Rotation Strategy In S&P 500 And Gold (SPY & GLD)

Many traders look at the gold and S&P 500 ratio. The ratio can be used to create sector rotation strategies are popular. One of the reasons is the anticipation of better and more efficient capital allocation, and perhaps a second aim is to reduce the drawdown. Today we backtest a strategy that rotates between the S&P 500 and gold: S&P 500 and gold rotation strategy.

When the S&P 500 and gold ratio is above its moving average, ie. when stocks are performing better than gold, we are long S&P 500 the coming month. When the ratio falls below the moving average we switch to gold. Pretty simple, but as it turns out, it works pretty well.

What is a rotation strategy?

A rotation strategy seeks to allocate capital efficiently between two or more asset classes or within the same asset class.

For example, as in this article, the strategy aims to increase the return by switching in and out of the S&P 500 and gold by using the gold and S&P 500 ratio. When the quantified rotation criteria say the next time period favors gold, we buy gold. When the criteria change, we sell gold and buy the S&P 500.

The logic is easy to grasp, but to make a profit is a whole other ballgame. Rotation strategies are no easy money.

How do you make a rotation strategy?

In order to make a rotation strategy, you need to start with a plan and an idea. We recommend always having one main principle in the back of your mind: simplicity is important and should be achieved. We have yet to see a rotation strategy that performs well if it includes many criteria.

Do sector rotation strategies work?

Some sector rotation strategies work, some don’t. Rotation strategies are no easy road to riches, as no strategies are.

However, as you’ll see in this article, our very simple rotation strategy between the S&P 500 and gold seems to work pretty well.

Furthermore, we have published sector rotation and momentum strategies in the past that show huge potential despite their simplicity:

Our S&P 500 and gold rotation strategy:

We tested our strategy by using the monthly spot gold price and the S&P 500 data from Yahoo!finance (^GSPC). The latter is, to our knowledge, not dividend-adjusted, thus it underrates the performance. Dividend reinvestments are a major part of the total return over time.

The S&P 500 and gold rotation strategy criteria:

We backtested the following the following trading rules:

Trading Rules

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If the S&P 500 and gold ratio (S&P 500 divided by the gold price) is above its 20-month simple moving average, we are long the S&P 500 from the close of the month until next month’s close.

If at next month’s close the S&P 500 and gol