Why do people prefer to buy gold when stock market moves downward?

Question

Most of us know that there's a common concept that the stock market index and gold price have an inverse relation or negative correlation. When the index moves downwards, the gold price often increases. And the common explanation to this is that people find gold to be safer than the stocks in the crisis period.

But my question: Why should people sell stocks at low prices and buy gold at a high price?

Shouldn't they buy gold early in time and sell gold during the crisis period since the price is high at that time or invest in a bank as a fixed deposit?

If they purchase gold at a high price, they can't ever sell keeping a profit since the price will go down when the market goes up at a later time. So where's the wisdom?

Answer 1

For the purposes of this question, let's stipulate that there is a negative correlation between stocks and gold (at least on some timeframe). The real question seems to be why it would make sense to buy gold when it has already gone up.

There is a potential confusion about cause and effect. The explanation is typically not "people buy gold because it has gone up" (although some of that occurs with the herd/momentum traders) but rather "gold goes up because people have bought it" (technically, "there were more buyers than sellers at the current market price, so the price rose to clear the market").

Investors and traders are, or at least aim to be, forward-looking. If people are selling stocks, it's because they expect that current stock prices are high in comparison to what they will be later.

What makes (in retrospect) a "crisis period" is enough people selling stocks (because they think stocks will go down) and buying gold (because they think gold will go up). Those on the early or "smart" side of the trend will do much better than those on the late or "dumb" side of the trend.

Of course, if it were easy to tell what's the "smart" side ahead of time, we'd all be rich. But the question seems to focus on the losing traders who buy high and sell low and therefore rue the outcome, while neglecting that everyone is trying to be on the early, winning side and at least some are (whether through skill or luck).

Answer 2

There are a lot of market myths spread by the public. Some include:

• Dividend Capture provides risk free money
• You should sell options because 90% of them expire worthless
• Stocks that go up must come down
• You don't lose until you sell
• You never lose with stocks
• You can’t make money in a crashing market
• The stock market index and gold price have an inverse relation or negative correlation

Regarding gold, for the past three recessions:

• In 1990, it lost about 10% of its value

• In 2000, it did nothing

• In 2008 it dropped 30% from its peak price before recovering and ending up 4% for the year.

Gold is ‘iffy’ during recessions.

Answer 3

Gold is considered a safe haven when everything else is going wrong. When the economy is doing well, gold has the big disadvantage that it pays neither interest nor dividends. You buy it, sit on it, and hope that it gradually goes up in price with inflation.

When the economy is failing, gold has obvious advantages. Shares can lose all their value if the company goes bust. The same goes for bonds issued by a company. As central banks intervene, interest rates go down, to the point where they are less than inflation. At that point, gold looks tempting.

If you are particularly pessimistic, then you might be worried that the central bank will introduce negative interest rates on savings. Alternatively, ill-considered attempts by the government to keep up public spending might cause hyperinflation. At this point, gold becomes a way of saving your wealth from economic collapse.

So people buy gold as a way of preserving their wealth, even if the price seems high.

I would add that gold has the advantage over other commodities that it is valuable in small quantities, standardized and easily portable. So you can buy it and hoard it at home. And if everything really does go wrong, you can take it with you when you abandon your home and become an economic migrant.

Answer 4

One should never buy or sell something based on past performance. Market timing, the craft to know when to buy or sell a security is nearly impossible, since every market participant has the same public information you have. So it's pointless to imagine being able to consistently beat the market doing that.

One should define an sustainable allocation and stick with it.

Answer 5

But my question: Why should people sell stocks at low prices and buy gold at a high price?

No one in their right mind says that. "Buy low and sell high" has been rule #1 of trading since... heck, since the first animals with enough brain power to understand "more and less" trading.

Shouldn't they buy gold early in time and sell gold during the crisis period since the price is high at that time or invest in a bank as a fixed deposit?

Again, you're assuming that this is not the common wisdom.

Answer 6

Gold is a currency hedge. Gold is not high if the currency is continuing to drop.

Even consider a major economic collapse and currency might fail to the point of the old currency never regaining value and the new currency not replacing the lost value. But gold, even if it dropped, could regain value because gold is also a commodity. Gold is a scarce commodity that takes-up a small amount of space.

I like gold but I like platinum better because platinum is a catalyst for producing hydrogen from water and a catalyst for producing electricity from hydrogen.