GeoVolitics and Gold

[00:00:01] Hello, this is Dean Curnutt and welcome to the Alpha Exchange, where we explore topics in financial markets associated with managing risk, generating return, and the deployment of capital in the alternative investment industry. Good listeners, welcome back to the Alpha Exchange, a podcast that, above all, asks you to think alongside me and the show's guests about market risk.

[00:00:30] It was Buffett who once said, risk comes from not knowing what you're doing. What a great, plain-spoken statement. It's likely that James Cordier of OptionsSellers.com would have benefited from hearing this before imploding from a short straddle position in NatGas. Turns out, Cordier is now not just a YouTube star, but also an author with a new book out called The Complete Guide to Options Selling. Sheesh.

[00:00:59] Perhaps the foreword was written by our friend Andy Cassano over at AIG Financial Products. But more seriously, hopefully the conversations you hear as part of the Alpha Exchange series do help you know what you're doing. Markets are a serious business. Don't let anyone tell you otherwise. The goal here is to contribute to your base of knowledge about them, the trades that live within them, and the various uncertainties that impose themselves on those trades.

[00:01:28] Buffett has another quote I often use. He has said, price is what you pay, value is what you get. As a card-carrying member of the Option Geek Club, I can't help but think about this through the lens of probability. If I got paid 20-1 to flip three heads in a row, do I take the bet? To be sure, I am unlikely to win. But those odds. This brings me to an upcoming trip I'm taking to Las Vegas, to the sphere, for the third time.

[00:01:56] I was lucky to see U2 and a UFC event there last year. This time, I'm going to see the Eagles. I'm an old-timer, but still love a great music live performance. And I can't speak highly enough about the concert experience at the sphere. It's truly in a class of its own. Before I share some of what's on my mind in the world of market prices, I ask that you indulge me for a few minutes to share an update on a project I'm truly passionate about,

[00:02:25] Macro Minds, the charitable initiative I founded back in 2019 to bring the street together for a one-day investment symposium in support of student education. I had the chance to appear on Bloomberg TV last week to discuss one of my favorite assets, gold, which will be a focus of this pod. As I sat in the green room, awaiting my time on set with Tom Keen, I saw a certain person walk by, Michael Bloomberg.

[00:02:52] A freshly minted 83-year-old, he was nevertheless in a hurry, moving with purpose. Seeing him, I couldn't help but recall the time I had taken a client to a Yankee game in 2009. Leaving the restaurant at the new stadium, we turned a corner and literally bumped into the mayor. I'm so sorry, Mayor Bloomberg, I said. He responded, no, you gentlemen, please go ahead. I work for you. Michael Bloomberg appears to work for a lot of people.

[00:03:21] He makes substantial contributions of time, money, and insight to a myriad of critically important societal causes. At the top of the list is education. Just last week, Bloomberg wrote an op-ed that appeared on the Bloomberg Terminal. It was called, Kids are Spending Too Much Class Time on Laptops. The first paragraph reads as follows.

[00:03:44] Over the past two decades, school districts have spent billions of taxpayer dollars equipping classrooms with laptops and other devices in hopes of preparing kids for a digital future. The result? Students have fallen further behind on the skills they most need to succeed in careers. The three R's plus a fourth, relationships. Creating a fourth R as a pillar of student education really resonated with me.

[00:04:12] Relationships are such an important component of business and life. As we are literally five years from the absolute teeth of the pandemic shutdown, who can forget the impact on markets, the economy, and everyday life, including the amount of time we get to spend with others? Around this time in 2020, it became clear that the MacroMinds conference I'd planned for April was not going to happen. Conference initiatives, especially for those in the financial services industry,

[00:04:41] are a fantastic way to meet new people, exchange ideas, and develop rapport. The COVID shutdowns deprived professionals of this important opportunity. I say that industry participants are at their best when they are engaging in mindshare and thought leadership together. We finally got the symposium off the ground virtually in 2021, and then hosted events in person over the next three years at the beautiful Time Center in New York City.

