Will Gold Really Hedge a Falling Stock Market?

Stock market weakness provides little support for the gold price

   

A common perception about gold is that it can act as a safe haven in the event of a severe stock market downturn.

This isn’t always true, however, since the relationship between gold and stocks has been anything but static. Investors who are buying gold as a “hedge” might want to take a closer look at recent history to gauge whether a selloff in stocks is indeed the ticket to getting the metal back on track.

The table below shows how gold performed during six stock market downturns of the recent past. Gold suffered a negative return on three of the six occasions in which stocks fell, and on average the metal produced average a return of -0.45%.

Gold fans will quickly point out that this average was far better than stocks, and the metal provided a return above, or equal to, stocks in each case.

At the same time, the data also demonstrates that a falling stock market isn’t necessarily a catalyst for a major rally in gold. A likely reason for this is that the increasing interconnectedness of markets means that a sharp downturn in one asset class can create selling in another as hedge funds and other fast-money players are forced to raise cash.

Date Range S&P 500 GLD
September-November 2008 -23.2% -5.6%
January-February 2009 -18.6% 7.1%
May-June 2010 -13.1% 5.5%
August-September 2011 -12.5% -0.2%
May 2012 -6.3% -6.3%
October-Nov. 15, 2012 -6.3% 3.6%

Also, there has been an unreliable correlation between gold and stocks over time. Since the beginning of 2005, the SPDR Gold Shares (GLD) has had a correlation of 0.14 with the S&P 500 Index. Correlations run from 1.0 to -1.0, with 1.0 indicating two securities move in tandem, -1.0 showing that they move in completely opposite directions, and 0.0 showing no correlation at all. As a result, the 0.14 number underscores the lack of a consistent relationship between stocks and gold.

gold.spx  Will Gold Really Hedge a Falling Stock Market?

Is This Time Different?

While the longer-term results don’t support the bull case for gold in a stock market selloff, the most recent spate of volatility does offer some good news for the gold bugs: From May 21 to June 5, GLD rose 2.8% while the S&P 500 fell by that same amount.

One reason for this sharp divergence was the complete breakdown in the traditional relationship between stocks and the U.S. dollar. Typically, stocks have a high negative correlation with the greenback, and the dollar tends to rally in a reliable fashion when equities are weak.

In the six selloffs shown in the table above, PowerShares DB US Dollar Index Bullish Fund (UUP) gained ground every time and delivered an average return of 4.3%. The headwind created by dollar strength in market downturns is one reason gold — which generates its best performance when the dollar is weak — can’t be counted on to rally when stocks fall.

During the past month, however, it has been a different story. The dollar actually sold off in tandem with stocks in the period from May 21-June 5, as gauged by the -2.9% return of UUP in that time. It’s this combination — the simultaneous decline of the dollar and U.S. stocks — that helped fuel the gain in gold … a more complicated story than the “gold as a hedge” theme that has been picking up steam in recent weeks.

What Does This Mean for Gold?

The recent stabilization of performance is a positive sign for gold bulls, but anyone buying gold as a hedge needs to realize it can only be counted on to offset a drop in stock prices when the dollar continues to weaken against foreign currencies. If stocks fall but the downturn is accompanied by strength in the greenback — as it usually is — a bet on gold essentially becomes a coin flip.

The bottom line: If you have a bullish view on gold, and a potential summer selloff in stocks is a pillar of your bull case, be sure to keep an eye on the currency markets. The direction of the dollar will go a long way toward determining whether the recent strength in gold is a short-term dislocation or the beginning of a longer-term trend.

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, http://investorplace.com/2013/06/will-gold-really-hedge-a-falling-stock-market/.

©2014 InvestorPlace Media, LLC

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