Investment horizon - precious metals and stock markets
The study has been authored by Vaneet Bhatia, PhD, Assistant Professor Assistant Dean, O P Jindal Global University, Sonipat, Haryana, India. The study has been published under a non-commercial content agreement.
Gold is considered to be the safest investment asset by various cultures and societies around the world. For the most part of recent history, gold has maintained its value amidst periods of economic crisis. Additionally, gold is considered as an asset of choice against rising prices, a safe-haven asset for investment and a hedge against adverse movements in various investment options (like the stock market, commodities, and currencies to name a few). Numerous studies have highlighted the advantages of holding gold in the investment portfolio (where an investor invests in more than one asset at the same time). However, there are some other precious metals (silver, platinum and palladium) that could offer similar benefits which are usually associated with gold. Can precious metals other than gold offer superior performance was the question we investigated in this study.
To explore the answer to the above-mentioned question, this study investigates the relationship between precious metals (gold, silver, platinum and palladium) and stock market indices of G7 and Brazil, Russia, India, China, South Africa (BRICS). The study is divided into three steps. First, it analyses the dynamic relationship (correlations) between stock market indices and precious metals over the sample period (2000-2017). Second, it investigates the hedging properties of both stock market indices and precious metals against each other. Third, it attempts to construct two asset portfolios to find the ideal investment weights (percentages) of precious metal and stock market index. We considered the analysis in variance (shock or fluctuation) of the selected variables.
Stock index data of representative national stock exchanges of selected countries included, Japan - Nikkei 225, US - SPX500, Germany - DAX, UK - FTSE 100, Italy - FTSE MIB, France- CAC40, Canada - SP/TSX, Brazil - IBOV, Russia - MICEX index, India- SP BSE SENSEX, China - Shanghai Composite Index and South Africa - FTSE Top 40. In addition to carrying out the analysis with weekly data, this study extracts the information available in the data to investigate the relationship over several time horizons, i.e., short-run (2-4 weeks and 4-8 weeks), medium-run (8-16 weeks and 16-32 weeks) and long-run (32-64 weeks and 64-128 weeks). This approach provides some interesting findings which could have gone unnoticed if the investigation was to be carried out without considering various time horizons.
Due to space limitations, this article highlights the main findings of the study. Chinese stock market exhibits a limited relationship with all precious metals when we consider weekly data or 2-4 weeks time horizon. But the relationship is strong in the medium and long-run. This finding was true for most precious metal and stock market index relationships for 2-4 weeks time horizon. It also suggests that stock and precious metal markets move in the somewhat opposite direction in high risk/variance/shock scenarios. Thus, precious metals and stock markets seem to provide maximum diversification benefit against each other during the short-run but seem to co-move in a similar direction in the medium and long-run. Moreover, results also suggest diversification opportunities between and within BRICS and G7 nations. The relationship with precious metals is somewhat similar for G7 stock indices except for the Canadian stock market. However, we find higher variations in the stock market and precious metal relationship among BRICS nations. It suggests fewer diversification opportunities among G7 nations in comparison to within BRICS nations.
While investigating the hedging characteristic of precious metals and stock indices against one another we find that it is economical to hedge in the short-run in comparison to the long-run. Moreover, precious metals seem to provide an economical hedge against adverse movements in stock markets and not vice-versa. We also note the high variation in hedge ratios in the long-run which suggests the increase in investment risk with an increased investment time horizon. Interestingly, we find that silver has superior hedging capabilities in comparison to gold, platinum and palladium in both the short and long-run. To construct optimal portfolios of precious metals and stock indices of G7 nations, results suggest that investors should consider investing more in precious metals in the long-run. Investment in precious metals for such a portfolio should be more in the case of short and medium-run. Similarly, in the case of BRICS nations optimal portfolio should consist higher weight of precious metals in comparison to G7 nations. Surprisingly, palladium seems to be the most suitable option to construct an optimal portfolio of stock market index and precious metal in both the short and long-run.
Overall, the findings of this study suggest that investors should pay attention to investment horizons while investing in stock markets and precious metals. Such a strategy could reduce the investment risks and may benefit investors by way of superior returns.
The study can be accessed by clicking here
(The study has been authored by Vaneet Bhatia, PhD, Assistant Professor Assistant Dean, O P Jindal Global University, Sonipat, Haryana, India)