(Updated: March 3, 2017)
Many investors hold gold and silver to hedge against various crises. But
does this hedge hold up during stock market crashes?
It’s a common assumption that gold and silver prices will fall right along
with the market. And if that’s the case, wouldn’t it be better to wait to buy
them until after the dust settles?
Before formulating a strategy, let’s first look at price data from past
stock market crashes…
The Message from History
I looked at past stock market crashes and measured gold and silver’s
performance during each of them to see if there are any historical
tendencies.
The following table shows the eight biggest declines in the S&P 500
over the past 40 years, and how gold and silver prices responded to each.
[Green signifies it rose when the S&P crashed; red means it fell more
than the S&P; and yellow denotes it fell but less than or the same as the
S&P.]
What Happens to Gold And Silver During Stock Market Crashes
There are some reasonable conclusions we can draw from this historical
data.
1. In most cases, the gold price rose during the biggest stock
market crashes.
Notice this was regardless of whether the crash was short-lived or
stretched over a couple years. Gold even climbed in the biggest crash of them
all, the 56% decline that lasted two full years in the early 2000s. It seems
clear that we should not assume gold will fall in a stock market crash—just
the opposite has occurred more often.
You’ll recall that gold did fall in the initial shock of the 2008 financial
crisis. This is perhaps why many investors think gold will drop when the
stock market does. But while the S&P continued to decline, gold rebounded
and ended the year up 5.5%. Over the total 18-month stock market
selloff, gold rose over 25%.
The lesson here is that even if gold initially declines during a stock
market collapse, one should not assume it’s down for the count. In fact,
history says it might be a great buying opportunity.
2. Gold’s only significant selloff (-46% in the early 1980s)
occurred just after its biggest bull market in modern history.
Gold rose over 2,300% from its 1970 low to the 1980 peak. So it isn’t
terribly surprising that it fell with the broader stock market at that point.
We have the opposite situation today. Gold has just exited one of its
worst bear markets in modern history—a 45% decline from its 2011 peak to its
2016 low.
3. Silver did not fare so well during stock market crashes.
In fact, it rose in only one of the S&P selloffs (and was basically
flat in another one).
This is likely due to silver’s high industrial use (about 56% of total
supply), and that stock market selloffs are usually associated with a poor or
deteriorating economy.
However, you’ll see that silver fell less than the S&P in all but one
crash. This is significant, because silver’s high volatility would normally
cause it to fall more.
Also notice that silver’s biggest rise (+15% in the 1970s) took place
amidst its biggest bull market in history. It also ended flat by the end of
the financial crisis in early 2009, which was its second biggest bull market.
In other words, we have historical precedence that silver could do well in a
stock market crash if it is already in a bull market. Otherwise it could
struggle.
The overall message from history is this:
• Odds are high that gold won’t fall during a stock market crash.
Silver might depend on whether it’s in a bull market.
So, why does gold behave this way?
Gold’s Yin to the Stock Market’s Yang
The reason gold tends to be resilient during stock market crashes is
because they are negatively correlated. In other words, when one goes up, the
other tends to go down.
This makes sense when you think about it: stocks benefit from economic
growth and stability; gold benefits from economic distress and crisis. If the
stock market falls, fear is usually high, and investors typically seek out
the safe haven of gold. If stocks are rocking and rolling, the perceived need
for gold from mainstream investors is low.
Here’s the historical data. This chart shows the correlation of gold to
other common asset classes. The zero line means gold does the opposite of
that investment half of the time. If it’s below zero gold moves in the
opposite direction of that investment more often than with it (and vice versa
if above zero).
Stocks Have a Negative Correlation to Gold
You can see that on average, when the stock market crashes, gold has
historically risen more than declined.
Gold has also historically outperformed the cash sitting in your bank
account or money market fund. Even real estate values follow gold only a
little more than half the time.
This is practical information for investors:
• If you want an asset that will rise when most other assets fall,
gold is likely to do that more often than not.
This doesn’t mean gold will automatically rise with every downtick in the
stock market. In the biggest crashes, though, history says gold is more
likely to be sought as a safe haven.
So, if you think the economy is likely to be robust, you may want to own
less gold than usual. If you think the economy is headed for weakness, then
you may want more gold than usual. And if you think the economy is headed for
a period of upheaval, you may want to own a lot.
There’s one more possibility we have to consider…
What if the Stock Market Doesn’t
Crash?
It’s not always easy to predict if stocks will fall off a cliff, so what
if they don’t? Or what if the market is just flat for a long period of time?
You might think that’s unlikely, given the number of risks inherent in our
economic, financial, and monetary systems today. But look at the 1970s—it had
three recessions, an oil embargo, interest rates that hit 20%, and the Soviet
invasion of Afghanistan. Here’s how the S&P performed, along with gold.
Gold Rose 2,328% Trough to Peak, While the S&P 500 Was Flat
The S&P basically went nowhere during the entire decade of the 1970s.
After 10 years it was up a measly 14.3% (excluding dividends).
Gold, on the other hand, posted an incredible return. It rose from $35 per
ounce to its January 1980 peak of $850, a whopping 2,328%.
In other words, gold’s biggest bull market in modern history occurred
while the stock market was essentially flat. That’s because the catalysts for
higher gold were unrelated to the stock market—they were more about the
economic and inflationary issues occurring at the time. We have to allow for
the possibility that this happens again: citizens are drawn to gold for
reasons unrelated to the performance of the S&P.
The Investor’s Best Strategy
Anything can happen when markets are hit with extraordinary volatility.
But regardless of what stocks might do, is it wise to be without a meaningful
amount of physical
gold and silver
in light of all the risks we face today? I don’t think so.
Perhaps the ideal solution is to have a stash of cash ready to deploy if
we get another big decline in precious metals—but also have a stash of
bullion already set aside in case the next crisis sends gold off to the
races.
