Owning gold has long been considered a safe haven for investors during recessions or bear markets.
Investors often turn to adding precious metals when markets are volatile or when geopolitics impacts the economy. It has been viewed as one strategy to hedge against the risks in the stock market or as an alternative currency to the central banks.
This article will examine:
-- How gold reflects market uneasiness.
-- Why owning gold in a bear market can be beneficial.
-- Timing to invest in gold.
-- How to add gold to your portfolio.
How Gold Reflects Market Uneasiness
Investors have shown strong interest in gold due to the economic uncertainty caused by businesses closing from the illness outbreak and the continued weakening of global interest rates, says Michael Underhill, chief investment officer at Capital Innovations in Pewaukee, Wisconsin.
The largest holders of gold globally are the central banks, which may need to sell the precious metal in the future to finance social programs and provide aid to stabilize their economies through this crisis, says Thomas Hayes, chairman of Great Hill Capital in New York.
Owning equities could reap greater returns in the long run.
In 2018 at the annual meeting of Berkshire Hathaway (ticker: BRK/A, BRK/B), CEO Warren Buffett compared $10,000 invested in an S&P 500 index fund versus gold in 1942, the first year he began buying stocks. The index fund would have been worth $51 million in 2018 versus the gold being worth only $400,000.
"While no one can predict what happens to gold over the next few days or months, the biggest holders will be under some pressure to sell," he says. "If you take a longer view, owning a piece of American business will pay you much more handsomely than the shiny metal that has captured the imagination of speculators for centuries."
Why Owning Gold in a Bear Market Can Be Beneficial
Gold can be a good asset to own during a downturn. In the latest bear market, gold acted as a solid diversifier to equities, both in the physical and futures markets, says Jodie Gunzberg, chief investment strategist at Graystone Consulting, a Morgan Stanley business.
From Feb. 19 to March 23, the S&P 500 lost 33.9%, and physical gold based on the London Bullion Market Association price lost 6.0%, while gold futures on the S&P GSCI Gold benchmark index ER lost 2.6%. Gold's loss was only a fraction of the equity drop, she says.
During the rebound period from March 23 to April 17, when the S&P 500 gained 28.5%, physical gold only gained 13.3% and gold futures gained 8.0%.
"Gold outperformed in the combined period from Feb. 19 to April 17 with a decline of 15.1% for the S&P 500 while physical gold and gold futures returned 6.5% and 5.2%, respectively," Gunzberg says.
On average in the past 10 years, for every 1% decline in the S&P 500, physical gold and gold futures increased 0.25% and 0.2%, respectively.
Gold could be less effective as a hedge than it was 20 years ago due to the financialization of the sector, says Charles Sizemore, chief investment officer of Sizemore Capital Management in Dallas.
Since most investors buy and sell gold via exchange-traded funds now, gold can be the "proverbial baby being thrown out with the bathwater," he says. "When investors have to liquidate positions to cover losses elsewhere, gold can get dumped."
Unlike other alternative investments, gold is uniquely positioned in the current bear market, Sizemore says. The Federal Reserve is expanding its balance sheet at a rate that far surpasses the expansion during and after the 2008 meltdown.
"While deflation is the far greater immediate risk, the longer-term risk is that the Fed's actions create longer-term inflation or general currency instability," he says. "Gold is the oldest and most reliable currency and inflation hedge."
Gold is viewed as a natural beneficiary of even lower global interest rates, Underhill says.
Investors should overweight gold since the yields for Treasury inflation-protected securities, or TIPS, will become more negative as the dollar weakens.
"We think the central bank's buying of gold will at least double," he says.
Timing to Invest in Gold
While gold prices have risen, it does not mean investors should refrain from adding it to a portfolio.
Physical gold is still a strong diversifier with a current 30-day correlation of -0.23 to the S&P 500, and while gold futures are slightly more correlated at 0.33, that is still pretty low, Gunzberg says. The average long-term gold correlation to equities is zero.
Even in long-term history, the highest correlation between gold and stocks was 0.56, which is still moderate and happened in September 2014.
"The bottom line is to add gold for diversification and dollar-cost average into it on down days until your target allocation is reached," she says.
How to Add Gold
Investors can add gold to a portfolio by purchasing physical gold, gold miner stocks or exchange-traded funds that either own gold or the gold miners.
One key factor is that the allocation to gold must be directly or underlying to either the physical commodity or to futures in order to get the diversification effect, Gunzberg says.
Gold miner stocks do not provide the same downside capture or diversification as physical gold itself. The NYSE Arca Gold Miners Index lost 26% in the drop between Feb. 19 and March 23, which is 10 times the loss from the S&P GSCI Gold (ER). For the past decade, on average, for every 1% decline in the S&P 500, gold miners lost an average of 0.34%.
"Volatility is only slightly higher for physical and futures gold as compared to the S&P 500, while the average volatility of gold miner stocks at 37.3% is nearly triple the S&P 500," Gunzberg says.
The bullion ETFs are the easiest and most direct way to get access to the commodity, Sizemore says.
"As a general rule, I tend to stay away from the miners because they are less direct and a lot messier," he says. "The miners have the same issues the rest of the world is having in virus-related labor shortages and logistical problems."
A great way to buy gold in your portfolio and "avoid all the late-night TV scams" is to buy SPDR Gold Shares ( GLD), the largest physically backed gold ETF, says Daren Blonski, managing principal of Sonoma Wealth Advisors in California.
This ETF gives investors exposure to gold without the inconvenience of buying and holding physical gold. But keep in mind that gold can also be a volatile investment, he says.
"An investor should not buy gold thinking it will stay stable, regardless of whether the stock market is selling off," Blonski says. "Those who sell gold love to sell investors on the misperception that it is safe and stable."
The VanEck Vectors Gold Miners ETF ( GDX) could be a good choice for many investors since it gives exposure to many miners rather than just a few, he says.
Investors could allocate 5% to 10% of their assets into this sector as a hedge against "continued money printing by the Fed," McCoy says.
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