Introduction

Gold prices and the stock market have long been thought of as two completely different entities.

Gold is a metal that has been used as a form of currency and investment for centuries. Gold is scarce, non-reactive, non-corrosive and durable, making it a valuable commodity.

The stock market, on the other hand, is a collection of markets where stocks (pieces of ownership in businesses) are traded between investors. It's a way for businesses to raise money by selling stocks to investors, and for investors to make money by buying and selling stocks.

However, a closer look reveals correlation indeed does exist between the two. Understanding the correlation between gold and the stock market can help you better allocate your investment portfolio.

Key Takeaways

• Gold and the stock market generally move inversely to one another.
• Investors often use gold as a safe haven investment, as it tends to be less volatile than stocks.
• Gold plays an important role in the stock market, as it is often used as a hedge against inflation.
• Gold can add diversity to an investment portfolio.
• Gold prices will trend upwards when the US dollar value weakens and vice versa.

How gold and stocks have historically moved together

Gold and stocks have a long-standing relationship dating back to the early days of investing. While the two asset classes do not always move in lockstep, they have tended to track each other fairly closely over time.

International market

According to Baur and Lucey (2010), gold prices and stock market returns are negatively associated. Their research suggests that gold has consistently increased whenever there is a stock market crisis. The US, UK, and German stock markets were taken into account in this analysis.

Source: Baur & Lucey, 2010

A portfolio analysis demonstrates that at times of market stress or turmoil, gold's negative correlation to stocks is transient.

Source: Baur and Lucey, 2010

On the day after an extremely negative shock to the stock market, gold returns are positive, but they turn negative shortly in the days that follow. After an extremely negative shock, the stock market returns revert back to positive leading to the cumulative stock returns to trend upward. Investors would suffer losses on their gold investment if they continued to hold gold following an extremely adverse shock.

Gold has historically been proven to perform well during shaky economic times. It did well during the Great Depression, the Second World War, the 1974 oil price shock, and the recessions in the 1980s and 2000s. (Frank A. Barber, 2021)

Local market

Source: Bursa Malaysia, 2022

As can be seen in the chart above, there is an inverse relationship between the gold spot price and the FBM KLCI Index.

Source: Diyar Abdulmajeed Jamil et al., 2020

Research was conducted which shows that a strong negative correlation exists among the Malaysian stock exchange index (KLCI) and the Gold prices index. The relationship between the KLCI index and the Gold index has been studied using daily data from January 2006 to May 2017. In both the pre-Covid-19 and Covid-19 periods, the KLCI and gold price correlation persists. (Damien Lee et al., 2021)

In the context of Malaysia, Ibrahim and Baharom (2011) only find a safe haven feature of gold during extreme stock market downturns from August, 2001 until November, 2005. Nonetheless, the characteristics tend to disappear during the second sub-period (December, 2005-March, 2010).

Why is the correlation between gold and the stock market important?

While the relationship between gold and stocks isn't perfect, it's worth considering how the two assets have historically moved together when making investment decisions.

The correlation between gold and the stock market is important because it can provide insights into the health of the economy. When the stock market is doing well, gold prices tend to fall, and vice versa. This relationship is due to the fact that gold is seen as a safe investment during times of economic uncertainty. When the stock market is volatile, investors tend to buy gold as a way to protect their wealth.

Additionally, the correlation between gold and the stock market can be used to predict market movements. If gold prices are rising, it could be an indicator that the stock market is about to fall, and vice versa. By understanding the correlation between gold and the stock market, investors can make more informed decisions about when to buy or sell assets.

The correlation between gold and the stock market is important because it can help investors diversify their portfolios and protect their assets during times of market turmoil. Gold is often seen as a safe haven asset, which means that it tends to do well when the stock market is struggling. By including gold in your portfolio, you can help offset any losses you might experience in other investments.

The potential of gold to act as a diversifier, a hedge, or a safe haven is affected by the different currency denominations. As a stock hedge, gold denominated in Malaysian Ringgit performs better than gold denominated in US dollars or British pounds. On the other hand, gold denominated in foreign currencies performs better as a safe haven against the stock market during sharp fluctuations in stock return, especially for gold denominated in the British pound. (Mohd Fahmi Ghazalia et al., 2016)

What causes the correlation between gold and stocks

There are a number of reasons for this relationship. Generally, when the global stock markets are down, investors tend to turn to gold as a more secure asset, causing the demand for gold to rise and the price of gold to increase. This is because investors often view gold as a safe haven asset, and so when stock prices are falling, they may move some of their investments into gold in order to protect their capital. Conversely, when the global stock markets are up, investors tend to turn away from gold in favour of higher-yielding investments, causing the demand for gold to decrease and the price of gold to fall. Research shows that the KLCI return significantly outperforms gold returns. They concluded that stock gives a better risk-return trade-off than gold. (Mohd Fahmi Ghazalia et al., 2016)

On the other hand, gold is also seen as a hedging tool against stock market risk exposures. Therefore, investors in these markets prefer to buy gold by selling stocks in low market conditions. This is supported by Baur and Lucey (2010) who found gold is a hedge for stocks since the assets are uncorrelated with each other on average. Mohd Fahmi Ghazalia et al. (2016) found that Kijang Emas provides investors with the compensating property of a strong hedge.

