Investors choose between gold and stocks depending on the economic conditions or individual risks associated with each investment. Stocks usually rise when the economy is healthy; when the economy underperforms, they typically fall. Should this climate persist, investors can turn to gold for long-term security.
Long-Run vs. Short-Run
When gold and stocks rise, investors can first make a decision on where to invest depending on how quickly they need to make a return on their investment. Gold usually presents an investment opportunity for long-term investors, as gold gains more than other securities over the long run. Stocks are most suitable for investors who seek to make a quicker profit. Such investors can invest in startups or growth companies, which usually yield a higher return in the short run.
Like stocks, gold commodities can be attractive when the price is increasing. The only inhibiting factor is the transaction cost involved in reallocating money from stocks to gold. Though this is feasible for a wealthy firm, a single investor may not be able to simply switch from stocks to gold commodities. Gold futures can be expensive and require a higher investment to buy a single contract in the futures market. Investors can instead seek other, cheaper products that mimic the risk profile or price fluctuations of gold commodities.
Individually, gold prices and stock prices move inversely. This means when stocks are lower, gold prices are higher. Because of this relationship, investors often consider gold a suitable hedge against a weak performance in the stock market. When stocks fall, investors usually choose to invest in gold, which causes gold prices to rise. When stocks rise, investors can move from gold products to make a quicker return on growth companies in the stock market. This can cause gold prices to fall.
When gold and stocks both rise, the investor can no longer look to this relationship as a suitable hedge for her portfolio. If the investor was using gold as a hedge for stocks, she might instead decide to use bonds to hedge against a potentially poor performance in the stock market, as bonds are also inversely correlated with stocks. Still, the investment vehicle that gold offers can be most appropriate during a global economic crisis when every other global investment alternative, including bonds, seems to be underperforming.
Video of the Day
- Comstock/Stockbyte/Getty Images