Gold Loses Its Value as Selloff Protection

This makes it reasonable to wonder whether gold no longer offers the diversification it once did against ordinary financial crises. After all, the more people there are who believe gold will rise when stocks fall, the more the price of gold is likely to be bid up ahead of a selloff in stocks.

That means when stocks do slide, there are fewer people left to buy the precious metal, and it does the opposite of what it's expected to do. (This is a simplified explanation, but it should provide the basis for understanding.)

One commodity that might offer better protection from a stock market decline is food. Unlike gold, agricultural commodities aren't widely used to diversify out of stocks, and demand is pretty inelastic.

For now, the easiest way for stock market participants to invest in this commodity is through the PowerShares DB Agriculture Fund (DBA). DBA invests 25% each in corn, sugar, soybean and wheat futures. Because futures contracts are purchased on margin, most of the assets in the fund are actually in T-bills. So after paying the ETF's 0.75% management fee, there will be some yield paid out at the end of the year, in addition to any gain in the value of the futures contracts themselves.

(By comparison, GLD invests in gold bullion, rather than futures contracts.)

DBA has only been trading since Jan. 5. During the first quarter stock market dip, the ETF dropped 3.5%, holding up a little better than stocks and a lot better than gold. In the current selloff, DBA is actually up a little over 1% (as of Friday) since July 19. But I should note that at its recent low it was down 3.2%. In other words, during the past two major stock market dips it has endured much better than stocks and a little better than gold.

This three-month chart also captures the low and sometimes negative correlation between DBA and the S&P 500.

A Better Way to Hedge? The Powershares DB Agriculture Fund has a low correlation with returns of the S&P 500

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So food, as represented by DBA, has a relatively low correlation with stocks during financial crises; but what about non-financial market disruptions, such as terrorist attacks? DBA did not exist in September 2001, but we can back-test to see how it might have performed. As you can see in the second chart, below, DBA offered some relief from the September 2001 selling but did not appreciate. The price of gold, however, did go up in the wake of those terror attacks.

What Might Have Been Back-testing shows agricultural indices holding up better than stocks after the Sept. 11, 2001, terrorist attacks

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If there is another terrorist attack, gold might well rise again, but the financial markets are a different place. There were no gold ETFs in 2001, and the yellow metal had not yet gained its status as almost a household investment. Now that there are more investors who expect gold to go up in a terror event, it may not be able to do so.

Further, these kinds of external events are so rare that it's reasonable to wonder if it even makes sense to hedge against them. And if you believe it does make sense to hedge against a so-called black swan, wouldn't you be better off using an inverse stock index fund, instead of gold?

Given that financial shocks occur more frequently than events such as terrorist attacks, and given that gold may not be as good of a hedge as it once was, something like DBA might be a better alternative.

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