Gold generally performs well in bad economies. Here's why.

The financial headlines haven't been great over the last few years. Facing persistent inflation, continual interest rate hikes and talks of recession, investors are worried about preserving their investments. More and more have been turning to gold as a way to protect their money.

History has shown that during stock market crashes, geopolitical tensions and other trying economic conditions, gold is often a popular investment. But why is this? What makes it more valuable than other investments in these times? That's what we will break down below.

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Why gold generally performs well in bad economies

There are several reasons gold does well when the economy is shaky. They include:

It's a hedge against inflation

One of the main reasons gold performs well in bad economies is that it serves as an inflation hedge. Inflation increases the price of goods and services, reducing the dollar's purchasing power (as we've seen all too clearly in recent months).

Gold, however, is a tangible asset that's been a trusted store of value for centuries. It's historically retained its value despite market fluctuations. As a result, gold prices tend to go up in inflationary periods as more investors seek it out to preserve their purchasing power, thus making it even more valuable.

It's a safe-haven asset

When investors are uncertain about the future, they tend to move their money into assets that are considered safe and stable. Throughout history, gold has been prized as a currency, an investment vehicle and a commodity. Its historical significance and reputation for reliable returns make it increasingly in demand in times of economic trouble, driving prices up.

Gold is also held in reserves by central banks around the world, including the Federal Reserve. During bad economies, these central banks often increase their gold reserves to alleviate risk and maintain stability. This drives the price of gold up even further.

Supply is limited

Gold is a precious metal that is mined from the earth, and there is only so much of it to mine. Unlike paper currency, gold can't be printed or created. Because it's scarce, as demand increases during times of economic uncertainty, so does its price.

It has a low correlation with other assets

During an economic downturn, investors can experience significant losses if their money is in highly volatile assets like stocks. As a result, when it comes to safeguarding your portfolio, "In general, more diversification is good," says Bryan Routledge, associate professor of finance at Carnegie Mellon University's Tepper School of Business.

"An equity portfolio that consists of every stock is better than a hand-picked few," says Routledge. "Similarly, diversifying across asset classes is helpful. Commodities are one such asset class to consider."

Gold is a great way to diversify your portfolio because when the value of other assets waiver, gold tends to do particularly well. For example, according to GoldSilver, gold prices rose in six of the eight largest stock market crashes of the last four decades. During the recession of 2007 to 2009, for instance, gold prices went up 25.5%, while the S&P 500 went down 56.8%.

Gold's ability to protect your portfolio from losses is another reason investors seek it out when the economic news is concerning.

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The bottom line

Despite global economic challenges, gold has remained a dependable asset for investors. In fact, tough economic times are precisely when gold tends to shine. It's a sort of self-fulling prophecy. A historically strong performance increases investor confidence in the precious metal, causing more people to turn to it in times of financial turbulence. The more people want this limited commodity, the higher price goes, in turn making the asset more valuable.

However, unlike other assets, gold doesn't typically suffer a boomerang effect once demand begins to cool off. It continues to deliver reliable returns over the long term, especially compared to assets like stocks, whose entire value can be wiped out suddenly with little to no warning.

That said, any investment decision should be made only after doing careful research and considering your individual needs and goals.

"For most folks, whether or not gold makes sense in your portfolio will depend on your investment philosophy," says Tyler Gray, CFP, managing director at SageOak Financial. "I would encourage folks to speak with a fiduciary advisor who will put their interests first and help them put together a plan they can stick to, regardless of the ups and downs of the financial markets."

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