Time and time again, gold has proven to be a safe, trusted asset during turbulent times. As people look for stability from more volatile purchases like stocks, gold continues to represent a lower-risk option.
Used in some of the world’s first currencies, the physical properties of gold make it a reliable store of value. Gold is finite and durable, so it is both in demand and long-lasting. Although more gold is mined every day, it is relatively rare, so yearly yields are not substantial enough to dramatically disrupt its value. On the other hand, the paper currency loses its value as more bills are printed.
Gold, therefore, has a unique ability to withstand adverse conditions. If an economic crisis hits, stocks fall because people assume businesses will make less money. However, the value of gold isn’t based on the expectations of companies’ future profitability, so such downturns don’t have as much of an impact on the price of the precious metal.
Studies show that on average, gold prices rise 15 days after a crash. Warren Buffett once said that “gold is a way of going long on fear.” Here’s how and why gold has been a consistent failsafe throughout crises.
Gold vs traditional currencies
Up until 1971, the value and purchasing power of major world currencies were backed (at least partially) by gold reserves. After President Richard Nixon removed the link, fiat money – government currencies that aren’t backed by gold or other commodities – became dominant globally.
Fiat money makes it easier to increase the amount of money in circulation. But if money is printed faster than a country’s real output, prices increase, and the purchasing value of money decreases – inflation. Essentially, unsecured fiat systems have higher inflation than those backed by gold: 9.17 percent versus 1.75 percent.
Gold is now regarded as a hedge against inflation during economic turns. Inflation can erode the value of even the world’s most important reserve currency: the US dollar. However, the cost of gold increases, and holders, therefore, get more US dollars per ounce of their gold.
Wartime and political tensions
During wars and periods of political instability, investors turn to gold for protection against a potential market downturn.
The particularly tense geopolitics of the late 1970s saw the Iran-Iraq war, the Soviet Union’s invasion of Afghanistan, and the Iranian hostage crisis. The uncertainty of the decade caused gold prices to rise by 23 percent in 1977, 37 percent in 1978, and a staggering 126 percent in 1979.
In 2001, after the September 11 attacks in New York City, gold soared from $215.50 an ounce to $287 an ounce. The subsequent US invasion of Iraq also saw an uptrend in prices – however, confidence that the war would be short and successful meant that it didn’t take long for the value to quickly return to its pre-war figures.
During financial crises, gold retains its purchasing power when confidence in other assets fails. The price of gold often moves in opposition to stock markets or economic swings.
The early 2000s saw the exponential rise of equity markets come to an abrupt end. Although gold had been relatively overshadowed during the dot-com boom, the burst caused a gold rush mentality. Rather than investing in the stock market, people switched to gold and the housing market (the latter would ultimately lead to another crash later). The combination of low interest for federal funds rates, a weak US dollar, and a poor fiscal policy framed gold as a sound alternative investment.
Only a few years later, when the housing market crashed and sparked the worst financial crisis since the Great Depression, gold emerged as a trusted fallback once again. Despite a preliminary dip in October 2008 when it fell as low as $681 per ounce, the metal bounced back by the end of the year to $884. Gold was one of the only markets to close the year with a gain. By 2011, it had stabilized even more and reached a record high of $1,895 per ounce.
The current pandemic has sent stock markets into a downward spiral, and simultaneously impacted gold too. As the crisis intensified in March, some investors initially flocked to cash to avoid risk, while others sold gold for profits to cover losses, meaning the price of the metal began to fall.
However, the decision by central banks around the globe to print more money and stimulate economies has contributed to fears of inflation. In response, gold – seen as a good hedge against inflation – is being regarded more favorably again.
Likewise, after the US Federal Reserve set interest rates to zero, the low returns on debt and bond investments meant investors had less incentive to hold dollars. To calibrate, gold has slowly climbed up in price, peaking at $1,769 per ounce in the second week of April, the highest point in almost seven years.
A historically consistent asset
Gold has historically been a good asset in a crisis because its returns are not closely correlated with risk assets like stocks and bonds. Gold also protects holders against central banks’ quantitative easing – initiatives that tend to happen during crises – serving as a much-needed contingency asset in uncertain times.
Gold manages to not only withstand but flourish during economic dips. For this reason, gold has and will always have the longevity that other assets do not possess.