Institutions: Gold Asset Allocation Strategies

Gold has experienced significant price appreciation in the last decade, and investors have taken advantage of rising prices. However, gold’s most compelling benefits derive from its lack of correlation with other asset classes, making it a valuable tool for portfolio diversification and risk management in an asset allocation strategy.

Portfolio diversification

Gold’s sources of demand are geographically diverse and range across a number of unrelated sectors, from jewellery and technology to the financial markets. This is often sustained despite changing market conditions, as stronger investment demand balances falling consumer spending during periods of recession.

This diversity of demand means that gold is normally not correlated with many of the assets that make up a typical investment portfolio. This makes it a valuable tool for portfolio diversification which typically endures in both stable and unstable financial periods.

Why invest in gold? Gold’s role in long-term strategies

Currency hedge

The stresses on the financial system since the credit crisis in 2008 have undermined confidence in the world’s major currencies. A change in the balance of the world economy has led to a widespread belief that the Chinese renminbi will take on a larger role in the global monetary system. The World Gold Council has published research into the function that gold will play during the transition to a multi-currency system.

Gold, the renminbi and the multi-currency reserve system - summary

Gold, the renminbi and the multi-currency reserve system

Gold’s typically strong inverse correlation with the US dollar and many other developed-markets’ currencies make it a valuable hedge against short- and long-term fluctuations in the value of major currencies. Because it normally also holds its value against major currencies, gold is also effectively used as an inflation hedge.

Gold and US interest rates: a reality check

Risk management

Investors can benefit from gold’s role as a diversifier. Gold can be used to reduce portfolio volatility, minimise losses during periods of market shock, and serve as a high-quality liquid asset when selling other assets would incur large costs or losses.

Gold has very low correlation to most assets over the long run, making gold’s contribution to portfolio volatility small. In fact, in most instances, gold helps to reduce volatility significantly. The 24-hour nature of trading and the range of investment channels for gold mean that its markets are deep and liquid. Gold is virtually indestructible, meaning that nearly all of the gold ever mined still exists today. Much of it is in tradable form, meaning that sudden excess demand usually can be satisfied relatively easily. Unlike debt instruments, investments in gold do not depend on an underlying company or sovereign which can default.

What drives gold?