Gold as a Hedge in a Bear Market

The decision to buy gold in times of financial stress is rooted in behavioral biases associated with the commodity’s long history as a currency (no longer true), a store of value and a safe haven asset. In the near past, gold was a strong safe haven in the aftermath of Sept. 11, 2001 and the Lehman Brothers bankruptcy in September 2008.

At the time of writing, the S&P 500 is down over 33% from its peak on Feb. 19. Surprisingly, gold is down about 5% as well.

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This is likely due to the recent rush for liquidity as market participants scramble to shore up their accounts to meet margin calls. I expect that the situation will correct itself soon and gold will take its rightful place as a hedge to the stock market.

As a result, we will take a look back at several of the more recent bear markets to see how gold performed two years after the start of the recessionary period.

2007 bear market

The 2007 bear market started on Oct. 11, 2007. Two years later, while the stock market was down by about 38%, gold was up by 40%. That was about a 78% outperformance.

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2000 bear market

The dotcom bear market began on March 23, 2000. While the market was down 25% two years later, gold held up well and was slightly above breakeven. It should be noted that the 2000 bear market was much longer than average (1.3 years) and did not bottom until Oct. 9, 2002. It also had a rare “W” bottom, versus the more conventional “V” bottom.

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If we were to extend the period to the bottom of the bear market in October 2002, gold’s outperformance reached nearly 60% as compared to the S&P 500 (gold was up by 10% while the S&P 500 was down by almost 50%).

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1990 bear market

The 1990 bear market was fairly mild. Even though gold held up well while the recession was ongoing, gold underperformed the index two years out from the start of the decline.

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Based on the past bear markets accompanied by a recession, it appears that holding gold in times of panic and the subsequent down period can pay off substantially. The last two bear markets were quite severe and gold excelled as a hedge. In contrast, the 1990 bear market was mild and gold did not work well.

This is something to think about as we enter another bear market in 2020. While it has not yet been determined if it will be a very bad one, it may be wise to load up on the yellow metal.

While cash is king, in times like these, gold is a beautiful queen.

Disclosure: The author is long the SPDR Gold Trust (GLD) via shares and options.

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