The S&P 500 has crashed when priced in gold

Key points:

• The S&P 500 priced in gold has plunged to a multi-year low, falling more than 25% in only 3 months
• After similar behavior, stocks were volatile, but showed excellent gains a year later (with one big exception)
• Even though these signals occurred after gold had already risen, it showed gains 6 months later all but one time

Stocks tank, gold soars

Stocks have taken something of a beating this year.

The S&P 500 has been vulnerable due to its top-heavy nature, and it got penalized as a result. And when we price the S&P in "hard money," meaning gold, the decline looks downright atrocious.

For one of the few times in the fifty years since gold has traded freely, the ratio between the S&P and the metal lost a quarter of its value in only three months.

These extremes tended to occur due to a combination of stocks dropping and gold rising, instead of only one side of the equation making a parabolic move.

The chart below shows the signal dates, when the S&P 500 / gold ratio dropped at least 25% in three months to at least a 3-year low, with the S&P 500's return over the following year from each signal. It was mostly positive, with the notable exception of 2008.

The table below shows the dates and returns for those who prefer numbers. We can see that over the next two months, the S&P's risk/return profile was uninspiring, but over the following year, it showed double-digit gains except for the disastrous signal ahead of the 2008 financial crisis.

Gold's prospects

Gold didn't fare as well, though we can see from the graph of return that it was still mostly positive over longer time frames.

The table of returns shows volatile performance over the following several months, often oscillating between gains and losses. Even so, it was positive after six of the seven signals over the following six months.

The ratio between the two assets was mixed, gyrating between positive and negative for months. Over the following year, the S&P 500 outperformed gold five of seven times, but the two times it didn't, it really didn't.

Since gold tended to drop over shorter time frames and rise over longer ones, it makes sense that the U.S. dollar showed the opposite pattern, and it does. A month after these signals, the dollar rose every time but once, but it declined either three or six months later every time but once.

As we've seen repeatedly lately, small caps lagged over several months, but their one-year return neared 25%.

What the research tells us...

Markets far and wide are making extreme moves, and core among them are stocks and gold. The volatility has been great enough to register among the most extreme moves in 50 years, and such uncertainty has typically been a sign that investors extrapolated too much negativity in U.S. stocks.

After similar extremes in the S&P 500 relative to gold, the equity index tended to form long-term bottoms, with the notable exception of the 2008 global financial crisis. Gold's performance after these extremes was mostly weak short-term, but without much long-term damage over the next six months, as the dollar tended to decline over that time frame.