Trading Nation

The problem with using gold to hedge

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The market’s ‘dread risk’
European versus American stocks

If you're using gold to hedge your portfolio, you have a problem.

The yellow metal is frequently lauded for its ability to offset stock market moves — rising when stocks fall, and falling when they rise.

That is precisely what investors have seen over the past 60 sessions; gold and the have experienced a correlation of negative 0.24, which indicates a relatively strong negative relationship. And the precious metal has risen about 1.5 percent in 2 of the 3 most recent sessions in which the S&P fell 2 percent or more.

But this doesn't mean that gold will rise every time your stock holdings fall. Examining the relationship over the past several years, one finds that gold and the S&P are a most volatile couple — occasionally moving nearly in lockstep, sometimes running away from each other and frequently displaying indifference.

Over the past 20 years, the two have experienced a daily correlation of negative 0.03 percent, indicating almost no relationship. The five-year correlation is negative 0.06, and the one-year correlation is somewhat more significant, at negative 0.121, with help from the stronger correspondence of late.

Given the long-term indifference, it isn't surprising that gold provides little shelter in the worst of market storms. Over the past 20 years, FactSet data show 23 weeks in which the S&P fell 5 percent or more; gold's average move over those weeks was a 0.16 percent rise.

Gold, then, may serve an important function as a "portfolio paperweight," refusing to bow to the moves of the equity market. But using the past few weeks as proof that buying gold is the same thing as buying portfolio protection would be a terrible mistake caused by short-sightedness.

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