Investing in precious metals has become an extremely popular choice for equity investors looking to hedge their portfolios. Generally, this commodity class has gained the reputation as a “safe haven” holding during volatile market periods, but recently precious metals have flipped sides and saw a period of relatively high correlation to equities [see also 2013 Commodity Trades You Wish You Made].
Gold and Silver Correlations
As equity markets continue to enjoy a strong year of returns, commodities have taken a beating. April saw the largest single day drop in gold in 30 years and saw silver hit new lows, causing many investors so question their choice in commodities as a safe haven.
What many have missed is how highly correlated these commodities actually were to equity markets in the last few years. For the average portfolio, a correlation above 0.75 is considered high and implies that the assets are behaving in a nearly identical manner. Moving further down the scale, 0.2 is moderate diversification, -0.2 is good diversification, and anything better than -0.7 is considered excellent diversification.
|GLD v SPY||0.65||0.78||0.57||-0.63||0.50||-0.70|
|SLV v SPY||0.84||0.84||0.77||0.12||0.41||-0.73|
The idea that precious metals represent uncorrelated plays on the market has not always been true. As demonstrated above, precious metals have actually shared a relatively high correlation to the S&P 500 in recent years.
This changed in 2013 when commodities appear to have flipped a switch and are returning to the ideal portfolio hedge; both GLD and SLV have correlations to the S&P 500 of -0.70 and -0.73 respectively. In other words, the two metals are exhibiting almost the opposite behavior of equities. With the two metals touting a near perfect 0.9776 correlation to each other (YTD), it certainly seems that investors could pick either of their favorite precious commodities to hedge against a market dip [see also Gold Miners Continue To Fail].
Big Opportunities for Bears
Equity markets can seemingly do no wrong, as markets continue to rise no matter what kind of data comes out. This unconditional rise and another round of quantitative easing are causing some analysts to worry that the current market levels are not sustainable and a correction could be coming. Investors who agree that a crash is around the corner should see the growing gap in correlation between precious metals and equities as an opportunity to use these commodities as a hedge once again.
For the first time in recent years, precious metals could actually act as a safe haven, and the appeal to invest should be very high for everyone wary of markets.
Disclosure: No positions at time of writing.