This week, our focus has been on the spreading panic over the coronavirus.
As I (Chris) have been reporting, this panic has led investors to take stocks to the woodshed.
On Wednesday, the Dow plunged into a bear market (defined as a 20% or more drop from a peak).
And the S&P 500 wasn’t far behind.
But regular readers shouldn’t sweat it too much.
Today, I want to deal with some important questions around our favorite precious metal here at the Cut – gold.
I’ve been recommending you stock up on gold since we launched the Cut to all paid-up Legacy Research subscribers in August 2018.
And since then, it’s up 20%.
As regular readers know, one of the main reasons you own gold is as “disaster insurance.”
In short, gold tends to rise as stocks plunge. This makes it a great way to hedge – or insure against – stock market turmoil.
But at least one reader expected more from gold…
Hi Chris, why has the price of gold fallen dramatically, since the VIX [the Volatility Index, Wall Street’s “fear gauge”] has gone up, stocks are down, and there is panic about the C virus? This seems odd to me. — Tom K.
My answer: It’s a great question, Tom. Thanks for asking it.
Since the coronavirus made front-page news in the U.S. on January 8, gold is down 3%.
That compares with a fall of 16% for our regular stand-in for the U.S. stock market, the S&P 500.
Take a look…
But that doesn’t worry me one bit.
Gold’s fall is a result of its recent strength… and has nothing to do with it no longer being a safe haven.
As the old-timers on Wall Street say, “When the times are dire, you don’t sell what you want, you sell what you can.”
That’s exactly what some overleveraged traders have been doing with their gold.
That’s because of margin calls.
Some traders borrow money from their brokers to buy extra shares and amplify their gains in a bull market.
And they often use their shares as collateral to back those loans.
If the value of that collateral falls… as it does in a stock market crash… the broker who loaned an investor the money can issue a margin call. That means the investor must add cash to bring his account level back up to the required minimum.
Investors typically sell other assets to raise the cash to satisfy the margin call. If they don’t, their broker could take their shares from them, and they’d lose everything.
That’s exactly what we saw happen with gold back in 2008.
As you can see, when the U.S. was in the thick of the financial crisis, gold fell along with the stock market. However, over time, gold rallied back sooner and more intensely than stocks.
What made the situation worse this time around was that, at the start of February, the level of cash in investors’ accounts was the lowest since March 2013. That’s according to research by BofA Securities.
This forced investors to sell even more of what they could get their hands on… including their gold.
Although this isn’t an ideal situation, I expect gold to be one of the best-performing assets over the months ahead.
Remember, the market sell-off has only strengthened the case for owning gold.
When the next recession hits, central banks will unleash a tidal wave of new cash. And investors will pile into gold to protect their buying power from the onslaught of paper money.