Will gold or gold shares offer the best downside protection in a global asset sell-off?

It is an axiom of capital markets that in a really big sell-off the good gets sold down with the bad. In short, investors are forced to sell off assets that they would like to keep in order to meet their obligations to pay on assets that have gone bad.

So gold bugs fret that precious metals could be sold down by hedge funds and other investors when the four-year bull market in equities eventually ends, as all bull markets do.

If we go back to 1974 and that stock market crash then indeed a bear phase for gold followed in 1975-6 in which the gold price halved before ramping up eight-fold to the still unsurpassed $830 peak of 1980.

1970s parallel

Clearly those investors who got it right and there were very few, bought gold 18 months after the stock market crash of 1974 and then waited five years. History could repeat itself and the parallels between the 2000s and 1970s are often debated.

On the other hand, gold is real money and a hedge against US dollar depreciation which would also be an almost inevitable consequence of a big market crash. For while the US dollar would probably at first strengthen in a flight to cash, it would subsequently weaken as the Fed lowered interest rates to save the US economy from collapse.

So holding some physical gold in a portfolio for relative safety, or trading in this commodity, makes sense. Gold and silver will always have a residual value, unlike paper assets.

Dr. Marc Faber holds that on a two-year view gold will outperform the major US stock indexes. But in a big stock market crash that might still mean a lower gold price, just not such a large decline as compared with equities.

Safe haven stocks

This might also be true for gold and silver shares. In bear markets the stocks that perform best are staples like utilities and beverage manufacturers. Perhaps gold and silver stocks would also be seen as a safe haven, particularly given the recent strong performance of gold and silver prices.

Indeed, precious metal related equities have lagged significantly behind the recent rally in the gold price to the highest levels since the $725 an ounce gold market top last May. It could be that an element of catch up will be seen in the short term. But the market is clearly nervous about the outlook if stocks undergo a major correction.

However, if gold maintains its current momentum towards the $1,000 mark then the stocks should benefit. And it could be that impending rule changes to gold trading among the central banks by the International Monetary Fund prove the key to such a gold price rise, by stopping market manipulation.

Actually the anticipation of a major shift in US policy on gold ownership helped to keep gold prices rising in the Great Depression of the early 1930s, so there is a historical precedent for such a countercyclical move by the yellow metal on the back of expected rule changes.