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As the United States prepares for a possible government shutdown starting October 1, that would bring most government operations to a standstill and idle millions of government employees, investors need to consider the consequences of this for their investments.

For most asset classes, a government shutdown brings about many risks that would lower their appeal especially for government dependent companies (such as defense contractors like Lockheed Martin (LMT) and Northrop Grumman Corporation (NOC)), and consumer companies like Mcdonald's (MCD) and Walmart (WMT) that would see a sizable set of consumers lose their income temporarily. But for gold and gold ETFs (GLD, PHYS and CEF), a government shutdown may be quite bullish for a number of reasons.

A Government Shutdown Would be Negative for Risk Assets

Obviously, a government shutdown introduces a lot of uncertainty into markets, which is generally very negative. Why own stocks when the U.S.' single largest spender is involuntarily cutting back on expenditures? The millions of government employees that ordinarily provide the spending for a large portion of the economy will no longer be spending and will have to cut back because they have been furloughed. Finally, the thousands of businesses dependent on the government for business and future contracts will see some of their revenue deferred. And while a short shutdown may not have much of an effect, the market is trading close to all-time highs and is really not discounting much in terms of negative consequences - so why should investors take the risk with little in the way of return?

Gold on the other hand has a strong negative correlation to the market and offers investors an asset class with plenty of bullish factors and the ability to rise even as risk assets drop.

Money has to go Somewhere

One thing investors need to remember is that there is always a good investment somewhere. Money has to go somewhere and for every asset sale there is an equivalent in some other asset class (remember selling a stock and holding cash is an investment in cash, which can be dollars, euros, yen, etc). So if investors sell stocks they will be buying something else, and while bonds may benefit, there is a good case against buying U.S. bonds when the U.S. government is shutting down - after all you're buying the primary asset of the dysfunctional government. Gold provides a "safety" asset class similar to bonds, but avoids the governmental dysfunction since it is not issued by governments.

Negative Economic Consequences are Positive for Fed Stimulus

As we have discussed earlier, a government shutdown of any medium or long-term length is going to have negative implications for the economy, the labor market, and the housing market - all factors that the Fed is looking at when determining whether to taper its quantitative easing program. This may mean that a Fed that was considering tapering in December (which we thought was very unlikely) may have to completely reconsider that stance and this wouldn't be something new. In fact, during the last major government shutdown in the mid-1990s when the Fed was considering raising rates, it had to reverse its stance. The Fed actually lowered rates in the wake of the 1995-1996 shut down in order to keep the economy on track. This time, the Fed would likely delay any tapering after a shutdown to see if the government closure had slowed the economy is any way.

We don't have to tell investors that a lack of tapering, or even the possibility of an increase in the Fed's quantitative easing program, would be very bullish for gold. All investors have to do is look to last week's historic rise in gold from $1300 to $1360 in a matter of minutes when it was clear that the Fed was delaying tapering.

Conclusion

One of gold's major strengths is that it is an asset class that thrives in financial uncertainty and chaos - and a government shutdown significantly increases the risk of financial uncertainty. Investors who are not exposed to gold should seriously consider taking a position in any one of the gold ETFs (GLD, PHYS or CEF) to hedge their portfolio against any medium-term to long-term government shutdown. Those wishing to increase their leverage to the gold price may want to consider some of the low-cost gold and silver miners such as Goldcorp (GG), First Majestic Silver (AG), and Randgold (GOLD) - though the miners always carry other risk that the gold ETFs do not carry. Either way investors should make sure that they take into consideration for their portfolio the risk that the US government shuts down - gold makes a terrific hedge for this uncertainty and should be owned in some way, shape, or form by all diversified investors.

Source: Government Shutdown: A Golden Opportunity For Investors Seeking Diversification