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How Gold Acts As An Insurance Policy In A Bear Market

gold insurance policy
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EDITOR'S NOTE: For most investors, gold is an additional return source; something you hold to diversify your portfolio. Frankly, that’s a reasonable perspective. It won’t go so far as to claim that “gold is money.” But it almost falls into the “gold as wealth insurance” camp; something like a gold insurance policy. Gordon Brown, the Chancellor of Her Majesty’s Treasury in the UK over twenty years ago didn’t buy it, so to speak. He sold half of the Crown’s holdings by the summer of 1999, driving gold prices down further to around $252 per ounce. Eric Fry’s article below recounts the dramatic story. For Brown unwittingly went against the foundational principle of investing: he started relatively high and sold at the lowest possible point. Fry is right in stating that “history has not been kind to gold haters.” It never has been, and it wasn’t going to be any different for Brown, as he was to learn just months after the final sale. It’s true that gold just “sits there.” But its manner of staying put or holding ground when monetary value sinks deeply is equivalent to a remarkable advance. And that’s what you want a safe haven to do.

Every Intelligent Asset Allocation strategy (the concept of which we started discussing last month) must include a commitment to what I call Wealth Insurance.

 

You need a “policy” that protects your wealth during bear markets and other periods of turmoil.

And when it comes to surviving a bear market, no other “insurance policy” is like gold. (Recall my “Gold Is Dead… Just Like Paul McCartney” article from October.)

It just sits there… until you need it to do something.

And the funny thing about gold is that it usually starts to “do something” at the precise moment when most investors have given it up for dead.

That’s what happened 23 years ago.

A Look Back

Back in 1999, the price of gold was so sickly that no one knew for sure if it would be able to get out of bed in the morning.

Trading around $250 an ounce, gold was nowhere near the high of $850 it had reached 20 years earlier. Gold was a dead asset, and no one wanted anything to do with it, including Gordon Brown, then the United Kingdom’s Chancellor of the Exchequer. And so the treasury minister resolved to sell half of the U.K.’s gold reserves and use the proceeds to do something more intelligent.

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Noble objective. Bad idea. Picture the scene…

The stock market was flying high — and gold wasn’t.

The dot-com mania was powering the stock market to spectacular heights, while also fostering all kinds of “new era” hogwash to justify the market’s sky-high valuations.

Meanwhile, gold had been in a secular bear market for almost two decades, declining steadily from its highs of 1980-1981. Popular economists had long written gold off as a go-nowhere, do-nothing asset. The public hated it. The media sounded the requiem for gold, and everyone marched along to it.

The “barbarous relic” appeared to have lost its luster for good.

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The price at the time of the announcement was $282.40 per ounce — close to a two-decade low. But gold prices would drift even lower. Gordon Brown made sure of that.

Thanks to his questionable decision to broadcast advance notice of the auctions, gold-holders worldwide decided to “front-run” his gold sales. At the same time, short sellers circled the gold market like sharks stalking a pod of hemophiliac dolphins, eagerly anticipating that first tasty drop of Brown’s blood.

By the time of the first auction, which was conducted on July 6, 1999, the price of gold had fallen another 10%. Its price would continue to decline in the coming days, eventually reaching its ultimate low on July 20, 1999.

The price: $252.80 per ounce.

The “strategy,” according to Brown, was to diversify Her Majesty’s Treasury’s holdings — to reinvest the proceeds from the auctions into foreign currency deposits in order to deal with gold’s “unacceptable” level of volatility. Her Majesty’s Treasury, under Brown’s stewardship, actually produced a series of reports forecasting “the overall volatility of the U.K.’s reserves could be reduced by 20% from the sale.”

In reality, Brown had chosen a generational low point in gold prices as the “ideal moment” to unload half his country’s gold reserves. Needless to say, that low has not been revisited since, nearly two decades after initiating his disastrous trade.

The sales, which took place across 17 auctions between 1999 and 2001, averaged out at roughly $275 per ounce and raised for the crown some $3.4 billion. Even today, with gold “languishing” around the mid-$1,300 range, it would cost nearly $17 billion to replace that very same yellow metal.

The monster gold rally of the early 2000s was not the only time the metal shined while stocks struggled. From late 1972 to late 1974, for example, U.S. stocks tumbled more than 40%, but gold tripled. It also posted gains during the stock market crash of 1987.

So I would expect gold to shine once again the next time stocks stumble.

Why Gold Isn’t Done Yet

Gold has become “your grandfather’s store of value.” It’s thought of as money for Luddites.

Every generation of investors contains a bunch of folks who pooh-pooh gold — who scorn it as a “barbarous relic” or an irrelevant bauble.

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But history has not been kind to gold haters; the naysayers usually face a day of reckoning.

That’s why it makes sense to buy gold as Wealth Insurance, and you don’t have to buy a huge amount of gold to have an excellent insurance policy. You can allocate just 15% to 25% of your portfolio to gold.

Its place in your portfolio could add a big boost to your portfolio when you need it most.

Sincerely,

Eric Fry

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