When gold price is up, stock is down. Is there a correlation between price of gold and stock market?
Gold is often referred as safe investment heaven.
But when we refer gold as ‘safe’ we are talking about safety with respect to what?
Gold works as a safety cushion for investors against stock market.
We are comparing gold and stock market.
Gold and stock market correlation cannot be established directly.
But when we see the historical performance of ‘gold’ and ‘stock market’ we can understand the correlation better.
In general, gold and stock correlation is inversely proportional.
Which means, when gold price goes up, prices in stock market will fall.
Historically it has been observed that when stock market is most pessimistic, gold performs very well.
This gold and stock market correlation is valid for all world economies.
Sale of gold coins, gold bars, gold etf are maximum when stock market is performing bad.
It has also been observed that gold demand picks up fast when country’s GDP growth rate is faltering.
In such situations people prefer to park their money in hard assets like gold.
Currency based investment options are left alone. Stock market is one such investment option that is left during financial crisis of world.
But this information that gold is negatively correlated with stock market is a valuable information.
It helps in creation of a diversified investment portfolio.
A case study to understand gold and stock market correlation
Consider a boy who was born in year 1980.
The boy started buying index funds right from his 21st birthday.
It was 21-August’2001 and Nifty was hovering at 1,000 levels.
He bought his first index fund units worth $300.
He also decided to diversify his portfolio, hence he purchased $300 worth of gold as well (approx. 1 ounce).
By Aug’2005 Nifty jumped to 2400 levels (2.4 times @ 24% CAGR).
In the same period, value of gold jumped from $300 to $450 (1.5 times @ 8.5% CAGR).
Return of 24% per annum of index is a fantastic growth rate.
Compare this with gold’s appreciation of 8.5% per annum, the performance of gold will look mediocre.
By 2008 Nifty jumped to 6000 levels (6 times @ 25% CAGR since 2001).
In the same period, value of gold jumped from $300 to $800 (2.7 times @ 13% CAGR).
Here again the return of 25% CAGR by Nifty is very good compared to average return 13% by gold.
So far so good.
The boy was happy to see his investments grow in Nifty and Gold.
But the boy was also getting increasingly anxious seeing the fast-growth rate of Nifty.
Nifty’s appreciation was too fast.
It did not take his fear to become reality in Jan’2008 when the stock market crashed.
Fortunately he did not ignored his uneasiness.
Just before the market crash he sold his units of index funds cashing-in $1800 from the stock market.
He did not keep his money ($1800) idle.
He bought gold worth $1800. At that time the gold was selling at @ $800/ounce.
By doing this he had 2.25 ounce ($1800/$800) plus 1 ounce (total 3.25 ounce) of gold as his investment reserve.
By Mar’2009, Nifty went below 2600 level. In the same time the gold price was trading at $900 per ounce.
The accumulated money from sale of 3.25 ounce of gold was $2925.
Again, the boy did not keep the money $2925 idle.
He immediately invested the money ($2925) in Nifty based index fund in 2009.
At this moment Nifty was trading at its lowest level.
By next 1 year (2010) Nifty jumped back to 6000 levels (2.3 times @ 131% CAGR in 1 yr).
Nifty tracking index fund units which was worth $2925 in 2009 was now worth nearly $6,700.
In the same period (2010) Gold price increased at marginal rate from $900 to $1300 (1.44 times @ 45% CAGR in 1 year).
It is worth noting the fact that Gold price appreciation was far lagging the Nifty.
Consider the kind of money the boy has made since year 2001.
Just because of the fact that gold and stocks market correlation is inversely proportional, the boy could do the following:
- The could boy utilise this fact to diversify his portfolio.
- He could grow his money from $600 to $6700 in 9 years
- Growth: 11.17 times @ 21% CAGR.
Careful diversification of investment portfolio between stocks and gold is a good option.
As there is a negative relationship between gold price and stock market, including both of them in portfolio gives a balance.