Gold and Stocks – The Best of Enemies

Gold and Stocks – The Best of Enemies

It’s a well-known axiom in the financial marketplace: Stocks and gold travel in opposite directions. When one is up, the other’s down and vice versa. The professional investor’s parlance for the phenomenon is “negative correlation.” I cite it in this blog often, in fact, as a signal to heed when you’re looking for a good opportunity to jump into the gold market.

Some may wonder why so much has to be written about stocks in a blog about gold. If they’re only paper assets, what’s the point?

Realistically, nobody can dissuade anybody entirely from wanting to buy and sell stocks. It’s too old an American custom. So it’s probably better for us to think about how we can do so with minimal damage to our financial resources. In this sense, we can at least become the Hippocrates of our own portfolios: “First, do no harm!”

It’s in this context we should look at some intriguing data from that appeared recently on CNBC, along with this enticing teaser: “Gold and stocks don’t always act like the best of friends, but as of late, they’ve become the worst of enemies.”

In the sixty sessions through close last Wednesday the correlation between the S&P 500 and gold futures has run a -0.63. Correlations span from -1 through +1. One is a perfect correlation, zero is neutral, and negative one is a perfect opposite. In other words, a negative one on a charting of stock market positions represents virtual assurance gold is on its way to the moon.

Based on this CNBC analysis of FactSet data back through 1984, -0.63 is the lowest correlation between gold and stocks on record. If you’re not a numbers investor, the one take-away you should keep in mind is the average correlation over the last thirty-two years between gold and stocks has been -0.06.

The present negative correlation between gold and stocks represents a strong buy signal – for gold. In this situation, gold may be acting as an investment proxy for remarkably low bond yields. Stacey Gilbert, head of Susquehanna’s derivative strategy, characterizes gold as your “natural defense mechanism” against negative-yielding bonds. Along with a bit of illustrative arithmetic, the authors point out: “[T]he tumbling correlation between gold and stocks means that we should expect a portfolio containing both broad stock exposure and gold to enjoy a better risk-reward profile than one that just holds the stocks.” In other words, if you add gold to your stock portfolio, you will reduce, or at least temper, the volatility of your stocks.

The CNBC article concludes, based on the current extremely negative correlation between gold and stocks, it’s now an excellent time to invest in gold. I couldn’t agree more. I would add one proviso. If Stacey Gilbert is correct in calling gold a “natural defense mechanism,” it’s fair to think of the shiny metal, then, as being somewhat akin to insurance. Just because you live in a pristine neighborhood doesn’t mean you don’t buy homeowner’s insurance. And just because you drive only ten miles a week, that doesn’t mean you don’t buy auto insurance.

You always need gold in your portfolio. Yes, it’s a good time to buy gold. But doesn’t it make sense a “defense mechanism” can also serve as a preparatory defense for bad times? Gold, in fact, is an investment for all seasons.