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The Role of Gold as Turmoil hits wider Financial Markets

As market turmoil hits both equities and cryptocurrencies, the heightened volatility in these assets underscores gold’s unique role as a safe haven, store of value and portfolio diversifier.

Stock Market Selloffs

With major US stock indices falling again sharply on Thursday (DJIA - 4.02%, NASDAQ - 4.08%, S&P -3.41%), last Monday’s equity market selloff and spike in volatility looks set to be a more prolonged affair than a one-off plunge and recovery. The Dow’s Thursday close of 23860 is 2756 points, or 10.3% lower, than the all time high of 26616 from 26 January, and the Dow is now officially in correction territory. This week also saw two records added to the history of stock market selloffs, Monday’s biggest ever points drop in the Dow, and Thursday’s second biggest ever Dow points drop.

Similarly the S&P 500 index closed on Thursday at 2581 and is now 292 points, or 10.1% lower than its all-time high of 2,872.87 from 26 January, again in correction territory.

The NASDAQ composite, which also reached its all-time high of 7505 on 26 January, is virtually in a 10% correction zone below 6755, as it closed just a few points over this level at 6777 on Thursday.

Finally, the CBOE Volatility Index (VIX), the widely used measure of stock market volatility - which is also known as the investor fear gauge - had spiked up massively late Monday and into Tuesday to the 35-40 range, and critically was again seen approaching those levels at Wall Street market close Thursday.

Equity market indexes across the globe, as normal taking their cue from Wall Street trading, have also been falling in tandem, with markets in Europe, Asia and the Americas all lower on the week.

Whatever the reasons for the shift change in market sentiment, from macro factors to algorithmic trading, these abrupt index plunges and the rise in volatility have spooked investors across the globe and have led to panic selling and active profit-taking. With a low volatility environment less certain than before, market consensus on ever-increasing stock prices may be beginning to unravel.

Clouds over Cryptocurrencies

In cryptocurrency markets, the price euphoria seen in December and early January led by Bitcoin and some other large alt coin rivals has also given way to deep corrections and unclear price direction.

Until earlier this week when Bitcoin rallied back to above $8000 from below $6000, Bitcoin’s price had been on a consistent downward trajectory for nearly a month. From its intermediate high of US $17,000 on 7 January, in less than 30 days, the price had collapsed to below US $ 6,000, an approximate 65% drop. From the ultimate high of just over $20,000 on 17 December to the recent low of below $6000, Bitcoin’s price collapse exceeded 70%. Similar price movements were seen across the board in other crypto coin prices, both large and small cap.

Coupled with Bitcoin’s equally sharp price gains in late 2017, the short-term price movements of Bitcoin, both up and down, are hugely volatile. As recently as a year ago in early February 2017, Bitcoin in US dollars was still trading in the $1000 range. It was only in May 2017 when the price first breached the $2000 mark and August when it initially hit the $3000 range. As its meteoric rise continued, by late October the price had again doubled to $6000, and it was just mid-November 2017 (less than 3 months ago) when the Bitcoin price first traded in the $8000 range, a similar price range to where it now finds itself back at now.

Mid-November is also arguably the point at which Bitcoin’s dizzying ascent really got going, shooting up to over $11,000 before the end of November. It was at this point that hundreds of smaller alt coin prices started to really explode upwards also, taking the broad cryptocurrency market and the overall sector MarketCap much higher.  Within a week between 1 December and 8 December, the Bitcoin price had again exploded to over $18,000, and the ultimate peak of $20,000 was reached less than 10 days later on 17 December.

After this, a series of lower highs and lower lows saw the Bitcoin price oscillate wildly in the $12,000 - $18,000 range before its prolonged fall from 7 January onwards to below $6000 on Tuesday 6 February, and its subsequent bounce  to $8000. This high price volatility must raise the question of Bitcoin as store of value, and to what extent it is primarily a payment system versus a dependable store of value.

Gold's Attraction in Market Turmoil

Investors in financial and other asset markets prefer predictability and stability. Hence investor apprehension at the growing uncertainty and heightened volatility in global stock markets and the recent pump and dump chart patterns of many cryptocurrencies.

