Gold as a means of portfolio diversification
Gold has unique properties as an asset class that could be used as a means to attempt to enhance portfolio diversification. A number of approaches are available for investing in gold, including the following:
- physical form of coins and bars
- futures and options
- indirectly, through gold-mining companies
- exchange-traded funds (ETFs)
- index-based hedged strategies (such as the S&P 500 Dynamic Gold Hedged Index)
Historically, gold has shown to move independently of other assets, thus it is generally used as a means of diversifying risk. Most often, gold is used to hedge macroeconomic events, such as inflation, deflation, and currency devaluation, potentially enabling investors to preserve their wealth. Gold has a negative correlation to the US dollar and is widely considered a currency hedge. The negative correlation between gold and the US dollar is often not evident on a daily or weekly basis, but it is almost always evident during periods of 12 months or longer.
Portfolio diversification strategies through gold Market Realist’s View
As we pointed out in the first part of this series, gold is increasingly being used as an alternative asset. In the past few years, gold’s investment demand has picked up considerably, and in the second quarter of 2016, gold’s (GDX) investment demand overtook jewelry demand.
Apart from this, gold is also considered a portfolio diversifier as well as a hedge against inflation and low interest rates. Investors add gold to their portfolios mainly to preserve capital in the event of global uncertainties. This means that price appreciation is a secondary goal, with minimizing downsides as the bigger motivation during market volatility. In other words, gold acts as insurance against geopolitical risks and uncertainties.
ETFs are the easiest way
ETFs (exchange-traded funds) are the easiest way to invest in gold. They’re also the most cost-efficient, charging relatively low annual expenses. The SPDR Gold Shares ETF (GLD) is the largest gold ETF, with a YTD (year-to-date) return of 26.6%, followed by the iShares Gold Trust ETF (IAU), which has had a YTD gain of 26.9%. The ETFS Physical Swiss Gold Shares ETF (SGOL) has risen by 26.7% YTD.
Gold mining companies
Investing in gold mining stocks is another way to get exposure to gold. Gold mining stocks have outperformed all other asset classes in 2016. The NYSE Arca Gold Miners Index, which is made up of companies primarily involved in gold and silver mining around the world, has gained 129% YTD. By comparison, the MVIS Global Junior Gold Miners Index, which is made up of the most liquid smaller companies in the global gold and silver mining industry, has risen by 167.7% YTD.
Investors can also allocate a small portion of their portfolios in physical gold like coins and bars, but delivery and storage can become major issues for investors buying physical gold.
Another option for investors interested in exposure to gold is an index-based hedging strategy. For example, the S&P 500 Dynamic Gold Hedged Index aims to provide exposure to the S&P 500 (SPY) while hedging the currency risk versus gold. Investors can also employ future and options strategies to buy gold.
Continue to the next part for a closer look at the inner workings of gold-hedged strategies.