[00:05:08] Our goal has been to provide a forum in which professionals could learn, strengthen relationships, and be inspired by the shared objective of supporting education-focused charitable organizations. In total, our efforts thus far have raised $1.7 million for 12 meaningful causes. We've had the cream of the crop in terms of our speakers, Howard Marks, Paul Singer, Boaz Weinstein, Cliff Asnes, Greg Glitman, and Ross Stevens among them.

[00:05:36] 2025 is about looking back and saying thank you to the speakers, sponsors, and supporters who have helped MacroMinds achieve this success on behalf of the organizations we've represented. It's also about the value of personal relationships built on goodwill. In business, and most certainly in life, having trusted, durable relationships with others is critical. For me, there's nothing more satisfying than playing a small role in fostering these connections through in-person events.

[00:06:05] While it may be a ways off, a goal of mine is also to host an event for the Alpha Exchange. Thank you for taking that brief detour with me. Now let's get to the subject at hand, market risk, and how to contemplate portfolio construction during these unsteady times. As we begin, and consistent with my penchant for looking backwards, it's impossible for me not to start with where we were five years ago this week.

[00:06:31] March 12th of 2020 marked the first day of the most outrageous trifecta of daily moves in modern market history of the S&P. March 12th was down 9.5%. March 13th was up 9.3%. And March 16th was down 12%. These three moves alone were enough to create a realized volatility level for the S&P of 18.4%

[00:06:59] for an entire year, even assuming the market was closed for the remaining 249 trading days and had zero vol on those days. This is basically three times the realized vol the market experienced in 2017 when it was open for 252 days. Such is the nature of variance when we square daily returns. When it comes to vol trading, big moves do indeed matter most.

[00:07:27] The fallout, as I have covered extensively through Alpha Exchange conversations, included firms like Malachite, Alberta Investment Management Company, and Allianz. These firms were short in the words of QVR's Ben Eifert, toxic tales of all kinds. These included VIX calls, variance caps, and skew locks. On the other side of these losses due to explosive vol were firms like Ionic, Longtail Alpha, Saba, and One River.

[00:07:56] And who could forget the second greatest trade of all time, Bill Ackman's incredibly well-timed credit derivatives hedge that netted $2.6 billion during that short period? Move fast and break things is an old quote from Mark Zuckerberg that aimed to capture a hard-charging Silicon Valley culture where the pathway to progress and riches has always put a premium on innovation,

[00:08:23] accepting failure as a natural consequence of launching new products. In markets, I say move fast and things break to reflect the inherent fragilities in our asset pricing system. In March of 2020 break things did, including even the U.S. Treasury market. I've developed a little framework to better understand risk-off events through stock and bond correlations. In it, there are three kinds of risk-off, which I call classic, taper, and liquidation.

[00:08:53] The last of these is, by far, the worst of them. It's when the market's need for instantaneous, cash-like liquidity is so great that even duration is a risk exposure that must be unwound. In liquidation, both the stock and bond market crash together, and that is what the market experienced five years ago at this time. We were amidst, perhaps, the most chaotic seven days of trading in market history.

[00:09:21] Nothing, not treasuries, not gold, can make it through. It is vol and vol alone that proves to be the only anti-fragile asset. I posted this table on Twitter along with how I mapped the three kinds of risk-off events referenced. The table shows the returns of five assets during the sheer chaos of March 9th to March 18th. The accident report reads as follows. S&P down 12.7%.

[00:09:48] TLT down 15.7%. The dollar up 6.6%. Gold down 10.8%. The VIX up 40.4%. And the VIVIX up 32%. On this last move in the VIVIX, I've made the point that there are a few assets that can experience stock-up vol-up.

[00:10:10] During the 2022 Fed behind the inflation curve period, I noted the empirical observation that higher inflation was associated with higher inflation volatility. And if the Fed's job at that time was not only to bring inflation down, but manage the risk that it might continue to rise, higher inflation vol implied a wider degree of potential outcomes and the need for the Fed to take out more insurance.

