Hedging Big Trouble

Gold gained in 3 of the last 4 stock-market routs...

The U.S. ECONOMY contracted 1.4% in the first quarter, writes Frank Holmes at US Global Investors.

That led some investors and analysts to raise the specter of the dreaded "R" word: recession.

This, combined with historically high inflation and expectations that the Federal Reserve will raise rates faster than anticipated, could point to trouble ahead for a market already trying to grapple with war in Eastern Europe, ongoing Covid lockdowns and more.

Investors, in fact, may be pricing in an economic downturn.

Below is the Wilshire 5000 Total Market Index divided by US gross domestic product (GDP). Named for legendary investor Warren Buffett, who once called the ratio the best gauge of stock valuations, the "Buffett indicator" has also served as an interesting leading indicator.

As you can see, valuations have historically peaked and then started to roll over between three and five quarters before a recession took place, the one exception being the pandemic-triggered recession in 2020. We're currently seeing the indicator reverse course, but the difference this time is that stocks have never been so overvalued compared to the US economy, making the risk even greater.

There are a number of things investors can do in advance of a possible recession, and that includes having exposure to physical gold as well as gold mining stocks. Both asset classes have historically helped investors offset potential market losses, and I believe there's good reason to believe they may do so again.

Take a look below. Going back 40 years, in every instance when the S&P 500 has fallen into a bear market – that is, when it fell more than 20% off its recent peak – physical gold and gold mining stocks have outperformed, by as much as 41 basis points in the case of gold stocks during the dotcom bubble in 2000.

The price of the yellow metal, meanwhile, delivered positive returns in all but one occasion, and that's when the whole world shut down in response to the onset of the Covid-19 pandemic.

Past performance is no guarantee of future results, of course, but I still like gold and gold stocks as a potential hedge against recessionary risk.

In more recent years, gold has had to compete with Bitcoin as a store of value. I also like Bitcoin, but unlike its digital cousin, gold has a centuries-long track record and enjoys near-universal trust and acceptance. Gold also has lower volatility than Bitcoin, is held by dozens of central banks and remains one of the most liquid assets on earth.

In 2021, the precious metal did more than $130 billion in trading volume every day on average. Only Euros, Pound Sterlings, US Treasuries and S&P500 stocks traded more.