Gold as a hedge against financial calamity

Investopedia says a hedge is “an investment to reduce the risk of adverse price movements in an asset”.

In other words, a hedge is an investment that is more likely to move up in value when other assets in a portfolio decline in price.

It has often been observed that gold has an inverse relationship with the stock market. When equities are high, gold can be relatively cheap.

When equities take a marked nosedive, often as not, demand for gold as a safe haven skyrockets.

In this sense, gold can be regarded as ‘insurance’ against financial calamity. In theory, at least, it may help to maintain overall portfolio value.

Our Senior Investment Manager, Jordan Eliseo, turned to recent history to test the validity of the idea.

The table below shows the returns for gold and for equities in the worst five calendar years for Australian equity markets between 1971 and 2019.

Source: The Perth Mint

“With the exception of 1990, when it was basically flat, gold delivered exceptionally strong gains in the years when equity markets suffered their largest falls,” Jordan reported.

The figures equate to an average increase of almost 40% for gold, whilst the share market saw average falls of almost 25%, he observed.

Jordan’s investigation also revealed that in these years of extreme volatility, gold outperformed bonds and cash as well.

While the data for 2020 is yet to be crunched, it looks almost certain that this year will deliver an even stronger message about the reasons to hedge your portfolio with an allocation to gold.