I always stress to friends and fellow investors that they should watch not only the stock market, but other correlated asset classes too. Different asset classes offer different clues to investors about what the overall sentiment and direction for the global economy is, which is vitally important.
For example, take the old adage that “when the US sneezes, the whole world catches a cold”. The dependency of most countries in some form on the US is one reason why if the US stock market falls, European stocks usually follow.
This being the case, what are the reasons to keep an eye on commodities as an asset class at the moment?
This month investors are faced with the Brexit deadline of October 31, along with US/China trade talks resuming. These are both key political events that will signal to the market whether to be optimistic or pessimistic regarding uncertainty in the global economy. While stocks will react, gold is likely to be the key barometer to watch for.
Historically, gold performs well when political uncertainty is high, as investors flock to it for safety in case their local currency devalues due to the actions of their government. One example of this is the British pound weakening due to Brexit uncertainty.
The equity bull run
In March of this year, investors celebrated the longest recorded equity bull run, as it passed the 10-year mark. Since then, all indices (including the FTSE 100) have shown high volatility, while struggling to make fresh highs.
Gold has performed very well since March, rallying from around $1,300 to $1,500 per ounce. Gold traditionally gets bought as investors cycle out and sell stocks when they feel the bull market is nearly over, to consolidate profits and move to a safer asset. However, some may jump out too soon, missing out on stock growth.
The final reason I am watching gold is because of the correlation it has to interest rates. Traditionally, when interest rates fall, gold performs well. Gold does not pay any interest, so when rates are low, there is less of an opportunity cost to hold it, making it more attractive.
Taking this a step further, we can look at gold prices as a barometer of whether investors think interest rates are moving higher or lower in the future. If gold sells off, investors likely think interest rates are going to rise, due to the economy performing well.
On the flip side, if gold is rising in price, then in my opinion it shows that investors think rates are going to fall, which is not a good sign for other asset classes, particularly equities.
Overall, the importance of knowing the price of gold and how it is performing is very high. Knowledge of this can help you manage your portfolio accordingly. And of course, investor nervousness can be a good opportunity to buy stocks at attractive levels for the long term.
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Jonathan Smith has no position in gold. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.