The Merits of Using Gold as a Portfolio Diversifier

Although not perfect (nothing is), gold has a tendency to go up in the face of external shocks…[and] tends to have a low and sometimes negative correlation to US equities. As such, with stocks up, gold being down is not a terrible outcome for the investor using gold as a diversifier. Let me explain further below.

So writes Roger Nusbaum (www.randomroger.blogspot.ca) in edited excerpts from his original article* entitled Understanding the Drop in Gold.

[The following article is presented by Lorimer Wilson, editor of www.munKNEE.com and may have been edited ([ ]), abridged (…) and/or reformatted (some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. This paragraph must be included in any article re-posting to avoid copyright infringement.]

Nusbaum goes on to say in further edited excerpts:

Over the years I have been consistent in believing that low to mid single digit exposure is enough to have the effect of being a diversifier…If equities are going up and your diversifier-sized position in gold is going down that is ok. If everything you own goes up together then you should expect it to go down together and in that case you really aren’t very well diversified.

(click to enlarge)

If you look at the chart above comparing a client holding GLD and SPY I think you see that gold does what it is supposed to more often than not. For much of the last decade stocks were not making much progress and gold went quite a bit higher. In late 2007 and into the first few months of 2008 there was a negative correlation. Starting in March 2009 everything went up for a while. Then in this down move for gold equities have gone straight up, so again a negative correlation, which is what people expect during moments of clarity.

Conclusion

Stocks up, gold down is not a terrible outcome for the investor using gold as a diversifier. Of course, it is up to each individual to decide whether, after accounting for all the pluses and minuses of a position in gold, it is still worth owning, but stocks up gold down is not a shocking market behavior.

[Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.]

*http://randomroger.blogspot.ca/2013/07/understanding-drop-in-gold.html (Random Roger © 2009)

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