Economic Crisis

Usually, everything is going fine. But from time to time something bad happens and the crisis breaks out. It may either apply to our business (or personal life), or the whole economy. Then, we talk about “economic crisis”.

There are many types of economic crises: currency crisis, debt crisis, bank crisis, broad financial crisis, GDP crisis, etc. We analyze “financial crisis” in a separate entry, focusing in this case on the latter meaning. We do this for two reasons. First, this is usually what people have in mind when they talk about “economic crisis”. Second, it is the most serious crisis as it entails the most severe effects on human welfare and the whole economy (in terms of increased unemployment and reduced income) often spurring other crises.

So, in the simplest terms, economic crisis is a sharp transition from expansion to a recession, or from boom to bust. Economic crises are, thus, related to the business cycle. They are characterized by a sharp fall in GDP and the rise in the unemployment rate. Investors are shocked and they panic. Nobody knows what will happen next, so there is a lot of uncertainty.

Economic Crisis and Gold

The widespread belief is that gold shines during economic crises. There is something in it, as the safe havens often thrive when economies are struggling, while markets are in turmoil. Indeed, as one can see in the chart below, gold gained during most of the several last US recessions (the timing of recessions is reflected by the rectangles).

_{Chart 1: Gold prices (London P.M. Fix) during recessions (indicated by the rectangles) from April 1968 to January 2019.}

However, the devil is in the details. Let’s take a look at the early 1980 recession. The gold prices were actually rising long before recession due to the accelerating inflation. But then the Fed under Paul Volcker raised the federal funds rate to combat inflation. Although the price increases were eventually curbed, the tightening of monetary policy led to the recession. And gold actually declined initially, only to rebound later. However, when the recession ended, the yellow metal entered a downward trend. Or, let’s look at the early 1990s recession. The price of gold rose only temporarily, as recession was relatively mild.

From that perspective, gold’s behavior in the aftermath of the Great Recession was exceptional. By that we mean  the fact that the recession ended officially in 2009, but gold rallied until 2011 and entered the bear market only in 2013. However, similar to the previous crises, the price of gold initially declined after the Lehman Brothers’ bankruptcy, as investors liquidated their gold positions to raise cash.

Silver and Economic Crisis

Although silver is generally very strongly positively correlated with gold, the chart below shows that it performed worse than gold during the US recession. However, we have to remember about dual nature of silver – i.e., it’s not only a monetary asset, but also an industrial metal. Hence, its performance during economic recessions is somewhat understandable. But when it shined – it shined brighter than gold.

_{Chart 2: Silver prices (London Fix) during recessions (indicated by the rectangles) from January 1970 to January 2019.}

Gold Mining Stocks and Economic Crisis

And how did gold mining stocks performed during the US recessions? Unfortunately, our data series for HUI and XAU indices is much shorter, as it begins in 1996 and lasts until 2016, encompassing only two recessions. However, the chart below clearly shows that the gold mining stocks were a much worse hedge against the global financial crises than gold and silver, as their decline in the very aftermath of the Lehman Brothers’ bankruptcy was much deeper, while their recovery much shallower.

_{Chart 3: Gold mining stocks (HUI Index – blue line; XAU Index – red line) during recessions (indicated by the rectangles) from June 1996 to June 2016.}

Investment Implications

What are the lessons learnt from economic crises for the precious metals investors?

First of all, not all crises affect the precious metals in the same way. The best (of course with regard to the PM prices alone; it’s obvious that crises are terrible events with many people bearing the burden of what they had nothing to do with) are US crises when the faith in the greenback is shaken, as gold is the main rival to the US dollar, and financial crises, as the confidence to the financial system declines then. Although inflationary crises may be beneficial for gold prices, it’s better when the Fed slashes interest rates, not raise them (as they do when inflation is out of control).

Second, gold – as a pure monetary asset – seems to be a better hedge against the economic crises than silver (which also has several industrial uses) or mining stocks (which are, after all, financial assets).

Third, gold’s response to crises may be not straightforward, but rather choppy or non-linear, as investors may initially dispose gold to gain some liquidity. Consequently, while gold is a hedge against systemic risk (the all-hell-breaks-loose situations like World War III, destruction of major stock and commodity exchanges, etc.), the precious metals sector may not provide a significant protection against economic crises in the way most people expect it to.