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Indicator of a Market Crash: Can Gold Price, and Gold Price Variance Predict a Stock Market Crash?


 

Summary:

1. Unusual activity in the gold exchanges that leads to variance in gold price can be an indicator of a coming decline in stock.

2. There is significant evidence of the presence of change in XAUUSD variance before recent a decline in stocks.

3. The data is tested to test the hypothesis.

 

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It is argued that gold (XAU) is a safe haven asset, and traditionally, the conventional viewpoint sees XAU as the most prominent safe haven asset. As risk perceptions, such as concerns of a sharp decline in asset prices become more prevalent, safe-haven assets become highly desirable/demanded. While this conventional viewpoint's accuracy is another matter of analysis, this report examines whether XAUUSD variation, a quarter before a severe market decline, significantly increase, signaling a severe decline may be near.


It may be argued that sophisticated investors 'sensing' a coming crash may contribute to an increased demand for XAU, leading to increased variance (risk) in XAUUSD. The expectance of statistically significant change in XAUUSD risk before a market decline, isn't very established, however.


So, is there a statistically significant change in XAUUSD risk profile before a severe decline in stocks? If this hypothesis is correct, statistically significant variance should occur before a market crash; for example, the 2000 decline, the 2008 event, and the 2020 severe market dip.


So, what does the data tell us?

By conducting a F-test on the risk profile, one quarter before 2020, 2008, and 2000 market crash, compared to two quarters before the start of the quarter before the crash, we should be able to gain some clarity. The hypothesis, therefore, is constructed as:


H0: σ2N = σ2C versus Ha: σ2N ≠ σ2C

, where

σ2N – the variance of the normal two quarters, before the start of the quarter before the recession,

σ2C – the variance of the quarter before the crash.


Testing reveals that the quarters before the 2000, 2008, and 2020 market crashes had a statistically significant change in variance, compared to 2 quarters before the start of the quarter before the decline, as this report's hypothesis postulates.


Table 1.


gold variance and market crash, cold risk. gold variance

F value for 2000 = 5.92 (CF at 98% CL =1.73)

F value for 2008 = 3.26 (CF at 98% CL =1.57)

F value for 2020 = 3.25 (CF at 98% CL =1.7)


As we can see, in all three tests, the null is rejected. We can say that there is statistically significant evidence that the variance in XAUUSD price changes one quarter before the market crash.


How can this analysis aid us in detecting risk?


We can continually scan for changes in the XAUUSD variance to judge whether there is a risk of a substantial move in the stocks. If, for example, we find that XAUUSD in the observed quarter is demonstrating statistically significant variance, compared to the previous two quarters, we should exercise caution and be on guard for a significant move in the stock market, this is because of the statistically significant change in price variance in one of the most prominent safe haven asset gold, altering us on unusual activity.


We should also evaluate the nature of the variance and other indicators of systemic instability. In case of an exogenous event changing the variance, as elaborated, the probability of a significant move in the stock market, logically, increases.

Continually examining this parameter is warranted, due to its statistical significance.



 

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