What Can the Lumber to Gold Ratio Tell Us About the Market?

By Ardi Aaziznia  |  
Bi-Weekly Market Updates  |  
May 18, 2021
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«  What Can the Lumber to Gold Ratio Tell Us About the Market?

This past Wednesday, inflation numbers were released and, as expected, they created jitters in the market. The speed at which prices rose month over month resulted in a major sell off.

We were fully hedged by being long VIX, which is something we discussed in our last biweekly market update. Our $20 strike VIX calls due in June went in the money last week and we exited them to cover some of the draw downs.

Inflation has taken a heavy toll on longer-duration assets and, over the last three months, the Nasdaq has been severely beaten up when compared to the Dow Industrial. One of the major causes of this upward move in the market has been the rise in commodity prices. While some of this can be attributed to a rise in demand, the majority of the price increases we saw were supply related.

Timing the Market: Lumber to Gold

One of the key ratios many active portfolio managers look at is the lumber to gold ratio. If the ratio is above 1, it means lumber is doing better than gold, signaling growth and economic expansion. As the ratio gets closer to a mean, it signals inflation and the potential for a sell off or correction in the stock market. We monitor this ratio closely and since last week we have watched a mean reversion unfold on our charts.

As set out in the above chart, as we get closer to the moving averages and the mean, we expect some correction in the market, primarily in the Dow and in cyclicals. In addition, we believe unprofitable tech plays such as Fastly, Spotify, Plug, and many others have even more room to go down.

Looking at our own proprietary index of 10 most unprofitable technology companies with the highest multiple, we can see while the underperformance has been evidence, there is still a divergence happening at a broader level.

Nevertheless, we must still all wait (somewhat patiently!) for the June numbers in order to assess whether this increase in inflation is truly transitory or not.

As always, please email me if there are any questions or concerns.

Ardi

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