When held it points towards the nearest gift that has not been found on Winter Island. If you already found the gift it points to, you have to hold it again in order to get the compass to point in the direction, but only if you are not directly holding it. Otherwise, it automatically resets. This process can repeat multiple times until the compass finds a gift that has not already been found.
When you hold the compass after finding the gift it points to, it shows a message in the chat saying either that you have found all the gifts or that the compass is pointing in the direction of a new gift.