Is gold the best hedge and a safe haven under changing stock market volatility?

a r t i c l e i n f o We evaluate the role of gold and other precious metals relative to volatility (Volatility Index (VIX)) as a hedge (negatively correlated with stocks) and safe haven (negatively correlated with stocks in extreme stock market declines) using data from the US stock market. Using daily data from November 1995 to November 2010, we find that gold, unlike other precious metals, serves as a hedge and a weak safe haven for US stock market. However, we find that VIX serves as a very strong hedge and a strong safe haven during our sample period. We also find that in periods of extremely low or high volatility, gold does not have a negative correlation with the US stock market. Our results show that VIX is a superior hedging tool and serves as a better safe haven than gold during our sample period. We highlight the practical significance of our results for financial market participants by conducting a portfolio analysis. In recent years stock markets around the globe have experienced high volatility and unexpected declining returns. A key question is which investment vehicles serve as a hedge (negatively correlated with stocks) or safe haven (negatively correlated with stocks in extreme stock market declines) in different periods of stock market volatility. Our paper attempts to answer this important question. We start with gold as a leading candidate since it receives widespread attention in the financial news. Jaffe (1989) shows that the addition of gold to various hypothetical portfolios increases the average return while reducing the standard deviation. Hillier, Draper, and Faff (2006) note that the major benefit of precious metals is shown to be their ability to hedge adverse market conditions because precious metals perform best during periods of high market volatility. However, the first study which formally tests if gold is a hedge or safe heaven was done by Baur and Lucey (2010). They find that gold is a hedge against stocks on average and a safe haven in extreme stock market conditions using daily data from 1995 to 2005. Another study on this specific topic was by Baur and McDermott (2010), who examine the role of gold in the global financial system by testing the hypothesis that gold represents a safe haven against stocks of major emerging and developed countries. Using data from 1979 to 2009, they show that gold is both …