Recession Watch: Is gold really a safe hedge?

Applying hedges during periods of economic stagnation or decline can best be compared to taking out an insurance policy to offset, or more likely, to try and mitigate adverse market movements in riskier assets such as stocks, corporate credit and real estate.  

Hedging does not come without risks as the both the choice of product and timing of when the trade is entered will have a major impact on its potential success. 

A good hedge is finding an asset where correlations to other asset classes decreases during recessions. Studies have found that gold’s correlation with stocks breaks down during recessions. This means that historically, gold will often move in the opposite direction of stocks during periods of recession. However, the mere fact that the economy enters a recession doesn’t necessarily lift the price of gold. It also depends on the behaviour of other markets. 

However, in general one can say that during a recession interest rates typically go down while stocks are being hurt by a decline in earnings as consumers’ fear of losing their jobs prompts them to save money instead of spending it. While both are likely to provide support, the risk aversion associated with an economic slowdown may trigger a need from investors to reduce exposure across the board. On that basis, an already elevated speculative involvement by hedge funds could trigger selling of gold, purely from the need to reduce exposure. 

There have been seven recessions since 1965 and during these periods gold rose during five while only suffering a noticeable decline in one.