Gold Won't Shine In The Next Recession

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Includes: BTC-USD, COIN, DZZ, GBTC, GLD, GLL, GTU, IAU, OUNZ, PHYS, QGLDX, SGOL
by: Pricechart Guy

Summary

The historical argument for gold's robustness in hard times is surprisingly weak.

Digital currencies such as Bitcoin throw a radical curveball into investment opportunities that might hold value or appreciate during a national recession.

Mild currency manipulations are hardly relevant; even catastrophic currency collapse will not translate to gold's utility as a wealth instrument.

Summary

Even more so than in previous business cycles, gold is likely to disappoint those looking to hedge against recession. There is little historical evidence pointing to gold as a significant store of value or it generating substantial ROI at/near recessions. The arguments against its stability or hedge against currency manipulation are well-worn already, but are covered here as a reminder and primer for new readers. In addition, the most interesting variable in the gold price trends discussion is the new prominence of digital currencies like Bitcoin. Suffice it to say that Bitcoin and its digital currency peers are volatile, perhaps too much so for use in regular trading, and all of it based on a kind of dependence on technology and the Internet that no other commodity or currency can match.

Gold and History

In the last 3 recessions (1990, 2001, 2008-9) only the 2001 recession saw a gold rise, and even that was not too impressive. On a longer time span, there have been only 4 instances in the last 100 years where gold rose prominently and would have been a great investment.

It is important to keep in mind the psychological place of gold in the overall market. Gold is often perceived as a store of value. However, this perception belies a painful truth: small bumps in the price of gold are often woefully insufficient to make up for the low correlation of bullish recessionary gold runs and the commodity's general price volatility. This fact weighs heavily on the idea of storing large amounts of savings in gold or derivative gold-based investment vehicles.

If the next recession sees a weakening of the dollar, it is likely gold will rise. However, this prediction comes with two disclaimers:

  1. Gold may not rise enough to compensate for opportunity costs like successful shorts, or put buys in the equity markets.
  2. Gold may not have enough entry/exit points that yield sufficient gains for various investors who enter and exit the gold trade on a multitude of time scales.

Chart 1: Gold Price, previous 100 years. Inflation-adjusted. Shaded areas - recessions.

Source: Macro Trends 100 year historical gold price chart.(r1)

Red circled recessions: significant gold price increases shortly before/during the recession.

Orange arrows: steep and/or persistent gold price increases that did not correspond to recessions.

There is an intuitive and appealing logic to gold as a store of value: as general panic rises and quality of life metrics go down, money will flow towards whatever holds value the best - gold, according to many. More so, rates from other investments such as bonds and dividends typically go down during recessions, so gold would be relatively more attractive since it is competing for capital in a low-rate environment. The gold-boosting recessionary dynamic did, in fact play out, most famously during the Great Depression. However, once again, this is not the norm. The past 100 years of gold prices and recessions point to many cases where a gold price boost in recessionary environments was very short-lived, very small, or simply nonexistent. It is also noteworthy that gold rose tremendously in 1971-1973, Sept 1976-Feb 1980, and 2002-2011 (Chart 1, orange arrows), times when recessions were not evident. In fact, note how the 2008-2009 recession coincides with a sharp dip in gold price, with the yellow metal clawing back prices seen in 2007 and resuming its climb to a peak after the recession officially ended.

One might argue that the new wave of negative interest rates already in place in some prominent central banks will intensify. Wouldn't gold's inherent rate of zero percent interest look good compared to essentially a fee on holding money? Perhaps to some extent, but investors and savers would wisely consider that a volatile commodity like gold could wipe out far more wealth with an unfavorable and persistent dip than even the cruelest realistic negative rates.

Gold and Bitcoin

Bitcoin is a prominent new development that has come into the mainstream. As a digital currency, Bitcoin floats somewhere between being a commodity and a currency. To be fair, gold has the same ambiguity, depending on one's perspective -- gold "doesn't change" while fiat money like dollars can be printed at will. The age-old argument between a currency becoming more worthless in terms of gold, or gold becoming more valuable in terms of a defined currency has a new, 21st-century curveball thrown at it with the emergence of digital currencies (also "cryptocurrencies") such as Bitcoin.

