Gold; most effective but under-represented in portfolios
To diversify its portfolio into different asset classes with low correlation has repeatedly shown to generate higher risk-adjusted returns than if one only exposes itself to, for example, equities. Still, many investors today are left with portfolios that do not contain the most effective asset when it comes to acting as airbags when the rest of the portfolio is volatile.
To diversify its portfolio into different asset classes with low correlation has repeatedly shown to generate higher risk-adjusted returns than if one only exposes itself to, for example, equities. Still, many investors today are left with portfolios that do not contain the most effective asset when it comes to acting as airbags when the rest of the portfolio is volatile.
Exposing to a mixed commodity ETF with the hope that a significant portion of the investment will be weighted against gold usually proves to be a bad idea since in most cases precious metals are underrepresented in commodity baskets.
Raw materials themselves are a complex type of asset and all sub-groups are characterized by different things. This means that what favors the price of energy can be negative for another subgroup and vice versa. However, when it comes to gold, the precious metal has six advantages over other commodities:
- Gold has delivered higher risk-adjusted returns over a longer period compared to other commodity sub-groups
- Gold offers a more efficient diversification
- Gold overperforms other commodities during periods of low inflation
- Gold has lower volatility
- The value of gold is preserved over time
- High liquidity
Thus, using commodities as an asset class to
diversify their portfolio can give you several benefits, but picking out gold
as an individual asset can generate even higher results over time.
What one should remember when it comes to
commodities is that they are speculative assets. This makes it worse for them
to simply think that they will generate higher returns over time because raw
materials do not generate any real growth. In other words, they should rather
only be used as a hedge at times when equities are more expensive in relation
to commodities, so that later, if the price of commodities in relation to
equities is higher, they are sold to allocate their capital to a larger
proportion of shares or bonds. With gold it is different. Since gold itself is
a value-preserving asset rather than a way of speculating, it should also serve
another function in a portfolio.
The problem with today's commodity index is that they simply lump all the raw materials into a basket. In most cases, energy and industrial metals are overweight, while gold is rarely more than 12 percent, and in most cases much less than that. Since gold has completely different properties than other commodities, it should also be treated as its own asset class.
Gold performs better than other commodities under low inflation
Inflation is also important to consider when considering how to expose yourself to commodities. Gold, unlike other commodities, tends to retain its value even during periods of low inflation.