I've always had the impression that a lot of people who hold gold, or believe everyone should have an allocation to gold, do so as a form of insurance. I was therefore surprised the other day to learn that gold is more or less uncorrelated to the stock market. I would normally expect "insurance" to be inversely correlated, maybe not perfectly, to whatever you're trying to insure against- you crash your car or your house burns down and the "value" of your insurance goes up to cover most if not all of your loss. The lack of correlation, though, suggests you can't count on it for that. For example, gold's reaction on Black Monday wouldn't have helped much at all unless the large majority of a portfolio was in gold and then only for a very short time. On the other hand gold was great after 9/11.
Maybe I misunderstand the prevailing reasons for owning gold but it seems it doesn't really serve the purpose I believed people want. What am I missing?
Comments
Reply: I am going to reply specifically to your premise -- which I assume you meant to say that gold and stocks are not inversely correlated...
Some 'ancient history': Once the Volcker Fed "killed" inflation in the early 80's, equities enjoyed the great 80's & 90's bull market. AU (like most commodities) were crushed, as fear of runaway inflation gave way to relentless DISinflation.
How about more recent history: I suggest you go to Google charts and compare SPY to GLD (or 'CEF' for periods prior to GLD being in operation). The inverse correlation, especially as meaured from major inflection points in either AU or the SPY is pretty compelling. Summarized as follows (figures are approx):
Jan2000-May 2007 CEF +152%; SPY (1%) Tech bubble peak to housing peak.
May 2007-Aug 2011 GLD+ 171%; SPY (21%); Approx pre-crisis pk in equities to commodity peak.
Aug 2011-Dec2015: GLD: (44%); SPY +83% (corresponds to the commodity bear)
That is about as non-correlated as you could hope for.
There is a longer term AU vs equities chart at this link: (halfway down the page)
https://www.caseyresearch.com/articles/ben-graham-s-curse-gold
It sure looks like a persistent, inverse correlation persists over extended & distinct market environments.
Now if AU or equities don't exhibit inverse correlations on a daily-basis, that is very important to day-traders, but I don't know that its pertinent to investors. --- One could make the very same argument that stocks and Treasurys exhibit random correlation (i.e non-correlation) on select days -- sometimes moving together, sometimes not. -- But they represent great diversifiers, one-to-the other. AU too, as demonstrated above is another great diversifier. Definitely, the best thing to have done on Black Monday was nothing (or buy, buy, buy --- if you could have gotten through to your broker on the telephone that day; (I couldn't). Certainly panicking on anomolous 'event' days is probably not adviseable.
AU also represents a great diversifer to a condition which the USA has not (yet) experienced, though other countries have -- dramatic currency debasement. Argentines, Venezuelans, and many others throughout history have experienced this outcome. Fiat currencies can be debased (that is the long-term effect of CB QE), companies bankrupted, bombs (or jumbo jets) can destroy buildings (i.e. real estate), the sovereign's bond can be ravaged by inflation. But AU is immutable. That is what makes it 'insurance'.
Perhaps you could provide some explanation about from who/where you 'learned' that there was no inverse correlation?
YTD 2016, the AGG, SPY & GLD are ALL up. As is EEM, PCY, & VNQ.
This is HIGHLY unusual, to have all such disparate assets up. This 'correlation' YTD, is not due to inherent correlations of their fundamentals. And it won't be long-lived. Its has to do with virtually all CBs engaging in unprecedented fiat currency debasement aka "Q/E". The CB's are creating asset inflation --- blowing asset bubbles --- hoping that asset inflation will be transmitted to the real economy to counter fundamental deflation pressures.
CBs will either succeed (inflation will accelerate) or fail (deflation will continue). On whether they 'succeed' or 'fail' will determine the angle of inflection of various asset classes. Neither eventual outcome is particularly good for our currency, our (real-) economy, or paper securities, in the long-run. Reliance on global Q/E as essentially governments' only policy tool will ensure that the future will be full of 'interesting times' -- to evoke the Chinese curse.
I completely agree with you that daily correlations don't matter but at some point regardless of whether you're simply trying to diversify or whether you're looking for insurance, they do matter. The correlation for gold and stocks based on the website I looked at and your conclusions about the details you presented suggest the relationship is more random than not. Sometimes gold is up when stocks are up, sometimes it's down while stocks are up and sometimes it doesn't change a lot.
I also agree with your comments about the CBs. The question is how to protect yourself or at least minimize the damage when the house of cards comes crumbling down. Maybe gold is the answer, maybe cash and maybe there just won't be many good places to hide. It doesn't seem like either stocks or bonds are a good answer so maybe that's what's causing some of gold's rally this year. Maybe people are preparing and believe gold is the best option.
Nice question and great response. Too often, people try to simplify the gold market. The demand for gold is extremely multifaceted and this confuses many would be comparisons. You've got CB and petro dollar diversification, industrial & institutional investors, 'insurance' investors, fundamentalists/survivalists, coin collectors, the extremes of the 'cash only' crowd, and I'm only starting.
That said, I have always been, and still am of the camp that suggests strongly that everyone should have some small percentage of their wealth in precious metals. Let's say 3-5%. I consider that a core investment. Insurance? feh. My grandsons have their bed buddies and my wee stash is my bed buddy. An ounce of gold in ancient Rome would buy you a nice toga and sandals. In the 1920's an ounce of gold would buy you a nice suit of clothes. Today at ~$1350 - it'll still buy you a nice suit of clothes. A silver quarter back in 1960 would buy you a loaf of bread. Today, a silver quarter is worth approximately $3.55 - and would still buy a loaf of bread. Is this insurance? I don't know.
Owning a greater percentage of pm's than suggested is speculation - which is fine, but let's call it what it is. A greater percentage and you're anticipating some appreciation. With the former, you're just hoping it will retain some iota of value.
About 7 or 8 years ago I read a quote from the Elder Baron Rothschild that to protect yourself against economic calamity, you should have 1/3 of your wealth in securities, 1/3 in real estate, and 1/3 in rare art. Define rare art as you wish, but it ain't Beanie Babies. With me, it's simple, I've collected coins since 3rd grade or about 60 years. I've had my best success in this arena. Ergo, I gravitate towards coins and pm's.
The nut question is would you sleep better at night while owning gold? If so, consider it insurance.
and so it goes,
peace,
rono