Gold has always been considered a safe haven, with many investors turning to the yellow metal during recessions and turbulent times. But SPDR Gold Shares ETF (NYSEARCA:GLD) has fallen 16% from its recent March 2022 high of 191.51. So why gold has fallen this year despite the economic turmoil? Will it recover soon? Let’s see what drives the price of gold and what could happen next.
Gold Has Historically Performed Well During Recessions
Gold’s value comes from its rarity as a precious metal and its long history as a stable medium of exchange.
Gold also has a low to negative correlation with the stock market, suggesting that movements in the price of gold don’t depend on moves in equities. As a result, gold is seen as an effective diversification tool for investors wishing to hedge their bets.
Since 1971, when the gold standard was abandoned, gold has largely experienced positive price movements during recessions most of the time. And in the last three recessions since 2000, its performance has thwarted that of the S&P 500. Although the value increases have not been dramatic, they are helping to shore up gold’s position as a hedge against financial turmoil and as a store of value.
For example, when the stock market crashed in 2007, investment demand for gold increased as investors sought a safer option. Between 2007 and 2011, the price of gold more than doubled. Likewise, with fear and uncertainty at an all-time high during the COVID-19 pandemic, gold-backed exchange-traded funds saw record inflows. As a result, the price of gold hit an all-time high.
However, while the price of gold tends to rise during turbulent economic times, it often stagnates or falls when the economy is strong and investors are looking for riskier investments. Therefore, investors must consider the overall macroeconomic and geopolitical environment when looking at gold.
It’s Not The First Time Gold Drops at the Start of a Recession
So one would expect gold bullion and its equivalents to hold up during a stock market crash. But historical charts reveal that time and time again, gold drops significantly when stock markets crash at the onset of a recession.
The global economy has been rocked by turmoil in 2022, with consumers facing high inflation and investors seeing dismal stock returns.
While these market conditions generally indicate an increase in demand for gold, this has not been the case so far this year, as gold prices have fallen. This is partly due to rising interest rates, which increase the opportunity cost of holding gold, as investors forego interest income that they could earn from savings accounts or obligations.
Gold prices are also hammered at the onset of a recession because of margin calls and corporate bond defaults. When the global economy deteriorates, this unraveling of shaky credit becomes the driving force behind the stock market’s fall. Liquidators are motivated to sell the debtor’s high-value shares before their value drops in a liquidator-driven liquidation.
Inflation Will Drive the Yellow Metal Higher
But it is not the only market force that affects this precious metal. While the above scenario temporarily puts downward pressure on gold, gold will take off once margin calls and corporate bond defaults run their course. General mistrust of the market during a recession drives investors away from the fragile stock market and into history’s most famous hedge gold bullion, seen worldwide as a reliable investment, especially in a weak economy.
History shows that gold often outperforms US equities and the dollar after interest rate hikes, having underperformed before rate hikes. Additionally, high inflation erodes the purchasing power of every dollar, prompting investment in tangible assets like gold and other durable assets.
Inflation is sure to fuel gold’s rise even higher because it will take an ever-increasing amount of fiat money to buy an ounce of gold. Plus, investors have relied on gold as an effective hedge against currency depreciation for centuries.
Featured Image: DepositPhotos @belchonock
