On Monday, April 15, gold had its largest price drop in dollar terms ever. Gold dropped by more than $140 an ounce in Monday’s trading. In percentage terms, Monday’s sell-off was not the largest price drop ever, but was second to the price decline that occurred on March 17, 1980. The price of gold fell by a whopping 9.3 percent on Monday.
It’s interesting to analyze these kinds of price moves in statistical terms. Statistics may not have been the most exciting class that you ever took, but using a statistical approach to market analysis is a worthwhile exercise. If you remember the normal probability distribution or “bell curve” from your elementary statistics class, it tells us that 68 percent of the time in a normal distribution, the price movement will be within one standard deviation of the mean. Ninety-five percent of the time the price movement will be within two standard deviations and 99 percent of the time the price move will be within three standard deviations. That means that moves of greater than three standard deviations are very rare events. Monday’s price move for gold based on standard deviations was more than six standard deviations from the mean.
Based on the familiar bell curve, moves like this should be extremely rare. They are rare, but in the markets, probability distributions have what’s known as “fat tails.” A fat tail distribution is similar to the bell curve, or normal probability distribution, with the exception that large unexpected price swings occur more often than a normal distribution would predict.
Gold has generated positive returns for the last 12 years now. Gold is known as an inflation hedge and investing in gold can be a good way to diversify a traditional stock and bond portfolio. While gold and other commodities can serve as an inflation hedge and provide good diversification, they can also be quite volatile.
Investors should always consider their investment time frame, personal risk tolerance and exposure to any one stock or commodity before making an investment. Take a look at the investment that you are considering and study its past volatility and decide whether or not you’d feel comfortable going through a period of high volatility with your investment. Gold has been considered a safe haven by many investors in recent years, but remember it can have some abrupt price swings.
Kenneth Roberts is a Truckee based Registered Investment Advisor. Information on his money management service can be found at his blog at www.sellacalloption.com or by calling 775-657-8065. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.