Gold, one of the oldest and most enduring asset classes, had an exceptional run in 2024, capturing attention across financial markets. Its role in investment portfolios continues to spark interest, acting as a hedge against uncertainty. On the other end of the spectrum, cryptocurrencies represent the newest frontier in finance. While opinions remain divided, some are enthusiastic supporters, while others remain skeptical, one thing is undeniable: Bitcoin has just crossed the remarkable $100,000 USD milestone. In this article, I’ll discuss gold’s role in an investment portfolio and pairs trading within the crypto market.
Is Gold a Hedge or a Safe Haven Asset?
Historically, gold has exhibited a low correlation with other asset classes such as stocks and bonds, making it an effective hedge against market volatility and economic uncertainty.
Reference [1] delves deeper into examining the role of gold as a hedge or safe haven asset. It defines a weak, strong hedge, or safe haven asset as follows,
-A weak hedge is an asset that has a negative conditional correlation with another asset or portfolio on average. A strong hedge is an asset that has both a negative conditional correlation and positive conditional coskewness with another asset or portfolio on average.
– A weak safe haven is an asset that has a negative conditional correlation with another asset or portfolio in times of market stress or turmoil. A strong safe haven is an asset that has both a negative conditional correlation and positive conditional coskewness with another asset or portfolio in times of market stress or turmoil.
Findings
– The study empirically analyzes the performance of gold across 24 countries over a 40-year period.
– Results show that gold acts as a strong hedge in Brazil, India, Indonesia, Italy, Mexico, Russia, South Korea, Thailand, and Turkey, and as a safe haven in Brazil, France, India, Indonesia, Italy, Mexico, Russia, South Korea, and Turkey.
– The study investigates whether gold can enhance overall portfolio performance as a hedge or safe-haven asset.
– The conditional comoment-based dynamic (CCD) strategy adjusts portfolio allocation to gold based on its properties and adds gold to the stock portfolio during the holding period only if it serves as a hedge or safe haven.
– Findings indicate that the CCD trading strategy outperforms the buy-and-hold strategy, generating higher returns, Sharpe ratio, and skewness when gold is utilized as a hedge or safe-haven asset.
Reference
[1] Lei Ming, Ping Yang, Qianqiu Liu, Is gold a hedge or a safe haven against stock markets? Evidence from conditional comoments, Journal of Empirical Finance, Volume 74, December 2023, 101439
Pairs Trading in the Cryptocurrency Market
Pairs trading is a popular strategy in equity and commodity markets. While successful in equities, limited research exists on pair trading in the cryptocurrency market. Reference [2] examines the application of pairs trading within the cryptocurrency market.
Findings
-The study applied the Distance Method and Cointegration Method to cryptocurrency pairs using both daily and hourly data for formation and trading periods.
-Results showed that the frequency of the selection period (daily or hourly) did not significantly affect the pairs chosen.
-Pairs selected using the Cointegration Method generally outperformed those chosen with the Distance Method.
-Intraday trading proved more profitable than longer-term trading but lost its advantage when a stop-loss was implemented.
-The Cointegration Method performed better than the Distance Method, as the latter incurred higher trading costs due to an increased number of trades.
– Pairs trading outperformed the buy-and-hold long/short strategy in the cryptocurrency market. But it underperformed the traditional Buy and Hold.
Reference
[2] Lesa, Chiara and Hochreiter, Ronald, Cryptocurrency Pair Trading, SSRN, 2023
Closing thoughts
As we navigate an ever-evolving financial landscape, understanding the roles of these two asset classes can help build diversified, forward-looking investment portfolios.