Gold's Role as Stock Market Insurance

by Barry Unterbrink

A minority of the population understands that gold is a monetary asset that should be held as wealth insurance. A larger percentage of the population is confused about gold because of mainstream sources of information many people consider gold a risky investment when in fact gold bullion is not an investment of all a rather money itself just like any Fiat currency held in a vault, gold does not pay interest or dividends.

It is important to understand the role of gold as money in relation to Fiat currency. Governments and banks work hard to ensure that people remain confident in their debt backed paper currencies, and the economy in general. Financing is Wall Street's lifeblood, so it will always seek green shoots of recovery around the corner just as it did in 1929, 2000, and 2008. Consumer spending and bank lending is what keeps the Fiat shell game going and people do not borrow or spend when they feel uncertain about their financial future.
There are three essential characteristics of money: it must be a store of value; it must be accepted as a medium of exchange; and it must be a unit of account, meaning that it must be divisible in each unit must be equivalent. Fiat currency has failed as a store of value and it has no intrinsic worth. How much does it cost to type and zeros on the computer screen or on a piece of paper?

Certainly less than it does today a drill a mile into the earth and extract and refine 2 grams of gold from a ton of rock. The U.S. Federal Reserve was created in 1913. From its creation through to this day, the U.S. dollar has lost approximately 98% of its purchasing power. On the other hand,  Gold has retained its purchasing power rising from around $21 an ounce in 1913 to $1,300 today. Through the ages, whether in Roman times, in 1913 or today, 1 ounce of gold has at least provided a man with a pair of shoes, a custom suit, and a briefcase, or the equivalent.

Gold as Stock Portfolio Insurance

Gold is the closest most negatively correlated asset to traditional financial assets such as stocks and bonds. Physical gold bullion should be a significant part of the strategic long-term allocation within a diversified portfolio. Wall Street pundits and the uneducated media regularly dismiss Gold, and other commodities as speculation, not to be owned for most investors. Do they know – or have taken any time – to research Gold’s role in a portfolio; to dig into the numbers and important relationships? 

We have looked at the Gold statistics over the past 40+ years, using publicly and historical information, and determined from the data that while Gold does not move in lock-step always to offset losses in stocks, it does show a very reliable pattern to mitigate losses in bad bear stock markets, and during times of high inflation. Your amount of assets in Gold should be your decision, based on your individual needs with your money; income needs, withdrawal rates, capital gains, liquidity, etc.

 

The Case for Gold Ownership 1972 - 2015

Note Golds surge after President Nixon took the U.S.A. off the Gold Standard in 1971, during which Gold's price was fixed at $35 an ounce. Stocks were entering a bear market, losing 40% during 1973 and 1974, while Gold skyrocketed almost 4 times in price, rising from $40 to $160.

Then a few years later, in 1978, we were hit with an Oil Embargo (remember gas rationing?), which started 4 years of high prices (inflation), which hurt the U.S. Dollar’s purchasing power. From 1978 through 1981, inflation ramped up a combined 50%. Gold prices rose +135%.

Fast forward to the next major bear market, known as DOT COM. This referred to the period at the turn of the century, 2000, where the Internet funding craze ramped up to unprecedented levels. Public offerings of Initial Public Offering shares in the technology sector met with wide-open pocketbooks with individual investors and institutions alike clamoring for ginormous profits. In the five years ending in 1999, when the DOT COM craze finally ended, stocks gained 228%, while Gold also rose 55%. Then when stocks fell about 40% in 2000-2002, Gold participated also and rose 18%.

Gold then began a 10 year rally, with no losing years starting in 2003, rising from $350 to $1,650 an ounce into late 2012. So far, investors, doesn't it looks like Gold is helping a portfolio including stocks, especially when the stock market is falling in bear markets?

The last period to measure is the 2007-2008 era real estate-led bear market in housing prices and financial assets, causing the stock market to lose half its value in a short 17 months. This should be in most of our minds, if you were an investor or saver 8 years ago.

Gold had its best year in 2007 (up 30%) since the late 70’s, as it rose perhaps in anticipation of / and on the fears of the banking and lending fiasco that led up to the falling stock market.

During 2007-2009, stocks lost 15% in those 3 years, while Gold gained $450 an ounce (+70%).

Granted, the long term record also shows Gold’s poor showing the past three years; being down sharply.  Is this cause for concern? We feel the roughly 40% decline in Gold prices since 2013 are due to super low interest rates competing with the no-dividend paying precious yellow, and a decent stock market. Owning Gold through 2015 was a drag on your returns in a diversified portfolio. Stocks gained about 45% the past three years. That's a healthy clip.

So the take-away here is that Gold is reliable for mitigating losses when stocks are down sharply, and when Gold really tanks, stocks usually have a a great year (1975, '83, '91, '97, '13) or at least stocks provide a nice offset to Gold's lesser declines, in years 1976, '88, '89, '96, '98, '14, '15.

Could the economic uncertainty (Brexit vote) and renewed price gains in Gold this year, up $250 an ounce, or +22%, be a precursor to an even worse stock market ahead in the second half? We’re not sure, but we are not selling our allocation to Gold for ourselves or our client accounts. Any geopolitical risks should only add to the demand for histories most popular precious metal, GOLD.