Gold: Time Tested Insurance Against A Stock Market Crisis

Includes: GLD, IAU, PHYS, UUP
by: Eric Parnell, CFA

I recently wrote an article entitled "U.S. Treasuries: Time Tested Insurance Against A Stock Market Crisis" that discussed how Treasuries (IEF, TLT) have generated strong performance and have provided a portfolio hedge during periods of extreme stock market turbulence. After viewing this article, one of my readers submitted a comment with a very good question – how did gold (GLD, IAU, PHYS) perform during these same past crisis periods? The answer – the yellow metal also provides time tested portfolio insurance against sharp stock market downturns.

As discussed in my previous article, seven separate sharp stock market corrections of -15% or more have occurred over the last 30 years. The following is the performance gold during these stock market pullbacks.

August 1987 – December 1987

Stock Market (S&P 500, Peak to Trough Total Return): -33.51%

Gold (Total Return Over Corresponding Time Period): +4.72%

July 1990 – October 1990

Stock Market: -19.92%

Gold: +7.98%

July 1998 – October 1998

Stock Market: -16.70%

Gold: +1.32%

March 2000 – October 2002

Stock Market: -49.15%

Gold: +12.52%

October 2007 – March 2009

Stock Market: -56.78%

Gold: +23.54%

April 2010 – July 2010

Stock Market: -15.60%

Gold: +7.99%

April 2011 – October 2011

Stock Market: -19.39%

Gold: +6.83%

In each of the above instances, gold posted positive returns in contrast to a sharply declining stock market. Thus, an allocation to gold has provided an attractive hedge for investors during periods of stock market uncertainty.

One point is worth mentioning in regards to the magnitude of returns during these time periods. Many of these major market corrections have occurred during periods when the U.S. dollar was weakening. The only exceptions were the 1998 pullback and the early part of the 2000-2002 correction when the U.S. dollar was in the midst of an extended bull market from July 1995 to February 2002.

This is notable since the performance of gold during the 1998 correction was by far the weakest of the group at just +1.32%. And while gold rallied by +12.52% in total during the 2000-2002 correction, it was actually mired in a chronic decline for most of the first half of this stock market decline, with gold down by -10.27% from March 2000 to April 2001. It was only in the later months of this stock market decline from April 2001 to October 2002 that gold was able to wash away this decline and continue higher in registering a solid overall advance.

Bottom Line

Gold provides time tested portfolio protection against stock market crisis. This hedge is particularly effective during periods when the U.S. dollar is weakening, but its efficacy can be eroded when the dollar is strengthening. Thus, monitoring movements in the U.S. dollar (NYSEARCA:UUP) would be worthwhile in managing this hedge. One final point, if we were to eventually enter a period of high inflation like we experienced in the 1970s and early 1980s, the benefit of owning gold would likely become vastly more profound.

Disclosure: I am long GLD.

Disclaimer: This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.