But it is during market turmoil that gold’s safe haven qualities come to the fore. Since gold has no counterparty or default risk it is a universally known and universally used safe haven for preserving wealth during market crises. Gold's high liquidity also adds to its safe haven appeal. During financial market turmoil, gold's price therefore generally reflects this movement out of risk assets and into the safe harbour that gold provides. The below chart plots a relatively comparison between the US dollar price of gold and the S&P 500 index, over the week beginning Monday 5 February, showing gold's outperformance as the US stock market suffered a series of selloffs.

USD Dollar Gold Price in terms of the S&P 500 Index, Week from 5 February 2018. Source: BullionStar Charts

Gold is also one of the traditional and best-known stores of value, some others being land and property. A reliable store of value asset will allow you to park your wealth and retrieve it at a later time knowing that it will still have value and will have retained the value that it had when you converted some of your savings or wealth into that asset. A reliable store of value will also adjust for inflation and retain its purchasing power relative to inflation. Physical gold in the form of gold bars and gold coins does just that and retains its purchasing power over long periods of time precisely because the gold price, as an inflation barometer, adjusts to reflect expected inflation.

Finally, gold can also reduce the volatility of a portfolio of investment assets such as stocks and bonds. By adding an investment in gold, the resultant portfolio displays less volatility of returns, and can also exhibit higher expected returns. This is due to the gold price having a low to negative correlation with the prices of securities such as stocks and bonds.

Eat Gold

A popular phrase in segments of the mainstream financial media is that “You Can’t Eat Gold”. We don’t know who first uttered this comment, but it was more than likely a talking-head or Wall Street analyst on CNBC or Bloomberg.

The disparaging claim seems to be based on concluding that in a financial or monetary crisis, if you own gold, that “You Can’t Eat It”. And so, according to the logic of whoever came up with the phrase, this would make gold useless during a financial crisis.

In addition to the misleading and irrelevant nature of the comment, which we will discuss below, the claim that “you can’t eat gold” is actually factually wrong. And that is because you can eat gold. And also drink it.

Eating and Drinking Gold

While gold can be eaten, it cannot be digested. But it is non-toxic to the human body. And it does not react chemically in the human body. That is why gold can and does appear safely in a number of foods and drinks, not surprisingly foods and drinks which are predominantly at the luxury end of the market.

Some readers will have heard of Goldschläger, a Swiss/Italian liquor which has flakes gold suspended within it. On a similar note, a Swiss gin called ‘Studer Swiss Gold Gin’ also contains flakes of gold. Staying within Switzerland, you can also buy edible gold products including “Swiss chocolate truffles with gold flakes”. Not to be outdone by the Swiss, the Emirates Palace Hotel in Abu Dhabi (United Arab Emirates) offers a ‘Palace Cappucino” which is sprinkled with gold flakes.

In Selfridges department store in London, you can buy a “billionaires soft serve” ice cream cone topped with both sprinklings of gold leaf and a gold leaf covered flake. While in New York, in Manhattan’s Upper East Side, a high-end restaurant offers a "Golden Opulence Sundae” topped with gold leaf, for US$ 1000 a glass. Back in England, a specialist cheese producer in Leicestershire created Britain's most expensive cheese - "Clawson Stilton Gold", a stilton cheese interwoven with edible gold leaf and shot-through with gold liqueur. These uses of gold in food and beverages illustrate that gold is a sought after and prestigious substance, but also that gold is real, that gold is tangible and that gold is of value.

Wall Street's Selective Focus

The logic of the “you can’t eat gold” comment, as well as being wrong, is also flawed. Because by extension, you can’t eat any of Wall Street's favorite investment assets. Imagine chewing on financial securities or fiat currencies. But whoever coined the phrase “you can’t eat gold” conveniently failed to mention this on CNBC. We would challenge anyone, especially CNBC and MSNBC, to eat share certificates or bond certificates or the electronic equivalent thereof.

Nor can you eat the electronic coins of cryptocurrencies such as Bitcoin, Ethereum’s Ether or Litecoin. Real assets such as art, antiques, real estate, agricultural land, or vintage cars are also off the menu. A possible exception is that can drink an expensive investment wine collection, but would you really want to do this, as then you would be consuming your principal investment?

