Gold as a crisis hedge revisited

What can I say about gold that hasn’t been said a thousand times? Not much, really. I have compiled my research some years ago in a paper. In essence, I think gold is predominantly driven by inflation expectations and real rates (with real rates typically being the flip side of inflation expectations priced in bond markets). But this relationship is non-linear and gold reacts far more in situations of extremely negative real rates such as an acute crisis or an unexpected spike in inflation expectations. There is little to no evidence that gold acts as a hedge against Dollar exchange rate fluctuations or to equity market volatility.

However, these are average observations, and Pedro Gomis-Porqueras, Shuping Shi, and David Tan have investigated gold as a crisis hedge with an interesting new approach. They looked at gold as a global asset class that should react to all kinds of crises, not just crises manifest in US assets. Then, they tried to split crisis periods from calm market periods with a new threshold approach. I won’t bore you with the details, but instead, just show you the crisis periods they have identified:

Crisis periods 1997 to 2019

Source: Gomis-Porqueras et al. (2020).

Just looking at the chart shows that gold prices tend to rise in times of crisis and that is what their study finds. In calm markets, there is no link between gold prices and equity markets or sovereign bond markets. But once a crisis hits and markets move fast, gold starts to become a good crisis hedge for shocks in equity markets, bond markets, and oil markets. Furthermore, the authors find that gold prices are always a good hedge against a stronger US Dollar, no matter the environment.

But the gold sceptics out there will notice that all the crises identified in the chart above happened during the last supercycle for gold that started in 1999 and probably ended in 2013. If gold is anyway in a multi-year bull market, it shouldn’t be too surprising that gold hedges against extreme market declines in other asset classes.

What makes the new study interesting is that with the advent of Covid-19 the authors could test their model and their results out of sample with a new crisis that hit outside a gold supercycle. And the good news is that in 2020, gold still acted as a crisis hedge. The results for 2020 were qualitatively the same as the results from 1997 to 2019. Thus, gold remains an attractive insurance against crises – even in the 2020s.