Is gold really the best hedge against inflation?

With so much talk around gold and inflation, why don't we look at how the major commodities and the S&P500 index have performed through this big inflationary stretch since 1983. Below are percentage returns off front month futures values for the period, Mar. 1983 - Mar. 2012.

Data source: Wikiposit

It looks like gold did not outperform any other commodity significantly, and if you're long inflation, the most expectedly profitable (and highly volatile) investment would be in the stock index.

Theoretical edge off Volatility Smile

Noticed this video from LibanmanFutures.

I like the mixed spread exploiting the volatility smile, and I wanted to add some thoughts:

• A dynamic delta hedge would likely reduce volatility of the trade's returns
• Having the actual return distribution as a known unknown; from the BSM perspective, we're likely to have a genuine edge with the seemingly undervalued options, and not so much if the others are really undervalued.
• Having an additional filter via a numerical fit of the volatility smile would likely give the trade some more of an edge.

The Speed Traders (Book Review)

I went through The Speed Traders: An Insider's Look at the new High-Frequency Trading Phenomenon That is Transforming the Investing World by Edgar Perez at the AUT Library earlier in the week. The book felt somewhat entertaining, not-so-informative for anyone with industry experience, and there was excessive moot around ethical opinions.

History of HFT

So it all started out with firms or departments who specialized in arbitrage, without any particular theoretical edge, needing speed. As competition grew, everyone relocated closer to the exchanges and the rest is history.

Trading Strategies

There are only 3 main categories of strategies involved.

1. Pure Classical Arbitrage
2. Buy-side / Sell-side Execution Algorithms (e.g. buy side at Knight Capital)
3. High Frequency Statistical Arbitrage /  Automated Market Making

There is a ton of individual strategies/opportunities within each category. The "simplest" category is of course pure arbitrage, and the most complex being Statistical Arbitrage where a robust, theoretical edge must be established.

Is speed alone enough?

No. Competition in this industry is extremely fierce. With big players like Getco spending $2M~/month on IT infrastructure, it isn't feasible to expect any significant edge in strategies heavily dependent on speed.

US Patent Database: Wealth of Information

As I've mentioned in the article around Intellectual Property in This Industry, it's usually a better idea to keep strategic business plans discreet. At the same time, from the perspective of a market participant, going through newly filed patents at the US Patent Office, by financial institutions is a great way to stay at the top of the game.



Examples of interesting patents

• Goldman Sachs looks to create near-1 delta products off option spreads
• NASDAQ OMX Group's proposed mechanism for balancing arbitrage-able index funds
• Barclays Capital's Interest Rate Prediction Models

A simple search for the key word "Arbitrage" resulted in 561 items. Yeah, lots of good stuff. Of course it'd still take some work to apply/extend these ideas into profitable, practical trading.