Gold acted very strangely last week, selling off hard when the markets were tanking. Here’s why that makes sense, and why the yellow metal is set for more gains
If you’ve been in the markets a while, you’re likely familiar with gold being referred to as a “chaos hedge” and a “safe haven asset.”
The reasoning behind the names is obvious. In times of market turbulence, investors often turn to gold (and bonds) to protect their wealth from whatever turmoil is occurring in the stock market.
This traditional dynamic was playing out as expected as coronavirus fears increased in the headlines as January turned into February.
Below, you can see gold’s market price compared to the S&P beginning on the first trading day of 2020, running through Monday, February 24.
Though gold had been grinding higher all year, it wasn’t really until the severity of the coronavirus became apparent the week beginning Monday February 17 that we saw a sharp divergence between gold and the S&P, with gold exploding higher.
This makes sense — again, it is gold acting as a wealth-preserver in uncertain times.
But then, last week, something odd happened. See for yourself …
Gold, the venerable safe haven asset, plummeted right alongside the S&P.
Why?
Had the yellow metal somehow lost its centuries-old reputation for financial safety?
No. It turns out, gold had simply become the asset-of-choice for panicking investors who needed cash.
Reports suggested that losses in equities became so severe over the course of the last week’s rout, many investors were forced to sell their gold holdings to meet margin calls.
(If you’re unclear on “margin call,” it’s basically when an investor borrows from his/her broker to buy stock, yet the market value of the stock falls, resulting in the broker requiring the investor to deposit additional cash or securities to meet minimum maintenance levels.)
Last Friday alone, gold fell as much as 5%, which is the most in almost seven years.
Now, at first blush, this selling seems illogical. After all, selling a “safe haven” asset during tumultuous times seems a bit anti-definitional.
***But this isn’t the first time that gold has fallen alongside stocks … and if we follow what happened last time, gold is in store for big gains to come
Gold bugs likely remember a similar swoon in the wake of the 2008 stock market carnage. And like today, it was part of a simultaneous, mass liquidation that took down stocks alongside of gold.
Below is a chart showing gold and the S&P from mid-March 2008 through mid-November 2008.
Stocks are getting trounced, down 32%. But gold is right there beside it, down 26%.
But as you’ll see below, over the following three years, give or take, gold exploded 170% higher while the S&P tacked on a modest 23%.
In hindsight, what was the cause of the gold/stock correlation that preceded this monster run for gold?
You guessed it — margin calls.
From Kitco:
In 2008 analysts explained that the unique phenomenon was a result of mass liquidation of all assets to cover margin calls as well as a major component of fear resulting in the liquidation of any investment vehicle that wasn’t bonds or cash.
It was only after the massive selling pressure in stocks worked its way through the market … which eventually lessened investor fears … which reduced the need to sell other assets in order to clear up cash … it was only then that gold really took off.
So, is gold poised to take off yet again this time around?
Well, here’s one more reason it might …
***The Fed just cut rates 50-basis points, and more cuts are likely coming
For more on this, let’s turn to global macro specialist, Eric Fry, editor of Fry’s Investment Report.
Tuesday morning, the Federal Reserve slashed its benchmark lending rate by nearly a third — from 1.75% to 1.25% … and the gold market soared on the news …
Aggressive rate cuts tend to undermine the dollar’s value and boost gold and silver prices.
That’s exactly what we saw Tuesday: Precious metals way up … the U.S. dollar way down. In fact, we saw gold post its largest one-day percentage gain since last June.
I expect both of these trends to “get legs” over the coming weeks. Here’s why …
For six long years, from May 2013 to May 2019, gold traded in a narrow $350 price range between $1,050 and $1,400 an ounce. On a net basis, the gold price fell 6% during that time frame.
But then, just about the time that most investors were expecting gold to continue its do-nothing pattern, the yellow metal started racing higher. Since last May, the gold price has jumped 30%.
Eric isn’t the only analyst expecting higher gold prices. Last week, Goldman Sachs upwardly revised its 12-month price projection — now not ruling out $1,800 an ounce.
“In the event that the virus effect spreads to Q2, we could see gold top $1,800/oz already on a three-month basis,” Goldman analyst Mikhail Sprogis wrote last Wednesday.
Goldman’s previous forecast called for gold at $1,600 an ounce by mid-2020. Now, the bank is projecting $1,700 in three months, followed by a further advance to $1,750 in six months.
***How to play gold now
The easiest, most traditional way is an ETF such as “GLD,” which tracks the market price of gold. We first put GLD on your radar in the Digest back on January 9th 2019. Since then, GLD is up over 30%.
But there are also specific gold-related stocks that are posting far greater returns. Eric holds two in his Investment Report portfolio.
Back to Eric:
That rally has produced some impressive gains for the easiest way for everyday investors to get in on gold. That’s the SPDR Gold Shares ETF (GLD) …
And it’s been even better for the two gold-focused recommendations I’ve made in Fry’s Investment Report. One has advanced 39% since last May, while the other has more than doubled.
But I’m expecting even larger gains ahead from these stocks, as the budding bull market in gold carries its price to new all-time highs.
For more of Eric’s thoughts on gold, as well as his specific gold recommendations, click here to learn about joining Fry’s Investment Report.
***As we wrap up, let’s not mistake recent weakness in gold for structural weakness
Investors selling gold to clear up cash for margin calls is very different than selling gold due to a reason that’s intrinsic to gold.
Big-picture, the case for more gains to come is as strong as it’s been. As to “why?” just ask yourself a few questions …
Is the Fed more or less likely to cut rates?
Is the Fed more or less likely to resume (or increase) some type of quantitative easing program?
Is our government more or less likely to continue running up outrageous debt obligations?
Will sovereign states around the globe continue to issue negative-yielding debt?
I’m guessing your answers point toward the same takeaway as do mine …
And in fact, if we look at how gold has acted the last few days, you can see the temporary nature of that sell-off …
I’ll give Eric the last word:
I think every intelligent asset allocation strategy must include a commitment to what I call “wealth insurance.”
And it’s why I believe most investors should put a small portion of their capital in gold. That step will go a long way toward protecting you and your family against financial distress.
Have a good evening,
Jeff Remsburg
