A Recession Is Coming, Which Should Make It Gold's Time to Shine

Gold has been a bad investment for several years, but it's time to consider adding hard assets to your portfolio with a recession imminent.

"You've got to trust your instincts

And let go of regret

You've got to bet on yourself now star

'Cause that's your best bet." 

Those lyrics appeared on 311's "All Mixed Up" in 1995, and they still ring true today. That song has been running through my head as the yield curve has inverted and equity markets only have sold off slightly.

I firmly believe that yield curve inversion is a sign of an impending recession. Why? Because the last nine recessions have been preceded by an inverted three-month/10-year U.S. Treasury yield curve.

Last Friday marked the first such inversion since July 2007, and I have to trust my instincts. There is a recession coming, and the time to sell stocks is before such an event, not during one. So, that's where letting go of regret enters the equation.

I don't care if the market rises 1% tomorrow, 1% the next day and so on. I'm a reducing the already-paltry equity exposures in my clients' portfolios now. That leaves a few options:

1. Panic. Don't do that. Don't ever do that.
2. Write covered calls. Be careful of the taxman here. Fidelity's write-up is a very helpful guide. "Qualified" covered calls -- those expiring more than 30 days in the future and not "deep in the money" -- are an excellent means of portfolio protection.
3. Alter your asset allocation. This is especially easy if your investments are held in a 401(k.) Simply log in to your account and increase the percentage of fixed-income funds while decreasing the percentage your 401(k) holds in U.S equity funds. That should take about one minute.
4. Consider adding hard assets to your portfolio. This is where I need to be careful not to verge into the realm of the kooks who fill my email inbox with doomsday strategies that account for a meteor hitting the Earth or the existence of secret pipelines. A short, well-managed recession is nothing to fear. They happen. It is when central bankers try to engineer a situation in which there are never recessions that the markets collapse. I don't think we are quite there yet, but in such a scenario, hard assets certainly outperform. 

The SPDR Gold Shares ETF (GLD) closed trading on Jan. 11, 2008, at $88.58 and closed trading on Jan. 23, 2009, at $88.53. That loss of a nickel in 54 weeks contrasted quite nicely with the S&P 500's 37% decline in that time period.

Those historical endpoints make a gold bug's heart flutter. Remember, though, that GLD closed trading Sept. 9, 2011, at $180.70 and trades today at $123.60. Also, even if you bought the SPDR S&P 500 ETF (SPY) at $140 in January 2008 and held onto it through that horrible crisis, you would have doubled your money as of today, almost to the penny. In that time the capital gain from holding GLD has been just under 40%. Or, looked at another way, the compound annual growth rate of GLD over the last 11 years has been a paltry 3% versus a figure near 7% for SPY.

Also remember that stocks pay dividends and physical gold does not, so the total return figures are skewed even more in SPY's direction. So, the stress you endured with your stock portfolio from October 2008 to March 2009 would have been well worth the wait, assuming gold was your only investing alternative.

Simply put, gold has been a disastrously bad investment for the past six years and has been a significant laggard versus other financial assets for this economic cycle as a whole. So, for me to put my clients' money in gold or gold stocks, I would need to be absolutely sure of how imminent a recession is. Of course, that level of certainty is impossible, but this is as close as we have been to a "gold bug's market" in a decade.

So, don't worry, I won't be filling your inbox with come-ons for gold investments, but for the first time in a decade I am advising my clients to buy gold.

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At the time of publication, Jim Collins had no positions in the stocks mentioned.