Wall Street analysts fail to mention that you can't eat stocks and ETFs

Gold's Many and Varied Benefits

But beyond the fact that you can in fact eat gold, and that Wall Street never points out the non-edibility of stocks and bonds, there are many beneficial reasons to buy and own investment grade physical gold of which we recently pointed out in 28 reasons to buy and own physical gold. What we are talking about is real physical gold in the form of gold bars and gold coins. This is true both during times of financial crisis, and also over the long-term as a form of investment and savings.

Gold is without doubt the ultimate safe haven asset. In times of financial crisis and turmoil, investors and savers flock to gold as a wealth preservation strategy. The reason for investing in gold during times of crisis is based on the fact that investors instinctively know that the gold price behaves differently to the prices of other assets, particularly during crises. This is because the gold price moves independently of economic and business cycles.

In times of war and social upheaval, physical gold's benefits also come to the fore. Since gold has a high value to weight ratio, significant personal wealth can discreetly be carried in the form of gold across borders and frontiers and within areas of conflict.

Since gold is a universal money supported by a highly liquid global market, it will always be accepted everywhere at the going gold price. Gold can easily be sold. Gold can easily be traded or even bartered with, especially in non-functioning economies where the local paper currency has collapsed or has become worthless. The fact that gold coins are regularly issued to elite military personnel in areas of conflict attests to gold's critical benefits in times of monetary crisis and localized economic collapse.

Gold as Store of Value

But gold is not just of use during financial crises. It is also an essential asset to own over the long-term as a strategic form of saving and investment. Physical gold retains its purchasing power over long periods of time. This is in contrast to fiat currencies issued by the world's central banks, which generally lose most of their purchasing power over time. In other words, gold is a great hedge against inflation, as the gold price adjusts upwards to offset inflation. The gold price even adjusts to inflation expectations, hence it is sometimes called an inflation barometer and is watched like a hawk by central bankers because the gold price signals future inflation.

Physical gold is also an asset without counterparty risk. This is because when you own physical gold in the form of gold bars or gold coins, there are no counterparties. In other words, the physical gold that you own outright is no one else's liability. Nor are there any governments or central banks involved in issuing gold, or in trying to increase and debase its supply. Gold also lacks default risk, because it cannot default.

Physical gold is also inherently valuable because it is a scarce precious metal that is difficult and costly to mine and refine. Gold's price will never go to zero because it has a finite and significant production cost. Physical gold is difficult to counterfeit, impossible to create artificially, and cannot be debased.

These are just some of the reasons for buying and owning physical gold. Please see BullionStar's recent article "28 Reasons to Buy Physical Gold" for a  list of reasons why you should consider buying physical gold.

Gold in Zimbabwe & Venezuela & South Korea

In the real world, owning physical gold can be of critical importance in scenarios where trust in a nation's money supply has evaporated, such as is currently the case in Venezuela or Zimbabwe.

Gold can also be of critical importance when entire nations suffer economic shocks.  A case in point is the interesting experience of South Korea during the Asian financial crisis that swept the region in the late 1990s. This crisis left the South Korean economy severely impaired, with it’s currency, the Won, collapsing against the US dollar.

In addition to a bailout by the International Monetary Fund, the South Korean government also launched a patriotic campaign in early 1998 to actually collect physical gold from the South Korean citizens which was then sold on the international market to raise much-needed foreign currency. This collective campaign was pursued precisely because the South Korean government understood that gold is a high-quality liquid asset that has substantial value.

National Mobilization of Gold

By mid-March 1998, the South Korean citizenry had donated more than 220 tonnes of gold, worth over US$2 billion, in the form of investment gold coins and bars, and other gold in the form of rings, jewelry, and gold medals. More than 3 million households were said to have contributed. This collective mobilization of gold to overcome a nation's economic adversity and raise financing is a great illustration of how gold comes to the fore in a time of crisis, due to its store of value, safe haven, and high liquidity characteristics.

In conclusion, knowing the many compelling reasons to buy and hold gold, and how gold can sometimes be a lifeline in a time of crisis, the claim that "you can't eat gold" is exposed for what it is, misguided and disingenuous, and shows either ignorance on the part of the people who use it, or more likely, a deliberate intention to mislead and deceive.