Every economy eventually skids into a recession as part of the natural cycle of ups and downs. And each recession has one common feature: big losses in equities.
In the dot-com crash, for example, most Internet stocks went down 70–90% from their all-time highs, which was a death sentence for investors who heavily speculated on tech stocks.
But even if you are diversified among different sectors, that doesn’t necessarily mean you are safe.
In 2008, the whole S&P 500 index suffered a fall of 38.5%. Now, if you could afford to wait until the market recovered, you were fine. But for those who needed money to cover immediate living expenses, or worse, retirement plans, it was devastating.
As such, hedging your portfolio against a downturn in equities is key to long-term success in investing and your prosperity.
So, how exactly do you shield your portfolio from a recession? The answer lies in the correlation of your assets…
The Best Hedge Against a Stock Market Crash
To avoid or mitigate losses during a crisis in equities, you want to hold assets in your portfolio that are not correlated to the stock market. In simple terms, that means they tend to move in the opposite direction from equities.
For example, treasuries and investment-grade corporate bonds are usually largely uncorrelated to the stock market. Unfortunately, an allocation to bonds hardly makes up for equity losses at current interest rates.
Worse, as bonds are approaching all-time highs after a multi-decade rally, buying this asset class at today’s prices exposes you to a lot of downside risk.
Bottom line: The standard 60/40 allocation won’t work this time around.
But there’s one time-tested asset class that beats everything when it comes to hedging losses during a stock market crash.
First, as you would expect, gold is not correlated to the stock market. That means if equities zig, gold usually zags.
Second and most important, gold’s correlation to stocks drops during a recession.
Look at the chart below to see how gold’s correlation to other asset classes changes when the economy moves from expansion to contraction…
(A “1” correlation means that the asset classes always move in the same direction; “0” means they move together about 50% of the time; and “-1” means they move in opposite directions.)
Gold is already uncorrelated to the S&P 500 during periods of economic growth. But as the stocks fall, the correlation grows even more negative.
That means gold will more often than not move in the opposite direction from stocks during a recession.
History Doesn’t Lie
There have been seven recessions since 1965. Below, note gold’s performance in each of them:
In five of the seven recessions, gold went up. And during three of those times, the metal soared double digits. Even in the midst of the 2008–2009 financial crisis, gold moved higher.
There was only one recession, in 1990, during which gold suffered a decline of 9.1%.
Now, you may be wondering why investors flock to gold when the market tumbles…
The reason is that gold has been a store of value and a unit of exchange for more than 5,000 years. Unlike paper asserts, such as stocks or currencies, gold has retained its value ever since then…
As financial turmoil stokes fear among investors, they buy gold coins or gold bars as insurance against risks such as government defaults, hyperinflation, bankruptcies—all that would make paper assets worthless.
Gold is called a “fear trade” for good reason. Historically, gold has been the best refuge against social, political, and financial calamity.
The Next Recession Is Imminent
The main takeaway here is this: to preserve your investment portfolio and financial well-being, you must own a meaningful amount of gold bullion before the next recession.
Look, we know that:
- gold is not correlated to the stock market
- stocks usually fall in a recession
- another recession will happen sooner or later
And there is no “in case”…
History clearly shows that the odds of another recession are 100%.
No prediction about future events or getting the timing right is required.
This makes gold an absolute portfolio necessity. I know many gold critics who own gold because of this exact argument.
But don’t get me wrong. I’m not suggesting that you sell out your entire equity portfolio and use all the money to buy gold. That would be foolish.
Gold is not a tool of speculation but insurance, and you must use it as such. The rule of thumb—which I personally follow—is to hold about 5-15% of your investments in gold.
Full disclosure: My personal allocation to precious metals is now at the higher end of that spectrum. Over the last few years, I’ve increasingly reduced my allocation to equities and bought more precious metals, which have been out of favor—and cheap—lately.
A little allocation to gold helps you shield the rest of your portfolio from the strong likelihood of financial losses, be it a fall in equity value or a currency devaluation.
And that’s the whole purpose of investing in gold.
Those who own gold stand a greater chance of winning in the next recession than those who do not.
It’s as simple as that. You don’t have to be a doom-and-gloomer to understand it.