Monday’s monster stock selloff is exhibit A for why I frequently recommend a 10% weighting in gold, with 5% in bullion and jewelry, the other 5% in high-quality gold stocks, mutual funds and ETFs.
What began on Friday after the positive wage growth report extended into Monday, with all major averages dipping into negative territory for the year. The Dow Jones Industrial Average saw its steepest intraday point drop in history, losing nearly 1,600 points at its low, while the CBOE Volatility Index, widely known as the “fear index,” spiked almost 100% to hit its highest point ever recorded.
Gold bullion and a number of gold stocks, however, did precisely as expected, holding up well against the rout and helping savvy investors ward off even more catastrophic losses. Klondex Mines and Harmony Gold Mining, among our favorite small-cap names in the space, ended the day up 4.6% and 4.8%, respectively. Royalty company Sandstorm Gold added 1.4%.
The research backs up my 10% weighting recommendation. The following chart, courtesy of BCA Research, shows that gold has historically outperformed other assets in times of geopolitical crisis and recession. Granted, the selloff was not triggered specifically by geopolitics or recessionary fears, but it’s an effective reminder of the low to negative correlation between gold and other assets such as equities, cash and Treasuries.
“We expect gold will provide a good hedge against a likely equity downturn, as the bull market turns into a bear market” in the second half of 2019, BCA analysts write in their February 1 report.
The reemergence of volatility and fear raises the question of whether we could find ourselves in a bear market much sooner than that.
So how did we get here, and what can we expect in the days and weeks to come?
Gold Has Helped Preserve and Grow Capital in Times of Rising Inflation
It’s important to point out that the U.S. economy is strong right now, so the selloff likely had little to do with concerns that a recession is near or that fundamentals are breaking down. The Atlanta Federal Reserve is forecasting first-quarter GDP growth at 5.4%—something we haven’t seen since 2006. And FactSet reports that S&P 500 earnings per share (EPS) estimates for the first quarter are presently at a record high. A correction after last year’s phenomenal run-up is healthy.
Several factors could have been at work last Friday, including algorithmic and high-frequency quant trading systems that appear to have made the call Monday that it was a good time to take profits. Other investors seemed to have responded to Friday’s report from the Labor Department, which showed that wages in December grew nearly 3% year-over-year, their fastest pace since the financial crisis. This is a clear sign that inflationary pressure is building, raising the likelihood that the Federal Reserve will hike borrowing costs more aggressively than some investors had anticipated.
As I’ve explained many times before, gold has historically performed very well in climates of rising inflation. When the cost of living heats up, it eats away at not only cash but also Treasury yields, making them less attractive as safe havens. Gold demand, then, has surged in response. This is the Fear Trade I talk so often about.
But which measure of inflation is most accurate?