Gold and stocks, although belonging to different investment classes, are interrelated in many ways. Their movements in the market are usually inversely proportional. In other words, when the stock market experiences significant declines, the price of gold tends to rise.
Gold: Reserve of Value
That is why historically, during periods of financial crisis, gold has proven to be a superior safe haven compared to stocks. This is due to its ability to preserve value over time, making it an attractive investment option when other assets, such as stocks, lose value.
Notable examples of this include the dot-com bubble crisis in 2000 and the economic collapse of 2008, in which gold investments offered positive returns, while the stock market suffered significant falls.
An interesting indicator used by investors to determine the appropriate time to concentrate their investments in the stock market or migrate towards gold is the financial reason Dow to Gold Ratio, which results from dividing the stock market index Dow Jones (DJIA) by the price of an ounce of gold in order to measure how under or overvalued one is compared to the other.
Historically, when this ratio has been above 15 investors have considered the stock market is overvalued compared to gold and, therefore, it is a good time to sell shares and buy gold. In contrast, when the Dow/Gold ratio has been below 5, investors have interpreted that the stock market is undervalued compared to gold and that it is a good time to reduce their gold holdings and buy shares. At the time of publication of this article (August 2024), the Dow/Gold ratio is at 16.27
The following graph shows the evolution of the Dow/Gold financial ratio over the last 100 years and the reflection of certain historical events in that financial ratio:
The Gold in High Volatility Scenarios
The inverse relationship between the price of gold’s performance and the stock market is especially evident during periods of high volatility. When fluctuations in the stock market intensify, investors tend to seek refuge in gold.
This is largely due to the fear generated by instability in the markets, which leads investors to sell assets perceived as riskier, such as stocks, and to invest in safer assets, such as gold. This dynamic has been consistently observed in various economies around the world, underscoring the universality of this inverse relationship.
Gold and Inflation
In inflationary environments, markets tend to become volatile, which generates uncertainty among investors. Gold, for its part, has proven to work even better under these circumstances, since inflation weakens the purchasing power of the currency, increasing the demand for assets that preserve their value, like gold.
After the global pandemic, with lower interest rates and abundant currency in circulation, an inflationary surge was inevitable, reinforcing the role of gold as a solid investment.
Gold Today: A Perfect Storm
In recent years, gold has had an exceptional performance during periods of high inflation and pessimism in the stock market. This trend has been amplified due to situations of global turbulence and complicated geopolitical scenarios. Furthermore, the recent trend of central banks and financial institutions to increase interest rates has negatively affected stock markets, while Gold has continued its upward trajectory.
Diversification as part of Strategic Investments
Portfolio diversification by combining stocks and gold is a smart investment strategy. Given that the price of gold and the stock market tend to move in opposite directions, including both in a portfolio can help maintain a balance, reducing the overall risk.
Before making investment decisions, it is crucial to consider the factors that affect the fluctuations of both the stock market and the gold market, in order to make up a diversified portfolio that reduces the risk and volatility inherent to each type of investment.
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