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 flipped sides and saw a period of relatively high
correlation to equities.
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.
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
(INDEXSP:.INX) in recent years.
This changed in 2013: Commodities appear to have flipped a switch
and are returning to the ideal portfolio hedge. The
SPDR Gold Trust
(NYSEARCA:GLD) and the
iShares Silver Trust
(NYSEARCA: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.
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.
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Editor's note: This article by Carolyn Pairitz was originally