A donkey walks into a bar. “Where’s the horse?” asks the barman. “Recession,” says the donkey.
Not funny, we know. But neither recession is a funny thing. People are losing jobs, while incomes are declining. In macroeconomic terms, recession is a significant decline in general economic activity in a country. In several countries, the rule of thumb is that two consecutive quarters of negative economic growth as measured by the GDP constitute a recession, but in the U.S., the recession is determined by the NBER, which uses more frequently reported monthly data – such as industrial production, unemployment rate, retail sales, etc. – to declare a recession.
There are many explanations of recession. For some economists, they results from exogenous negative shocks to the economy, while for others they are the inevitable consequences of the precedent artificial booms. Anyhow, hardly anyone likes that part of the business cycle. With the possible exception of gold bulls, of course.
Recession and Gold
Indeed, the yellow metal does not flourish in prosperity, when there is excessive optimism and confidence in the Fed and the U.S. economy. However, gold thrives when economies are struggling. Gold is a good investment during recessions due to its role as a safe haven. As one can see in the chart below, gold gained during most of the several last recessions, including the Great Recession (the timing of recessions is only approximately reflected by the rectangles).
Chart 1: Gold prices (London 10:30 a.m. fixing) during recessions (indicated by the rectangles) from January 1970 to January 2015
The yellow metal has low or negative correlation with other assets – this is why it is a good portfolio diversifier and it often shines when other asset classes suffer. For example, the yellow metal generally performed better than stocks during recessions, standing out as having the best combination of return and risk. Even during the 2008 crash, gold finished the year with a 5 percent gain (although it initially lost due to the rush to raise liquidity at any cost). However, investors should be aware that gold prices do not perform in the same way during different busts. Gold usually perform best in contractions accompanied by high uncertainty and a weak U.S. dollar, high and accelerating inflation, or low and declining real interest rates. Given that the yield curve has already inverted, there are high odds of the U.S. recession in the near future. Although inflation remains subdued, the outbreak of recession with low real interest rates should support the gold prices.