In this note, the manager looks at correlations between global equities, and gold and gold equities, during five periods of sharp stock market falls.
The key question for some investors seems to be whether or not the precious metal should rally if inflation gathers pace. The simple answer is: not necessarily. Inflation is only half the story.
The price of gold, and gold mining shares, are overwhelmingly driven by the outlook for real interest rates. Typically, gold and gold mining prices increase when real interest rates are falling and decrease when real interest rates are rising. The inverse relationship between the gold price and real interest rates is clearly illustrated in the chart below.
Gold, and gold mining equities, are driven by the real interest rate environment. Global equities, on the other hand, have their own particular drivers. Therefore, it follows that an allocation to the yellow metal, and those companies that mine it, can serve as a key portfolio diversifier. This is particularly the case for those investors with a high allocation to global equities.
Below, we set out five distinct periods in which global investors experienced severe market corrections, as shown by the MSCI World Index (a proxy for global equities), to see how gold and the FTSE Gold Mines Index (a proxy for gold mining equities) performed. The corresponding correlation tables are also displayed.
As can be seen, the correlation between the gold price and the MSCI World Index was below +/-0.3 in each of the five periods. The correlation between the FTSE Gold Mines Index and the MSCI World Index was below +/-0.5 in all but one of the five periods.
Given the diversification benefits of combining non-correlated assets, the case for adding gold and gold mining equities to portfolios with a high proportion of global equities appears compelling.