In recent years, political tensions have risen globally in response to the US-China trade-war, tricky Brexit negotiations and various international crises. In turn, the price of gold has rallied.
Many investors like gold as an addition to their portfolio to hedge against market crashes, which is why it’s classed as a safe-haven investment.
As recession looms
Not that long ago, coronavirus was a mere cloud on the horizon, but it’s now a full-blown storm and last week caused global financial markets to crash.
In an unexpected turn of events, gold has also seen signs of a sell-off. Why? In a nutshell, ‘asset-liquidation’. This is when people sell off their assets to meet their financial needs.
Many institutional investors, including hedge funds, insurance companies and banks, will have margin calls to meet. This is when they’ve bought stocks with money that doesn’t belong to them, i.e. on-margin. A margin call occurs when the borrowing hits a certain point, triggered by losses in the markets.
These investors then must pay back what they owe, so will liquidate other assets to do so.
This should not be a scenario long-term investors find themselves in because it’s usually day-traders who buy shares on margin. However, every investor should know most shareholders in financial markets are institutional, and not individual. This means it’s the institutional investors that move the markets and not the little guys like you and me.
Portfolio diversification is good
I don’t think holding bullion in your portfolio is a bad idea. It’s a sensible thing to do if you’re diversifying your range of investments.
I do think safe-haven investments exist, and gold is most definitely one of them. However, be wary of buying it when the price is high, as there’s always a risk of its price falling when asset-liquidation comes into play. This is something that happened in the 2008 global financial crisis.
We could say the same of any asset though, including bonds, index funds and equities. Never buy at the height and never sell at the bottom of market fluctuations.
Although the markets have tumbled, I don’t think it’s a good idea to be buying some equities until we know more about the spread of the virus and can see an end in sight.
Nevertheless, I think it’s the perfect time to do your research. There are many FTSE 350 companies that will soon be in bargain territory, and it would be a shame to miss out. Look for companies recently overpriced and that can recover quickly. Shares that spring to mind include advanced technology engineer Meggitt and pharma giant Astrazeneca.
I’ll also be updating my watch list with less popular stocks that may rebound in a recession. These include FTSE SmallCap warehouse and logistics firm Wincanton. It has a £330m market cap, a price-to-earnings ratio of 7 and 4% dividend yield, but it has a high level of debt.
Meanwhile funeral plan retailer Dignity has a £286m market cap, P/E is 9 and its dividend yield is 4%. It’s a share that will see its business in demand in good times and bad. Earnings per share are 63p, but it too has high debt.
For now, I think it’s best to watch and wait, as Warren Buffett once said: “Risk comes from not knowing what you’re doing”.
