Black Swan Event and Gold

A black swan is an unpredictable and rare event in the markets. Is gold a hedge against black swan events?

 

Black Swan Theory

Black swan events can lead to severe and far-reaching consequences for the economy and the financial markets. Some notable examples of black swan events include the 1987 stock market crash, the bursting of the 2000 dot-com bubble, and the 2008 global financial crisis (GFC).

Coined by writer and former Wall Street trader Nassim Nicholas Taleb, the term "black swan" comes from the notion that all swans are white. However, the discovery of black swans in Australia shattered this assumption, leading Taleb to use it as a metaphor for unexpected events in the financial markets.

Black swans often catch investors, analysts, and financial institutions by surprise, leading to widespread panic, sharp declines in asset prices, and even triggering recessions. Catalysts include natural disasters, geopolitical conflicts, financial crises, technological failures, and rapid shifts in sentiment and positioning.

These tail risks highlight the limitations of traditional risk models, which often assume that markets follow predictable patterns and that extreme events are improbable. However, the financial markets are inherently complex, and unpredictable forces can sometimes spoil the party.

 

Black Swans and Gold

While theory implies that gold is a hedge against black swan events, the noble metal enjoys varying degrees of success. For example, gold is a safe-haven asset that benefits from economic and geopolitical uncertainty. And when anxiety reigns, the turmoil can cause investors to seek refuge in gold, which drives up the price.

However, it’s important to differentiate between the short and long term. When shocks occur, volatility can push the gold price lower. This happens because liquidations affect all assets, and when other commodities plunge, gold rarely escapes the carnage.

Furthermore, leveraged investors confront margin calls during black swan events, which requires them to raise cash to maintain their stock positions. And this sometimes forces them to sell their gold positions to cover the losses. Consequently, gold’s performance is often mixed during black swan events.

As evidence, the chart below highlights the behavior of gold and the S&P 500 leading up to, and during, the 2008 GFC. The gold line tracks the gold price, while the blue line tracks the S&P 500. As you can see, when the S&P 500 began its descent in mid-to-late 2007, the gold price soared.

Yet, when large institutions filed for bankruptcy in late 2008 and the S&P 500 crashed, gold crashed along with it. Thus, while theory implies that gold should benefit from the chaos, the reality is that gold is still a risk asset, and everything typically drops when panic erupts. For context, U.S. Treasury bonds and the U.S. dollar tend to outperform during crises.

Is Another Crash on the Horizon?

While black swan events often come out of nowhere, a few common ingredients often precede their arrival. And with unanchored inflation, surging home and stock prices, and a rapid rise in interest rates part of the post-pandemic cocktail, it’s likely only a matter of time before an unexpected event rattles the financial markets.

To stay vigilant, we analyze several technical and fundamental indicators to avoid getting caught off guard. Moreover, our premium alerts dissect these variables to determine when the economic cycle should shift.

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