Following the multi-year bull run in global markets, there are a number of signs that volatility, turmoil and swings in sentiment will return in 2019, marking what could be the start of a new cycle.
Many investors are therefore turning their attention to so-called defensive assets, such as gold, government bonds and some currencies like the US dollar, to provide some downside protection to their portfolios.
Applying these ‘hedges’ during periods of economic stagnation or decline can best be compared to taking out an insurance policy to offset, or try to mitigate, adverse market movements in risk assets such as stocks, corporate credit and real estate.
However, defensive assets are not without risks, as both the choice of product and timing of the trade can have a major impact on investor returns.
Gold’s performance during recessions
Historically during recessions, gold will often move in the opposite direction to stocks, which makes it an effective portfolio hedge.
However, the mere fact that the economy enters a recession does not necessarily lift the price of gold, which also depends on the behaviour of other markets.
“During a recession, declining interest rates and stock prices will typically increase the demand for gold, making the price of this precious metal go up. Yet in certain cases, risk aversion may trigger a need from investors to sell assets across the board, including defensive assets like gold.”
During a recession, declining interest rates and stock prices will typically increase the demand for gold, making the price of this precious metal go up.
Yet in certain cases, risk aversion may trigger a need from investors to sell assets across the board, including defensive assets like gold.
As history has shown us, the latter is unusual, but it can still happen. In the seven global recessions that have occurred since 1965, gold’s price rose five times (proving its worth as a defensive asset), traded sideways once, and suffered a noticeable decline in one of them.
Will the coming recession be different?
One key consideration for gold in the event of a coming recession is the likely policy response.
Following the global financial crisis, gold’s price experienced a rally every time the US Federal Reserve signalled another round of monetary easing.
When the US Fed Chairman Ben Bernanke tipped the markets off that a second round of quantitative easing was on its way in August 2010, gold rallied to new highs above US$1,265/oz and ran up to its all-time high of US$1,889/oz in late 2011.
In later years, however, gold began to change its behaviour as the market realised that central bank policy was not bringing the kind of inflation that gold bulls anticipated.
While gold prices have remained relatively stable for several years, that does not mean this precious metal is permanently down for the count.
“While gold prices have remained relatively stable for several years, that does not mean this precious metal is permanently down for the count.”
If the world is indeed going into a new recession, now it will be doing so with record levels of debt and low – and in some cases negative – interest rates.
With so little policy room to work with and having demonstrated that tools such as quantitative easing, zero-interest rate policy and negative interest rate policy do not work, policymakers will inevitably reach for something new.
Rather than adjusting interest rates, governments could instead look to policies such as nominal GDP targeting, which targets the sum of spending in an economy, and fiscal forcing of the economy.
These measures could prove far more inflationary if the focus is on injecting money into the economy to be spent rather than used to inflate asset prices, which was the chief result from low rates and quantitative easing.
In this kind of scenario, gold would be more likely to retain its value relative to other assets, helping the metal to regain its ‘safe-haven’ status and its place in defensively-positioned investor portfolios.
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