Investors have been fleeing from riskier assets given the advances made during the Israeli ground invasion on the Gaza Strip, causing the CBOE Volatility Index (VIX) to make a large jump. Let’s take a look into what VIX is at a base level.
The VIX is a measure of what the markets expect volatility to be like for the next 30 days based on the variance (not the volatility) of index options within the S&P 500. It’s also a tradable index. An interpretation of this is the markets ‘fear index’, or an appetite for risk. What does the value of the VIX mean? If the VIX is at 15, it means the market expects a 15% change in the S&P 500 in the next 30 days.
A high VIX score equates to markets’ expecting high volatility, but not necessarily bearish conditions. Note that the actual outcome of market volatility in the following 30 days may be markedly different than what the VIX expects.
Given the above, what does this mean for gold? Gold is seen as a shelter from the market-storm: uncertainty or volatility. So in theory, when there is high uncertainty in the equities markets, some should move into gold to hedge any possible losses. By virtue of having more people rush into gold, the price should move upwards-this should correspond to an overall positive correlation between VIX and Gold.
Let’s see how this actually plays out-see the rolling correlation chart below. Negative correlations suggest the two prices move opposite of each other, and positive correlations suggest they move in tandem (in varying degrees).
From the basic assertion above, these are not the results one would expect at all! Why might this be? Well, for one, gold has many other features that affect it aside from the markets expectation of simple non-directional volatility. Geopolitical events can cause knee-jerk reactions, and economic announcements have their own effects. This aside, there is still insight to be derived.
Something within the composition of the relationship between gold and VIX has changed in this timeframe. For the past two years, it has been a largely negative correlated relationship amassing around -0.4 to -0.3. However, come summer of 2013, there has been a dramatic reversal of this trend, pushing it into unprecedented territories of a positive correlation upwards of +0.5. The large swings following summer of 2013 before leveling off in April could be noise, or the effects of this relationship changing.
Could this mean that people’s perception of gold has changed, perhaps into a more speculative tool rather than a counter-measure to instability? We’d love to hear your thoughts on this correlation analysis. If you already play VIX indexes on your equities investments, consider taking a look at doing it with gold.