This is the final installment in a three-part series exploring three key reasons why gold could be the best hedge in the event of a major market correction. For part one, click here. For part two, click here.
As we wrote previously, there are many stories in the news lately exploring the various ways to protect yourself from a major market correction. They talk about hedge funds shorting US municipal debt, junk bonds, and foreign bonds in Asia and the eurozone. However, hardly anyone in the media mentions the use of physical gold bullion to protect your savings from a stock market crash. We believe gold will outperform any of these conventional “safe havens” for three key reasons.
The third promising factor for gold in the event of a major market correction is that there are simply few alternatives. Even the conventional “safe bets” don’t hold up to scrutiny in today’s environment.
Treasury bonds have been one of the most traditional investments for protecting savings and providing cash flow. However, bond yields are currently at record lows and will probably move even lower in the event of a market correction. The return on a 5-year Treasury has fallen by an average of 4.3% in each of the past three recessions. In the likely event that this trend continues in the next market correction, the nominal yield could become negative. In other words, investors would be paying the government to take their money!
But the most shocking insight is that this is happening already, when viewed in terms of real return. Real return is what investors take home after accounting for inflation. The Consumer Price Index (CPI) published by the Bureau of Labor Statistics showed inflation in June at 2.1%. Meanwhile, the yield on a 5-year nominal Treasury was 1.63%. So, the real return on these bonds is already negative.
This means that physical gold, which has grown more than 6% from its December 2013 lows, is already a better alternative.
Investments like Treasury bonds have a fixed yield denominated in dollars, while hard assets like gold have an intrinsic value. So if inflation is running at 6% and your bond yield is 2%, you’re actually losing 4 percentage points a year. However, the intrinsic value of physical gold would be appreciating 6% thanks to that same inflation.
This phenomenon is not unique to the United States. The rest of the world mimics the policies of the US and gets the same results. Bond yields in most foreign markets are also at historic lows. Various central banks continue to take the same actions as the Federal Reserve. Diversifying into foreign bonds can be just as poor an alternative.
As we wrote in the last two articles, we strongly believe physical gold to be one of the best options for protecting yourself from a major stock market correction. The first reason is because it is out of favor. We believe this makes it undervalued in the long-term. Second, many “weak hands” have abandoned the market, and serious long-term gold investors have established a floor to the price. Combine these with the fact that the traditional “safe havens” are just not what they used to be, and we believe that physical gold bullion is uniquely positioned to be the best hedge during the next market correction.