11
June
How Does Gold Reduce Volatility?
The gold price is typically less volatile than commodity prices and most asset classes. This is because the depth and liquidity of the gold market, which are supported by the availability of above-ground stocks of gold in near market form, mean that sudden excess demand for gold can usually be satisfied with relative ease. As a result, gold is generally slightly less volatile than the benchmark S&P500.
Gold tends to become more volatile when the price is rallying, whereas with equities the reverse is true. So price volatility for gold contains different information from high volatility in equity markets, where it generally signals a crash or certainly very nervous, fragile markets.
The downside risks associated with the gold price are very different from those associated with other assets, a factor that enhances gold’s attractiveness as a diversifier. Specific risks to which equities are exposed, including exposure to the economic cycle, are not shared by gold and it’s inverse correlation make it an essential diversification in an investment portfolio.
Gold is appreciated by many investors because of its ability to provide protection against certain risks that can be hard to quantify. Although the likelihood of some of these scenarios materialising may be limited, gold is valued as a hedge against geopolitical risk and uncertainty and because it can provide liquidity – depending on the form in which it is held – enabling investors to meet their liabilities when other assets may suddenly and unexpectedly become illiquid. Gold is recognised globally as an alternative currency and can be used as a form of payment, reinforcing its longstanding role as a safe haven asset.
There is a commonly-held misconception that since the credit crisis' eruption in August 2007, gold has become a volatile asset. Its volatility certainly has increased since then, but gold has remained less volatile than other major asset classes such as the rest of the precious metals sector, oil, the GSCI commodity index and nearly all equity markets including the benchmark S&P 500.