As stock markets dropped precipitously in recent days, the price of gold—considered a safe haven from riskier assets like stocks—has fallen too.
But gold didn’t fall nearly as much. True, the front month of Comex gold for March delivery—one measure of the yellow metal—lost 11.26% in the last five trading sessions to end at $1,485.90 on Monday.
Yet consider that the 1.97% drop on Monday took place as the Standard & Poor’s 500 tumbled nearly 12%.
“What gold did [Monday] is one of the main reasons people want to own gold in their portfolio, because it has in the past, historically, frequently offered some protection against the sudden sharp downward move in equities,” says George Milling-Stanley, chief gold strategist at State Street Global Advisors.
Why Gold Fell
But why did gold fall at all if it’s supposed to provide safety? According to Milling-Stanley, investors were selling their gold positions to raise cash to cover margin calls.
Investors often buy stock on margin—or with borrowed money. If stock prices drop dramatically, and the value of this investment sinks, “your broker will ask you to put additional margin,” he says. “Rather than having to sell equities—which people otherwise might do—they sell something that has held up in value, which is gold, so they are able to meet those margin calls, and they are still involved in those equities hoping that they will recover.”
This pattern has repeated during every major stock market sell-off. It happened in the stock market slide at the end of February, before Federal Reserve’s first “off-cycle” rate cut of half-a-percentage point. It also happened when stocks tanked at the end of 2018, during the financial crisis of 2008-’09, when the “dot-com” bubble burst in 2001, and on Black Friday in 1987, Milling-Stanley says.
“It still seems to surprise even seasoned observers of the gold market, but it shouldn’t surprise them anymore,” he says.
Typically, gold tends to recover within the days and weeks afterward, “and usually goes to new highs, especially if equities remain depressed,” Milling-Stanley says.
“The only danger is if we get additional declines in the equities markets,” he says. “If we do slide into an official recession, globally, then you may see further selling of gold in order to meet additional margin calls.
“Really everything depends on the equity markets right now,” he says.
In gold trading on Monday, the price of spot gold, or the current price, recovered to about $1,510 and then dropped back below $1,500. The next level Milling-Stanley is looking for is about $1,589.
Why Own Gold
Investors typically own gold for diversification from standard assets including stocks, bonds, real estate, and private equity.
While it doesn’t provide a coupon or a dividend, the compound annual growth rate for gold since 1971—when the free market in the metal was created—has been about 7.75% a year, Milling-Stanley says.
Gold also is attractive to some investors because it’s liquid, meaning it’s easy to buy and sell. Current market dynamics aside, “typically gold prices strengthen when other parts of the portfolio falter,” he says.
State Street’s $47 billion exchange-traded fund, SPDR Gold Shares (GLD), tracks the price of gold, minus administrative costs, and is considered a well-known benchmark in the market. The shares outstanding on the New York Stock Exchange are backed by US$47 billion worth of gold bars held at HSBC in London.
Milling-Stanley describes it as a “cost effective way to own exposure to movements in gold.” It’s also a liquid way to trade it.
The fund is down 10.25% for the week through Monday, but only 0.88% year-to-date, according to Morningstar. Through the market tumult, it “has not seen massive redemptions,” he says.
How to Incorporate Gold in a Portfolio
The Colony Group, an $11 billion investment manager with offices across the country, allocates about 5% of its standard, moderate-risk portfolio to so-called non-traditional liquid assets, including metals as well as real-estate investment trust, according to Richard Steinberg, the firm’s chief investment strategist.
Currently, the firm’s core portfolio doesn’t include gold, although the manager of Colony Group’s value-oriented holdings bought it at the end of last year, Steinberg says.
The strategist says gold can be viewed as a safe haven for investors in a normal market. Non-traditional assets, including gold, have the potential to be a drag on a portfolio, but they still provide diversification and “smoothing effects,” he says.
Steinberg suspects one reason gold fell along with the market recently is that investors, including wealthy clients, like to generate cash in their portfolio “as a psychological buffer.”
But most high-net-worth and ultra-high-net-worth clients “have enough cash on the sidelines to meet their one-to-two-year burn rate or spend policy,” Steinberg says. That means “they have the opportunity to remove some of the emotion and look for market opportunities in these types of environments.”
Gold, he says, “would be one of them.”
Steinberg manages a tactical ETF for Colony that allows him to make valuation decisions across all asset classes, including non-traditional assets. He hasn’t traditionally owned gold. “But it’s starting to look interesting,” he says.