Beyond stock market diversification, go for true portfolio diversification.
Over the years I have frequently been asked about the idea of adding precious metals, especially gold, to a portfolio. Recent economic events, the stock market volatility and movement in gold prices have renewed the interest in this asset and I anticipate again answering the near, age-old question “What about gold?” After all, humans have been chasing gold for centuries.
Should You Try Investing In Gold To Diversify Assets?
Certainly our interest with owning or investing in gold comes and goes, but an obvious part of gold’s recent allure is its current prices and the returns over the last few years. Regardless of the sector or nature of a particular investment, elevated prices and returns always seem to attract investor interest. It seems that the glitter of gold investments and the returns they provide have piqued the interest of many. While I think that part of human nature frequently makes us foolish investors (who love chasing returns), I must admit that gold returns have been fairly impressive of late, meriting the attention it’s been receiving lately. In general though, I think that gold may have a small place in a portfolio. For instance, anyone who did invest in gold 10 years ago has done well: the per-ounce spot price of gold has risen more than 300 percent over that time, hitting a record $1,226.56 in December.
Billions of dollars have flowed into gold investments in recent years as investors have ridden this ever-rising price wave. Economic uncertainty, the value of the dollar and the federal budget deficit have also propelled this trend. And don’t forget that gold is also a hedge against inflation –- even though inflation has been historically low for quite some time.
- Check out the MarketSafe Diversified Metals CD from EverBank. I believe it to be one of the safer ways to own gold given that you’re investing in a certificate of deposit. But the CD is only available for purchase for a limited period. Read more about this in our EverBank Diversified Metals CD discussion.
- You can buy Gold ETFs. You can check out SPDR Gold Shares (ticker symbol GLD) and iShares Comex Gold Trust (traded on the American Stock Exchange: ticker symbol IAU). For those on the aggressive end of the spectrum, you can take a look at ProShares Ultra Gold (ticker symbol UGL).
- You can also buy a mutual fund or ETF that invests in mining companies. This is an indirect way to invest in precious metals. An example is the Market Vectors Gold Miners ETF (trades on the American Stock Exchange: ticker symbol GDX).
- You can buy gold coins as well.
Has The Price of Gold Peaked?
The current debate is whether gold has started to peak in price after a pretty good run. There are a few signs of uneasiness in the market: earlier this year, for example, investors pulled $937 million out of the largest U.S. Gold Exchange Traded Fund (ETF). But their combined withdrawals amounted to just a small fraction of the fund’s $40 billion in total assets, so I doubt we can call this a significant trend.
Whether or not prices have peaked, gold’s record run has convinced many to consider gold as part of their portfolio. Actually, most financial experts will tell you that it makes sense to own gold because of its lack of correlation to equities. And I personally think that’s the key when holding or adding anything to your portfolio. You must ask yourself: am I just chasing returns or am I adding value to my portfolio by increasing diversification and risk hedges?
For instance, when you look at the prices of blue chips and a precious metal like gold, there will be times when they appear pretty synchronized and moving in the same direction. For these classes, last February saw their correlation coefficient at an 80% plateau for a week, before gold prices started falling some weeks later.
Soon after, the correlation fell to 29 percent; not quite to the two-year mean of 15 percent, but a lot closer than before. So why would this make your portfolio happy? Because a low correlation shows the value of gold as a risk diversifier. Remember, it is the risk correlation that affects you, as an investor, revealing just how well you are diversified. With gold zigging and stocks zagging, portfolio risks hopefully can be spread out better.
Certainly, this added level of diversification (not to mention fairly robust returns) has many looking towards gold. How this affects gold’s prices and future returns remains to be seen, but at least gold, with lower correlation coefficients is resuming its role as a proper risk diversifier. And really, if we’re going to consider gold as an investment, we should be focusing on diversification and putting less emphasis on returns, especially in the short-term.
Historically speaking, there are obviously some periods when you could have made a killing in gold if you timed it just right by getting in before the bubble and then getting out at the top, but like any other investment or investment sector, you would almost have to be a psychic to achieve that. Personally, I will continue to avoid potentially “hot” investments and focus on maintaining a broadly diversified portfolio with low correlations among asset classes. And I would encourage anyone to limit their exposure to any one investment area. From my experience, successful investors are not trying to get the best absolute return they can. Rather, they are focused on managing risk and on getting the reasonable returns they need.
