Why Does Gold Sometimes Drop in Price During a Crisis?
Last week was an absolute bloodbath for markets, as stock markets shed trillions of dollars worth of paper wealth. The Dow Jones lost over 3,500 points over the course of the week, prompting the Federal Reserve Chairman to pledge the Fed’s full support to markets on Friday afternoon. But that failed to stem markets’ fall, and there’s every indication that this week could see even more losses.
One of the curious things to notice was that, although gold initially shot up in response to the weakness in markets, it stayed relatively flat through the middle of the week and then plunged on Friday. Casual observers may have been wondering why that was. Isn’t gold supposed to be a hedge against stock market crashes? Shouldn’t it have gone up in price as stocks fall?
There’s a reason gold was falling at the same time as stocks were. And that’s because many investors were in a mad scramble to get cash. At the outset of a stock market crash, institutional investors and even some retail investors sell as many assets as they need to in order to get cash. They may need to build up cash reserves, cover short or long positions, or pay bills. But they’ll sell whatever they have to get cash.
For investors who have been in gold for a few years, they’ve seen great gains, maybe 30% or more. So even selling on a day when gold is down $60+ nets them real gains, plus drums up cash.
We saw this same pattern during the 2008 financial crisis, when gold and silver both went down during the worst parts of the crisis. That was due again to investors divesting themselves of any assets they could in order to drum up cash.
But once the worst part of the crisis was over, people realized that the economy wasn’t going to get better overnight, and realized that gold was the best asset to hold, the gold price shot up and didn’t look back.
We’ll see similar patterns this time around too, with short-term drops in the gold price as institutional investors dump their gold. But unlike 2008, more retail investors today are savvy to the importance of gold and are demanding to hold it in their portfolios. So investment demand for gold will be higher during the next financial crisis than during 2008. That means gold won’t see the same month-long drops as it did back then. Make sure you invest in gold today and protect your investment portfolio before stocks crash any further.