Diversification Benefits of Gold, Oil and the US Treasuries to the S&P500 Index during the Economic Business Cycle

Gold, Oil, and the US Treasuries provide different diversification benefits when combined with the S&P500 Index. Correlation of Gold prices to the stock market remains low in Bull and Bear markets. Gold provides consistent diversification benefit to the stock portfolio. Another way to diversify the risk of the S&P500 Index is to own long-term US Treasury bonds. During the Bear market, the US Treasury bonds have the highest negative correlation to the S&P500 Index – stocks decline and bond prices rise. During the bull market, this correlation turns positive – both stock and bond prices increase together. In contrast, the US Crude Oil provides less diversification and more risk. Oil prices fail to have a predictable pattern. Oil prices move inconsistently in relation to the stock market.

First, I will take a look at the full business cycle – during ups and downs of the stock market. I will analyze the time period from Nov 18, 2004 until Sep 28, 2018. This time period includes the financial crisis of 2007-2008, and one of the longest 9-year bull market recovery in history so far.

Despite the Financial Crisis, the stock market recovered and reached the new all-time high (see Chart 1). The total return for SPDR S&P500 (SPY) index was 224%. During the full business cycle, the correlation between the S&P500 index and Treasury Bonds was 0.83 (see Table 1). The US Treasury bonds returned 113% during this time period.  It was good to be invested in both the S&P500 and the US Treasury Bonds (see Chart 1 and Chart 2).

20181011CorrelationBusinessCycle

(Table 1. Data provided by Yahoo! Finance. Daily data for exchange traded funds SPY (S&P500), GLD (Gold), TLT (Treasury) includes time period: 11/18/2004 -9/28/2018, data for the exchange traded fund USO (Oil) includes time period 04/10/2006 – 09/28/2018)

2018-10-01_Data

(Chart 1, Data provided by Yahoo! Finance. Adjusted monthly data for exchange traded fund SPY includes time period: 12/01/2004 -9/01/2018)

2018-10-11_TLT

(Chart 2, Data provided by Yahoo! Finance. Adjusted monthly data for exchange traded fund TLT includes time period: 12/01/2004 -9/01/2018).

Gold is also providing a good diversification benefit. The correlation between gold prices and the S&P500 Index was low at 0.33 during Nov 18, 2004 – Sep 28, 2018 (see Table 1). Despite being volatile, Gold was able to appreciate by 154% over this time period (see Chart 3). Gold prices provided diversification benefit with a positive price appreciation during the recent business cycle.

2018-10-01_Data

(Chart 3. Data provided by Yahoo! Finance. Adjusted monthly data for exchange traded fund GLD includes time period: 12/01/2004 -9/01/2018).

 

In contrast, Oil prices had a substantial negative correlation of -0.65 to the S&P500 Index during the full business cycle Apr 10, 2006 – Sep 28, 2018. Oil prices experienced high volatility and poor price performance. Oil declining by 77% during this time period (see Chart 4).

2018-10-01_Data

(Chart 4. Data provided by Yahoo! Finance. Adjusted monthly data for exchange traded fund USO includes time period: 4/01/2006 -9/01/2018).

 

Next, I will break down the recent business cycle into a Bear and Bull Market segments. The Bear market covers the time period from 10/01/2007-03/02/2009 when the stock market declined by 52.9%. During this extreme selloff, investors need diversification and low correlation. The two asset classes that provided the hedge against the stock market selloff were Gold and Treasury Bonds.

During the Bear market, Gold had 0.03 correlation to the S&P500 Index, and the US Treasury bonds had amazing -0.83 correlation (see Table 2). Both Gold and the US Long Term Treasury Bonds appreciated by 23% during the bear market from 10/01/2007-03/02/2009. In contrast, Oil had a strong positive correlation of 0.71 and lost money together with the overall stock market. Oil was down by 60% during the recent Bear market. It is logical to see oil prices decline when economy is in recession and demand for oil is down.

2018-10-01_Data

(Table 2. Data provided by Yahoo! Finance. Daily data for exchange traded funds SPY, GLD, TLT, and USO includes time period: 10/01/2007-03/02/2009)

 

Finally, I will analysis the behavior of Gold, US Treasury bonds and Oil prices during the recent Bull market. The Bull market covers the time period from 03/02/2009 to 09/28/2018 when the S&P500 Index had amazing return of over 400% total. During this time period, investors desire positive correlation to the stock market.

The US Treasury bonds had positive 0.84 correlation to the S&P500 Index and appreciated by 51% total (see Table 3). Both stocks and government bonds experienced a positive performance during the Bull market.

Gold prices had a low correlation of -0.20 to the S&P500 during the Bull market. Gold provided diversification and total return of 24%. Gold was a good asset class to be invested during the Bull market.

In contrast, oil had a poor performance during the recent Bull market. Oil had a negative 0.81 correlation to the S&P500 and lost 36% during the Bull market. Usually, we would expect oil prices to appreciate and have a positive correlation to equities during the Bull market. However, the structural changes in the oil market with the increase in supply and moderate demand caused prices to decline.

2018-10-01_Data

(Table 3. Data provided by Yahoo! Finance. Daily data for exchange traded funds SPY, GLD, TLT, and USO includes time period: 03/02/2009-09/28/2018)

Among the three asset classes analyzed above, Gold and the US Treasuries provide the best diversification and risk hedging benefits to the S&P500 Index. They hedge downside risk during bad times and provide price appreciation during good times. During the Bear mark, the US Treasury bonds had a negative correlation. During the Bull market, this correlation changed from negative to positive. The second-best asset class to provide diversification was Gold. It had the most consistent low correlation to the stock market. Gold has also appreciated in price over time. The worst diversification benefit came from owning oil. Oil prices declined both during the Bear and Bull markets.

Disclosures:

The business cycle analysis is based on historical data and future expectations that may not be correct. The history may not repeat itself and future price behavior may be different from the one described in this article. This paper was written as an opinion only. The data is not guaranteed to be accurate or complete. Please consult with your financial advisor before making an investment decision.

Data:

Yahoo! Finance data accessed on September 28, 2018 https://finance.yahoo.com

 



Categories: Finance, Economy, Markets, Commodities

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