Historically, correlation among different risky assets has increased during periods of financial crisis: losses in one market spread to others, thus creating “contagion”. The increased correlation phenomenon is confirmed by our previous analysis on the topic (https://bsic.it/new-old-high-correlation/).
Furthermore, there is also the so-called “flight to quality”, meaning that investors move their allocation towards assets that are perceived to be safer compared to more volatile and cyclical ones. Among these assets, gold has often played a prominent role, being a safe haven during the downturns. However, according to recent studies, it seems that this relationship weakened during 2008-2014.
Throughout this article, we want to give a quick overview of some of the main papers on the topic, providing our view on recent and future developments as well. In particular, we focus on the paper of Choudhry, Hassan and Shabi (Relationship between gold and stock markets during the global financial crisis: Evidence from Nonlinear Causality Tests), which provides a rather revolutionary view compared to other works on the theme (e.g. Coudert and Raymond (2011) and Tuysuz (2013)).
The recent global financial crisis is considered the worst since the Great Depression. The crisis started with the burst of the price bubble in the US real estate market in mid-2007, and reached its peak by October 2008 when Lehman Brothers defaulted. It was (also) a liquidity crisis, as the interbank markets across advanced economies became dysfunctional in August 2007. Investors were “running to quality”, and the best evidence of this fact is the growth of the price of gold: it increased from USD 660 per ounce in August 2007 to USD 1,000 around March 2008! On the other side, global equity markets were collapsing, with the period September to October 2008 being one of the worst of modern financial markets history. Given such reactions, it became of interest to several researchers to investigate the empirical relationship between the two asset classes.
In recent years, among the others, Coudert and Raymond (2011) and Tuysuz (2013) investigated the hedge and safe haven characteristics of gold during the financial crisis. However, most of the studies adopt a unidirectional approach, ignoring the possibility of mutual dependence among various asset classes. The paper we consider, instead, exactly explores the possibility of the existence of non-linear, non-unidirectional dependencies. The authors took daily data from January 2000 to March 2014 in order to analyze the impact of the financial crisis on the price of gold and on the value of the main stock exchanges. The data are split into two samples, the pre-financial crisis (January 2000 to June 2007) and the financial crisis period (July 2007 to March 2014). FTSE 100 (UK), S&P 500 (US) and Nikkei 225 (Japan) represent three of the largest markets in the world and gold returns based on the UK pound, the US dollar and the Japanese yen are applied in the tests.
From this study, indeed, a little evidence of causality between gold and stock returns during the pre-crisis period emerges, with gold rightly considered as a safe haven during the pre-crisis period. However, the results are the opposite during the crisis period, providing evidence against the ability of gold to act as a safe haven during the recent global financial crisis; similar results are obtained when testing between stock volatility and gold returns, implying the same conclusion. Evidence of reduction of gold as a safe haven in the UK, the US and Japan from the pre-crisis period to the crisis period is therefore evident.
The inability of the yellow shining precious metal to act as a full hedge against recent crisis has been clearly confirmed also in the two recent turmoil that affected the world in 2015 (we are talking about the Greek crisis and the Chinese market issues). In our opinion, this is due to other external factors that affected more heavily the gold than just the fear of the investors on the major stock exchanges of the world.
The fluctuation of gold price is affected by many factors; the US Dollar Index is the one of them. Before investing in gold it is essential to understand the close relationship between the price of gold and the value of USD. Anyone who takes attention to gold and currency markets closely will find that the gold price and Dollar Index generally trend in negative correlation.
Gold and USD are considered as global currencies. Many foreign banks hold dollars as a reserve currency, or invest more in gold to preserve their assets during volatile economic conditions. When USD weakens, banks and investors around the world buy more gold to protect their money and hedge against USD weakness; when USD strengthens, more and more investors and banks invest USD to discard gold. Due to the fall in demand, the value of gold depreciates. This choosing of investors brings about negative relationship between gold and the USD.
In addition, the price of gold is commonly expressed as USD per ounce; therefore, any fluctuations of USD are likely to affect the dollar price of gold. Since gold is mainly consumed in China and India, it becomes more expensive and, consequently, demand shrinks. As USD rises, the gold price in dollar falls, and vice versa. It is worthwhile to note that the value of gold is unlikely to inversely fluctuate exactly in line with the value of USD. In fact, this reciprocal relationship is generally not obvious in a short period, but is almost obvious during periods of 12 months or longer. Weak forecasts about Chinese economy played another important role in pushing down the price of gold and in limiting its jump during period of political uncertainty and geopolitical tension. On the other hand, we can confirm that the price of gold has not been affected by the net purchases of gold by the major central banks of the world, with Russia in the first position, as it was rather cyclical in the last four years.
Gold hit a five-year low on Wednesday as haven buying failed to strengthen following the attacks in Paris and confirming that it is no more seen as a heaven asset for risk averse investors. The metal, which is traditionally bought during times of uncertainty, reached a five-year low of USD1,064.95 a troy ounce before rebounding later in the day. Gold investors are more focused on prospects for a rise in US interest rates in December, seen as a negative influence for the precious metal as it provides no yield. US inflation figures for October released on Tuesday added to those fears, showing an increase in consumer prices, reinforcing expectations of a US policy shift next month.
Despite high geopolitical tensions, gold is not benefiting from flight-to-quality buying. That may be partly because of the weak oil price. During periods of escalating geopolitical tension gold is more likely to trade higher when the oil price goes up, according to historical data. Instead, investors seem to be buying US Treasuries as a haven asset.
We will remain focused on the price of gold over the next times, especially approaching a possible Fed hike in December, trying to study further correlations with other assets classes and having a look at the possible geopolitical scenarios that will arise in Middle East.
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