When the Dow Jones Industrial Average plummeted 725 points on Monday, July 19 the price of gold barely budged. The following day, as the Dow regained 550 points, gold climbed $2.20 an ounce. The precious metal’s performance during this latest bout of extreme stock market volatility is a perfect illustration of the diversification benefits that gold brings to an investment portfolio.
It’s well known that gold provides a reliable hedge against downside risk in the stock market. But far less recognized is the fact that gold also performs well when the stock market soars.
A historical comparison of gold against the Standard and Poor’s 500 stock index provides the proof. Whenever stocks tumbled between 1971 and 2019, gold had a negative correlation with the S&P 500; in other words, gold would perform well in response to a plummeting stock market. But when stocks climbed rapidly, gold also rose because the precious metal has a positive correlation with the S&P 500 in highly bullish markets.
In effect, gold provides the best of both worlds to investors: downside protection and upside appreciation.
Of note, other commodities—be they energy or agricultural futures—do not demonstrate the same characteristics as gold. When the stock market sinks, most other commodities fall with the S&P 500 because they are positively correlated with stocks. When the S&P 500 is up strongly, non-precious metal commodities have only a slightly positive correlation with stocks.
The bottom line is that gold is a unique vehicle for diversification that gives investors downside protection when stocks are falling, and upside potential when
stocks are climbing.