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{ 10 comments… read them below or add one }
SVB, yet another great investment tip from you. Not only have you shed some credible light on investing in gold (versus those con men on radio shouting the greatness of investing in gold), but you have pointed out ways to do it. I like gold as a part of a diverse portfolio as you suggest. I advise holding it for the long term too and don’t try to time the market–even the pros can’t seem to time the market when it comes to investing.
Thanks for the compliments ConsumerMiser, you know that flattery will get you everywhere! I love gold, actually, and especially appreciate the concept of diversifying using assets that are distantly correlated. Have to thank my guest writer, Todd S. for the insights, but I’ve also written quite a bit on the subject of diversifying using more esoteric asset classes. Would suggest a 5% to 10% allocation relegated to precious metals.
This is a good article but personally I think jumping on the gold bandwagon now is somewhat missing the boat. Like you said, had you invested 10 years ago you would be sitting pretty. However, is the upside still there? Personally I do not think we will see gold go much higher.
However, I do see upside to some other commodities. I like oil, I think it is cheap now and the world’s hunger for oil will not decrease over the next 5-10 years.
I have a small amount of gold that I bought at a price far, far below what gold is selling for today.
I of course hear that voice that says “oh, you should have bought more gold.” My problem with that is that I follow a philosophy of only investing in things that I have studied enough to have confidence in. You cannot learn everything about everything and I don’t think that the average person absolutely needs to invest in gold. If you are not willing to put in the work it would take to understand gold well, my thought is that it is better not to get involved. If you invest without knowledge, you’ll get in at the wrong time and be surprised by the results obtained and lose confidence before the investment has time to pay off.
Rob
Somewhere down the road gold will eventually rule the day as all the fiat currencies collapse on themselves – unless the world’s major central banks suddenly get religion and decide to stop supporting their respective governments’ overspending by slowing down the overheating printing presses.
In the near term gold may fall a bit, but that’s not dissuading me from adding it to my portfolio for diversification.
Best,
Len
Len Penzo dot Com
Diversifying your investment portfolio is always a good idea. Having some limited exposure to physical gold may not be a bad idea, but physical gold as an investment over time is really not a great way to grow your investments to outpace inflation. To capitalize on the gold craze in the moment, your best bet is probably gold ETF’s. But the real question is, should you long or short gold? The price of gold has a ceiling, but where is it?
Gold has always been a Great Hedging Strategy. Even in turbulent times during the recession 2008 Gold has firmly stuck its ground with a increasing growth till now. There are mixed views around the globe regarding the trend of gold when to buy and when to sell. Over history it has been seen that gold prices have corrected only a couple of times. This clearly shows the strength of gold in certain types of economic conditions. As far as the current scenario is concerned, gold is actively witnessing participation of traders for gains on a daily intraday basis. In India, gold intraday trade has significantly gone up. With many good commodity advisory companies coming up, traders now take their help to trade the best possible way in gold with complete guidance. I run such a company that provides commodity services in MCX by offering gold tips, silver tips, metal, copper and other mcx tips. These tips are being used by a lot of commodity traders to aid them to earn on an intraday basis. To sum it up, i would like to quote an indian saying “Investing in Gold is always Cheap, Be what ever the prices are”
As you said gold is a great way to add diversification to you portfolio in the long term. Short term and gold is just another trade like any other future or commodity, which is fine, but you have to keep in mind that if there’s a catastrophic failure in the market like in 09 then gold probably will drop in price as well. I also recently read Graham’s Intelligent Investor and he states that growth wise gold is not a very good hedge against inflation.
I see gold more as a protection against a market crash or the even foretold failure of the US dollar from out national debt. While these may never happen it’s always good to have insurance. That means gold bullion, and less investing in ETF’s and mining companies unless of course this is a short term play on the market.
That’s a spin I hadn’t heard before. Good points. I still think I’d rather not touch something that looks like bubble #3 (after .com and real estate). But it’s by far the most persuasive argument I’ve heard so far for investing in gold.
Yeah, gold is a great investment. But why not platinum? Why just gold and silver? Also, I think that gold is more of a protection against a market crash or any future failure of the US dollar due to our oversized national debt.