While the global stock markets have been on a downward spiral, gold seems to be rising. According to CNBC, gold prices inched higher around mid-2020 to trade at more than $1,800 per ounce, surpassing a significant milestone not reached since 2011. This surge has left many investors wondering whether it is the best time to invest in the precious metal.
If the stock market crashes what happens to gold? Before making any investment decisions it is essential to understand what effects a stock market crash would have on gold value. Most investors assume that gold prices will fall right along with the market. Other investors believe that their precious metals retain or gain value.
This article explores what happens to gold when the stock market crashes. With this information, you’ll be able to make better investment decisions.
History: How Stock Market Crashes Affect Gold Prices
Suppose you’re looking to invest in gold and other precious metals to avoid the effects of a falling stock market. In that case, it’s essential to do comprehensive research and work with a reputable investment partner. To help you understand what happens to gold when the stock market crashes, let’s look back throughout history and see how stocks’ performance has affected the precious metals market.
Since the early 1900s, the precious metals market has been rocky. However, no matter how deep it falls, it has proven to have the ability to rise again. Gold, in particular, can recover its value quickly.
Despite President Roosevelt fixing the gold price in the 1930s, shares in Homestake Mining, the United State’s largest gold producer at the time, increased by more than 100%. Then 1970 saw gold hitting rock bottom, but it’s value increased by 440.6% over the next three years. In the early 2000s, gold enjoyed a significant improvement in value even when the stock market experienced a dramatic fall.
The value of gold dipped in 2008 but improved by 5.5% by the year’s end. According to many investment experts, it’s usually best to invest in gold when it falls in value. That’s because the chances are that it won’t take long to regain and even surpass its previous value, offering maximum selling opportunities.
Negative Correlation Between Gold’s Value and Stock Prices
A stock market crash usually causes an increase in gold prices because there’s a negative correlation between stock prices and the precious metal’s value. While the stock market benefits from economic growth and stability, precious metals benefit from financial distress and crisis.
When stock prices fall, investors usually become fearful and turn to gold to escape the market crash’s adverse effects. On the other hand, the demand for gold usually falls when the stock market is thriving.
If you’re wondering why this negative correlation happens, it has to do with reliability. Gold has proven to be a reliable investment throughout history, thanks to its resilience during economic distress. It’s a safe investment option for apprehensive investors as it has a history of surviving stock market crashes.
What Influences Gold Prices?
A combination of various factors influences the price of gold, including supply and demand and investor behavior. Let’s explore these factors.
Supply and Demand
We don’t consume gold, unlike commodities like fuel and food. Virtually every piece of gold ever mined still exists on Earth, and miners find more of the precious metal each day. But why doesn’t the price of gold drop over time since we have increasingly more of it above ground?
One reason is that the number of people who might want to invest in precious metals is always growing. The jewelry market also plays a significant role in the supply and demand for gold.
Namely, the gold used in jewelry effectively goes off the market for prolonged periods. While countries like China and India consider this form of gold a store of value, the investors who purchase it don’t often trade it. Instead, jewelry demand usually rises and drops with gold prices. When the prices rise, the demand for jewelry plummets based on investor demand.
The Federal Reserve-controlled monetary policy is perhaps the most significant influence on gold prices. Interest rates play a significant role in gold prices due to a factor referred to as Opportunity Cost—the concept of giving up an almost guaranteed gain in a particular investment for potentially more significant growth in another investment.
As interest rates hold near their historic lows, C.D.s and bonds seem to yield nominal returns that are less than the national inflation rate. The result is minor gains with real money losses. Consequently, gold becomes an enticing investment opportunity despite its 0% yield since the opportunity cost of forgoing interest-based investments is low.
Conversely, when interest rates rise, it boosts the yields for interest-based assets and pushes the opportunity cost higher. In this case, the chances are that investors will forgo gold as lending rates increase since they would be getting a higher guaranteed return compared to gold.
The Federal Reserve Commentary can also influence the gold market. The Federal Open Market Committee (FOMC) holds meetings at least once every six weeks to discuss the state of the U.S. economy and the monetary policy’s future. If the FOMC concludes that rates could increase soon, gold’s value usually reacts poorly since the opportunity cost of forgoing interest-based investments rises.
On the other hand, if the FOMC implies that rates could remain steady, gold prices usually rise since the opportunity cost of forgoing interest-based investments remains low.
The U.S. Dollar Value
Gold prices are generally inversely proportional to the value of the U.S. dollar since gold is dollar-denominated. That means that when the U.S. dollar becomes stronger, gold prices tend to fall. On the other hand, a weaker U.S. dollar is likely to drive gold prices higher thanks to increasing demand.
This increased demand is because investors can purchase more gold when the U.S. dollar is weaker. Investors usually consider gold a hedge against inflation. Inflation refers to an economic situation where general prices rise, and the consumer’s purchasing power decreases due to a fall in the value of the U.S. dollar.
When the inflation rates skyrocket and the value of the currency falls, most other investment opportunities fail to generate inflation-beating returns. That’s why most investors start to invest in gold when inflation starts to increase. Even if high inflation rates rise for years, the precious metal serves as an excellent hedge because fluctuations in the currency’s value don’t affect it.
Political uncertainty and instability is another major factor that influences gold markets. Many factors can lead to global growth uncertainty and result in the rise of gold prices. For example, not being sure how Brexit will affect relations between the United Kingdom and Europe, whether it’s possible to deal with terrorists menacing in the Middle East, or how U.S. political tensions play out.
However, investors should understand that you cannot quantify uncertainty. It’s an investor-dependent psychological factor. That means it can vary from one event to the next.
During periods of economic uncertainty, more people resort to investing in precious metals because of their enduring value. Many investors consider gold as a safe haven during times of economic instability.
When the actual or expected returns on real estate, bonds, and equities fall, the interest in the precious metal investment usually increases, leading to an increase in its prices. People can use gold to safeguard themselves against economic events such as inflation or currency devaluation.
Rural demand plays an integral role in gold demand in a country that depends mainly on monsoons for high-yield harvesting. Monsoon season plays a significant role in gold consumption because when the harvest is good, farmers use their earnings to purchase the precious metal to create assets. Conversely, when the monsoon season is deficient, farmers usually sell gold to generate cash.
As an example, India’s annual gold consumption is at least 800 tonnes, and rural India accounts for 60% of this consumption. If farmers have a low-yield harvest after a bad monsoon season, their collective lack of purchasing gold affects the entire country’s gold investments.
If you’re looking for an asset that increases in value when most other assets decline, you can’t go wrong with gold. Gold usually rises when the stock markets crash. Throughout history, the precious metal has proven to be a safe haven in times of economic downturn.
If you think the stock market will crash in the next few years, you might want to consider investing in more gold. If you believe the stock market is likely to thrive, you might want to reduce your precious metal investment.
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