Chart of the Week

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Fools Gold

With the current market volatility, people are scrambling looking for ways to hedge risk. This, of course, is right up my alley, so I’ve been taking notice of what people are talking about in terms of market volatility in the blogsoshere, twitter, conventional television and other platforms for investment pontification. There are some people out there with some pretty crazy ideas for how to hedge market risk. Probably the worst market volatility hedging strategy I've heard people chattering about is what seems to be a pretty tried-and-true hedging strategy: buying gold.

That’s the master plan for some people: buying gold? Are ya kiddin' me?. Buy gold at the top? And maybe even sell stocks at the bottom to boot? Not smart. If you're buying gold right now, you're setting yourself up for a fall. It's not a hedge, it's a sucker bet. This Chart of the Week shows that gold is not really the hedge people think it is.

 

Gold and stocks are traditionally said to be inversely related. However, there is nothing that guarantees that relationship. As shown in the chart above comparing GLD (the gold ETF) and SPY, gold and the equity market may both move higher or may both move lower. For example, in January, both GLD and SPY fell. Back in November of last year, GLD fell sharply without SPY doing much at all. The presumed hedge that gold provides is simply not as solid as many investors believe. This is not a way to lessen the effect of market volatility, it is a way to add risk to your protfolio.

 

Puts, on the other hand, are entirely related to the underlying. They are absolute protection against adverse price movement with no surprises. Heging market volatility are what puts were designed for.

 

Want to hedge your exposure to market volatility? Learn how to use puts as a hedge.

 

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