Sahm Rule

One of the most important economic and investing puzzles is how to spot a recessions. There are myriads of indicators and people are constantly creating new ones! The recent example of a new recessionary measures is the Sahm Rule Recession Indicator, developed by Claudia Sahm, the Fed economist.

Sahm rule is based on the unemployment rate, but it’s better. It is the three-month average unemployment rate minus its minimum from the previous twelve months. When this measure exceeds 50 basis points, economy is headed for recession, according to Sahm. 

The three-month average is used to smooths out some of the monthly random variation in the rate and avoids false positives, while we use moving minimum, as this type of trigger takes into account structural changes over time in the natural rate of unemployment.

Sahm Rule and Gold

What is the link between the Sahm rule and gold? Well, if this indicator is able to spot recession in advance, it gives the precious metals investors time to prepare and take more bullish positions. 

Let’s take a look at the chart below. As one can see, the measure has correctly called every US recession since 1970. What is in particular important, the indicator sent an alarm signal in January 2008, warning of the unfolding Great Recession. And it sent few, if any, false alarms in the past, which means that it is a reliable (although not very timely) indicator, which can be useful in gold investing.

_{Chart 1: Sahm Rule Recession Indicator (the difference between the three-month average of unemployment rate and the minimum from the previous twelve months) from January 1970 to December 2019.}

However, as of January 2020, it tells us not to worry, as the three-month average unemployment rate is just at the same level as its minimum of the past twelve months. It implies that, according to this index, we are neither in a recession nor close to one, which is bad news for the gold bulls.