When the Stock Market Starts Waving a Knife

The stock market is teaching us that when things are good, they’re great. And when things are bad, they’re awful. Simply put: volatility is back.

Many of the largest investment fund managers agree that the rocky ride has a long way to go. As recently as last week Gerry O'Reilly, a Vanguard portfolio manager who runs the largest equity fund in the world stated that he expects volatility to continue.

Today’s volatility comes from investors becoming increasingly cautious. For years, investors have made full commitments to the equities market. Expectations of late, however, have tempered. Moreover, as the Fed raises rates other fixed income investments become more attractive. As a result, strategic, long-term investors are counterbalancing the volatility with gold.

“Historically gold has outperformed equities by an even larger magnitude when volatility is rising from an already elevated level,” explained CFA Russ Koesterich at BlackRock.

Koesterich goes on to explain the research behind this statement. “Looking at monthly Bloomberg data from 1994 to the present, changes in the VIX Index, a measure of U.S. equity volatility, explain nearly 20% of the variation in the relative return between gold and the S&P 500 Index. In months when volatility rose, gold outperformed the S&P 500 price return by roughly 2% on average.” The VIX, a popular measure of volatility in the equities market, is sometimes appropriately called the “fear index.”  

His research showed that in periods where the VIX rose above 20 and increased further “gold outperformed by an average of nearly 5%, beating the S&P 500 roughly 75% of the time.” Today, the VIX stands at 18.07 with many expecting an increase as experts work to detangle recent Fed remarks and the future of trade deals comes into focus.

The problem for most investors is that the power of gold as a steading force is not seen until it’s too late to make the investment. In other words, to benefit from gold’s unique characteristics in a portfolio, an investor must commit before the VIX rises. Unfortunately, even the most foresighted investors fail to appreciate the value of proactive measures. They ignore the art and science of asset allocation in which an investor balances risk and reward through exposure to a variety of assets like stocks, bonds and precious metals.

Gold is important when strategizing for asset allocation because historically it has a lower correlation to equities than other investments like REITs, private equity, commodities, and hedge funds. Research shows that during periods of turmoil gold has risen as global equities dropped. This phenomenon played out during the Long-Term Capital Management crisis, the September 11th terrorist attacks, the 2008 Global Financial Crisis, and especially Brexit during which gold climbed 9.8% and global equities fell 1.2%.

We’ve seen volatility start, but we haven’t seen it all. There is plenty of reason to believe volatility will not only continue but intensify. The time to counter the market swells is now when gold has the greatest potential to protect long-term wealth.