Gold bullion can be a good way to play the market, but only if you don’t ask too much of it. The ultimate ‘safe haven’ means different things to different people. History shows that some of gold’s apparent appeal isn’t in fact warranted.

Investors tend to see gold as a tool for hedging risk, a portfolio diversifier that can act as insurance by rising in price when other things fall. Many short-term traders, on the other hand, think gold offers a good bet when bad things are happening more broadly – and it’s here that gold bugs can get stuck sounding like ghouls. We simply can’t wait for Armageddon to hit, because we will get rich just in time to get fried.

Short lived Bullion gains from recent political crisis

From the Russian invasion of Afghanistan in 1980 to the terrorist attacks of 9/11, gold is often seen jumping on political crisis. But against those events, history also offers many examples when gold held flat or fell when bloodshed broke out. This year’s threat of nuclear war between the US and North Korea, for instance, gave the yellow metal only a brief pop.

That move was in fact driven by speculative traders themselves, buying Comex gold futures and call options and so pushing up the price of those contracts. Gold’s gains proved short-lived because, away from the derivatives market, physical investment demand actually eased off, with gold-backed ETF funds failing to grow and private investors selling coins and small bars to take profits from the spike.

Most clearly retail traders have been following this strategy since Donald Trump won the US election in late 2016. Buying and selling as little as one gram at a time of large, vaulted bullion bars, they have increasingly used the peaks and troughs created by action in the derivatives market to trade gold’s price range over the last 18 months.

Gold Investor Index

BullionVault’s Gold Investor Index tracks how many people bought gold over how many sold each month. It shows that interest in physical gold has moved in the opposite direction to gold prices almost 90% of the time since November 2016. That contrasts with less than 45% of the time across the previous 18 months, before Trump won the White House.

So if the Donald really does risk starting a war with North Korea (or with Iran, Russia, or China) many private traders buying and selling physical gold either don’t believe it or don’t think gold would keep rising on that outcome. But what about the metal’s other claim to ‘safe haven’ status, the idea that it acts as a hedge against losses in the stock market?

Protection against short-term volatility

Day-to-day, buying gold to protect against short-term volatility in the stock market has been no better than a coin toss. Since the FTSE 100 index was launched in 1984, it has risen in 55% of all weeks. Gold rose 52% of the time when the FTSE went up, and it rose 49% of the time when the FTSE fell. Across longer time frames however, gold has tended to rise when equities have fallen.

The track record isn’t perfect, and the past is of course no guarantee of the future. But our research into risk shows that in 2008 – the worst year of the last 40 for UK assets – a typical portfolio split 60:40 between equities and bonds would have cut its losses in half by moving 10% into gold. That switch would also have doubled an investor’s total return across the worst 5-year period, from 2000 to 2004.

Bottom line?

History says that trying to trade gold bullion as a political or short-term ‘safe haven’ is unlikely to pay. Smarter traders have in fact gone the other way over recent months, selling when the headlines screamed crisis and buying back when prices then eased. Or take the long view, and use gold to balance the risk of extended falls in the stock market.

It isn’t guaranteed to work. But that is how things have tended to play out for the ‘safe haven’ metal.

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Commodities and Shares Editor
30th May 2018
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