I Thought Gold Was A Safe Haven! Why Did It Tank With Stocks?

Authored by Mike Maharrey via Money Metals,

And in the blink of an eye, the expectation of a “soft” landing turned into worries about a crash landing!

It was a bloody Monday in the stock market as analysts digested the dreary jobs report released Friday and suddenly discovered the rot in the economy’s foundation.

They fretted that the Federal Reserve waited too long to cut interest rates and worried its lallygagging would tip the economy into a recession.

(I have argued for months that the problem started long before the first Fed rate hike. It began when the central bank decided to keep the easy money spigot wide open for more than a decade. You can read more about that HERE.)

The carnage in the U.S. stock market was widespread.

• Dow Jones: -1033.99/ -2.6 percent
• NASDAQ: -576.08/ -3.43 percent
• S&P 500: -160.23/ -3 percent
• Russell 2000: -70.15/ -3.33 percent

The selloff wasn’t limited to the U.S. Markets around the globe bled red ink. Some $6.4 trillion was wiped off global stock markets. For instance, Japan’s Nikkei 225 Index plunged 13.2 percent as investors absorbed the recent interest rate hike.

It just goes to show how quickly market sentiment can shift. 

The reasons for the global selloff went beyond worries about the U.S. economy. As a Bloomberg article put it, investors are coming to terms with the fact that they were operating under a lot of erroneous assumptions.

“One thing is clear: the pillars that had underpinned financial-market gains for years — a series of key assumptions that investors across the world were banking on — have been shaken.

They look, in hindsight, a bit naïve: the U.S. economy is unstoppable; artificial intelligence will quickly revolutionize business everywhere; Japan will never hike interest rates — or not enough to really matter.”

So, What Happened to Gold? 

Gold and silver didn’t escape the carnage. 

At its low, the price of gold was down 3.2 percent before rallying later in the day to recover the $2,400 an ounce level. Nevertheless, the yellow metal finished down 1.3 percent on the day.

Silver got pounded even harder, dropping as much as 7.2 percent at its intraday low. Worries about an economic slowdown and an ensuing decrease in silver demand hammered the silver price down.

You might be wondering why gold – supposedly a safe haven – dropped during the broader selloff. Shouldn’t a good haven do well amid market chaos?

In fact, the plunge in the price of gold was perfectly normal given the market conditions. Gold often sells off early in a bear market for stocks.

In 2020, gold had a 3 percent decline multiple times in the early days of the pandemic selloff. In October 2008, gold plunged by more than 7 percent in the early days of the financial crisis.

But why? 

Precisely because gold serves as a hedge.

Investors often liquidate winning gold positions during a sharp downturn to cover stock losses. But gold generally falls less sharply and recovers more quickly – exactly the scenario that played out on Monday.

Here’s how an analyst explained it to Bloomberg: 

“Virtually every time there is marked equities weakness, investors who hold gold as a risk hedge will liquidate part of their holdings to raise liquidity against any potential margin calls. When the dust settles, they almost invariably buy it back.”

Margin calls are a big problem for investors during a sharp stock market downturn.

When an account falls below a certain threshold, brokers demand additional deposits of money or securities to bring the account balance up to a required minimum level.

Given gold’s liquidity, investors can quickly sell to raise the cash necessary to cover margin calls.

It’s important to put Monday’s gold selloff into perspective. Even with the downturn, gold hit a record just a few weeks ago, and the yellow metal is still up well over 15 percent on the year with bullish factors firmly in place. 

A recession would likely mean deeper and quicker interest rate cuts. As a non-yielding asset, the mainstream tends to view lower interest rates as positive for gold.

And of course, a return to easy money is a surrender to inflation. In other words, the inflation dragon will likely be resurrected (if you actually believe he is dead).

As far as silver, an economic downturn would temper industrial demand, and the white metal is much more volatile than gold.

But silver is fundamentally a monetary metal, and it tends to track with gold over time. In fact, silver has historically outperformed gold in a gold bull market. For example, during the pandemic, gold increased by about 40 percent, while silver increased by 141 percent.

Whether Monday’s selloff was just a tremor before the earthquake, or the beginning of the great unwind, there are plenty of reasons to be bullish on both gold and silver.

These price dips could be viewed as a buying opportunity.