Aug 24, 2012

Gold vs. stock market: Can we use gold to preserve our assets from market crash?



Gold has always been considered to be one of the few hard assets which successfully store value through the time. Proof of that fact is the long term performance of the precious metal. 

Probably most of the investors have faced the question “Can we use gold to preserve our assets from market crash?” In that regard is observation of the 6 year performance chart of gold, represented by (GLD), and S&P500 index (SPX) which lead to the following conclusions:
  • For the last three years Gold (GLD) followed SPY corrections with certain lag
  • Market corrections tend to be more severe compared to gold corrections
  • For the last 6 years GLD outperformed SPY with 153% return vs. 10% for the index

S&P500 corrections vs. Gold corrections
S&P500 vs. Gold corrections
*Note that the chart is in log scale.

As numbers show all of the registered corrections for the period tend to be more severe for SPY compared to GLD. The reason for that could be found in the statute of the gold as a safe heaven. Just imagine where you could put your money in time when every asset price drops. The logical answer is hard assets with good historical price performance. Since in long term GLD clearly outperforms SPY it is rational that after the initial selloff most of the investors jump back in the gold and prevent its price form huge drop.  This fact again is supported by the perception of gold as save heaven asset good to be invested in long run.     

The lag

Most recent bear market which triggered recent economic turmoil started at the end of 2007. During that year when the broad market (SPY) started falling still the gold continued its rise until March 2008. That is 4 months lag. Consequent market corrections in 2010 and in 2011 had the same occurrence – the gold made its peak soon after the market hit the roof. Thus selling gold in the middle of the market correction sounds reasonable.

The correlation

There is wide known that the gold has negative correlation with the dollar and the positive with the global markets. However note that those correlations are not perfect i.e. not always for example as dollar falls the gold appreciates with the same margin. In its “Gold investment statistics commentary” the World Gold Council stated:

Looking back to Q1 2012, gold had a higher correlation to global equities, emerging markets and commodities than the long-run average; however, this correlation was not indicative of a direct economic relationship.

Gold correlation to global assets
Gold correlation to global assets
Source: gold.org

The correlation coefficient changes over time influenced by numerous factors but the relation is the same – positive with the markets and negative with the dollar. What does it means for the investor? Simply that one can use the gold as dollar hedge while using it as a market hedge is a bit tricky. That is because, as observation results showed, in short term you cannot avoid drop in the price of gold when everything is melting down, however in long term compared with the stock’s performance the winner is the metal. Thus you can boost your performance and add value if you have wide gold investment horizon.

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