Much has been made recently about gold’s use as a hedge against poor stock market returns. Unfortunately, this strategy has some holes in it. While it is true that gold tends to perform in the opposite direction as stocks during secular markets, it tends to perform similarly to stocks during shorter cyclical time periods.
From 1966-1982, when the S&P 500 did nothing, gold went from $35/oz. to over $800/oz. During this secular commodity bull market, stocks certainly performed in opposition to gold. However, when breaking down these 16 years into shorter time frames, it is noteworthy to understand when gold made its biggest runs. Between 1970-1973, the stock market performed decently well, while the gold market performed very well. However, in the 1973-1974 time frame, both markets took a strong beating, with the S&P losing some 40% and the gold market being cut in half. Once the carnage was complete, both markets recovered in late 1974, and began rising in conjugation once again. Stocks rose a little, while gold rose another 800%. While their rise certainly was not symmetric in nature, it is important to understand that both the gold and US stock markets rose and fell in tandem. After 16 years, the sum total of all that those cyclical markets showed gold up 2000% with the S&P unchanged.
Something similar is likely to occur during this commodity super cycle, and in fact, it has already begun. Gold’s rise from late 2002 to today is far superior to the overall market’s returns. However, when the US market falls, and the economy follows suit, it will likely bring the gold market down with it. This not only makes sense fundamentally, but is backed up by historical precedence. In Gorton and Rouwenhorst’s paper published in 2004, gold’s performance since 1959 mirrored the performance of stocks during any given part of the economic cycle. Gorton and Rouwenhorst showed that the early recessionary period was the worst time frame for both stocks and gold, while both sectors performed very well during the late recessionary period.
For those investors wanting a hedge against stock market volatility, gold may not necessarily be the right investment. Gold’s performance is highly correlated with the stock market’s performance during cyclical 3-5 year periods, and better hedges exist, such as agricultural futures or even TIPS (Inflation protected bonds. Yes, the government lies about inflation, but at least it provides some hedge). Passive investors willing to ride out the storm for 10-15 years may find gold to be an excellent market hedge. Until then, however, expect gold and stocks to rise and fall in tandem.
by The Commodity Investor
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