Is Gold An Effective Hedge Against A Financial Crisis?

 |  Includes: GLD, LQD, SPY
by: Robert Singarella Jr.


A comparison of the relative performance of investment grade bonds, equities, and gold suggests that it is not unwarranted to say gold was a relative safe haven during the financial crisis.

Equities were clearly the worst of the possible choices during the crisis. They lost over twice as much of their value than either of the other assets.

Further analysis would be needed to determine the better relative safe haven between investment grade bonds and gold.

Among the many reasons that gold is recommended as an investment is the claim that gold can hedge against financial or political crisis. I decided to explore that claim using the 2008 financial crisis for the analysis. I plan to do a more rigorous analysis in the future, but I'd also be interested in hearing some feedback on my initial thoughts on this topic.

Saying something is a hedge against a financial crisis is an ambiguous statement at best, so it's important to start with clear definitions. It's obvious that, if you knew the crisis was coming, the best possible option would be to take short positions or simply hold cash. However, the reality is that we don't know when a crisis is going to take place; therefore, I am only going to consider the relative performance of the following:

  • Shares of GLD as a proxy for gold.
  • A position in the S&P 500 index as a proxy for equities.
  • A position in LQD as a proxy for investment grade bonds.

I used 01/02/2008 as the starting point for the analysis, assuming that the position is opened on that date using the closing price. That gives a benchmark level for each asset's value shortly before the crisis started. The S&P 500 hit its lowest level on 03/09/2009 when the index closed at 676.53. In order to ensure that nothing important was cut from the data set, I used 06/01/2009 as the final date in the analysis. All of the assets under consideration had reached their lowest values before that date, so there is enough information to evaluate how much damage was done during the crisis.

Click to enlarge

Source: Data by Yahoo Finance. I made the chart by calculating the percentage return for each asset assuming an investment was made on 01/02/2008.

The first thing that stands out is that equities clearly lost the most value by a considerable margin. Gold declined by about 17.5% from the initial price to its lowest price, the corresponding decline for LQD was 20%. They did not hit their lowest points at around the same time either and the behavior of each asset during the crisis was unique.

Using this data, it's not all that bold to say that gold was a safe haven relative to stocks; however, I don't think the same can be said of the comparison to LQD. Gold had a somewhat smaller drawdown than LQD, but I don't think it was worth the higher volatility of gold. When LQD crashed, so did gold. Gold then had a rapid rebound followed by another crash. Both gold and LQD reached their breakeven level around the start of 2009, but LQD would face a 10% drawdown before again reaching breakeven midway through 2009.

The reflex reaction after looking at the chart is to say that gold was a better safe haven than LQD, but that fails to consider investor psychology. Even though both gold and LQD faced two significant drawdowns during the crisis, I feel that the nature of the drawdowns in gold would be more likely to cause an investor to sell near the lowest point. So, I would conclude that investment grade bonds were a better safe haven during the crisis than gold; however, I admit that there is plenty of room for debate on that point.

One final thought, I did this analysis to consider which of the given assets was the best safe haven relative to the others. This is obviously not an exhaustive list of all possible assets and strategies that could be used, but it does allow some general conclusions to be made. Also, the irony of saying that an asset that lost 17.5% of its value at one point is a "safe haven" is not lost on me, but that is what you get with the relative comparison.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.