Fear of a market correction? Buy that gold stock as a cheap hedge
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Diversification can mitigate many sources of risk, such as the risk associated with investing in a single stock, in a single sector or in a single country. What it cannot mitigate is market risk, which is the extent to which your portfolio is affected by the movement of the market as a whole. Regardless of the quality of your stock picks or the number of stocks your exchange-traded fund (ETF) holds, a bear market will generally result in losses for your portfolio.
The perfect stock for the role
When it comes to mitigating the risk of a market correction, we should look for assets that have a slightly negative correlation to our equity portfolio. That is, when our actions zigzag, they zigzag. This is called a hedge. We hope that it rises a little over time so as not to lose value, but above all that it functions like a parachute in times of crisis. When the market crashes, we want it to rise in value, so we can sell it for a profit and use the proceeds to rebalance our stock position at a low price.
Barrick Gold (TSX:ABX)(NYSE:GOLD) is our top candidate here. As Canada’s largest gold producer, it operates 16 sites in 13 countries, with over 71 million ounces of proven and probable reserves. Although subject to fluctuations in the spot price of gold, the company has very sound fundamentals, having met or beat the market consensus on its financial and operating results for 11 consecutive quarters in the third quarter of 2021.
Barrick Gold currently has an operating margin of 41.70%, profit margin of 16.60%, ROA of 4.20%, ROE of 8.40% and ROI of 13.70 – impressive financial ratios for his sector. With an exceptional current ratio of four and a long-term debt ratio of 0.22, the company’s balance sheet is healthy and sustainable compared to its peers.
Why it’s a big hedge
Beyond its strong fundamentals, Barrick Gold performs extraordinarily well as a hedge in times of crisis due to its low to sometimes negative correlation with the broader stock market. Currently, Barrick Gold has a beta of -0.09, implying a weak inverse relationship with market action. In other words, it has the ability to outperform when the market underperforms.
For a thought exercise, let’s see how Barrick Gold fared in times of crisis compared to iShares S&P/TSX 60 Index ETF (TSX:XIU), examining their performance during two major market corrections on Portfolio Viewer.
During the Great Financial Crisis of 2008, the “flight to safety” phenomenon, where investors dumped risky assets, caused “safe” assets in demand such as gold and treasury bonds to skyrocket. US Treasury. Here we see that during the crash, Barrick Gold rose sharply – the inverse of the index.
Once again, the same was true during the COVID-19 crash of 2020. Barrick Gold rose sharply, while the broad index fell. It was one of the few stocks in the Canadian market that did not end up in the red during the initial downturn.
The insane takeaway
Barrick Gold’s low negative beta, coupled with its lack of correlation with US markets and the “flight to safety” phenomenon, make it an excellent choice for hedging against a market correction. Because the company has great fundamentals and a profitable business, its stocks could be a good alternative to gold bullion or gold ETFs in a portfolio. Investors should consider allocating a small portion of their portfolio to it.
During a correction, the rise in the stock price can be sold at a profit and used to tactically rebalance other stocks when they are low. Holding these stocks for the long term can also smooth your returns by reducing portfolio volatility. However, it is important to properly size your position and your portfolio allocation. Too much could reduce overall returns, as the stock tends to underperform the broad index on a risk-adjusted basis.