How are Equities and Gold Prices Correlated?

Correlation between Gold and Equities

While gold has an inverse relationship with the dollar, stock markets also have a deep connection to the metal. Investors commonly perceive gold as a haven in the event of a severe stock market downturn. Presumably, when we experience a global market decline, stocks and currencies move downward. Some investments become less desirable and investors assume gold will give them some breathing room. However, this does not always hold true, and investors can get burnt. Just remember that Gold has a direct correlation with the fear factor. The higher the fear factor in the world, the higher will be the gold prices. Balance all correlations can vary between equities and dollar.

Gold is on a historic tilt, surpassing records that have stood for decades and taking aim at a psychologically round-number level.

The rush for bullion, unsurprisingly comes amid the worst public-health crisis in generations, but what does the climb in the centuries-old haven asset mean for stocks over the longer term?

Gold has traditionally rallied as stocks have fallen because of the yellow metal’s status as a safe play during times of uncertainty.

When the gold price is up, the stock is down. Is there a correlation between the price of gold and the stock market? Gold is often referred to as safe investment heaven. But when we refer to gold as ‘safe’ we are talking about safety with respect to what?

Gold works as a safety cushion for investors against the stock market. We are comparing gold and the 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.

Those who had invested only in equities over the past few years have probably learned their lesson the hard way. But investors who were well-diversified right from the beginning are well aware that when equity fails to deliver, other asset classes can come to the rescue. And gold is the most prominent among these asset classes.

It is an often-stated fact that equity and gold do not go hand in hand. Hence, when equity tends to go up, gold comes down and vice-versa. And this gives investors enough opportunity to gain from either asset class, especially when the other is making a loss.

In general, gold and stock correlation are 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.

However, interestingly, gold’s 12-month correlation with the S&P 500 over the past 45 years averages zero. So, whether gold is a haven asset or just a teaser remains a mystery.

A look at gold and equity market performance demonstrates that a falling stock market isn’t necessarily a catalyst for a major rally in gold. Since 2005, the SPDR Gold Shares ETF (GLD) has had a correlation of 0.14 with the S&P 500. Correlations vary from 1.0 to -1.0, with 1.0 indicating that two securities move in exactly the same direction, -1.0 showing that they move in opposite directions, and 0.0 showing no correlation at all.

Typically, stocks have a high negative correlation with the US dollar. However, gold has an opposite relationship. The US dollar tends to rally when equities are weak, thus putting downward pressure on gold. This can make gold and its related stocks move in the same direction as the dollar instead of the opposite.

Gold-based stocks such as Goldcorp (GG), B2Gold (BTG) and Alamos Gold (AGI) mostly follow the gold market’s returns rather than the overall stocks market’s. These three companies make up 9.9% of the Market Vectors Gold Miners ETF (GDX). Another ETF that follows gold is the iShares Gold Trust ETF (IAU).

While the inverse relationship between these two asset classes has been in existence for long, it is not just a matter of theory. An ETIG analysis of the monthly returns generated by these two categories since January 07 also indicates the same. Though the period under consideration is not too long, it encapsulates one year each of a bull and bear run.

During April-October 07, when the equity market was in the midst of a bull run, gold managed to generate only decent returns after a few pitfalls during the initial months of the concerned period. However, there has been a reversal in trend this year due to the crash in the equity market. Each dip in the market has been compensated by an upswing in gold prices.

And this trend is only reinforced by the increase in popularity of gold exchange-traded funds  over the past couple of years, since they were first launched in India. The crippling of equity markets globally, followed by the huge surge in world gold prices, have turned out to be a blessing in disguise for gold ETFs which are relatively nascent products compared to equity and debt funds.

Though gold ETFs is considered a niche category, it has grown from a mediocre Rs 96 crore in February 07 to over Rs 700 crore by October 08, accumulated by just five players in the industry. A growth of over 600% in less than two years is quite commendable. After small hiccups in early 07 due to a fall in gold prices, these funds picked up pace and currently top the mutual fund category charts with the highest returns over a one-year period. Gold ETFs returns over shorter durations are also impressive, especially when compared with the benchmark indices and equity funds.

For those who are not well-versed with the concept, gold ETFs are also termed as paper gold or yellow paper, and are probably one of the easiest and most cost-effective ways to accumulate the precious metal. Though sold by mutual fund companies, these units can be bought and traded on the bourses (currently only the NSE Nifty), just like any other share or stock, and investors need to have an account to acquire gold ETF units. 

Thus, a depository participant can safely hold the paper gold, without worrying about the hassle of lockers. Gold ETFs also score over physical gold in terms of tax benefits in the case of physical gold, investors get long-term capital gains tax benefit only after holding gold for three years, but if gold is held in paper form, this tax benefit gets triggered after just one year. Also, while physical gold attracts wealth tax, gold ETFs do not do so.

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