Gold and the Fear Index

One of the most commonly mentioned benefits of physical gold is the protection it offers against “volatility” and “volatile investments”. What is a “volatile investment”, and how does gold mitigate its risks?

Volatility is a measure of how much the price of an economic unit (a share, a quantity of a commodity etc) is likely to change in the near future. Very volatile shares might rapidly gain or lose value, while more stable shares will stay at pretty much the same price.

There can be all kinds of reasons for investments to become volatile – some, like currency, are inherently prone to changing price rapidly, while others can be influenced by politics, both global and local, business decisions or mistakes, business reputations and public perception and even the actions of individual investors.

Measuring market volatility – The VIX index

The best way to measure volatility in the US economy (and by extension the global one) is the VIX index, sometimes called “The Fear Index”. The VIX is the stock ticker for a collection of options and shares on the Standard & Poor 500 index, a market capitalisation of 500 major US companies.

Through tracking the price changes on this spread of shares, the VIX can indicate a more general picture of what prices are changing in the market as a whole, and as such how volatile the market is. When the VIX is high, market volatility is high and investments are uncertain almost across the board, while when it’s low it’s much safer to invest as you’re less likely to get caught in a sudden price spike.

There are seven generally accepted reasons for investors to care about volatility, four of them to do with retirement and long-term investment.

The Covid-19 pandemic prompted a major spike in the VIX index in March 2020, as it surged to its highest level ever, surpassing even the peak created by the 2008 financial crisis. Lockdowns, furloughs, exorbitant government financial aid and uncertainty about the long-term repercussions of these measures sent the market spiralling downwards and uncertainty reached fever pitch.

Since then, the VIX spike has abated somewhat as the initial shock has worn off, but the index is still above the level seen for several, relatively calm, years beforehand. The outlook for the US and most other global economies remains uncertain at best and severely recessionary at worst. While markets have recovered some of what was lost in the major March slide, the outlook is not a smooth ride.

2020 Financial Outlook

Goldman Sachs expects the S&P 500 to lose 18% over the next three months as the number of coronavirus cases rises. US Federal Reserve Chairman Jerome Powell recently said the pandemic would cause long-term damage to the US economy and “the path ahead is both highly uncertain and subject to significant downside risks.” Company administrations and redundancies are just the tip of a financial iceberg. The deteriorating relationship between the US and China, the looming Brexit deal deadline and the monetary policy decisions of debt-laden governments the world over, will likely mean volatility is heightened for some time to come. All of this will create an extremely volatile investment environment, not least as investors struggle to secure their own portfolios against potential massive losses, both in economic and real money terms.

Having a strong physical gold base to your portfolio allows you to not only avoid the risk of complete financial ruin from a high VIX, it also gives you a stable platform from which to risk more disposable money and try to make sizeable gains from a more volatile investment environment. Remember, a high VIX level isn’t necessarily something to be feared if you have a solid, inflation-immune base of capital to fall back on – something that gold investment provides.

Rising Gold Prices

One thing to note, however, is that if you’re planning on buying investment gold it’s a good idea to do so as soon as possible. One effect of a rising VIX is a rising demand for gold as savvier investors try to lock down their gains prior to the storm.

• The value and stability of your portfolio can be affected overall by price volatility
• The more the price of your investment changes, the more emotionally draining it is to keep track of it
• High volatility means a greater chance of a shortfall if you’re planning to liquidate your investments for cash
• Higher volatility makes it harder to save for the long-term or retirement as you can’t rely on your investments to hold their value
• When retired, the more volatile your investments, the less money you may have to draw upon.
• On the plus side, volatility does give you the chance to buy investments cheap and sell them at a much higher rate
• Volatility directly affects the pricing of options, potentially making flexible investment more difficult