With its storied history, gold is an investment that holds its value. It is also an important commodity for any investor. Investors who are interested in investing in gold do so for three reasons, as a hedge to offset losses, a safe haven, and as a direct investment.
Whether it’s gold exchange-traded funds (ETFs) or gold stocks or even physical gold assets, investors have several options when it comes to investing in the gold market. Indeed, many investors see gold as an excellent hedge against the weakness of the U.S. dollar during times of economic crisis and inflation.
Gold trading history has seen gold as a commodity that retains its value despite financial and geopolitical uncertainties.
A strategic asset allocation in a diversified portfolio, gold performs well in normal, low-inflation economic markets. Even during times of geopolitical and economic uncertainty, gold hedges against stock volatility.
Increases portfolio efficiency
While the ideal investment portfolio is dependent on an investor’s long-term outlook, diversification is an important concept for the modern investor.
Gold brings a special element to a diversified portfolio. Portfolio diversification traditionally centers around three main asset classes; stocks, bonds, and cash. This leaves gold as an underutilized and overlooked investment option.
The ideal balanced portfolio would represent non-correlated assets. As gold tend to go up when stocks tumble, there is virtually zero statistical correlation between gold and stocks.
Gold though is not the only strategic asset to provide portfolio efficiency. Bonds and cash have similar properties and historically have proven to be highly attractive from a diversification point of view. But with global interest rates widely expected to trend higher, bond valuations face a downward pressure. Similar, central banks pushing yield to negative diminishing cash’s positive returns.
The overall performance of gold is akin to fixed income investments. Precious metals are an attractive investment option because they increase portfolio efficiency while lowering portfolio risk.
Lowers risk while increasing return
Ultimately, gold’s role in a diversified portfolio is to serve as portfolio insurance.
The perception is, gold, provides a hedge against economic slowdown and inflation. As a risk management tool, gold is decoupled from economic developments and is less prone to manipulation. Historically, gold have also proven to be especially useful in protecting portfolios against severe market drawdowns, such as the 2008 financial crisis.
When analyzed against several market uncertainty in recent decades, particularly the U.S. Credit Downgrade, Yuan devaluation, and Brexit, gold has performed admirably. Where heightened turmoil and volatility have resulted in negative equity returns, gold has posted positive returns.
Its effectiveness against traditional risk assets defends investors against high equity exposure.
Portfolio Allocation
As gold mainly serves as a dynamic hedge on the risk management front, essentially as an investor’s insurance policy against economic downturn and market turmoil, the average investor should be careful with how much of their portfolio they allocate towards gold.
The best gold trading strategy is 5%-10% strategic portfolio allocation.
Gold does not earn dividends and interest like other productive enterprises, namely equities and bonds. Rather, gold serves your portfolio as a store of value. It preserve purchasing power, particularly over the long term. It’s resistant against the appreciation and depreciation in currencies, allowing it to maintain spending power over time.
As a pro-cyclical source of demand, gold should be held in diversified portfolios with a long-term outlook. Gold is highly volatile in the short term. Much like commodities, gold is vulnerable to swings. It can have spectacular highs and horrendous lows.
Therefore, it is advisable to maintain gold in a portfolio for some period of time. This precious metal is most favorable when held 10+ years within a balanced portfolio.
At one time in world history, gold was used as global currency. Now, it serves to ensure modern investment portfolios are well-diversified. Its ability to remain resilient during times of economic and geopolitical uncertainty makes it an additional option to integrate with other asset classes to effectively manage portfolio exposure.
