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How to Use Gold as an Investment in a Bear Market

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During March's stock market sell-off, gold proved why many analysts view it as a safe haven: It zigged while stocks zagged.

That's not to say that the yellow metal didn't suffer some losses. In investors' immediate rush to raise cash, they sold gold along with everything else.

But gold's deepest plunge in March was a 12% drop, versus the S&P 500's 36% free fall. Gold rebounded quicker as well. Year to date, it's up 11%, beating both the U.S. 10-year Treasury note (up 10%) and the S&P 500 (down 9%).

The shiny metal has been used as a successful hedge against bear markets in traditional markets for ages. If you're thinking of investing in this commodity today, here's how to use gold as an investment in a bear market.

-- Using gold as a safe haven.

-- Benefits of gold investments in a bear market.

-- Downsides of gold investments in a bear market.

[See: 7 Things to Know Before You Invest in Gold.]

Using Gold as a Safe Haven

"Gold is a hedge against systemic financial risk," says Joe Foster, portfolio manager and gold and precious metals strategist at VanEck investment management. "The source doesn't matter. It can be a pandemic, a currency crisis or inflation or deflation. It's a form of portfolio insurance against those risks."

There are several reasons why gold is a safe haven, Foster says. There is no counterparty risk, meaning that its value doesn't depend on the economic standing of another entity. "You own it free and clear," he says.

Gold was used as a sound form of currency for centuries, so it has historical significance, he adds, and supplies are limited to what is mined annually or what is already above ground.

Chuck Self, chief investment officer at iSectors, an exchange-traded funds investment strategist, says because gold is uncorrelated to stocks and bonds, it acts like a third asset class and adds diversification to portfolios -- which makes it a hedge. He notes that while gold does not move with stocks, that doesn't mean it acts the opposite of stocks. "If your stocks are down and gold is flat, that's a win," Self says, because gold didn't fall.

Investors who want to buy gold for their portfolio can choose physical gold (also referred to as bullion), gold-backed ETFs or gold-mining stocks. The easiest way to add gold is with gold-backed ETFs or stocks.

Foster says gold stocks are influenced by the price of gold and often will outperform gold prices when values are rising and underperform gold prices when the metal's value falls.

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Like other investments, dollar-cost averaging is the best way to add gold to a portfolio, says Pete Thomas, senior vice president at Zaner Precious Metals. "Set aside a certain amount of money every month that is not going to impact your lifestyle and automate it," he says.

Experts say a long-standing rule of thumb for gold is to keep 5% to 10% of it in a portfolio at all times to have it as an insurance policy, so when bearish times come it can act as a safe haven.

Benefits of Gold Investments in a Bear Market

Gold shines when stocks are in a bear market, for safe-haven reasons, and that's why market strategists recommend a small holding in all market cycles. "In a bear market, that's when the risks really come out in the financial system and all the warts come out," Foster says.

When businesses weaken and bankruptcies pile up in a recession, scandals often emerge, he says, noting that investors who own gold would be sheltered from that counterparty risk.

Because gold holds its value better than stocks in a bear market, it can be sold if needed to raise cash.

Will Rhind, CEO of GraniteShares, an ETF company, says because of gold's scarcity, it will hold its value in the current environment compared with the U.S. dollar, which may be devalued because of all the "money printing" by the Federal Reserve's ultra-low interest rates and massive monetary stimulus. Concerns about rising debt levels and inflation have boosted gold as investors see its role as a long-term store of value, he adds.

Downsides of Gold Investments in a Bear Market

Gold may have plenty of upsides, but no investment comes without risks.

Gold isn't immune to sell-offs. Rhind points out that gold fell in early March as investors sought to sell liquid, high-quality assets in order to raise cash to meet margin calls or for other reasons. That also happened in 2008, he says. Once that pressure to raise cash is over, gold rebounds, just as it did in 2008 and in late March.

Thomas says when traditional assets are in bear markets, that's when gold becomes desirable, and that's when it gets pricey and its scarcity can make it hard to locate. Demand for physical gold coins and bars was extremely high in March and remains elevated today, and dealer prices reflect that demand.

[READ: How to Prep Your Portfolio in a Recession.]

Because dealers are having a hard time sourcing physical coins and bars, they are charging higher premiums than usual, Thomas says. Normally, dealer premiums on coins and bars from sovereign mints -- such as the U.S. Mint or the Royal Canadian Mint -- are about $15 above the spot price. Thomas says now he is charging about $135 above the spot price for a 1-ounce gold coin, such as a Canadian Maple Leaf.

"And that's if you can get it," he says. "That's why you should buy gold when it's quiet and no one is talking about gold."

That premium reflects how volatile gold prices can be in the short term. Although gold prices over the long term are steady, in the short term, they can swing because of the surrounding turmoil.

When adding gold to your portfolio, keep in mind that as a hedge, it helps to mitigate losses. It's not a growth stock or a get-rich-quick asset. It's there to give investors long-term stability, Thomas says.

"Don't look for miracles from it," he adds.



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