Generally speaking, the price of gold tends to rise whenever stock prices are down. It’s a common trend that many investors either take advantage of or write off as a coincidence. You might be wondering, however: Is there a direct correlation between gold and traditional stocks?
For the last few decades, investors have considered gold to be a welcome buffer against major changes in the stock market. Investors like to diversify their portfolios with gold to hedge the risk against their stocks. However, there seems to be little—if any—real evidence of a direct correlation between gold and stock prices.
In this post, we’ll be taking a look at the history of gold and stock prices to better understand the correlation.
Why Do People Invest in Gold in the First Place?
Humans have long had a fascination for gold, and gold is still considered a valuable investment worldwide today. For centuries, people have bought gold for status, financial stability, and numerous other reasons. Not only is gold a worthwhile investment; it also has considerable intrinsic value.
Here are a few reasons why people invest in gold:
Hedges Against Inflation
Because gold isn’t directly correlated to movements in the stock market, it’s an excellent tool to hedge against inflation. Whenever there’s a financial crisis or event that causes too much market fluctuation, investors can rely on gold to remain stable. In some cases, gold will increase in value when stocks drop.
High Demand and Strong Global Market
No matter where you are in the world, there’s a demand for gold. Investors consider gold a good investment primarily because it’s extremely liquid. Buying and selling gold is typically easy because there are so many people holding and wanting it. What’s more, gold prices don’t necessarily fluctuate based on breaking news as would stock in, say, Facebook or Apple.
Unlike traditional stocks, gold is a relatively low-maintenance investment. Whether you’re investing in physical gold or an ETF, you don’t have to be as vigilant about monitoring your assets. For example, let’s compare investing in gold with investing in real estate. While owning a property can be a worthwhile investment, think of all the upkeep you have to do to maintain its value.
Physical gold can stay in a safe for decades without any wear and tear.
Stocks vs. Gold as an Investment
Whenever comparing gold and stocks as an investment, you have to think long-term. If you look at performance in the short term, stocks will almost always come out on top. Gold, on the other hand, is for those who want a solid investment strategy over the next 30 to 50 years.
On the surface, there’s no obvious winner between the two. Instead, successful investors like to diversify their portfolios with both gold and traditional stocks. However, there is a time when buying gold can be the smarter move.
Gold is a limited resource that has a reputation for stable growth. As a result, gold is considered a safe investment to give investors more confidence during uncertain financial climates. Investors who have a huge stake in the market can use gold as a tool to protect their overall wealth from unpredictable movements.
If you invest your entire portfolio in the market, you’re at a much higher risk of significant loss during a financial crisis. For that reason alone, gold can represent a smarter investment strategy. The following historical milestones can help give us a better picture of gold’s staying power.
The Great Depression (1929-1933)
The Great Depression was one of the worst economic downfalls in modern history. It drove the unemployment rate in the United States up to 25%. The Great Depression began with the stock market crash of 1929, a crash so severe that it destroyed millions of investors in a matter of months.
As a result, consumer spending dropped significantly across all industries, leaving many in financial ruin. By 1933, roughly 15 million Americans were jobless, and there was no silver lining in sight.
In the early stages of the Great Depression, the price of gold was relatively stable. Between 1933 and 1935, the US government raised the price fix of gold from around $21/oz. to $35/oz. Because the price of gold was fixed during the financial crisis, it’s tricky to measure its performance. However, one thing was for sure: Investing in gold was far more stable than traditional stocks.
The End of the Gold Standard (1971)
The gold standard is a monetary system in which a country’s currency is backed by how much gold it owns. As a result, a country cannot add more cash into circulation without increasing its gold reserves. The primary purpose of a gold standard is to keep a country’s ability to overspend and inflate the economy in check.
Today, no country uses the gold standard but it was the norm for almost every nation until relatively recently. The United States used the gold standard up until the Nixon Shock in 1971. Now, the United States has a fiat monetary system in which the currency isn’t backed by any single asset.
From 1971 until 1980, the price of gold continued to grow rapidly. However, gold prices started to drop around 1999 due to speculation that the central banks were reducing their gold reserves.
The Financial Crisis of 2007-2008
The financial crisis of 2007-2008 was the result of the bursting housing bubble. From the late 1990s up until 2007, the housing market in the United States increased by 130%. This massive increase in the market led to lower mortgage standards, which eventually made the bubble pop. The economic impact from the bursting housing bubble caused stock prices to plummet rapidly, leaving millions of Americans broke.
In 2008, the Federal Reserve was responsible for bailing out several corporate banks, including Bear Stearns and Morgan Stanley. During this time, the price of gold shot over $1,000/oz. However, the day Lehman Brothers went under, gold prices dropped back to about $775/oz.
Only until 2009 did the price of gold start to stabilize. So, what causes this kind of volatility in the gold market? In short, to bail out the banks, there had to be an immense amount of cash. During the economic crisis of 2007-2008, the market was more inclined to pay higher rates for a dollar loan rather than a gold loan. Therefore, there was a drop in gold prices.
The Different Forms of Gold Investments
There’s no doubt that investing in gold can be a smart choice for almost all investors. With stable prices and easy access, it’s an excellent way to protect your portfolio from drastic changes. However, that’s not to say that investing in gold doesn’t require careful investigation. First-time investors sometimes waste money purchasing the wrong types of gold products.
Here’s a breakdown of the most common gold products for investing:
Physical Gold (Coins, Bars, Etc.)
Physical gold is one of the most popular products. Gold can come in many forms, such as jewelry, coins, and bars. One of the key advantages of investing in physical gold is that you have direct ownership over your asset. However, physical gold requires storage and isn’t as liquid as other products.
Gold Mining Stocks
Investing in gold mines doesn’t correlate directly with the price of gold because you’re investing in the mining companies themselves rather than the product they’re after. While investing in mining stocks can be profitable, it requires extensive research. As a result, it’s typically not a sound investment for beginners.
Gold exchange-traded funds (ETFs) are one way you can invest in gold without physically owning any. Investing in Gold ETFs works similarly to investing in traditional stocks. One advantage of investing in a gold ETF rather than physical gold is you don’t have to worry about storage. However, you don’t have ownership over your gold assets when you choose this route.
When Should You Buy Gold?
If you’re looking to buy gold as a way to diversify your portfolio, there isn’t necessarily a “best time of year” to invest. Instead, you should take a look at your overall investment strategy. Sure, investing in gold is an excellent way to hedge against inflation, but it’s not a get-rich-quick scheme. If you’re looking to get a high ROI in a short time frame, you’re better off in the stock market.
However, if you’re looking for something stable that will protect you from sudden market movements, go for gold. If you’re new to gold investing, start with a small amount of your portfolio to get your feet wet. Top investors generally have 5-10% of their portfolio invested in gold.
As you can see, history shows that gold stays relatively strong no matter how the market moves. Whenever traditional stocks fall, gold tends to be a haven for investors to protect their overall wealth. That’s not to say that gold is invincible.
If you’re looking to learn more about gold investing, feel free to check out some of our other posts to help you get started.