It’s something you hear over and over: Gold is a safe haven in times of crisis. It has been since the beginning of time.

The conventional wisdom is that gold becomes a safe haven whenever the stock market appears vulnerable to a downturn, because gold does not typically move in tandem with stocks.

But is this always the case?

Let’s look at two recent examples…

The Great Financial Crisis

The first example is from the last financial crisis. Indeed, back then, the yellow metal outperformed the stock market.

Just look at the chart below…

Chart

Both the S&P 500 and the gold futures sold off at first during the financial crisis.

Gold, however, was able to find a bottom much faster. Then, it gained strength while the stock market continued to sell off.

All in all, the S&P 500 lost 58% of its value from the start of the crisis in October 2007, to the end in March 2009. Gold, on the other hand, gained 25%.

The Current Crisis

Now, let’s examine another chart. This time, we’re looking at the S&P 500 and gold charts from March through April 2020…

Chart

After the most vicious stock market selloff in history, both gold and stocks began recovering roughly around the same time.

As we can see from this chart, gold once again found a bottom sooner than the stock market.

Stocks, however, have since gone on to outperform gold futures. Gold came under selling pressure on April 14, while the S&P 500 closed the week on its highs.

As stocks and gold begin to show signs of diverging, with stocks going higher, the mainstream conclusions seem to be that we’ve found a bottom in the markets.

This would suggest we are about to start what will be a fast and furious economic recovery.

However, as Andy and I have written before, the current buying in the stock market is exactly what we’d expect to see in a countertrend rally. Anyone who thinks we’ve seen the bottom is in for a surprise.

But there’s another major surprise coming: Gold will fail to provide any shelter in the storm Andy and I see forming. Here’s why…

Gold in Times of Deflation

Gold works quite well as a hedge against inflation.

In other words, you want to own it when there is an expansion in the total supply of money and credit in the economy. Gold tends to go up then, because its price in U.S. dollars varies with how weak or strong the dollar is.

There’s more credit available to borrowers, and lenders are eager to provide this credit. So the dollar can lose some of its purchasing power. When that happens, gold tends to become more expensive.

In a deflationary environment, however, gold is far less effective of a hedge.

Deflation is the contraction of the total supply of available money and credit. We saw the first glimpses of the coming deflationary cycle in the February selloff this year.

Almost no asset class was safe as people scrambled to get their hands on U.S. dollars. Gold resisted at first but gave in on March 9. It lost more than 9% of its value in just five days of trading.

The first wave of this new cycle should have been a wake-up call to everyone. Investor psychology changed extremely quickly and crowned the U.S. dollar as the cash king.

That said, there will be opportunities for traders as we head into this deflationary environment. But the only way you can profit from them is if you have cash to invest.

So if you haven’t built up your cash position yet, now is the time.

Regards,

Imre Gams
Editor, Money Trends

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