Michael A. Gayed, CFA Twitter: @pensionpartners

Before It’s Too Late: Using Lumber, and Gold to Actively

Manage Stocks & Bonds

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

Who WE ARE and What We do

About Us

• Investment manager of mutual funds and separate accounts

• Absolute return and equity sector rotation strategies

• Quantitative, objective investment process utilizing the principles of intermarket analysis

• Open, transparent communication through various writings, media appearances, and social media

• For more information, contact us at solutions@pensionpartners.com

Enough about us…

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

A Look at SIGNALS AND STRATEGIES

Why We’re Here

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

DEFINING Intermarket Analysis

Introduction

• Branch of technical analysis

• Study of asset class and sector relationships

• Relative movement across and within markets can be predictive of on-coming booms, busts, volatility, and economic changes

Ways of using intermarket analysis?

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

What We Will Be COVERING Today

Our Agenda

Part I: Asset Class Diffusion

• Lumber as a Cyclical Leading Indicator

• Gold as a Non-Cyclical Commodity

• Trading Rule and Volatility Signaling

Part II: Strategy Implementation

• Defense Using Bonds, Options, Low Vol Stocks

• Offense Using Small Caps, High Beta, Cyclicals

• Combining Offense and Defense, Why It Works

Part III: Examples

Questions

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

What We Will Be COVERING Today

Our Agenda

Part I: Asset Class Diffusion

• Lumber as a Cyclical Leading Indicator

• Gold as a Non-Cyclical Commodity

• Trading Rule and Volatility Signaling

Part II: Strategy Implementation

• Defense Using Bonds, Options, Low Vol Stocks

• Offense Using Small Caps, High Beta, Cyclicals

• Combining Offense and Defense, Why It Works

Part III: Examples

Questions

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

Role of COMMODITIES on Equities

Asset Class Diffusion

• Traditional studies focus on asset class specific factors to outperform a passive buy and hold index

• Different approach is to look at one asset class to see if there is information which spills over to another

• Gradual diffusion of information from commodities to equities provide information on risk-seeking behavior

• Lumber relative to Gold contains such information, helping to answer the question of when to play offense/defense

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

The Cyclical LEADING Indicator

Lumber

• Media tends to focus on “Dr. Copper” and Oil

• Investors may be underestimating importance of Lumber, particularly due to housing/construction link

• Average new home contains over 14,000 board feet of Lumber, and reacts quickly to housing starts data (Rucker, Thurman, and Yoder)

• Housing tends to move ahead of expansions/recessions (Leamer)

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

The Cyclical LEADING Indicator

Lumber

• Endangered Species Act of 1973 reduced logging and deforestation, making Lumber highly sensitive to demand fluctuations

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

The Non-Cyclical UNCORRELATED Asset

Gold

• No statistically significant correlation between Gold and macroeconomic variables (Lawrence)

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

COMBINING Lumber and Gold

The Trading Rule

• Commodities exhibit momentum in various time frames from 1 to 12 months, strongest at 3 months (Miffre and Rallis)

Going back to 1986, developed following rule:

If Lumber is outperforming Gold over the prior 13 weeks, take a more aggressive stance in the portfolio for the following week.

If Gold is outperforming Lumber over the prior 13 weeks, take a more defensive stance in the portfolio for the following week.

Re-evaluate weekly and make changes to the portfolio only when leadership between Lumber and Gold changes.

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

Lumber Relative to Gold Anticipates VOLATILITY

Volatility

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

Lumber Relative to Gold Anticipates TAIL RISKS

Volatility

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

What We Will Be COVERING Today

Our Agenda

Part I: Asset Class Diffusion

• Lumber as a Cyclical Leading Indicator

• Gold as a Non-Cyclical Commodity

• Trading Rule and Volatility Signaling

Part II: Strategy Implementation

• Defense Using Bonds, Options, Low Vol Stocks

• Offense Using Small Caps, High Beta, Cyclicals

• Combining Offense and Defense, Why It Works

Part III: Examples

Questions

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

Spectrum of RISK Based on Volatility and Beta

Offense and Defense

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

The Lumber-Gold BOND Strategy

Playing Defense

• Best defense is low or negatively correlated asset class

• Bonds do not penalize you for false positives the way shorts/cash do

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

The Lumber-Gold BOND Strategy

Playing Defense

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

The Lumber-Gold BOND Strategy

Playing Defense

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

The Lumber-Gold BUY-WRITE Strategy

Playing Defense

• Options hedging can help mitigate downside

• Covered call options overlay using CBOE S&P 500 BuyWrite Index to replicate hedged exposure

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

The Lumber-Gold LOW VOLATILITY Strategy

Playing Defense

• Rather than using options, rotate to low volatility stocks

• S&P 500 Low Volatility Index measures the performance of the 100 least volatile stocks in the S&P 500

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

The Lumber-Gold SMALL CAP Strategy

Playing Offense

• Small caps are traditionally higher beta and more volatile

• Revenues tend to be more domestically sensitive, dependent upon consumer demand

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

The Lumber-Gold HIGH BETA Strategy

Playing Offense

• Higher risk tolerance rotations can be done in high beta

• The S&P 500 High Beta Index measures the performance of the 100 constituents in the S&P 500 that are the most sensitive to changes in market returns.

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

The Lumber-Gold CYCLICAL Strategy

Playing Offense

• Stocks more directly tied to the business cycle

• Uses the Morgan Stanley Cyclicals Index (November 1986 to July 2013) and the US Cyclicals Index (July 2013 to January 2015)

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

Putting It All TOGETHER

Offense and Defense

• Offense as small-caps or cyclical stocks, defense as Treasuries produces superior risk-adjusted results

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

Putting It All TOGETHER

Offense and Defense

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

DOWN Capture More Important than Up

Why This Works?

Takeaway? Lumber and Gold contain important information on domestic cyclical demand, helping to better manage risk and enhance returns before it’s too late.

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

What We Will Be COVERING Today

Our Agenda

Part I: Asset Class Diffusion

• Lumber as a Cyclical Leading Indicator

• Gold as a Non-Cyclical Commodity

• Trading Rule and Volatility Signaling

Part II: Strategy Implementation

• Defense Using Bonds, Options, Low Vol Stocks

• Offense Using Small Caps, High Beta, Cyclicals

• Combining Offense and Defense, Why It Works

Part III: Examples

Questions

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

1987

Examples

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

1990

Examples

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

2000-2002

Examples

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

2007-2009

Examples

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

2011

Examples

BEFORE IT’S TOO LATE: USING LUMBER, AND GOLD TO ACTIVELY MANAGE STOCKS & BONDS

THANK YOU for Listening

Questions

Happy to answer any questions you may have.