Is Gold the Remedy for Bear Markets? Stick with Investments, Not Speculation

In the midst of the recent market downturn, financial news pages were filled with advice on how to counteract the decline in equity prices.  One perennial favorite is to advise investors to invest in gold as a store of value and a hedge against bear markets.  Several clients have asked if this is a wise strategy.  The answer, from our perspective, is no.  As alluring as it is to think there may be an antidote to the down side of equity investing, unfortunately, the relationship between risk and return does not allow for any easy loopholes, and furthermore, as with any investment, if the financial press is writing articles about it, you can rest assured that prices have already adjusted to the “insights” they are pedaling.  We have two main objections to the protect-yourself-with-gold philosophy, discussed briefly below.  

Commodities Don’t Work for You. Gold is a commodity whose value fluctuates predominantly based on what others think it is worth.  It does not pay you interest, like bonds.  It does not pay you dividends, like stocks.  It does not confer shares in a company, comprised of dynamic people, who will react to changing economic environments and try to ensure that the value of their company appreciates over time, regardless of oil prices, interest rates, volatility in emerging markets, etc. The only reason an investor buys gold is the hope that some other investor will think that the same gold is worth more in the future.  In other words, the investor is simply speculating as to the future price. 

Market Timing Strategies Are a Perilous Endeavor.  Additionally, the price of gold is extremely volatile, as evident in the chart to the right with inflation-adjusted prices for gold over the past 90 years.  While it does often rise during recessions (indicated on the chart by the shaded bars), the increases are abrupt and have often been followed quickly by even more significant decreases (see, e.g., 1974, 1983, 1991), meaning that the success of the strategy depends on effectively timing the market.  As we have discussed in other posts, trying to pick hot stocks or other investments at just the right time–buying at the lowest low and selling at the highest high–is a very risky endeavor, which, for most investors and even for most investment managers, is a losing proposition.  Market prices adjust rapidly to new information–see the box to the left for one example–and acting on that information too late can erase any potential gains.  Thus, if your goal is not to hold gold over the long-term but simply to trade into gold during bear markets, the likelihood of missing the jump in gold at the onset of (or just preceding) a market downturn is high, as is the likelihood of missing the jump in equity prices when the market rebounds. 

We prefer to stick with investments that work for us–that pay us income each year and are based on companies that will continue to grow and adapt over time–and that do not depend on market timing.  The DFA equity mutual funds that we use are fully invested in the market at all times.  They will decline in bear markets, but they will also experience the full rebound in bull markets, and thankfully, the market does go up roughly 70% of the time!