Throughout history, gold has been viewed as an asset with high intrinsic value which can be flocked to during market downturns. The price of gold typically fluctuates with political, economic and inflationary threats, falling during booming markets and rising in recessions. Since the precious metal doesn’t generate cash flow, its value has been closely tied to the status of the economy. Yet, gold exhibited quite the opposite tendencies in recent years.
Tracing back the history of gold reveals that its biggest appeal has been crisis insurance whether it’s in the form of jewelry or an investment vehicle. However, the perception of gold is beginning to shift which could could severely impact the value of the precious metal.
Is Gold Counter-Cyclical?
In the world economy, gold is one of the most complicated assets to price. Unlike stocks, currencies and other commodities, the value of the precious metal isn’t determined by fundamentals or supply and demand. Instead, it has been widely thought that gold moves inversely with the strength of the economy. When the economy is doing well and growing, gold prices tend to fall and vice versa when the economy contracts.
This occurs since gold holds high intrinsic value in the eyes of investors, whether it’s in the form of jewelry or financial investments. That said, many macroeconomic variables in booming and busting economies play a huge role in influencing the price of gold. These include interest rates, oil prices, inflation and the FX market.
Theoretically when interest rates are low, inflation and unemployment are high and domestic currency is weak, gold is meant to trend upwards. These key macroeconomic variables often point to slowing and contracting economics, so in this scenario, gold is considered a safe haven because it retains or increases in value.
Failure as a Safe Haven
If history has told us anything, all of the previous assumptions have generally turned out to be false. Today, investors can buy gold in the form of gold futures, coins and ETFs such as the SPDR Gold Share (GLD), to name a few. Since the U.S. formally abandoned the gold standard in 1973, the arguments for gold as a safe haven has been flawed.
In each of the crashes over the past 30 years, gold prices have either risen minimally or even fallen. Dating as far back as the stock market crash of 1987, gold rose a meager 5%, while the financial crisis of 1998 saw the precious metal rise 2%. And in the months following the 2008 Financial Crisis, gold fell an astronomical 30%.
All along, the main driver of gold prices has been supply and demand. If gold were to act as a safe haven, then value of the precious metal would be completely independent. However, since gold cannot be valued by traditional measures such as discounted cash flow, retail demand dictates its value on the open market. Moreover, emerging markets still rely heavily on commodities, meaning gold is likely to be more volatile rather than safe.
New Safe-Haven Investments
During this current market volatility, where gold has been stuck in a bear market, there are a number of new safe havens that investors can buy to help protect their portfolios. Bonds have typically been the first stop for investors when markets begin to tail off. With the proliferation of ETFs, investors are increasingly turning to bond ETFs for its low costs, tax efficiency and diversification. Meanwhile, Treasury Inflation Protected Securities (TIPS) protect investors from the negative effects of fluctuating prices. These can act as a dependable hedge and are well suited to bolster a retirement strategy.
With gold’s safe haven status eroding, volatility indices, like the VIX, are becoming the preferred method for hedging risk. Smart beta assets like the CBOE Volatility Index, tracks the market expectations for stock market volatility over the next month. In the months leading up to and following the Financial Crisis, the VIX index reached an all time high of $60, reflecting the mechanism hard at work. In this day and age, there are a bunch of safe instruments to preserve capital and protect against market downturns.
Final Take
Over time, gold has been thought to be the ultimate safe haven investment to hedge against market volatility. But since the gold standard was abandoned in the early 70’s, this relationship has failed to hold. In fact, there has been little to no correlation between volatility and gold prices when you observe the past 3 market crashes. That said, there are many alternative assets which truly hedge against recessions and volatility.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
