The recent crisis in America’s subprime mortgage market sent ripples through stock markets across the globe. The ensuing panic-selling by jittery investors resulted in a worldwide slide of share prices and the threat of serious economic consequences. This, alongside several interest rate cuts from the US Federal Reserve Bank, has sent the dollar sharply lower.
A widespread loss of investor confidence in the banking system and traditional investments has led to a ‘flight from risk’, where investors look to a safer investment option, such as gold, which has proven itself to be a safe haven in times of financial crisis.
This is the conclusion of recent research commissioned by the World Gold Council (WGC) which examines the performance of gold compared with other mainstream assets during the current credit crisis as well as during significant periods of financial distress in recent history.
The WGC analysis looked at gold’s performance in the aftermath of 11 September, 2001, the bursting of the dot.com bubble and the Asian currency and rouble crises, showcasing gold’s role as a portfolio diversifier and safe haven cushioning investors against losses.
2007 credit crunch
The current credit crisis saw gold initially underperforming as it was liquidated to cover losses in other assets. However, as tensions mounted, investors looked to gold as a ‘safe haven’ investment and it has since been the best performing asset in all major currencies, apart from oil.
The WGC report tracked gold’s performance against the major bond and equity markets, the G-6 trade-weighted dollar and oil for two significant periods in the financial markets in 2007 – 25 February to 25 June and 26 June to 26 September.
In the first period gold underperformed as investors remained unconcerned about growing tensions in financial markets (See Chart: Gold vs other asset classes, ‘credit crunch’ 2007). However, as the threat of financial crisis became more evident in the June to September period, gold outperformed the major equities and bonds, overshadowed only by oil. Gold also gained 9.6% in trade-weighted dollar terms in this period.
From September onward, gold has been the clear outperformer as investor nervousness has ebbed and flowed and the dollar has been under heavy pressure. Gold has also been shown to be the strongest performer in all major local currencies.
Gold after 9/11
In the weeks following the terrorist attacks of September 11, 2001, shock waves were sent through stock markets worldwide. Heightened political tension and panic-selling in the immediate aftermath saw the gold price fall from $287 to $279. In the following weeks, investor interest in gold increased, with people viewing it as a safe haven that would cushion portfolios against further losses. A flight into gold followed as equity markets and the oil price lost ground.
After the attacks, the world’s markets continued trading and it took Wall Street only one week to become fully operational again, providing a great boost to investor confidence. This new-found confidence was the reason for gold’s underperformance in October 2001, as investors took an optimistic view of the medium term and sought out value in the equity markets.
In the three months from September 11 onward, the bond markets were the strongest performers in the UK and eurozone, and equities were strongest in the US and Japan. Gold was the second best performing asset in three of the four regions.
The dot.com bubble bursts
Spring 2000 saw the burst of the technology equity bubble, with the overall market decline lasting from 10 March to 14 April. The technology-heavy NASDAQ dropped 34 percent over the period; while the S+P and gold fell by just three percent. The immediate investor reaction to the dot.com bust was a flight to gold and bonds, although, over ensuing weeks, the bond market was the primary beneficiary of investor nervousness.
It took until the end of June for investor confidence to filter back into the markets. From March to June 2000, equities were the strongest performer in the US, while gold was the strongest in the UK and bonds the strongest in Europe and Japan.
There were a number of reasons for gold not being the strongest performer in dollar terms over this period – including the independent strength of the dollar, central bank gold sales and earlier investment activity that had taken place in 1999 as investors became concerned about possible ramifications of Y2K at the turn of the millennium.
Asian currency and rouble crises
The close of the 1990s was a time of financial upheaval. It began with the crisis in the Asian economies, followed by the rouble crisis in Russia and problems at Long Term Capital Management (LTCM). The period of stress spanned from July 1997 to April 1998 and during this time gold’s performance was mixed.
During the Asian crisis, gold found itself under pressure, but this can be seen as confirmation of gold’s role as a safe haven, rather than an argument against it. The Korean government found itself in particular difficulty. After the fall of the Korean won, the country’s government offered to buy gold from the populace, which was subsequently sold on the international market to raise much-need dollars to meet Korean international debt obligations.
In the spring of 1998, the rouble crisis developed as the government in Russia worked to maintain the rouble’s exchange rate steady against the dollar despite increasing internal strain. The government was forced into devaluation in August and the rouble subsequently floated in September.
Gold’s immediate response in September was minimal, but the metal’s comparatively low volatility over this period reinforced its use as a stabiliser in investment portfolios.
Golden days
Gold cannot be considered a panacea for all ills. The performance of the price depends heavily on the nature of the external problem. Where geopolitical tensions are involved, the price tends to rise as investors use it as a hedge against risk and for its portability and universal acceptance as a currency. For the gold price to rally in the wake of a crisis there generally needs to be an element of financial tension that could have an impact on the smooth running of financial markets.
The report also stressed that while dollar weakness has been an important element in contributing to the rally in the dollar gold price during the recent credit crisis, it is not a necessary condition. It also highlighted that gold has acted as a safe haven for investors across the globe, and worked as a hedge against both equity weakness and tensions in the bond markets, although the relationship with equities was generally found to be stronger.