Bitcoin is volatile, making any hope of capital gains or even preservation a delicate balance against the substantial chance of heavy losses. As with all risky investments, there is a large risk of loss and this article is by no means a recommendation to go long cryptocurrencies. Bitcoin's run-up (see Chart 2 below) has generated commentary that compares it to an irrational bubble that will burst any day, leaving Bitcoin buyers out to dry. Such skepticism is warranted. Gold is a globally recognized asset that has a history and association with wealth, security and opulence that dates back millennia. Gold has use in industry, in decorations/jewelry, and for "apocalypse" traders who, reasonably or otherwise, generate an impressive demand for gold coins.

Chart2: Bitcoin Price, Jan 2014 - Present

Source: World Coin Index Bitcoin BTC/USD.

It is noteworthy to comment on recent significant Bitcoin news: the split and introduction of Bitcoin Cash. Without going into technical detail, the takeaway is that Bitcoin and other digital currencies are subject to a kind of risk hard to mirror with paper currencies, let alone commodities. A split or ever-newer introduction of alternative digital currencies is to be expected and will certainly put a crimp into the argument for Bitcoin's stability or even whether or not it will continue to exist, and in what form. However, the craze for digital currencies overall is very unlikely to abate. Given that fact, I think that whatever risk Bitcoin in particular may present, the opportunities opened by the digital currency revolution are enough to siphon at least some capital that would have gone into gold.

Gold and Currencies

Currencies, though of course subject to political whim and central bank miscalculations, are, at least ideally, calibrated for the optimal functioning of the issuing country at any given time. This gives a handle, albeit a slippery one, for rational investing outlooks and forecasts that compare currency pairs. Anyone who buys or sells currencies recognizes that an issuing country will not try to boost the value of its currency into the stratosphere since exports would suffer and the overall economy would be hurt far more than the benefits of having an excessively "strong" currency. Currencies are not a nation's "stock" and benefits do not accrue to citizens and industries without limit as they would to investors that bought into an equity bull run.

On the flip side, a currency with its value in free fall is just as bad. Though at first it may seem attractive since exports become far more competitive on the international market, the negative effects, such as more expensive foreign debt and imports, are virtually certain to spill over into social unrest and, in extreme cases, a nullification of the issuing government's credibility. See recent Venezuela, Zimbabwe, and the Weimar Republic.

In such instances, I will admit that gold shines. I won't even do the math, but will blatantly assume -- and I think you will agree the assumption is warranted -- that gold has risen in terms of Venezuelan Bolivars over the last few years. Unlikely as it seems, a similar situation can happen here. The same antagonistic utopian ideologies and political madness can grip the U.S. If (when?) they do so on a large enough scale, the USD will sink to hell while gold bugs gloat smugly atop their yellow, shiny mounds of precious metal and foresight.

Of course, in such a dystopian scenario, effective mechanisms and regulations of modern trade and investment may also vanish. Readers will agree that at the moment, a gold bar is more valuable than a sandwich. What if there is no reliable way to convert gold bars into cash (or sandwiches) and you are near starvation?

Source: Dilbert comics, by Scott Adams

Summary

I can't say with certainty that gold will disappoint when the next recession hits. However, I feel the odds and the logic are enough in favor of a bearish gold outlook to move some speculative capital to instruments such as the ProShares UltraShort Gold ETF (GLL) or DB Gold Double Short ETN (DZZ) when more recessionary markers start to flash. Admittedly, negative rates are a new kind of thorn in the side of this bearish argument. My assertion about gold's volatility presenting a bigger risk than negative rates could be wrong, though I wonder how gold prices would become stable enough to hold off occasional panic selling.

As you can see, I am not of the opinion that gold will counteract equity losses in the next recession. There may be some sporadic price bursts that correspond to media hype or geopolitical panic, but such behavior is not what I would expect from an alleged "store of value".

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.