Read our research to explore the importance of gold in portfolio diversification.
Asset allocation is a vital aspect of any investment strategy. Balancing asset classes of different correlations can significantly enhance returns whilst reducing risk.
Many investors believe their portfolios are sufficiently diversified. However, the majority of investment strategies focus primarily on only a few asset classes – stocks, bonds and cash. Such portfolios may be vulnerable when these asset classes react to market conditions in a similar fashion.
To counter this effect, many investors now seek more effective diversification by incorporating alternative investments, such as commodities, into their portfolio.
Gold has shown very strong returns over recent years. Still, its most valuable contribution to a portfolio lies in the fact that it is not correlated with most other assets (see chart below). This independence comes from the fact that gold’s price is not driven by the same factors that drive the performance of other asset classes. For more information on gold’s correlation with a range of assets, data and charts covering a number of countries are available to download from our investment statistics page.
The sources of demand for gold are far more diverse – both geographically and by sector – than those of many other assets. This helps to explain the independence of the gold price. It also explains why demand has remained robust despite a rally that’s spanned several years. Between 2002 and 2011, the value of global gold demand increased by 512%.
Moreover, most spending on gold is discretionary. 55% of total appetite over the five years to December 2011 came from the jewellery sector. A further 33% came from investment, while technological applications account for 12%. This market structure is unusual for commodities. Demand is usually driven by non-discretionary spending and is therefore differently exposed to the vagaries of the economic cycle.
Gold has seen recent growth in investment demand, at both the institutional and retail levels. This has further broadened the precious metal’s demand base, with tonnage demand increasing 143% over the last five years (to year-end 2011). Stronger investment demand can act as a counterbalance should recessionary pressures dampen consumer spending on jewellery.
Independent studies have shown that gold offers enhanced opportunities for diversification, relative to most other alternative assets. While traditional diversifiers often fail during times of market instability, even a small allocation to gold can significantly improve the consistency of portfolio performance. Particularly appealing to many investors is the fact that this protection applies during both stable and unstable financial periods.