Does Gold really outperform during recessions and inflation?

By: Dan Ashmore
Dan Ashmore
Dan is currently living in Medellin, Colombia, where he is desperately trying to pick up just enough Spanish so… read more.
on May 12, 2022
  • History says gold drops in short-term via large-scale flight to quality during periods of sudden volatility
  • Over longer time period, gold does perform well during recessions, notably in the 80's and the 2008 GFC
  • High inflation environments akin to what we are seeing now have also been very kind to gold historically

It’s rough out there. Like, really rough.

Even before this week, stocks were off to their worst start to a year since 1939. The EU and UK are on the verge of recession, yet we have 8 hikes priced in by the Fed before the end of 2022. And don’t even ask about crypto, where $18 billion stablecoins are imploding and entire ecosystems disappearing.

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Given this intensely bearish sentiment, I thought it would be prudent to assess the performance of gold as a safe haven.

Gold

Humans have been obsessed with this shiny metal that we call gold for as long as they have walked the Earth. A (relatively) fixed supply and historical ties to monetary systems (the Gold Standard was only abolished by Nixon in 1971) means it occupies a unique spot in the macro landscape.

It has always had the mythical “store-of-value” title assigned to it, but how has it actually performed during recessions, and could it be a good asset to hold going forward?

History

The first case to assess was the Great Depression of 1920’s/1930’s. Between 1929 and 1934, gold rose from $20 to $35 per ounce. This came amid a period when US President Roosevelt signed into law a doctrine forcing holders to turn their gold over to the government for $20.67 per ounce. With people clinging to the metal as a result of the Gold Reserve Act re-affirming the Gold Standard (several other countries had abandoned it during the Depression), its allure grew. Eventually, the US government increased the price as part of its continued efforts to steady the economy.

But that’s a long time ago, and with the Gold Standard now a thing of the past, not wholly relevant in the context of today’s environment. Yet gold has continued to perform conversely to the market ever since. The below chart shows the price of gold since 1970, which can be seen to spike during recessionary periods.

Flight to Quality

In looking at the above graph, it is clear that Gold performs counter-cyclically, increasing in price as the economy contracts. But if we look at shorter time periods in isolation, this is not always the case.

Take March-20, for instance, when the markets first realised that the COVID pandemic was not just another virus. While the monthly return was positive at 2.2%, some of the daily returns were highly negative, including March 17th, when Gold fell a staggering 6.8%. Four of the twenty-two trading days that month yielded negative returns greater than 3.5%, as the markets wobbled severely due to the black swan event that was COVID-19.  

This data is interesting, even if is drawn from the highly unusual month that was March 2020. Because while the first graph shows us that during recessions, gold does indeed act as a store-of-value, the second graph suggests that in times of extreme fear and volatility, it goes down with the rest of the market – at least in the short-term, as it preceded to rise to where it is now.

And this latter claim is backed up by recent events, with the pattern not isolated to March 2020. As May has seen a downturn across the board thus far, gold has followed – down 3.6% from the price at which it closed in April. Or course, April was also a brutal month for markets, and gold was down then too – currently 5.6% below its March closing price.

Repeated Pattern

Indeed, we see this time and time again. In times of sudden uncertainty, there is a flight to quality across the board – and that includes capital shifting away from gold. Investors want cold, hard cash, with everything else plummeting, in these sudden onsets of volatility. The past couple months are a good example of this, as the Russian war has rocked the geopolitical climate and uncertainty reigning supreme.

So while markets are highly turbulent right now, gold has done what it often does – followed the market. Of course, the returns are nowhere near as negative as stocks or other risk-on assets – see below graph – but it does shed some value.

However, if this downturn turns out to be a sustained bear market and history is to repeat itself, gold should move upwards. The pattern thus far year-to-date matches what we seen before – a slight downtick as the rest of the market nukes. If the market stays red and this becomes the norm, gold would be following the historical pattern if it began to hold and rise counter-cyclically.

Inflation

One final factor I want to analyse before signing off is the correlation between inflation and gold’s returns. This is pertinent given the current climate of rampant inflation and slowing growth, in other words, an economy’s worst nightmare.

CPI of 8.3% was announced yesterday for April, meaning inflation is still hovering at 40-year highs. I plotted gold’s annual returns against the year-over-year inflation rate since 1970, and calculated the correlation coefficient at a relatively boisterous 0.55, suggesting a moderately strong relationship. The graph below details the movements in percentage terms, and it’s clear to see the relationship visually.

Conclusion

To conclude, we are currently seeing the EU and UK on verge of recession, markets in a sharp decline and fear spreading throughout the economy that a long-overdue correction is finally imminent (if not here already). Historically speaking, this plays out as a promising set-up for gold should the bear market persist beyond just short-term volatility.

Should it indeed turn out to be a persistent bear market, the added factor of high inflation remaining a stark problem paints gold in an even more attractive light. It’s a relatively unique (and scary) set-up to have both heightened inflation and decreasing growth and sentiment, but for gold they are the factors that have propelled it in the past.

If history repeats, gold is well placed to capitilise in this market.

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