Episode 2 – Is Gold a Reliable Safe Haven Asset For Your Portfolio?

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Hello, everybody. Thank you for tuning in to Market Musings, a Mercer Advisors podcast, where we provide a data driven, common sense perspective on the economy, markets, and investing. I’m your host, Don Calcagni, Chief Investment Officer at Mercer Advisors.

Today’s topic is whether or not gold is a reliable, safe haven asset during times of market or economic stress. And this is a particularly relevant topic at the moment, given the elevated market volatility that we’ve experienced here over the past 12 to 18 months. And that increase in market volatility is due to a variety of different things, the debt ceiling, geopolitical tensions, monetary policy. The Fed has certainly been very aggressive in raising interest rates.

But there are certainly other things that have impacted market volatility. We’ve had a regional bank crisis here over the past several months, where we saw the high profile failure of Silicon Valley Bank and the ultimate takeover of First Republic Bank by JPMorgan. And so it’s natural, I think, for investors during such times, to seek out these safe haven assets in which to invest their portfolios, either in whole or in part.

And I think the conventional thinking is that gold historically has been a reliable hedge against market volatility, specifically declines in equity prices. And so I think what we’re going to do here, in the spirit of our podcast theme, is to focus on the data.

So let’s back up and take a closer look at the returns data on gold during times of market stress. And I think when we do that, what we find is that the returns on gold are actually highly random and uncorrelated with equities. And to a layperson, when you hear that gold is uncorrelated with equities, you may be thinking, well, that sounds like a good thing. But that’s not actually what we’re looking for here.

If you want to hedge a portfolio against declines in stock prices, you would actually want those safe haven assets to actually be more negatively correlated to changes in stock prices. But what we find is that there’s no statistically meaningful relationship between the price of gold versus equities, bonds, interest rates, or even inflation for that matter. There’s really no identifiable pattern when it comes to looking at gold relative to stock prices.

When we actually look at the correlation of gold to the S&P over the past 20 plus years, what we find is that the correlation has ranged from a low of -0.6 to a high of positive 0.7. And so for those of you that are familiar with correlation as a measure, you’ll recognize that that is quite a range in terms of correlation.

And so let’s actually look at a more meaningful test case. Let’s look at 2008. And so 2008, that was the year of the global financial crisis when Lehman Brothers filed for bankruptcy. Bear Stearns ultimately failed and had to be taken over by JP Morgan. It’s also when Merrill Lynch collapsed into the arms of Bank of America. So it was a very dramatic year in terms of US financial history.

So when we look at 2008, what we see is that gold was actually positive in 2008. It was up 4.3%. Whereas the S&P 500 index was -37% for the entire year. So at first glance, you could look at that and say, wow, it looks like gold actually did its job in 2008.

However, upon closer inspection, what you’ll see is that all of those returns in gold came early in the year before the crisis actually really started. So, for example, gold was up 21% through March 17 of 2008. So in the first 2 and 1/2 months of the year, it was up 21%. However, from March 17 through the end of December, gold actually collapsed about 14% in value during the remainder of the year.

And so that’s very interesting because the bulk of the crisis occurred later in the year. It was on September 15 that Lehman Brothers filed for bankruptcy. So I think when you look at the data, when you look at 2008, what you see is that gold actually did not hedge the biggest declines in stock prices during the majority of 2008, if it had not been for that run up in gold prices really early in the year before the crisis really gripped the markets.

In reality, gold was actually negative for the rest of the year. Let’s look at another case. Let’s look at August of 2011. In August of 2011 is when the S&P downgraded US government debt. Sounds very analogous to where we are today, where Congress and the White House have yet to come to an agreement on either increasing or suspending the debt ceiling.

So for the month of August 2011, stocks fell 5.4%.

And that was really on the news of the downgrade in US government debt. So stocks fell 5.4%. Gold rose 11.4%.

So again, you could look at that and say, well gold did its job. However, by the end of September of 2011, so just another month later, gold actually gave up all of its gains for the month of August 2011, and was actually trading lower by the end of September than it was on July 31, immediately before S&P downgraded US government debt.

So I think this is interesting. We saw that gold actually did its job for the month of August 2011, when S&P downgraded debt, but very quickly actually gave back those gains. So again, back to our view, gold not a reliable hedge against market volatility. And interestingly, if we go back to 2011, what we observe is that by the end of the year, gold was actually -5.7%.

It was down 5.7%, from where it stood on July 31.

So despite this historic downgrade in US government debt, we see that gold was actually trading lower at the end of the year than it was immediately prior to the downgrade. Stocks, on the other hand, actually recovered most of their post downgrade losses and finished down only 1.3% from where they stood immediately prior to the news of the US debt downgrade.

So again, very interesting where we just don’t seem to see a pattern here between gold prices and stock prices, at least not something that would be reliable enough where we could confidently conclude that gold is a hedge against market risk.

When we step back and we actually look at much longer periods of time, what we observe is that since 1975, gold actually has exhibited higher risk than stocks have. So just to give you some data points here. Since 1975, gold has returned about 5% annually, versus 12% for stocks. So no surprise there. We would expect stocks to have higher returns than gold.

However, when we actually look at the standard deviation, that is a measure of risk that we use in finance–

when we look at the standard deviation of gold, it’s actually higher than that of stocks. Standard deviation for gold since 1975 has been 17% annually versus about 15% for gold. So said differently, to put that in English, gold has exhibited higher risk than stocks since 1975. In addition to the fact that gold has also delivered lower returns than stocks have since 1975.

So again, I’m not saying that stocks are a proxy for gold or vice versa. I just wanted to highlight that gold has delivered lower returns and higher risk since 1975 than have stocks as a whole. And it’s interesting. And again, if you look more closely at the data, what you’ll see is that between January of 1980 and March 2003, gold lost 35% of its value.

So for the entirety of 23-year history, gold lost 35% of its value. That is a really long period of time to deliver negative returns to your investors. An investor buying gold on January 21, 1980 paid $850 per ounce. That investor did not break even. Gold did not see $850 an ounce until January 3, 2008. A solid 28 years later before they actually broke even.

So I think the takeaway here is that in our view, gold’s behavior when we actually look at the data, it’s far too inconsistent, far too unreliable for investors to reasonably use it as a hedge against market volatility or broader stress in the broader economy.

At the end of the day, our view is that the best thing for investors is to resist the allure of gold and to remain fully invested in a very low cost, globally diversified portfolio that has a risk appropriate allocation to cash to things like short-term, high quality bonds and other liquid assets that can help see us through any future rough patches in the markets and the economy.

Well, that’s all for today. Thank you for listening. And if you should have any questions, please feel free to reach out to your advisor here at Mercer Advisors. I’m Don Calcagni, and we look forward to seeing you next time.

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