Is the yellow metal losing its historic diversification benefits?
- Changing correlations
- The new bond connection
- A model portfolio look-back
Ever hopped a bus in a strange city and wondered if the driver were taking you farther away from your intended destination rather than toward it? This phenomenon is actually fairly common. If you look at the route maps, you'll find a lot of backtracking along some local routes. Ultimately, you get to your destination, but sometimes, you end up taking some scenic detours along the way.
Like novice bus riders, many financial advisers and investors are feeling a little disoriented by the course their portfolios have been taking recently. Alarm bells are ringing as recent allocations to gold, made with a belief in the metal's historically negative correlation to stocks, are, instead, becoming more tightly correlated to equities.
To see what the kerfuffle's all about, take a look at the chart showing rolling 30-day correlations between COMEX spot gold settlements and the closing value of the S&P 500 Composite. Since mid-2008, gold's undergone a transformation, becoming more of a fellow traveler with large-cap domestic stocks than a contrarian play. The S&P 500's correlation coefficient has stutter-stepped its way from -0.48 to 0.79 in 21 months.
There's no refuge from coincidence to be found offshore, either. In fact, the correlation of gold to the MSCI All-Country World Index (ex-U.S.) is even tighter now, having ranged from -0.43 to 0.89 in the past couple of years.
Luckily for owners of a more diversified portfolio, the trend for bonds has moved in the opposite direction. Gold's correlation to the Barclays Capital Aggregate Bond Index has gone from slightly positive (0.03) to decidedly negative (-0.50) since mid-2008.
So, does this increasing correlation mean gold's returns are really becoming more stocklike? Well, yes and no. Short-term correlation is measured by comparing the degree and direction of daily price changes chalked up by differing assets. As you can see from the charts, there are times when gold's correlation moves in a positive direction and other times when the coefficient moves negatively.