When the market cycles as it has recently, with the pundits calling “woe” and predicting the end of Greece and everybody else with it, discussion always comes back to whether you should hold part of your investment in gold. When financial markets really fail, usually for nations that have lost a war or experienced a similar trauma (good examples are Germany and other countries after World Wars 1 and 2, Russia in 1991), gold can be a life-saving asset!
The scenario that brings this discussion up is one in which the stock market is going down significantly; if you make assumptions about how much gold goes up when the market goes down, it’s not difficult to calculate how much gold you might want to hold to provide a hedge.
Suppose your total portfolio is made up of stocks and gold. Now make an assumption that if the value of your stocks goes down by 1%, gold goes up by g%. If g = 1 then this means that gold goes up as fast as the market goes down; if g = 1/2 then gold goes up half as fast as the market goes down; if g=2 then it means that gold goes up twice as fast as the market goes down.
That was easy! Now let’s see what happens if your stocks go down and gold goes up by different amounts. If you want to ensure that the value of your portfolio has not gone down, then with a little algebra we can work out the amount of gold that you need in your portfolio for its value to stay unchanged.
The following table shows how this works out; if you would like the calculation that it is based on so that you can do your own math, drop us an email.
The numbers in the table are the percentage of the portfolio that needs to be in gold if the stock market falls by different amounts (the rows) and shows how that changes according to how much you think gold goes up if the market goes down (the columns). For example, if stocks fall 20% and gold moves up at the same rate that stocks go down, then 17% of the portfolio needs to be in gold for its value to stay the same.
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How much faster than the market does gold move? |
||||
|
100% |
Same |
Half as fast |
||
|
How much do stocks drop? |
0 |
0% |
0% |
0% |
|
20% |
8% |
17% |
35% |
|
|
30% |
11% |
23% |
51% |
|
|
50% |
14% |
33% |
100% |
|
Rather than provide 100% protection you might feel that you want to cushion the effect of a disaster rather than completely reverse it, in which case you would use a slightly different formula (or pick half of the amount of gold that the formula gives, for example)!
Before you start you really should question the assumption that gold goes up when stocks go down, and take a very hard look at what the relationship is! “Goldbugs” are very bullish on the gold/stock relationship but you need to test that for yourself!
That is the critical question to understand and Bloodhound can give you an idea; the following two charts show the last 14 years of history for the SP500 index (SPX) and for the CBOE Gold index (GOX). You can make your own evaluation but you can see that sometimes they go in different directions but since 2003 they have seemed to move together, not the hedge you want!
Our view? Gold is a strategy for a very rainy day and those don’t come around very often. Otherwise the charts show that that the relationship between gold and stocks is very hard to predict! We think the Bloodhound Model Funds provide a much better investment!
It always helps to see market movements in context, and Bloodhounds Chart Compress feature makes that easy to do. Here is the recent 100 point drop in the SP500 index seen in relation to its behavior over the last 24 years. If you check the performance of our model funds over this same period they show that consistent investing in the same strategy works much better!
