According to a report in the Business Insider, global equities yesterday tipped the scale at a record $66 trillion driven by powerful bullish sentiment in countries such as India, Brazil, Hong Kong and Japan, and most significantly, by the S&P 500 (INDEXSP:.INX), which breached the magic 2000 level on a closing basis for the first time ever.

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Are markets getting ahead of themselves?

Eddies of stimulus, growing ever wider in their expanse and strength, are emboldening investors to turn a blind eye to geopolitical issues such as in Iraq, the Ukraine and the Gaza Strip. Last Friday, ECB President stoked equity sentiments by announcing the likelihood of a major stimulus effort in the Eurozone. Brazil, Korea and China have recently embarked on some form of stimulus programs in recent months. Japan is already in the midst of a major monetary easing program.

Markets appear invincible, but there’s an old adage that says markets are really at their weakest when they appear strongest.

Soros’ and his put position

Is it any coincidence that legendary investor George Soros upped his defensive bet on the markets, through put positions on the S&P 500, by nearly 606% in Q2? In fact, his 11.3 million puts, valued at approximately $2.2 billion, constituted about 17% of his portfolio and was its single largest position. It was also his biggest since 2008.

It could be that the position was simply a hedge against his portfolio, or may well have been extinguished after June 30, but the fact remains that Soros’ puts are now increasingly in the news, and also getting larger in percentage terms, as shown by this chart courtesy of Zerohedge:

Stocks soros puts zerohedge

Gold: A defensive play

If you are getting wary of the froth in the equity markets, it might be a good idea to hedge your bets with an exposure in gold through a pure-play gold ETF such as SPDR Gold Trust (ETF) (NYSEARCA:GLD) (see details below) or through ETFs that are based on underlying stocks of gold miner companies.

A 13F filing by noted gold player John Paulson & Co reveals he continues to hold 10.2 million shares in SPDR Gold Trust (ETF) (NYSEARCA:GLD) – a holding worth about $1.31 billion as at Q2 end.

Coming back to George Soros, in Q2 the legendary investor hiked his stakes in gold miner ETFs such as Market Vectors Gold Miners ETF (NYSEARCA:GDX) and added call options of that fund to his holdings. Soros also bought a million shares in Allied Nevada Gold Corp. (NYSEMKT:ANV), though he trimmed his holdings in Barrick Gold Corporation (NYSE:ABX) substantially.

Nevertheless, it appears that top fund managers are not averse to exposure in gold. It may therefore make sense, in these times of highly bullish equities, to diversify, at least partly, into gold.

SPDR Gold Trust – A great liquid alternative

This gold-backed ETF has been around since 2005 (as shown in the chart below) and is the investment mode of choice for investors seeking an exposure to spot gold through an exchange traded vehicle.

Stocks GLD Monthly

Gold may offer benefits that cannot be solely obtained by investing in bonds, stocks or other alternative strategies,” says David Mazza of State Street Global Advisors. “ In other words, whether an investor is considering adding alternatives to their asset allocation, has already done so, or is primarily focused on traditional assets, a gold investment can be a potentially strong complement to these strategies and may enhance portfolio performance.”

Gold – for good times and bad

Gold has outperformed other assets, even (sometimes) US Treasuries, during periods of global stress such as wars, recessions and the collapse of bubbles, as shown in the chart below.

Stocks Gold-turmoil

“Broadly speaking, economic growth spurs demand for gold in the form of jewelry and technology, whereas recessions promote buying (investing in) gold as a store of value,” says Mazza. “In turn, this creates a balance that drives gold’s lack of correlation to other assets.”

Low correlation to stocks

As shown in the chart below, gold has a negative correlation with stocks compared to hedge funds, private equity funds and REITS, a very useful property in these days when equities are ruling at all-time highs. This means that if stocks fall, gold could very likely go up.

Hedge funds correlation with stocks

Liquidity and return benefits

According to the World Gold Council, gold most commonly responds to factors associated with currencies, rather than commodities. In addition, its demand profile shows that consumers, investors and central banks are its largest buyers, differentiating it from other metals such as copper, nickel, silver, platinum and palladium which have substantial industrial applications.

Gold’s benefits of liquidity, daily pricing and diversification are comparable to those of other liquid alternatives (to stocks, bonds and cash) such as managed futures, and long-short equity funds. Gold has the added advantages of lower costs and transparency, without the problem of divergent find manager performances.

In fact, gold has outperformed the average alternative manager by 896 bps annually over the 10-year period ending 6/30/2014, says Mazza, referring to the table below.

Stocks gold returns

GLD – gold without the physical headaches

“SPDR Gold Trust (ETF) (NYSEARCA:GLD) was intended to offer investors a means of participating in the gold bullion market without the necessity of taking physical delivery of gold, and to buy and sell that participation through the trading of a security on a regulated stock exchange,” says Mazza. In addition, investors obtain the liquidity and diversification advantages of gold in a secure and relatively cost-effective transaction.