Although markets have performed strongly in 2019, the issues that made last year so challenging have not entirely gone away. As such, an allocation to gold could help protect investors in the event of a market downturn given the metal’s ‘safe haven’ properties, according to consultancy Capital Economics.
Gold is perhaps one of the best-known ‘safe haven’ assets – or those which perform well during a downturn – given its lack of correlation to equity markets, its properties as a store of value and its role as a hedge against inflation.
While equity markets ended 2018 in the red following several sell-offs, gold managed to outperform.
As the below chart shows, the developed markets-focused MSCI World fell by 3.04 per cent last year as the S&P GSCI Gold Spot index was up by 3.23 per cent – in sterling terms.
Performance of indices in 2018
Source: FE Analytics
While the threat of inflation seems subdued and equity markets are on the rise this year there is more than enough of an argument for an allocation to the yellow metal, said analysts at Capital Economics.
Economists at the consultancy looked at all eight instances since 1990 when the S&P 500 fell by more than 10 per cent over a period of at least one month (thereby ruling out some large short-lived drops that were quickly reversed).
“In seven of the eight cases the gold price increased, often substantially, as equities fell,” they noted.
“On average the gold price rose by 7.2 per cent while equity prices fell by over 25 per cent, suggesting that the metal has tended to play its expected ‘safe haven’ role rather well.”
The one instance where it did not increase as equities fell was in late-1998 when – to maintain the rouble’s peg to the dollar and then slow its decline after – the Russian central bank sold more than 130 tonnes from reserves, lowering the price.
There have been other examples of gold being sold during times in economic turmoil because of its liquidity, causing prices to fall.
Some examples, according to the economists, were witnessed in the aftermath of the Asian financial crisis in the late-1990s and during the global financial crisis.
“However, while such ‘fire sales’ of gold represent one small risk of holding gold as a portfolio diversifier when a financial crisis is particularly acute, this has been the exception rather than the rule when US equity markets have fallen,” noted the economists. “The big picture is that gold’s strong performance during falls in the S&P 500 has been consistent.”
Rolling one-month total returns over 3yrs
Source: FE Analytics
While gold has shown some negative correlation to US equity in times of stress, it will also lag when they are rising so any boost to returns would quickly be lost once equity markets find a floor.
Yet if the eight previous crashes in the S&P 500 are split into two camps – ones which preceded or followed US recessions and those that did not – a different picture begins to emerge.
Sell-offs in the first camp – those in 1998, 2010, 2011, 2015 and 2018 that were triggered by concerns about high valuations or global growth – would usually have seen the S&P 500 recover quicker and outpace gold within a year.
The second camp – 1990, 2001 and 2008, where the falls in the index coincided with US recessions and were more prolonged – show that gold would have insulated investor returns from the decline in equity markets for the duration of the slump.
In the near term, the consultancy anticipates a good year for the precious metal and for ‘safe haven’ assets more generally after taking a more bearish view on the US equity market.
The recent inversion of the US Treasury yield curve, the consultancy said, is a bad sign for the blue-chip index and expects it to fall sharply during the year as growth in the economy disappoints.
“In the past when the yield of the 10-year Treasury has fallen below the yield of most Treasuries with shorter maturities, the S&P 500 has fallen in the next 12-to-18 months,” they said. “That is because yield curve inversion has preceded significant weakness, or a recession, in the US economy.”
As such, the consultancy expects gold investment will be strong this year – particularly in the form of exchange-traded products (ETPs) – boosting prices to $1,400 per ounce by the end of the year. It has stopped short of forecasting an outright recession, expecting a slowdown in US growth instead, although the economy should begin to recover by mid-2020 and unwind some of the gains made by the yellow metal by the end of next year.
Growth in the exchange-traded fund space has soared in recent years, particularly in Europe where assets have hit $48bn and account for 45 per cent of the global gold-backed ETP market, according to a recent report by the World Gold Council.
European funds’ share of total AUM
Source: World Gold Council
“Mirroring their US counterparts, European investors sought refuge in gold-backed ETPs during the global financial crisis, and the euro sovereign debt and banking crisis that followed in its wake,” the trade body noted.
“But as the gold price came off its highs in 2012, so too did AUM as investors switched back to risker assets in search of greater returns.”
However, demand has surged more recently for three broad reasons: loose monetary policy and negative yields, geopolitical uncertainty, and financial market performance and volatility.
“European investors have seemed to exhibit a greater level of concern about the instability – both global and local – which has plagued the macroeconomy since 2016,” the trade body noted.
“While the US economy has fared better in recent years, Europe continues to suffer negative interest rates and a turbulent political environment.”