Gold and the Fear Index

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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.

 

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.

 

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

 

Recently, the VIX has seen some significant movements, dropping to a record low in July after the Federal Reserve released its regular statement on monetary policy and stated that it would begin a wind down of the post financial crisis stimulus program. This suggests that the Fed considers the economy stable and has positive signals to that effect, and had a calming effect on the markets.

 

In August, however, with the renewed US/North Korean tensions and threats of actual nuclear exchange from both sides, the VIX spiked to its highest level since the election, a sign that many previously bullish US investors have begun to realise that the Trump administration is not as business friendly as it claimed to be. With no sign of a resolution, the Fear Index is predicted by some to continue to rise, with some like Larry McDonald at ACG Analytics suggesting that it might herald “a new volatility regime”. McDonald has predicted that the VIX will quintuple by Halloween, saying: ‘The VIX will touch 60 before we have pumpkins on our doorsteps.’ He hasn’t been proven right yet, but the VIX has risen significantly.

 

This rise would be the highest since the 2008 financial crisis, and would occur if specific events like the Federal Reserve hiking interest rates and further international and domestic incidents occur between the US and other countries. Central banks will be facing pressure to raise rates as commodity prices rise, adding to global inflation, which in turn increases volatility as share prices adjust to keep up. 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. 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.

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