US Treasury Bonds are purchased by selling existing (now 29 years remaining to maturity) bonds.

Since 1990, this hypothetical portfolio has increased around 6 times, while gold has increased around 4.5 times.

It is interesting to see that two different asset classes, with two different underlying world views have shown similar performance. The Bond portfolio buyer assumes that paper currencies will hold value, and that the credit risk of US government is beyond reproach. On the other hand, Gold buyers assume that there is a high chance of real devaluation of paper currencies.

At this juncture, one can only speculate if the US Constant Maturity Treasury strategy starts to show consistent losses, whether Gold will follow suit or not. If US Treasuries lose value due to a perception of return to normal economic activity, Gold and Bonds will move in the same direction. However, if the US Treasuries lose value due to heightened credit risk perception, Gold price is likely to move sharply higher, with a clear diversion from this trend.

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