The index was created by Charles Dow in 1896, which makes it one of the oldest stock indexes in the world. It also remains one of the most closely monitored and regularly cited stock indexes as a measure of stock market performance, especially by the general public. However, as the Dow is a price-weighted index, it does not take into account the market capitalization of each stock, allocating disproportionately great weight to stocks with a high share price. Another drawback of the index is that it includes only 30 companies – this is why some analysts believe that the S&P 500 is a better representation of the overall market performance.
Dow Jones and Gold
The relationship between stock valuations and the price of gold is widely debated. The standard view is that these two markets are negatively linked: when stocks go up, the yellow metal dives, and vice versa. This is indeed often the case, as gold is a safe haven, so when traders go into defensive mode, they may prefer gold to relatively risky stocks. Clearly, as the chart below shows, there have been many periods when stocks and gold were moving in opposite directions (the second half of the 1990s, i.e., the formation of the dot-com bubble, is one of the best examples). This is why gold is also a good portfolio diversifier, as it often provides a hedge against the Dow Jones Industrial Average. Hence, it is a good idea to add some gold to an equity investment portfolio.
Chart 1: Gold prices (yellow line, left axis) and DJIA (green line, right axis) from 1971 to 2017.
However, the chart, which presents the gold price and the DJIA, also shows periods of co-movement (think about the 2000s – the global commodity and equity boom). Actually, the correlation between the monthly average of gold prices and the Dow in the years 1971-2017 is positive and quite high (about 0.74). This is because equities are typically negatively correlated to the U.S. dollar, just like gold.
Hence, the gold-stock relationship changes over time, depending on external conditions, especially macroeconomic factors. Although there is often a shift of funds from equities to the gold market in times of stock crashes, the link between the Dow Jones and gold is complex and dependent on external macroeconomic factors. Indeed, although gold is perceived as a haven in the event of a severe stock market downturn, the falling stock market does not have to trigger a major rally in gold (think about the Lehman Brothers’ bankruptcy and the initial decline in gold prices).
Dow Jones and Silver
As one can see in the chart below, there is no clear correlation between silver prices and the Dow Jones. Although both asset classes moved in tandem during most of the 2000s, there were also periods of negative correlations or independent behavior, for example due to different specific developments in the silver market (see: Silver Thursday).
Chart 2: Silver prices (blue line, left axis) and DJIA (green line, right axis) from 1971 to 2017.
Hence, as silver prices are very closely linked to gold prices, this metal also serves as a safe-haven asset and a portfolio diversifier, as it hedges against the downturns in the Dow Jones. Having said that, investors should be aware that falling stock prices do not have to trigger a rally in silver prices (think about the initial reaction of silver to the bankruptcy of Lehman Brothers).
We encourage you to learn more about the precious metals market – not only about the link between the Dow Jones Industrial Average and gold and silver, but also how to successfully use both silver and gold as an investments and how to profitably trade them. A great way to start is to sign up for our gold newsletter today. It’s free and if you don’t like it, you can easily unsubscribe.
