Bitcoin, gold, and VIX are worth considering in flat yield environment Bitcoin, gold, and VIX are worth considering in flat yield environment Bitcoin, gold, and VIX are worth considering in flat yield environment

Bitcoin, gold, and VIX are worth considering in flat yield environment

Equities 7 minutes to read
Peter Garnry

Chief Investment Strategist

Summary:  In today's equity update we take a look at yesterday's price action and show how government bonds were flat as a pancake offering no help to portfolios bleeding from declines in equities. Going forward with higher policy uncertainty, inflation and low interest rates, long volatility will likely be a crucial component to bolster risk-adjusted returns. We take a look at how to do this but also at other alternatives such as gold and Bitcoin which are worth considering in a prolonged inflationary environment with deep negative real rates.


Much has been written already about the death of the 60/40 portfolio and we have also talked about it on our daily morning podcast and on our Special Edition post from March 25 called Roundtable on the crisis and its aftermath where our CIO Steen Jakobsen talks about the need for long volatility components in portfolio construction.

Low interest rates

Central banks around the world have doubled down on their monetary policy since the Great Financial Crisis pushing down rates again and substantially increased their asset purchase programmes. In their forward communication with the market rates will stay compressed for a long time as the global economy will take time to heal from the Covid-19 induced economic crisis. The latest strategy change is the concept of average inflation targeting which means that the Fed will allow inflation to overshoot and thus accepting deep real negative interest rates. A potential next step in this logic is the concept of yield curve control in the case the bond market pushes up interest rates on inflation or fiscal deficit worries.

Overall, it is reasonable to assume that expected returns on government bonds will be close to zero for many years. One thing is the low expected returns, but what is more frightening is what we saw yesterday where governments bonds offer limited negative covariance to equities when we have a tail-risk event (a large daily negative return in equities). In most crisis events since 2008 the long end of the government yield curve has provided that, but no longer. The chart below shows how European government bonds were flat as a pancake. Only long volatility expressed through long VIX futures provided protection. Our view is that there will be a historic rotation in asset allocation strategies and the hedging and derivatives strategies will be reborn to accommodate portfolio managers.

Source: Bloomberg

In one of our recent Saxo Thought Starters piece Limiting drawdowns by adding volatility exposure to your portfolio we show how just a 4% allocation to long volatility reduces drawdowns without sacrificing too much on returns. Historically a long volatility position continuously rolled had large negative carry because the VIX future curve most of time is in contango; in other words, you pay a premium for long volatility expectation that never materialises. Now as government bond yields have gone to zero or in some cases negative, the spread to the negative carry on long volatility makes the long volatility component much more attractive and feasible on a relative basis. We would go as far as recommending investors to replace most of their government bond holdings with investment-grade corporate bonds. Because if you are not getting any future returns and there is no negative covariance during tails why not go a bit further out on the bond risk curve and get a bit more yield and offset the higher risk by adding long volatility?

For European investors the Lyxor S&P 500 VIX Futures Enhanced Roll UCITS ETF (VOOL:xetr) is the only easily accessible ETF to get this exposure. Managing and rolling VIX futures are not something we recommend for the ordinary retail investor. An alternative for those investors that can invest in non UCITS funds the iPath S&P 500 Dynamic VIX ETN is worth considering. As the chart below shows the dynamic VIX ETN manages the negative carry from the VIX curve contango much better than the UCITS fund which means that a larger exposure can be allocated to this VIX fund to offset tail-risk events in equities. We know it is complex and out of reach for many retail investors, but we are in a new environment and all investors should think about how to protect wealth and construct meaningful portfolios in a flat yield environment.

Source: Bloomberg

Inflation and debasement introduce new risks

Low yield environment and the lack of negative covariance from government bonds during tail-risk events in equities is one key risk going forward for portfolio that we have discussed, but the next big risk source will come from inflation. Yesterday, our colleagues Ole S. Hansen, Althea Spinozzi, and Christopher Dembik held a webinar on inflation called Everything you need to know and how to hedge against it; you find on the previous webinars page.

Many traditional things such as inflation-linked bonds and gold makes sense in an inflationary environment because their value historically is protected from inflation. Gold has that other advantage that sometimes it adds good hedging during tail-risk events in equities such as the period 19 February to 23 March this year (see correlation matrix). A third option against debasement is the digital currency Bitcoin which could become more attractive in a prolonged inflationary environment. All these components that we have described are components that investors should consider and in our next Quarterly Outlook we will focus more intensively on asset allocation in this new regime post Covid-19.

Source: Bloomberg

Appendix

5-year chart on the STOXX Europe 600 Index, Lyxor S&P 500 VIX Futures Enhanced Roll UCITS ETF, and iShares Core EUR Govt Bond UCITS ETF

Source: Bloomberg

Quarterly Outlook 2024 Q3

Sandcastle economics

01 / 05

  • Macro: Sandcastle economics

    Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.

    Read article
  • Bonds: What to do until inflation stabilises

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain inflation and evolving monetary policies.

    Read article
  • Equities: Are we blowing bubbles again

    Explore key trends and opportunities in European equities and electrification theme as market dynamics echo 2021's rally.

    Read article
  • FX: Risk-on currencies to surge against havens

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperform in Q3 2024.

    Read article
  • Commodities: Energy and grains in focus as metals pause

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities in Q3 2024.

    Read article

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
Full disclaimer (https://www.home.saxo/legal/saxoselect-disclaimer/disclaimer)

Saxo Bank (Schweiz) AG
The Circle 38
CH-8058
Zürich-Flughafen
Switzerland

Contact Saxo

Select region

Switzerland
Switzerland

All trading carries risk. Losses can exceed deposits on margin products. You should consider whether you understand how our products work and whether you can afford to take the high risk of losing your money. To help you understand the risks involved we have put together a general Risk Warning series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. The KIDs can be accessed within the trading platform. Please note that the full prospectus can be obtained free of charge from Saxo Bank (Switzerland) Ltd. or the issuer.

This website can be accessed worldwide however the information on the website is related to Saxo Bank (Switzerland) Ltd. All clients will directly engage with Saxo Bank (Switzerland) Ltd. and all client agreements will be entered into with Saxo Bank (Switzerland) Ltd. and thus governed by Swiss Law. 

The content of this website represents marketing material and has not been notified or submitted to any supervisory authority.

If you contact Saxo Bank (Switzerland) Ltd. or visit this website, you acknowledge and agree that any data that you transmit to Saxo Bank (Switzerland) Ltd., either through this website, by telephone or by any other means of communication (e.g. e-mail), may be collected or recorded and transferred to other Saxo Bank Group companies or third parties in Switzerland or abroad and may be stored or otherwise processed by them or Saxo Bank (Switzerland) Ltd. You release Saxo Bank (Switzerland) Ltd. from its obligations under Swiss banking and securities dealer secrecies and, to the extent permitted by law, data protection laws as well as other laws and obligations to protect privacy. Saxo Bank (Switzerland) Ltd. has implemented appropriate technical and organizational measures to protect data from unauthorized processing and disclosure and applies appropriate safeguards to guarantee adequate protection of such data.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc.