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Is Gold a Good Investment During a Crisis

Published by honor in category Precious Metal Information Guides on 13.06.2024
Gold price (XAU-GBP)
1,859.63 GBP/oz
  
- GBP1.31
Silver price (XAG-GBP)
22.51 GBP/oz
  
- GBP0.15

In today’s economic climate, safeguarding personal investments during a crisis is a formidable challenge. Whether dealing with stocks, bonds, cryptocurrencies, or investment gold, the uncertainty accompanying a recession can cast doubt on their security.

Let’s examine whether investment gold is truly a safe haven during a crisis. To provide context, I will analyze the performance of this precious metal compared to other asset classes such as stocks, cryptocurrencies, real estate, and bonds.

However, it is important to note that the performance of gold is influenced by numerous macroeconomic indicators, such as inflation, interest rates, unemployment rates, the number of bankruptcies, and the dollar index (DXY). Therefore, the price of gold does not necessarily increase during a crisis. But first, let’s delve into…

…What is a Financial Crisis?

A financial crisis, or recession, has a specific definition. Even though it might sometimes seem like we are already experiencing a crisis, financial institutions require certain conditions to be met to formally acknowledge one:

“A recession is a significant, widespread, and prolonged slowdown in economic activity characterised by two consecutive quarters of decline in an economy’s gross domestic product”

This is the definition accepted by the international financial community. However, there have been instances where this definition has proven inadequate. The most notable example is the Great Financial Crisis of 2008, which was triggered by the collapse of one of the largest American investment banks, Lehman Brothers. As Peter Schiff, CEO of Euro Pacific Capital, points out:

“[About the 2008 financial crisis] I only found out about it after a year. We were almost out of recession the moment the government told us we were in recession”

Therefore, it could be believed that the timing of a recession is often incorrectly identified, which is why the fear surrounding it is so pronounced. Predictions about the onset of a financial crisis are inherently uncertain.

To safeguard our investments, it is crucial to be prepared in advance. Diversifying our investment portfolio allows us to benefit from the various phases of economic cycles, whether they are periods of growth or decline.

Read more on the topic here: The ‘calm’ period of the financial crisis may be over

How Does Investment Gold Do in Times of Crisis?

Now that we understand what a financial crisis is, let’s examine how gold prices have performed during the last six recessions since 1971. This year is significant as it marks the decoupling of the US dollar from gold.

To analyse the behaviour of gold prices during a crisis, we will review their percentage changes. I will use the periods identified by the Federal Reserve as financial crises for this analysis.

The Crisis Official Period of Crisis % Development of the Price of Gold
Oil Crisis of 1973 November 1973 – March 1975 +73.83%
Stagflation in the 1980s June 1979 – November 1982 +57.12%
Black Monday (1987) October 19, 1987 +4.64%
The Dot-Com Crisis March 2001 – November 2001 +6.37%
The Great Financial Crisis of 2008 December 2007 – June 2009 +11.19%
The COVID-19 February 2020 – April 2022 +19.67%

Table 1: Gold Price in Period of a Crisis

As we can see, gold has generated significant returns, particularly during the crises of the 1970s and 1980s. However, it’s important to note that these increases do not represent the peak prices of gold.

In September 1980, gold reached a record high of $666.75 per troy ounce. With a calculated yield of 19.67%, the price of gold at the end of this period was $375.8 per troy ounce.

Read more on the topic here: What is happening to the price of gold?

Investment Gold and Other Assets in Times of Crisis

To provide more context on gold’s performance during a crisis, let’s compare it to other common asset classes. I will focus on stocks, Bitcoin, real estate, and US government bonds, which are among the most prevalent investments in the market.

The Price of Gold and the S&P 500 Index

Since 1971, when US President Richard Nixon, suspended the convertibility of the US dollar and gold, the US has experienced 6 financial crises. With the exception of the one in in 2020, marked by the COVID-19 pandemic, all were caused by the intervention of the Federal Reserve.

By artificially lowering interest rates, loans are used for speculation in the capital markets – this is how the dot-come crisis happened. Cheap credit also created the housing bubble that burst in 2008. The constant printing of dollars by the Federal Reserve led to the worst inflationary periods in the UK in the 1970s and 1980s.

The creation of the money supply during the pandemic to provide funds to household and businesses led to the creation of the current inflationary period.

