Go for Gold in Search of Diversification, Risk Reduction

With the SPDR Gold Shares (GLD) — the largest gold-backed exchange traded fund by assets — higher by 12.26% year-to-date, it’s easy for investors to renew their affinity for the yellow metal.

On the other hand, it’s advisable to not become overly enthralled by barely more than four months of performance and rather focus on how gold and ETFs such as GLD can benefit long-term portfolios. Those benefits include broadening portfolio diversification and the potential to more effectively manage risk in turbulent market environments.

Examining the diversification point, while many advisors grapple with exactly how much of a portfolio should be allocated to gold, the reality is that many portfolios are equity- and fixed income-heavy — perhaps too heavy. Gold or a fund such as GLD or the SPDR Gold MiniShares (GLDM) can act as a diversification tool.

How To Use Gold For Diversification

Diversification isn’t just about having another asset in a portfolio. It’s also about reducing correlations to the portfolio’s existing exposures. Data suggest the yellow metal does just that.

“Unlike several other asset classes typically used as portfolio diversifiers, gold has historically been an efficient source of portfolio diversification, with its low correlation historically growing stronger over time, while many real assets have moved in an opposite direction, more closely aligning with movements of traditional equities and bonds,” according to State Street Global Advisors (SSGA).

SSGA data indicated that from 2009 through today, gold has been less correlated to the equity-based MSCI World Index than broader commodities strategies, real estate, and private equity. That lack of correlation to traditional and alternative assets is an important trait when remembering that gold and the related ETFs don’t offer the protection of dividends or interest payments.

As for risk management, gold has a well-established though not foolproof reputation as a safe haven asset. It’s long been a favored destination of market participants when inflation spikes. Other scenarios include macroeconomic turmoil, or when geopolitical concerns are elevated.

SSGA noted that gold proved sturdy during calamitous market settings. These include the dot-com bubble, the aftermath of the 9/11 terrorist attacks, and the global financial crisis.

“With a reputation as a perceived safe-haven asset, gold’s performance has the potential to shine during extreme volatility and market turbulence, growing less correlated to traditional equities and providing a potential ballast for portfolios that can help limit drawdowns,” concluded the ETF issuer. “Gold’s historic benefits may potentially provide advantages to the modern-day portfolio that can help investors navigate these evolving risks.”

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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.