Investors should also consider gold as a diversifying asset. In an environment in which correlations are elevated, gold continues to march to its own drummer. Since 2010, gold’s correlation to the S&P 500 has been 0.06, a remarkably low correlation in an environment in which most assets, apart from Treasuries, tend to move together.
The bottom line is that I continue to advocate a strategic allocation to gold, in addition to investing in a broader commodity benchmark.
Market Realist –
Gold adds diversification benefits to your portfolio
The above graph shows the correlation coefficient of gold (GLD)(IAU), the S&P 500 (SPY)(IVV), the iShares Emerging Markets Fund (EEM), and the iShares Barclays 20+ Year Treasury Bond ETF (TLT), considering monthly returns for ten years.
The correlation coefficient, which always lies between -1 and 1, is the extent to which two securities move with each other. A correlation coefficient of 1 means that the two securities move in absolute tandem with each other. A coefficient of -1 means the two securities are inversely related. A coefficient of 0 means the two move in random directions. It’s the most desirable coefficient as far as portfolios are concerned.
The correlation between gold and the S&P 500 is 0.1. Between gold and Treasuries, the correlation is also 0.1. Between gold and emerging markets, it’s slightly above 0.3. The correlation between gold and the S&P 500 is much lower than between the index and emerging markets. Surprisingly, the latter stands at 0.8. The correlation between the S&P 500 and Treasuries is -0.3. Gold, which has a correlation close to 0, is a better option in terms of diversification.
This means that gold adds diversification benefits to a portfolio containing the other three assets. So gold needs to be in your portfolio and you should own gold, at least in a small amount.
Please read our series on Keep gold in your portfolio to diversity and hedge inflation for more on gold.