Gold steps up once again as the ultimate bear market hedge

As inflation and a weakening economy continue to apply downward pressure on the financial markets, gold appears to be stepping up as a worthy hedge.

“Gold has once again reestablished itself as the preeminent hedge against inflation, more so than bitcoin,” said Ed Butowsky, managing partner at Chapwood Investments.

“With the recent ban on gold exports, the value of it will appreciate based on its scarcity,” he said.

So far this year, the precious metal is down just 50 basis points, which compares to a 17.3% drop by the S&P 500 Index over the same period.

Critics of including gold in a diversified investment portfolio will often point to its long-term track record, which can be both sluggish and volatile. Last year, for example, when the S&P gained 28.8%, the price of gold fell by 4.1%. But in 2020, when the S&P gained 18.4%, gold was up an impressive 24.8%.

“Gold is range-bound but obviously has done far better than stocks and bonds,” said Dennis Nolte, vice president of Seacoast Investment Services.

“We think the performance will improve as the economy slides into recession later this year and interest rates moderate,” Nolte said.

Gold, which is among the most unique asset classes because of its status as both a currency and a commodity that doesn’t pay a dividend, might be a lousy long-term investment. But it typically shines brightest during times of economic distress and uncertainty.

Since 2005, gold has outperformed the S&P during every period in which the index pulled back 5% or more. And the greater the pullback for stocks, the better the performance of gold.

Sam Stovall, chief investment strategist at CFRA, maintains a log of market pullbacks of 5% or more and found that since 2005, when the market pullback was between 5% and 10%, gold suffered an average decline of 1.7%.

When the S&P experienced corrections of between 10% and 20%, gold produced an average gain of 3.2%. And during the three bear markets since 2005, when the S&P declined by more than 20%, the price of gold experienced an average gain of 7.6%.

“Gold probably shouldn’t be a long-term hold, because it does better in falling-rate environments, because of the cost of carry, plus it doesn’t pay a dividend,” Stovall said. “But it does well in inflationary environments because people are uncertain about what things are going to cost in the future.”

Michael Reynolds, owner of Elevation Financial, said it’s important to consider investment time horizons when making gold a permanent part of a client’s portfolio.

“Over the long term, you don’t see the returns from gold that you would in a stock portfolio, because it tends to perform in short bursts really well,” he said. “But it’s good as a portfolio ballast, which is why I recommend between 5% and 10% in gold on a regular basis, especially for clients who are between five and 10 years from retirement.”

Reynolds stressed that making gold a permanent allocation will mean sacrificing some returns in exchange for lower volatility.

“A lot of people who are already in retirement also like gold because it balances things out,” he added.

John Bernstein, founder of Bernstein Financial Advisory, uses gold and other commodities as part of a version of risk parity he calls a “better balanced portfolio.”

“This strategy uses some leverage to obtain full balance,” he said. “Since I don't think using leverage would be appropriate for many of my clients, I use a modified version of risk parity investing.”