by Daniel Putnam | August 13, 2013 8:11 am
Last Friday, David Faber made two predictions in a widely covered CNBC interview:
This raises the obvious question: Will buying gold stocks in a bear market actually work?
For this trade to make money, gold stocks would need to move in the opposite direction of the broader market in a downturn. However, a look at the number shows that while gold miners can outperform on a relative basis when stocks are weak, there have been very few occasions in which they have bucked the trend and managed to deliver a positive return in a tough market.
The past three major market downturns (2007-09, 2000-02 and 1987), along with the correction of 1990, show a clear pattern: In all cases, gold stocks — in this case, measured by the PHLX Gold/Silver Index (XAU) — comfortably outperformed the S&P 500 on the downside. On three occasions, however, the XAU suffered sizable losses in absolute terms.
The one exception was 2000-02, when miners made it through the tech-bubble crash with a gain — perhaps creating the perception that the asset class is a safe haven during periods of turmoil.
Nonetheless, investors still would have lost an average of 17.7% by holding gold stocks through these corrections:
|Start Date||End Date||S&P 500 Return||XAU Return|
Since the beginning of 2009, the S&P 500 has suffered 18 downturns of 5% or more. During these periods, gold stocks — in this case, measured by Market Vectors ETF Trust Market Vectors Gold Miners (GDX) — showed the same performance characteristics as they did in the major downturns. GDX generated slight outperformance, with 10 occasions in which it beat the S&P and eight in which it lagged. On average, the fund returned -7.6% against -8.6% for the S&P 500.
||End Date||S&P 500 Return||GDX Return||Difference|
Again, the miners delivered better performance — but not by a wide enough margin to qualify gold stocks as being a legitimate hedge against a downturn. Further, GDX only registered absolute gains in four of the 18 5%-plus market downturns, showing the difficulty of Faber’s prediction (market falling, gold stocks rising) coming to fruition.
Another aspect of this story is that gold stocks have underperformed sharply in each of the past two corrections — September-November 2012 and May-June of this year. In fact, these rank as the second- and fourth-worst periods of relative performance for gold among the past 18 downturns. Granted, this has been one of the worst periods for gold stocks in history, so it would be unreasonable to expect them to gain traction in anything but a perfect environment.
That’s not all there is to the story, however. The chart below shows the rolling five-year correlations of the XAU with the S&P 500 in the past 24 years. (In other words, 1988 measures the period from 1983-1988, and so on). The correlation has been steadily rising since reaching a nadir in 1998, and it currently stands near its peak. This can change quickly, of course. But for now, it indicates that gold stocks are unlikely to provide much in the way of a hedge — and it might help to explain their poor results in recent corrections.
Does that mean gold stocks can’t rally from here? Not at all — in fact, the past few sessions have created a “W”-shaped formation, which has been a positive sign for the group in the past.
Instead, it indicates the futility of trying to bottom-fish in gold miners without support from the rest of the market.
You can buy gold stocks on the basis of valuation, hope that their abysmal recent performance will correct itself, or even the expectation of a mean reversion relative to gold itself — just don’t buy them for bear market protection.
With a few exceptions, the numbers just don’t support the case.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.
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