By ShareProphets | Tuesday 16 May 2017
Gold bugs will need no convincing. Gold bears will say yadda, yadda, yadda. But for those on the fence this research note from Palisade is worth a read. Beware of the risks of having no gold exposure in your portfolio.
Gold investors are worried about record high valuations in the S&P 500, despite the fact that gold stocks have shown a negative correlation to the general equities since 2011. The reason for this fear? 2008.
The market crash of 2008 did not just hurt the S&P, it hurt real estate and gold equities. The sell off was brutal. So was 2008 an isolated incident or does a crash in general equities always spell doom for gold and gold stocks?
We examined five previous bear markets starting in 1973 in the S&P and looked at the performance of gold and gold stocks.
The End Of Bretton Woods & The Oil Crisis: January 1973 – October 1974
The stock market crash of 1973 was spurred by overwhelming public debt and inflation – the result of generous social programs and the Vietnam War. President Nixon abandoned the Bretton Woods system in 1971, and ended the convertibility of the US dollar to gold. The dollar had become overvalued, despite its gold backing decreasing by over 60%. A deteriorating economic situation was exaggerated by OPEC’s oil embargo, initiated when the US declared its support for Israel during the Yom Kippur War.
By the end of this recession, the S&P 500 was down 48% while gold gained 139% and gold stocks gained 189%.
The Iranian Oil Crisis & Lingering Inflation: November 1980 – August 1982
The 1980-1982 bear market was incited by a second oil crisis, this time due to decreased production during the Iranian Revolution of 1979. While global supply only decreased by 4%, the first oil shock was still fresh in everyone’s mind and crude oil prices more than doubled. This crisis was followed by the Iran-Iraq War in 1980, where oil production ceased in Iran and significantly reduced in Iraq. The US was also feeling the lingering affects of inflation, and raised rates accordingly.
By the end of this recession, the S&P 500 was down 27% while gold lost 46%; gold stocks lost 64%. Gold’s loss in this recession was due to astronomical interest rates, reaching a historical high of 14% from June to October 1981. The drop was also exaggerated by the incredible gain gold witnessed leading up to period. Gold increased 436% between 1974 and 1980.
Black Monday & Iran…Again: August 1987 – December 1987
After the 1980-1982 bear market, the US had a period of recovery and rapid expansion. The S&P 500 gained 230% from its low in 1982, and uncertainty began to rise. This doubt was once again exaggerated by oil, with reduced demand and increased production resulting in an oversupply in the world market. Oil prices dropped by more than half in 1986 alone, leading to the collapse of OPEC. In October 1987, Iran fired a missile and hit an American supertanker, and the next day another. On October 19, 1987, the S&P 500 dropped more than 20%.
By the end of this recession, the S&P 500 was down 34% while gold gained 6%. Gold stocks were down 21%.
The Dot-Com Bubble & 9/11: March 2000 – October 2002
The 1990s saw the exponential growth in computers and internet usage. The Information Age was born. Institutions and retail investors alike began eagerly investing into anything dot-com related, and capital was invested without traditional investment metrics. High-risk stocks also saw an additional inflow of capital due to the due to the Taxpayer Relief Act of 1997.
The telecommunication sector jumped head first into the trend, and upgraded its networks to service the growing internet users. Expansion was funded heavily with debt, however, the investments in infrastructure was simply not justified by projected returns.
Eventually capital dried up, and many telecom companies were forced to declare bankruptcy. Dot-com also fell heavily. The events of September 11 were the nail in the coffin, and the NYSE was forced to suspend trading for several days.
By the end of this recession, the S&P 500 was down 49% while gold gained 12% and gold stocks gained 28%.
Global Financial Crisis – October 2007 – March 2009
Our most recent recession and a story that should still be familiar in the minds of our readers – The Global Financial Crisis of 2007 and 2008. It was created by greed and leverage, beginning with the subprime mortgage crisis in the US, before developing into an international banking crisis. Investment banks such as Lehman Brothers simply took on too much risk, and central governments were forced to bail-out the bankers to prevent a full-fledged collapse of the world’s financial system. Nevertheless, the world did see what was dubbed the Great Recession, which also resulted in the European Debt Crisis.
By the end of this recession, the S&P 500 was down 57% while gold gained 26%. Gold stocks did not fare so well, down 46%.
Repeat Of Past Mistakes – Near-Future To ???
During four of the past five recessions, gold was up significantly. Gold stocks were in the green during just two of those occasions. The fact of the matter is that gold stocks are still equities. When equities sell of, investors rush to cash and in many cases gold. This is exactly what happened in 2008, where gold posted a 26% gain. Gold stocks marginally beat the S&P, but still witnessed significant declines.
There is no clear magical formula for a recession, however, it appears there are some common themes. First, what goes up, must come down. There have been run-ups in the stock market prior to each recession, and eventually investors take their gains or simply run out of capital.
Interest rates play a large factor. High interest rates stifle economic growth, but if too high, also suppress gold prices as investors would rather invest in something that pays interest.
Lastly, recessions are initiated or exaggerated by global unrest.
Since the last recession ended, the S&P 500 is up 255%, while gold has gained 33%. Interest rates have also increased, as the Fed maintains a hawkish stance for the near future. So, for the time being, gold prices are likely to remain depressed.
Gold stocks for the year are stagnant. And this may be because gold investors are still scarred by the previous recession, where gold gained but gold stocks fell by almost 50%.
It is our opinion that the situation today best mirrors 1973, rather than 2008. 1973 was spurred by overwhelming debt and inflation. It is no secret that the world’s governments will continue printing money to fund growth and to service debt. But like clockwork, eventually something gives. We foresee the debt bubble finally popping, and the coming turmoil exaggerated by the foreign policies of the US Government.
The recession of 1973-1974 saw gold prices gain 134% and gold miners increase 205%. In the next market crash, history is favoring a similar situation and gold will be the safe haven from inflation and uncertainty.
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