[00:10:35] Other stock-up vol-up assets include gold and Bitcoin, which have been the subject of two recent pods. The first was called digital gold and actual gold. The second, geovolitics implied correlation and option pricing. Check them out. Each is about 15 minutes long. Perhaps the strongest stock-up vol-up asset is vol itself.

[00:10:59] And that's why I point out the surge not only in the VIX during that outrageous period in March of 2020, but also in the VIVIX. When the VIX rose to 81, the market price of VIX options suggested it could go much further. No surprise that when volatility explodes, so too does the vol evolve. Things get really messy when the VIX is that high.

[00:11:23] The VIVIX, a measure of implied vol for VIX options, closed at a record of 207 on Monday, March 16, 2020, when the S&P fell by 12%. How was this reflected in VIX option prices? The distribution of potential VIX outcomes for April 2020 was inconceivably wide. For example, with April VIX futures closing at 61.5, the mid-market price of the April 130 call

[00:11:51] almost double the future was $3.40. And while markets logically priced out-of-the-money puts on the VIX to reflect the typical experience that vol rises faster than it falls, downside puts were pretty expensive as well. The April 40 put, with a strike price down 33% from the current April VIX future, closed at $2.475 mid-market.

[00:12:18] One could have collected nearly $6 to bet that the VIX would finish in a 90-point range over the next month. I wanted to review this period because, as I often say, market prices are a never-say-never business. It's like the Guinness Book of World Records. Ask someone, what's the longest measured human fingernail in history? They think, okay, well, this is the Guinness Book of World Records, so let me make an outrageous guess.

[00:12:46] I'll say five feet. Nope, the answer is 42 feet. Market prices, in a similar way, can clear at levels that are so well outside the boundaries of what we deem possible. Just ask Gabe Plotkin. I also wanted to review it because of my statement that vol, at a reasonable price, is the only anti-fragile asset in the world.

[00:13:08] When the VIX is at 83% and the Treasury market is buckling, and it's clear the Fed and Treasury are about to kitchen sink it, vol is no longer anti-fragile. In fact, it's in the crosshairs of those with unlimited capital whose motivations include a sharply lower VIX. So you do have to pay attention to price. I have no crystal ball, but for now, I don't see a liquidation event coming in markets.

[00:13:37] I do see, however, troubling uncertainty in markets and around the world. And now, more than at most other times, I find it critical that investors seek out assets that are just not like equities. For me, gold is that asset. It's different. Let's explore this idea. First, let's consider the 10% drawdowns in the S&P since the global financial crisis. I posted this table on Twitter.

[00:14:03] Over the past decade, there are six such drawdowns. The most recent one occurred from Feb 19th to March 13th, leaving the S&P 10.1% lower. This one is unique in the combination of its speed, just 22 days, and low level of realized volatility, just 21%.

[00:14:23] You can find another 10% drawdown around the XIV event in Feb 18, but that came with a 34 realized vol and had two down moves of around 4%. This drawdown has featured seven daily moves of down 1.2% or more, but no move larger than down 2.7%. Every other drawdown shown has featured multiple down 3% days in the S&P.

[00:14:51] Let's look at the performance of gold during this and the other five 10% drawdowns. Up 1.6% during the most recent one. Down 8% during the 2022 bear market that, of course, featured higher inflation and much higher rates. S&P fell by 25% during that 2022 drawdown.

[00:15:12] Gold was down 3.6% during the previously discussed COVID meltdown when the S&P shed 34% from February 19th, 2020 to March 23rd of 2020. It was up 5% during the late 2018 drawdown of 20% in the S&P that some refer to as the Powell mistake. Gold was down 2.4% during the Volmageddon event of Feb 2018 when the S&P lost 10.2%.

[00:15:40] And it was up 2.9% during the lengthy drawdown of 14.2% in the S&P from May 2015 to Feb 2016 that featured an awful bear market in crude. So, gold is not entirely impervious to S&P drawdowns. It cannot survive liquidation as it, like Treasury securities, will be sold to raise cash.

[00:16:05] It will also struggle during a taper risk-off like the 2022 tightening cycle when the dollar rose by 18% during the stock market drawdown. But it does quite well overall. And it especially thrives in the, quote, classic risk-off when rates and the S&P fall together.

