What Can Happen to Gold When Stocks Pull Back?

Many investors wonder how they should expect gold prices to behave when there is a significant pullback in stocks. Looking at historical patterns when stocks retreat significantly, three key scenarios emerge regarding how gold prices are likely to behave. Those scenarios are ruled by the answers to three major questions, which we discuss below.

The first question is, how fast do the stocks pull back? The speed at which stock prices drop is a key predictor of what could happen to the price of gold in that timeframe. When the drop is swift, gold prices are also likely to drop. Why? When stock prices unwind overnight, or drop steeply over a few days, many investors are compelled to sell anything they can sell in order to get their hands on cash to cover their losing positions.

As margin calls spread through trading platforms at a fast pace, there is no chance to weigh options. You just sell anything for which there is a buyer, and more often than not gold gets sold because it is easy to sell. This is why gold prices will also fall when there is a swift correction in stock prices.

Conversely, when stocks fall over an extended duration of, say, three months, investors have time to go through what they own and choose what should go first, and how much of it to sell. In such a case, gold prices are unlikely to drop, and they could even rise as investors unwind their stock positions and seek safe haven assets.

The second question that determines how gold prices behave when stocks retreat is, how much borrowing supported stock prices? Here, we are looking at investors, not the companies whose stocks are seeing a price drop.

When heavy borrowing backs stock acquisitions, a stock market correction compels shareholders to sell anything they can sell because they need a lot of money to plug the holes created by the stock drop. Today, heavy borrowing has helped more people acquire stocks, so a major price retreat is likely to cause gold prices to go into correction as holders of stocks scramble to get cash to cover their positions.

On the other hand, in situations where borrowing is minimal, stock price corrections are unlikely to trigger a drop in gold prices because the pressure to get cash is minimal, so most people will leave their gold holdings intact.

The third question is, how long do people plan to hold gold? For those who plan to hold their gold for long, stock corrections don’t trigger a change in their gold holdings because they acquired that gold with a long-term view in mind. For those with a short-term perspective in mind, such as speculators, a significant drop in stock prices leads them to quickly sell gold in order to settle their margin calls.

That said, each of those questions has to be analyzed on its own, and in combination with the others in order to arrive at a fairly accurate conclusion of what impact gold prices could suffer should stock markets experience a sizeable correction. As entities like New Pacific Metals Corp. (NYSE American: NEWP) (TSX: NUAG) will tell you, data has to be curated carefully so that a full picture can emerge upon which price prediction scenarios are generated. Do your homework as an investor!

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