Look to gold for protection from market turbulence: How owning precious metals can provide a hedge against choppy markets

Americans Invest In Gold
The gold price has recently stayed around the range of between $1,310 and $1,360 (Source: Getty)

While the main goal of investing is to grow one’s wealth, cautious investors should consider how to preserve their wealth in the event of a sudden market crisis.

One classic solution is adding exposure to precious metals, such as gold and silver, which are commonly considered as safe haven assets.

The importance of safe havens was proven by recent stock market corrections. London’s blue-chip share index, the FTSE 100, hit a high of 7,778 points in mid-January, but fell nearly nine per cent to 7,092 by 9 February. Similar drops were seen across global markets before they stabilised.

Exposure to precious metals could have reduced the potential portfolio losses. First, because owning different asset classes adds diversity to a portfolio and, second, because metals, especially gold, tend to be negatively correlated with the rest of the market; when stock and bond prices fall, gold prices may stay the same or go up.

So while stock markets have been volatile over the past two months, gold prices have stayed within the range of $1,360 and $1,310 per ounce since early January, a variation of around 3.7 per cent. This ability of gold and other metals to act as an insurance, or hedge, against market turbulence is their main appeal.

Read more: The price of gold has risen to a fresh four-month high on a weak US dollar

“Precious metals are basically a hedge against catastrophe, and as such shouldn’t make up more than five to 10 per cent of a portfolio,” advised Laith Khalaf, senior analyst at Hargreaves Lansdown.

Precious metals also act as an inflation hedge; the purchasing power of gold, for instance, is relatively stable, partly because there is a limited supply of the metal in circulation. Central banks can print more money which devalues a currency and companies may issue new stock which dilutes existing shareholders’ ownership, but gold cannot be created from thin air.

There are headwinds facing precious metals. Gold and silver are non-yielding assets: they do not pay dividends or interest (technically, they are negative-yielding assets, due to the fees from buying and storing them). Meanwhile, markets are anticipating central banks, specifically the US Federal Reserve, will raise interest rates.

“Rising interest rates are not a positive omen for precious metals, because gold and silver don’t yield anything. Given cash hasn’t yielded very much for the last decade, that’s meant the opportunity cost of holding precious metals has been low, though tighter monetary policy means that dynamic’s now changing,” explained Khalaf.

Despite this, gold is still holding up well, according to Adrian Ash, director of research at online precious metals marketplace BullionVault.

“As US Treasury prices have sunk and bond yields spiked, gold has held firm versus the dollar,” he told City A.M.

“Resurgent inflation, plus fears that 2018 will mark the big top in equities, only add to gold’s attraction as a defence against the threat of further losses in debt and credit instruments. UK investors face those same risks, as well as fresh volatility and political uncertainty as the March 2019 Brexit deadline draws ever closer.”

One way to invest in the asset is to buy bars and coins made from a precious metal. This avoids counterparty risk: if you owned gold through a brokerage, there is a risk the broker could go insolvent.

An alternative method is to invest in an exchange-traded fund (ETF) backed by a physical asset.

Read more: UK investors are bullish on emerging markets, says Franklin Templeton

“The problem with (buying gold coins and bars) is that you don’t get direct translations to the gold spot price, because typically those are retail products that are bought and sold with high premiums or discounts to the actual gold price,” Will Rhind, founder and CEO of commodity ETF provider GraniteShares, told City A.M.

“If you buy your own bars and coins, you’re going to have to store them yourself and you’re going to have to insure them yourself. All things being equal, the cost of doing that is more than if you were to just invest in a gold ETF.”

Rhind added that the current environment is positive for commodities.

“We’ve come out of a bear market in commodities and gold over the last sort of two years and prices have started to move upwards.”

A third way is to invest in a precious metal miner. These firms should benefit from rising commodity prices, while paying a dividend to shareholders. But there are drawbacks.

“Mining companies offer another way to play precious metals, though the price of these companies is more in tune with global equity markets, and so acts as a less effective hedge in a portfolio,” warned Khalaf.

Anthem Blanchard, co-founder and CEO of precious metal marketplace Anthem Vault, warned against investing in gold mining stocks.

“A company could be incompetent, or it could be wonderful but have bad timing, or it could be amazing but the government of the country it decided to locate its mines in could take them over,” he said.

“Gold can just be sitting in a vault, or in a mason jar you bury somewhere on your property. You don’t have to worry what the balance sheet looks like of the earth you’ve buried it in.”

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