[00:16:26] A great example of this is the period in 2011 that included both the intensification of the Eurozone sovereign crisis as well as the U.S. debt ceiling showdown. From May to late August 2011, the S&P fell by 17.5%. The TLT soared by 18% and gold was up 21%. To be clear and to repeat, gold is not a hedge. A hedge is an insurance contract that you must part money with in order to obtain.

[00:16:56] Gold was up 27% last year and is already up 15% in 2025. There are no positive carry hedges in the world, but there are assets that act considerably defensively for periods of time, are trending higher, have natural buyers, in the case of gold we can cite central banks, and also possess the rare feature of stock-up vola. Gold has all four of these right now.

[00:17:23] The last of these has not kicked in, but there is scope for that to occur. Assets that become more volatile as they rise are mostly limited supply assets. Think corn, wheat, Bitcoin, vol, and gold. Gold, as opposed to the U.S. government bond market, is a disciplined asset with predictable, constrained supply. In contrast, the world is absolutely awash in U.S. treasuries.

[00:17:49] As an aside, that period I referenced in 2011, when gold in the bond market soared as the stock market plummeted, occurred not too long after the Simpson-Bowles plan was submitted in late 2010. This bipartisan effort was aimed at finding ways to tackle the U.S. debt problem. The work was summarized in a document called, quote, The Moment of Truth, and featured lines like the following, quote, Our nation is on an unsustainable fiscal path.

[00:18:19] Spending is rising and revenues are falling short, requiring the government to borrow huge sums each year to make up the difference. We face staggering deficits. Quote, Federal debt is high and unsustainable. It will drive up interest rates for all borrowers, businesses, and individuals, and curtail economic growth by crowding out private investment.

[00:18:43] Quote, Rising debt will also hamstring the government, depriving it of the resources needed to respond to future crises and invest in other priorities. Quote, Predicting the precise level of public debt that would trigger such a crisis is difficult, but a key factor may be whether the debt has been stabilized as a share of the economy or if it continues to rise. In 2010, when this report was issued, U.S. national debt was $13 trillion.

[00:19:12] It's now $35 trillion, give or take a trillion. On this last comment, Alan Simpson just recently passed away at the age of 93. I was lucky enough to have Senator Simpson speak at one of my events in 2012, and I will always remember him saying, quote, The problem with the debt is that no one actually knows how big a trillion is. Amen.

[00:19:36] So, back to gold, not as a hedge, but as a highly valuable diversifying asset that is trending higher. I looked at daily returns of the S&P and GLD since the inception of the GLD in 2004. Now, there could be conceivably some starting point bias here, but the realized correlation of daily returns between them over this time frame is just 5%. That is just magical.

[00:20:04] You can't find equity assets that are so unrelated to each other as this pair is. I did some further work, which resulted in a chart that I love and posted on Twitter. It shows observations of six-month S&P returns that are either greater than positive 25% or less than negative 25%. So, we're looking only at the big up or big down periods in the S&P over the last two decades.

[00:20:31] Then, I mapped those against the six-month realized correlation between the GLD and S&P for each period. What is so powerful is that conditional on the S&P being down a lot, the correlation with the GLD is noticeably lower than when the S&P is up. You want assets in your portfolio that can serve as a ballast during stormy weather. Conditional anti-correlation is sort of like being long vol.

[00:20:58] For years and years, post the GFC especially, duration had this property, delivering positive even if smallish returns, and consistently rallying during equity risk-off periods. The bond market also had a captive buyer, the Fed. With inflation still far above the Fed's target, and with simply too much supply of treasuries on an ongoing basis, as a market reality, you can't count on duration as much as you once could have.

[00:21:28] Gold has no one in the C-suite. It has no marketing budget. It doesn't report earnings. But what it does have is a history of returns and correlations that investors identify with. Gold occupies a unique part of our collective intelligence on how markets work. In the words of previous AlphaExchange guest Jordy Visser, gold has brand.

