Saturday, May 22, 2021

Does Paper Gold hedge against stock market corrections?

Gold is an unprintable zero-yield currency.  So it should do well when real interest rates fall, or when they are expected to fall.  Like in a stock market correction.  Lets check the behaviour of GLD in past corrections.

Since GLD's history only goes back to 2004, we start in 2008.  The chart below covers the the 17-month bear market from Oct 2008 to Mar 2009.  S&P 500 (the purple line) was down 55%, while GLD (the candlesticks) was up 40%.

It wasn't smooth. GLD had a vicious 7-month 1/3rd drawdown, followed by a swift 4-month 50% recovery, bringing it back to where it started the drawdown. 

Why did it fall?  Interest rates were falling throughout this period, but there was a pause from May to Sept 08, corresponding to GLD's fall:

Source: MacroTrends Federal Funds Rate - 62 year historical chart

Flat rates would have stopped gold rising, but why did it fall?  Probably due to the panic, with funds needing to liquidate anything they could.  No one knows, but the important thing is that it did.  How would you buy-and-hold or trade through this?

Next we have a series of smaller corrections.

  • A brief two-month 16% S&P 500 correction from May-June in 2010, shown by the dotted rectangle below.  GLD up ~3%.  Its too short a time for the chart to mean anything.  And this was within a wider multi-year gold bull market.
  • A more substantial 5-month 19% S&P 500 correction from May-Sept in 2011.  GLD was up 4%.  We can see GLD's big spike as the stock market corrects, but GLD's final red candle has it falling 9% in a week.  Excluding this fall, GLD was up 13%. 
  • Again, we can see how hard it is to trade or buy-and-hold.
  • After the above spike, gold entered a 7 year bear market.  We only get one stock market correction in this time, 3-month correction from Nov 2015 to Jan 2016.  GLD exploded when the market dived:
  • The 3 month 2018 bear market from Sept to Dec 2018.  GLD was up 3-4%, and a lot less volatile than the S&P 500 which was down 20%:

  • With hindsight, the above was the beginning of a new bull market in gold.  Which we may still be in now.
  • GLD fell with everything else in the 2020 crash.  It was down 7% vs the S&P's 33%.   With a maximum drawdown of 8%, it held up ok.


On average, GLD has risen during small corrections.  But not during large bear markets or liquidity crises.

I'm expecting a short correction in the second half of this year.  Like 2018 or 2015-16.  I'm thinking of going long gold.  The odds are on your side if you buy gold before a (brief) downturn.  But the charts above give some idea of the risks involved.  2015-2016 in particular shows how dangerous it can be to be early.

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