Gold vs S&P 500
Gold price relative to cash value / market conditions is one of the first things people wonder about in times of financial crisis. Should I buy gold as a way to preserve my capital? Should I hedge my portfolio with gold? Can I eat all the gold I own when the world plummets into an apocalypse? These are the types of questions that we are going to discuss today by analyzing historical data to make a predication about investment risks.
We start off our analysis by considering the market to be the S&P 500 index, although an imperfect model for the general market, it is reasonably well and also easy to analyze. For the value of gold, we will be using data from the London Bullion Market which we are able to download daily historical data. From these sources, we are able to generate Figure 1 as shown below.
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| Figure 1: Gold value vs S&P 500 value in USD. Left axis, S&P 500, right axis Gold |
Unfortunately, looking at just the bare data will not be able to help us very much as inflation occurs which causes both S&P 500 and Gold to increase in value over time, causing us to state that both Gold and S&P500 value increase over long time periods (which is true, but we want a shorter-term answer). To do this, we can adjust the value for inflation to create a true present day value as seen in Figure 2.
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| Figure 2: Inflation Adjusted value for Gold and S&P 500 |
Finally, one more change is to be done to the data. Currently, the data includes valuation everyday, which can be highly volatile. As such, comparing price changes on a day-to-day basis is basically a coin flip (calculated out as 50.7% positive relationship vs 49.3% inverse relationship between gold value and S&P 500 value). Thus to compare micro-trends (as smaller time periods than the macro-trend as stated earlier) we will take a moving average of the data to smooth out the volatility. The price functions for both gold and S&P 500 to be used can be seen in Figure 3.
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| Figure 3: Moving averages applied on Gold and S&P 500 to minimize daily volatility. |
We thus can now move onto our quadrant analysis. In Figure 4 is plotted everyday the price change between S&P 500 and Gold. What this means is that if S&P 500 value goes up, and Gold goes up, it will be plotted in quadrant 1. By analyzing the plot, we can see that there is a inverse relationship between Gold and S&P 500 pricing 77.2% of the time, i.e. a likely relationship. Alternatively, Gold and S&P 500 move in the same direction 22.7% of the time, with only 4% of it being in quadrant 3.
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| Figure 4: Quadrant analysis of Gold change vs S&P 500 change. |
Thus, we can conclude that Gold is a good investment to hedge your portfolio, as only 4% of the time will both Gold and S&P 500 trend downwards. However, it is currently a worse investment than the S&P 500 as 70.2% of the time the market is growing, the value of your gold will decrease.
