How Gold Performs During A Financial Crash

How Gold Performs During A Financial Crash
September 23, 2011

Over the past couple weeks, gold has fallen from a high of around $1920/oz to an intraday low of around $1730/oz (about a 10% drop). On Sept. 22, 2011, alone gold fell about 3.7%. This has happened as the global economy marches ever closer to Lehman 2.0 – a three-pronged collapse of the European banking system, the US economy and the Chinese economy. I am being inundated with questions from people wondering why gold is falling as the financial crisis worsens. After all, isn’t gold some sort of safe haven?

The first thing investors need to understand is that gold is priced in US dollars. This means that as the dollar rises the price of gold falls, all things being equal. The dollar is quickly rising because it is a safe haven (US Treasuries are a safe haven that must be purchased in US dollars) and because asset liquidations around the world are gaining speed causing a growing shortage of dollars.

The second thing investors need to understand is that gold, as an asset that has performed well, is a source of funding for margin calls made on declining assets. This means that gold is undergoing a degree of "forced selling."

One only has to go back a couple years to see how gold reacts during a financial crisis. The chart below shows the price of gold during the financial crisis that arguably began with the collapse of Bear Stearns in March 2008. (There are multiple ways to define the true start, but I had to draw a line in the sand and the first major i-bank collapse sounded like a good place to start.) During this time, gold prices fell by about 25% and subsequently recovered all losses. This was a scary ride for anyone holding gold at the time, but it’s an incomplete view of gold’s performance during the crisis.

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