Does Gold Work in a Stock Market Crisis?

Jonas Elmerraji, CMT

There are plenty of good reasons to like gold right now. But its utility as a stock market hedge isn’t one of them.

As the S&P 500 closes in on new highs amid lots of economic uncertainty, plenty of attention is being put on gold.

And for good reason – gold is in full-blown breakout territory this summer.

(At the same time, the economics of long-beaten-down gold mining stocks are such that they’re effectively a leveraged bet on gold prices.)

But that doesn’t mean that gold is a safe haven for investors getting anxious about the stock market.

The conventional wisdom has long been that gold is a wise contrarian play to frothy stock market valuations. But that doesn’t pan out in the data.

Looking back at all 15% or worse S&P 500 drawdowns from 1975 through today – times when investors could reasonably feel like stocks were in crisis territory – gold has only “worked” about half the time.

What’s a better investment than gold when stocks are in crisis? Stocks, for one:

Gold_SPX_avg_returns

The chart above shows average returns of gold vs. stocks following a 15% drawdown in the S&P 500. While both assets initially have a strong positive correlation, that typically reverses strongly about 40 trading days following the drawdown point, and continue to be negatively correlated for about four months.

The stock market's mean-reverting tendencies make it a better absolute bet than gold when there's blood in the streets.

Looking at individual returns 180 days and 252 days (or about one trading year) later, gold returns are left-skewed and lack the fat tails of stocks following a crisis.

combined_distribution

That jives with this chart from Verdad Capital that shows gold’s status as the worst of a collection of stock market hedges:

SPX_hedges_compared
Source: Verdad, Bloomberg, S&P, Russell, MSCI, Barclays, JPM, GS, CBOE, Eurekahedge, SG

Does that mean you shouldn’t own gold right now? Of course not! 

From a trend following standpoint, gold’s price action looks stellar right now.

But it does mean that if you’re allocating to gold in hopes that you’ll have a hedge against stock market risk this summer, then you might be in for an unpleasant surprise if this market does wind up taking a turn for the worse.

It’s a much better idea to decouple gold from your stock thesis in 2020. 

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