With the next global crisis rapidly approaching, how will gold perform during the next round
of worldwide carnage?
How Will Gold Perform During Next Financial Crisis?
The analysis of gold in a portfolio context is a well-worn tradition in our annual gold
studies.
We presented an extensive discussion of the extraordinary portfolio characteristics of
gold, the relationship between gold and interest rates, as well as the opportunity cost of
holding gold in the 2015 In Gold We Trust report, while in 2016 we examined to what
extent gold is suitable as a hedging instrument, i.e., as portfolio insurance.
In this context we considered gold as a fundamental component of a permanent portfolio and thereafter
discussed its anti-fragility properties…
First, we will examine the relationship between gold and the US dollar.
This relationship is particularly important in crisis situations.
In the subsequent section we will delve more deeply into the relationship between gold
and real interest rates, and in the last section we will take a closer look at the relationship
between gold and stocks.
In this context, we are focusing particularly on the performance of gold during severe bear
markets in stocks.
Gold and the US Dollar Despite the structural problems of the US
economy, the US dollar remains the undisputed senior international fiat currency and with
that a mirror image of global events.
The following chart shows the thirty-month rate of change of the USD Index.
As one might suspect, the USD Index is very useful as a coincident indicator of economic
and political events and crisis situations, as it regularly mirrors local crises.
Crisis situations abroad that don't impact the US economy directly – such as the Latin
American debt crisis, or the Asian & Russian crisis – traditionally lead to flight into
the dollar.
A rising USD Index reflect these developments.
Particularly in such stress situations many investors still have confidence in the US
dollar and regard it as a safe haven from external threats – a quality frequently
attributed to gold as well.
In line with this, one might be inclined to expect a positive correlation between gold
and the US dollar.
As the chart above illustrates, this is not the case though.
In reality there is a significant negative correlation between the USD Index and gold.
How does that mesh?
A possible explanation for the negative correlation between gold and the dollar may be found in
the attribute as a safe asset in crisis situations.
Although the dollar and gold may superficially be considered substitutable, a closer examination
reveals a different picture.
In local crises, the US dollar is seen as a desirable asset by many market participants
because the survival of the fiat money system as such is not questioned.
It Is Different In A Systemic Crises It is different in the case of systemic crises.
In these situations, confidence in fiat currencies and the banking system is shaken and many
market participants pay heed to gold's historical function as money.
Particularly in systemic crises, gold is perceived to maintain its value, while paper money is
in danger of becoming completely worthless.
In general, the traditional inverse correlation between gold and the US dollar is very helpful
in a portfolio context to reduce volatility.
That applies specifically to the current market environment, since the US dollar has already
appreciated significantly against other fiat currencies in recent years.
Over the medium to long term not only the instability of the monetary system, but the
US dollar's high valuation should provide significant upward potential for gold.
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