What factors affect the correlation between gold and the stock market?

While it is true that gold and stocks have historically had an inverse relationship, this is not always the case. There can be periods where both gold and stocks move in the same direction. Such as in times of economic growth where increased consumer spending and corporate investment tend to lead to higher stock prices and higher gold prices due to increased demand for gold as a safe-haven asset.

Moreover, gold and stocks are both sensitive to inflation. When inflation is high, central banks tend to raise interest rates, which can cause the prices of both gold and stocks to fall. So while gold and stocks may not always move in the same direction, they do tend to be closely linked.

Gold and stocks are both sensitive to changes in the denominated currency. When the currency strengthens, gold and stocks tend to go down. This is because when the currency appreciates, it is more expensive to buy gold. As the cost of buying gold increases, demand for gold decreases, resulting in a decrease in its price and vice versa. Also, when a currency appreciates, it can make exports more expensive, which can hurt the earnings of companies that have a large presence in international markets. This can cause stock prices to decline. Additionally, when a currency appreciates, it can make foreign investments more attractive relative to domestic investments, and investors may shift their portfolios away from domestic stocks and into foreign stocks. This could also lead to stock prices declining.

How can investors use the correlation between gold and the stock market to their advantage?

In times of economic uncertainty or market volatility, investors who are seeking a stable investment can turn to gold as a safe haven to safeguard their wealth instead of stocks. Baur and Lucey (2010) findings suggest that investors buy gold on days of extreme negative returns and sell it when market participants regain confidence and volatility is lower. However, this relationship is not always strong or predictable, and there have been periods when both the stock market and gold have performed well or poorly at the same time.

Moreover, gold has shown to be a hedge against stocks on average, meaning that it can help smooth out overall portfolio performance. Gold can be a valuable addition to a portfolio for diversification and provide protection against inflation. Gold can potentially provide a buffer against losses in other investments. While there is some truth to this, it is important to remember that gold is not a perfect hedge against stocks.

Bottom line

There is generally no strong or consistent correlation between the stock market and gold prices. The stock market is driven by a variety of factors, including the performance of individual companies, the strength of the economy, and investor sentiment, while gold prices are influenced by supply and demand dynamics, inflation expectations, and geopolitical risks.

It's important to note that the stock market and gold are two very different types of assets, and they serve different purposes in an investment portfolio. The stock market offers the potential for long-term growth through the ownership of shares in successful companies, while gold can be used as a hedge against inflation or as a way to diversify a portfolio. It's generally a good idea to have a mix of different assets in your investment portfolio to spread risk and maximise potential returns.

Ultimately, the relationship between gold and the stock market is one that cannot be ignored. This is because both provide an opportunity for investors to invest their funds and profit. They both offer different benefits, with gold being less volatile and the stock market providing great returns if the market performs well. Thus, it’s important to understand how the two interact in order to make the most of your investments.

Reference

• Baur, DG & Lucey, BM. (2010). Is Gold a Hedge or a Safe Haven? An Analysis of Stocks, Bonds and Gold.
• Bursa Malaysia. (March, 2022). GOLDETF: GLISTENING AMID THE RUBBLE.
• Damien Lee Iung Yau, Chiam Pei Ching, Josephine Yau Tan Hwang, Sin Kit Yeng & Joanne Shaza Janang (September, 2021). Does the Factors Affecting Gold Price Changed During Covid-19 Period in Malaysia?.
• Diyar Abdulmajeed Jamil, Fria Abdul Kareem, Nawzad Majeed Hamawandy, Rafiq Tofiq Khoshnaw, Ranjdar Mustafa Ali & Zaito Awla Abubakr. (December, 2020). Impact of Gold Prices on Stock Market: A Case study of Malaysia.
• Frank A. Barber. (October, 2021). How Does Gold Perform During a Recession?.
• Ibrahim and Baharom. (2011).The role of gold in financial investment: a Malaysian perspective.
• Mohd Fahmi Ghazalia, Hooi Hooi Lean & Zakaria Baharia. (2016). Gold Investments in Malaysia.

Author

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This article is written by Joyce Lok Wye Jen, Research Analyst Intern

Joyce Lok Wye Jen is currently majoring in Finance at Tunku Abdul Rahman University of Management and Technology (TAR UMT). Joyce interns at TED Optimus Sdn. Bhd. for 3 months. She participated in Bursa Inter-Varsity Stock Challenge 2022 (BISC). She is also a CFA Level 1 candidate. She is an in-house author from TED Optimus.