first majestic silver

Why The Gold Slump In A Bear Market?

March 22, 2020

New York (Mar 22)  Gold is considered a useful way to protect your portfolio at times of market decline. Academic studies generally support this. For example, research by Dirk Baur and Brian Lucey broadly supports this conclusion for investors in the U.S. the Europe.

However, with the recent market crash gold has performed poorly. For example, over the past month the S&P 500 has fallen approximately 30% and gold too, has lost 10%. That’s not what we’d expect. Though gold is never a perfect hedge, seeing gold lose value during a clear market panic is unusual. So what’s going on?

Dash For Cash

On feature of the crisis so far is the stress on balance sheets from such an abrupt slowdown in activity. Often during recessions activity may slow somewhat as consumers hold back on purchases and business run down inventories. However, this time many businesses have been forced to shut or severely limit operations by the virus response. While a decline in revenues is never pleasant, a drop to zero income is a problem of a different order. This means that businesses need money right now. We’re perhaps seeing that reflected in the markets, as there is such a broad need for cash, all available assets are being sold. On this view, gold has not been excluded from the general rush to sell, and the strength of this impulse is stronger than in the past given the abrupt economic impact. That may change as the crisis reaction becomes more measured and government support is established, but for now, cash is clearly king.

 Strengthening Dollar

The other piece of the equation is the strengthening U.S. Dollar. Gold can be thought of, in some ways, as a currency like the Euro or British Pound. As with all currency pairs what matter is what’s happening on both sides.

To understand the currency exchange rate between the U.S. dollar and the Euro, you need to look at both trends in the Dollar and in the Euro. The same is true of gold when priced in dollars. Here we’ll consider gold priced in U.S. Dollars, and since early March the trade-weighted U.S. dollar has spiked over 3%. That matters. All else equal the price of gold would fall 3% as a result. Now, this isn’t the whole issue with gold, pick any major currency and it’s likely gold still shows a price drop. Still the strengthening U.S. Dollar is a contributing factor.

No Guarantees

The final consideration is that any hedge or safe haven asset is never guaranteed for any given crisis. For example, in certain crises oil has been a great hedge, specifically because rocketing oil prices have caused crises in the past. However, this time oil’s decline has been even more abrupt than the drop in stocks.

Most studies suggest that though gold often does well in a crisis, that’s not always the case. For example, gold is a useful store of value at time when inflation is expected to rise. That’s less of a concern in this crisis so far.

What Next?

This crisis is still playing out. The price moves described here will be different as soon as tomorrow. It is certainly unexpected for gold not to rise consistent with a stock market crash, but not impossible. Perhaps more worryingly for gold investors, after crashes gold then starts to perform poorly because the stock market then often rebounds. Since this crisis is still playing out, the price action of gold appears unusual in a historic context, but the abrupt decline in economic activity and extreme focus on cash is perhaps somewhat unusual too.

Forbes

Gold Eagle twitter                Like Gold Eagle on Facebook