Recessions have a huge impact on every aspect of our lives’.
A recession can negatively impact your work, your health and your entire community. For investors, a recession is what tests the resilience of a portfolio. Investors spend many hours and a lot of money building a balanced portfolio that can survive an economic downturn and leave them relatively unscathed.
Research from Trinity College demonstrates that gold is the best hedge against a stock market crash and recession – here are three reasons why:
1. Currency risk
When there’s a recession, currency markets take a hit. This is because governments print more money in an effort to stimulate the economy. As the value of the currency falls, this makes imports more expensive and increases inflation.
From 2002 to 2007, the dollar fell 40% in value. In 2002, a euro was worth $0.87, increasing to $1.44 at the end of 2007. During that same period, the price of gold jumped from $347.2 to $833.75 an ounce. As countries like the US kept increasing the national debt, the value of the currency declined, and this increased overall currency risk.
With a devaluation of the currency and therefore inflation, the purchasing power of your money also decreases. This is clear when we compare what £1 could buy you in 2005, versus what £1 can buy you in 2020.
During a recession, currencies lose value and you lose purchasing power. Having gold assets protects you against currency volatility.
2. Portfolio risk
Any investor who’s aiming for a diversified portfolio will have gold in their portfolio. This is because gold tends to have a negative correlation with the stock market. When stock prices are plummeting, gold is expected to increase in price. This softens the blow of a crash and reduces your overall risk of losses.
This graph from Reuters demonstrates the price of gold in comparison with the stock market during the last few recessions:
As we can see, the only time gold decreased was when interest rates were very high in the 1980s and 90s. Currently in 2020, interest rates are at record lows in order to support the market – even more of a reason to stick to gold.
This explains why investors buy gold: to make sure their portfolio doesn’t take too much of a hit during a recession. However, it’s important to note that this only works if you hold physical gold. Any paper assets such as bonds, dividend-paying stocks and even gold ETFs will not hedge against a drastic market drop – only physical gold will.
Investors with diversified portfolios make sure to buy assets that are outside of the currency-denominated financial system, such as stocks and bonds. Gold is therefore a must-have.
3. Infrastructure risk
Gold has been used as a store of wealth for thousands of years, first smelted in ancient Egypt, around 3600 BC. It’s been used as a currency in almost every country, and has remained a highly regarded metal and commodity for centuries.
This goes to demonstrate that it’s a physical asset that has value in and of itself, and that the crazy turmoils of the outside world don’t do much to impact it. If there ever was a monetary collapse, we can be pretty confident that gold would still be valued as a currency.
Having assets outside of the international monetary system means that you face much less risk in case of a credit default crisis or general collapse of the financial system. Even if your gold dealer or storage house goes bankrupt, you are still the owner of your gold and have the right to physically hold your precious metal.
This is one of the main reasons people buy gold: to sleep well at night. Whether there’s a recession, a pandemic or a stock market crash, owning gold will give you the peace of mind that you’ll always have something to be able to provide for your family.
Gold is a commodity with a unique characteristic: it is the oldest form of money. By buying and holding gold, you are protecting yourself against currency, portfolio and infrastructure risk. For this reason, gold will always create that feeling of safety and will have value, no matter what happens.