Precious metals have been among best performers this year, but investors shouldn’t wait for conditions to be just right before looking into gold allocations.
Gold should not be used as part of a market-timing trade, but rather as a core investment portfolio diversifier, Jerry C. Wagner, President and Founder of Flexible Plan Investments, said on the recent webcast, What’s the Optimal Percent Allocation to Gold?.
In a 43-year study of gold measured against all asset classes, titled The role of gold in investment portfolios, he found that the precious metal showed an average correlation of 0.06, which suggests that there is almost no relationship or dependency with other basic asset classes, making bullion a great portfolio diversifier.
“Financial advisors have long valued gold as a diversifier because it doesn’t always move the same way stocks or bonds do. Studies show that gold is superior to general commodity exposure in portfolio construction in several market scenarios,” Wagner said.
Financial advisors on the webcast also seem to agree with this sentiment. In a survey of advisors attending the webcast, 86% of respondents pointed to portfolio diversification as the main draw for gold investments, compared to 3% looking for the best tax treatment and 11% shooting for short-term performance.
Wagner pointed to seven scenarios where gold has outperformed: Real returns on the 10-year Treasury bond are negative. Equities are in a bear market. Commodity prices are in a bull market. The U.S. dollar is in a bear market. U.S. Treasury bonds are in a bear market. Inflation is rising. Lastly, market volatility is high.
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Gold can “act as an important counterbalancing portfolio component under a variety of very specific market and economic conditions,” Wagner said.
However, Wagner warned that gold may underperform when the economy is suffering through deflation.
Currently, gold has enjoyed a great year as unconventional monetary policies, depreciating currencies and negative interest rates helped drive record demand for gold investments.
Despite the recent outperformance in gold, Wagner argued that gold prices have also broken out of long-term down trends and may have more room to run.
“Since 1972, when gold was freed from price restraints, gold bull markets have averaged 94.8% and consumed an average of 555 days,” Wagner said. “The present rally has seen an increase of just 27% over 245 days. So in price movement we are just over 28% of the way through a normal bull rally in return and 44% of the way based on time.”
Looking ahead, 60% of advisors surveyed on the webcast are looking to increase gold allocations ahead, with 39% saying they will stand pat.
Financial advisors who are considering allocating a portion of their client portfolios into gold may adjust their traditional 60% stock and 40% bond split. Through their 43-year study, Wagner contends that the best risk-to-reward combination included a 25% allocation to gold, with any percentage allocation to gold up to just over 45% outperformed a simple balanced portfolio on a risk-adjusted return basis.
However, Wagner warned against gold mining stocks, labeling gold producers as an “imperfect proxy for gold bullion.” Gold mining sector reflect the underlying fundamentals of the individual miners ad are much more volatile than bullion.
Consequently, investors may consider something like the Gold Bullion Strategy Fund (QGLDX) to gain exposure to gold price movements. QGLDX is the first and only no-load gold bullion fund available to non-exchange traded fund, mutual fund investors. The fund tries to reflect the daily percent change in gold bullion as determined at the end of each day. In contrast, other gold-related funds primarily track gold mining stocks.
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QGLDX may utilize near-term futures and gold ETFs to capture the price movements of gold. Additionally, the fund may include short-term bond allocations further support stable pricing and offset the fund’s expense ratio.
Moreover, unlike other gold investments, QGLDX may offer some tax benefits. Investors will not have to fill out the onerous K-1 form and will not be subject to the collectibles tax rate associated with other physically backed gold holdings. The fund is taxed as a normal mutual fund with the usual ordinary income, with the usual capital gain or loss tax treatment.
Financial advisors who are interested in learning more about the bullion market and gold as an asset class can watch the webcast here on demand.