The Price of Gold and Bitcoin

As a new financial instrument introduced in September 2008, the comparison between Bitcoin and the price of gold is relevant to the pandemic induced recession of the early 2020s. Based on the impressive growth of Bitcoin in the second quarter of 2021, we could see that it does much better in times of crisis compared to the price of gold.

However, if we look at a slightly longer period of time, for example two years, the price of bitcoin has collapsed by 73%, in contrast to the price of gold, which has seen a drop of only 12%.

At the same time, we see that the price of gold reacts much faster to economic uncertainty, unlike Bitcoin, which saw a significant increase only towards the end of 2020.

The Price of Gold and Real Estate Yields

The Dow Jones US real estate index tracks the performance of 75 US real estate funds. These funds deals with the use of investors’ capital to generate income from real estate through: renting, mortgages, leasing.

The performance of these funds decreased with the financial crisis of 2008 and the pandemic.

As an index directly affected by the development of the mortgage market, when too much credit causes a recession, the funds suffer significant losses.

The Price of Gold Compared to the Real Interest Rate

The price of gold compared to the real interest rate I am making the last comparison between two of the safest financial instruments, investment gold and US government bonds. The latter have as an argument the fact that in the financial world it is believed that the US government can never go bankrupt.

In times of crisis, investors turn to these two assets to protect their investments

The real interest rate, the difference between bond returns and the rate of inflation, determines investors’ interest in investment gold. If the real interest rate becomes too low or even negative, investors will turn to investment gold at the expense of US bonds.

Over the past year, real U.S. Treasury yields have turned positive from record negative levels. However, gold retained its position in investors’ portfolios. This is due to the fact that at the beginning of the year the US was on the verge of insolvency, but also because in August the rating agency Fitch downgraded the credit rating of the US government.

Compared to the other four asset classes, investment in gold is a safer option during times of crisis

This is due to its unique characteristics, which I will discuss below.

However, it’s important to note that while gold has often outperformed other assets during crises, this is not always the case. Numerous macroeconomic factors influence gold’s performance. For instance, during the dot-com crisis in the early 2000s, the US stock market outperformed gold.

This occurred against a backdrop of stable gold prices. In contrast, by the end of 2002, the US stock market was in freefall. The Nasdaq index, which comprises stocks listed on the Nasdaq exchange in the US (primarily technology companies), lost 75% of its value over those two years. Investors endured losses estimated at over five trillion dollars.

Why is Investment Gold Safe During a Crisis?

The performance of investment gold during times of crisis can be attributed to its nature as a safe financial instrument. For millennia, gold (along with silver) has been the most widely used form of money due to its limited supply. We cannot create infinite gold, and even if large reserves are discovered, extracting them involves significant costs.

Gold mining encompasses expenses related to field exploration, rock sample analysis, ore extraction, separating gold from other materials, transportation, refining, smelting, and the actual production of gold bars and coins.

Beyond these inherent characteristics and physical challenges, gold has consistently been regarded as a valuable asset. This is evident in the growing demand for gold by central banks worldwide. Over the past two years, their purchases have reached record levels. In the first ten months of 2023, central banks bought 15% more gold than in the same period in 2022.

How do I start investing in gold?

For beginners, the best way to start investing in gold is by purchasing physical gold bars and coins. This method is both straightforward and secure.

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Owning physical gold ensures that you possess the actual metal, unlike exchange traded funds (ETFs) or “paper gold,” which carry the risk of counterparty bankruptcy. Physical gold guarantees your ownership of the asset.

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Before making any purchases, it is advisable to educate yourself thoroughly on the subject. Investment gold is not an income-generating asset and does not provide short-term returns. It is a long-term investment designed to preserve your purchasing power.

Key Takeaways

Qs we have observed, in most cases, gold has outperformed other asset classes, such as the stock market, Bitcoin, real estate, and US Treasuries. Gold investments are considered a hedge against inflation, providing security from economic uncertainties in the global economy.

Including investment gold in your portfolio can provide stability during uncertain times. Depending on the proportion of gold in your portfolio, it can offset losses from other asset classes during a crisis or even generate positive returns.

Gold price (XAU-GBP)
1,859.63 GBP/oz
  
- GBP1.31
Silver price (XAG-GBP)
22.51 GBP/oz
  
- GBP0.15

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