[00:21:50] And add to that, as another guest Mike Novogratz has said about Bitcoin, I'll say, gold has value because we say it has value. Call investors' response Pavlovian in nature, but gold is long chaos. A rallying gold price is our way of saying that all is not well, that an accident may be forthcoming. To recap, and because I'm a simple fellow, I've suggested four assets to be long.

[00:22:17] The S&P, gold, Bitcoin, and put spreads on the S&P. I've argued that, unlike gold, Bitcoin retains a fair amount of risk asset characteristic, leaving it vulnerable to large down days in the S&P. To wit, when the S&P fell 270 basis points on March 10th, the IBIT fell by 9%. Gold, by contrast, fell just 90 basis points.

[00:22:42] But Bitcoin does retain such attractive and explosive option characteristics. To me, it's worth a small portfolio allocation. The put spread recommendation has been very well timed. In mid-January, you could have bought a three-month 95-80 put spread on the S&P for around 1%. That insurance contract pays out dollar for dollar on declines in the S&P after the first 5% loss and down to a loss of 20%.

[00:23:11] It's marked really well through the 10% drawdown we discussed. Let me finish with one last bit on gold. My own way of thinking is to find asset prices that help me think about the state of risk in the world. Gold is one of them. And on a second derivative basis, gold vol is also one. Since 2024, the GLD is up 46%. How about the GBZ, index of implied vol on gold?

[00:23:40] It's almost exactly flat over this period. So, the quote, stock up, vol up property I'm always going on and on about in gold hasn't really happened. That is fair to say. The rise in gold has been quite controlled. And I see both information content and opportunity in gold vol. I see growing uncertainty in international affairs.

[00:24:03] Whereas the U.S. typically acts as global policemen, the complicated relationship that the Trump administration has both with traditional allies and adversaries does not lend stability. Perhaps this will all work out. But the pathway to a new world order pursued rapidly may be accident prone with market implications. Gold is long a sense that all is not well and should be a beneficiary, especially if U.S. growth and the U.S. corporate profits machine slow.

[00:24:32] I argue that we may be building to a stock up, vol up event in gold. In this case, far upside, out of the money and long dated calls on the GLD can work, especially as they enjoy a substantial amount of what we derive geeks call vega convexity. This is the change in the options vega as a result of a change in the options implied vol. At the money options have no vega convexity.

[00:24:59] That is, if I'm long an at-the-money straddle, for example, and the implied vol rises, of course my straddle is worth more because it's long vega. However, the vega itself does not change as the result of the implied vol rising. But for deep out-of-the-money puts and calls, if we increase the implied vol, the options vega goes up a bunch as well. The option becomes more sensitive to changes in implied vol exactly when I want it to.

[00:25:28] Here's a pricing exercise using the December 375 call on the GLD. This option is 35% out of the money, carries a vol just below 20, has a delta of 6.5, and a price of right around $1.20. Suppose we shock the vol to 30. The resulting option price is five times higher at 6.28. While it's impossible to possess the extent to which Bitcoin can impose FOMO on investors,

[00:25:58] the consistency with which gold is trending higher and the way in which it fits into our psychology of thinking on risk can also lead to a chase that gathers steam. This extremely out-of-the-money option on gold, to me, carries a lot of information content. It's the market's way of expressing uncomfortable scenarios in which investors may be forced to buy assets that thrive during chaos.

[00:26:23] Gold is long my theme of, quote, geo-voletix, the intersection between a deteriorating backdrop of global stability and market volatility. Well, that's going to be it for me for now. As we are soon to close out Q1 of 2025, I thank you for being listeners and value your feedback. We're working on some fun stuff here at the Alpha Exchange, including some new ways to deliver content in video format. Let's all keep trying to figure this stuff out together. Until next time, be well.

[00:26:53] You've been listening to the Alpha Exchange. If you've enjoyed the show, please do tell a friend. And before we leave, I wanted to invite you to drop us some feedback. As we aim to utilize these conversations to contribute to the investment community's understanding of risk, your input is valuable and provides direction on where we should focus. Please email us at feedback at alphaexchangepodcast.com. Thanks again and catch you next time.