Many people think of gold as the investment to hold when the economy sours and stocks head south. Indeed, gold was true to its reputation earlier this year when global stocks fell out of bed due to the coronavirus-induced economic shutdown. But as the precious metal proved during the stock market’s recovery from late March into the summer, gold can also perform well when equities are rallying. In other words, gold offers investors the best of both worlds.
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Academics perform this analysis by looking at the average annual movement of the Standard and Poor’s 500 Index (its standard deviation). When the S&P 500 is in rally mode, rising at a rate more than double its average annual movement, gold is positively correlated with stocks, typically rising at about 1/5 the rate of stocks, as indicated in the chart below from the World Gold Council. This year the correlation has been far higher as both gold and stocks had a strong second quarter.
When the stock market is not volatile, moving within its typical annual range, gold is ever so slightly negative correlated with stocks.
The great diversification benefit to holders of gold comes when stocks are sinking, as they did from late February into late March. That’s when gold is negatively correlated with stocks.
This is why gold is the ideal way for investors to diversify: it protects your portfolio when stocks are sinking and can help lift your portfolio when stocks are rising.
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