We realize the chart analysis we provided this morning (showing the price of the XAU and the relative price of the GLD to M2 money supply) was short in duration. So, we expanded the time frame to the beginning of 2000 and substituted the GLD for the price of gold. Here is the chart.
If you think it would be a good time to buy the XAU when the standard deviation of the relative price of gold to M2 money supply was less than -1, then you would be correct. At least by the historical relationship. Since the beginning of 2000, the XAU has averaged a 3-month, 6-month, and 1-year average return (for any respective day) of 3.1%, 6.8%, and 14.7%, respectively. In you also work through the math, the Sharpe ratio of these returns work out to be 0.21, 0.32, and 0.54, respectively.
We built a simple trading strategy around the standard deviation of the gold price relative to M2 money supply. The strategy assumes you bought the XAU at any point when the standard deviation was less than or equal to -1. Using this strategy, the 3-month, 6-month, and 1-year return average is 8.2%, 18.8%, and 31.2%, respectively. Significantly better than the average buy-and-hold case. The strategy also appears to reduce the overall risk in the trade, as the Sharpe ratio for these periods work our to be 0.42, 0.77, and 0.95, respectively.
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