While gold has traditionally been seen as a tactical way to help preserve wealth during market corrections, times of geopolitical stress or persistent dollar weakness, we think there is a case to be made for gold as a core diversifying asset with a long-term strategic role in multi-asset portfolios. The expanding universe of investable asset classes and the relative ease of shifting across different assets mean that multi-asset portfolios today look different from the “balanced” stock and bond funds of the past. Gold’s historically low or negative correlation with most other asset classes argues in favor of a strategic allocation for long-term investors. We look at how gold-backed assets have behaved over time as a portfolio diversifier, tail risk hedge and inflation hedge.
- Increase Portfolio Diversification
When building a multi-asset portfolio, investors must consider not only the potential or forecasted risk-return characteristics of a particular asset class, but also how that asset class behaves relative to other investments. While asset classes with high forecasted risk-adjusted returns are preferred, investors may want to broaden their search for asset classes that move differently relative to one another (low correlation).
A low correlation between asset classes may lower portfolio volatility and, all else being equal, increase portfolio diversification and enhance the overall risk-adjusted return of the portfolio. Figures 1 and 2 depict gold’s historical correlation to major equity and bond markets. These very low or negative correlations highlight the potential long-term diversification benefits gold could bring to a multi-asset portfolio.
- Tail Risk Hedge
Gold has historically been used to provide potential tail risk mitigation during times of market stress, as it has tended to rise during stock market pullbacks. Figure 3 shows that gold was able to deliver competitive returns and outperformed other asset classes during a number of past black swan events. This demonstrates that including gold in a multi-asset portfolio might help investors moderate market volatility and reduce portfolio drawdowns.
- Inflation Hedge
Our analysis of gold’s performance since 1970 shows that gold offers potential preservation of purchasing power in varying inflationary environments. During periods when the annual rate of inflation in the US has been below 2 percent, the price of gold has risen at an average annual rate of 6.7 percent. Moreover, during periods of moderate inflation — defined as an annual increase between 2 and 5 percent — gold has risen at an average annual rate of 7.4 percent. But gold has shown its greatest historical effectiveness in preserving purchasing power during periods when inflation has been running above 5 percent a year. During such times, the gold price has increased by an average annual rate of 15.2 percent. 
Historically, the price of gold has been influenced by real rates of return. One of the main reasons why gold did not appreciate during the 1980s and 1990s was because other asset classes performed so well. Conversely, gold has appreciated at times when real returns on assets like bonds have been low. We compared gold prices with real returns, with real returns calculated by subtracting the US core consumer price index (excluding food and energy) from the yield of US 10-year Treasury notes (see Figure 4).
In the 1980s, T-notes averaged a real rate of return of 4.50 percent, and 3.44 percent in the 1990s. Real returns continued to drop in the first decade of the new century, averaging 2.28 percent. Since the start of this decade, real rates have averaged 0.60 percent — the latest sharp drop relating to the Global Financial Crisis and the extraordinary central bank policies such as quantitative easing that followed. The last time real rates were so low was in the 1970s when they averaged 1.02 percent. Those low real rates were one of the major reasons why the price of gold appreciated from $43/oz. in 1971 to $512 at the end of 1979. Again, the disinflationary trend over the past 35-plus years and the low-to-negative real rates around the world that still prevail have been in gold’s favor, as Figure 4 shows.
While gold has traditionally been seen as a tactical way to help preserve wealth during market corrections, times of geopolitical stress or persistent dollar weakness, we think there is a case to be made for gold as a core diversifying asset with a long-term strategic role in multi-asset portfolios.
Authors: George Milling-Stanley Head of Gold Strategy and Robin Tsui ETF Gold Specialist with State Street Global Advisors. To find out more about State Street Global Advisors talk to your financial adviser
Bloomberg Barclays 7-10 Year Treasury Index: An index designed to track the performance of the US Government bond market and includes public obligations of the US Treasury with a maturity of between seven and up to (but not including) ten years.
Bloomberg Barclays Emerging Markets USD Aggregate Bond Index: A hard currency debt index that includes fixed and floating-rate US dollar-denominated debt issued from sovereign, quasi-sovereign and corporate EM issuers.
Bloomberg Barclays Europe Aggregate Corporate Bond Index: An index that measures the investment grade, euro-denominated, fixed-rate bond market, including treasuries, government-related, corporate and securitized issues.
Bloomberg Barclays US Aggregate Bond Index: An index that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market.
Bloomberg Barclays US Corporate Bond Index: An index that measures the investment grade, fixed-rate, taxable corporate bond market.
Bloomberg Barclays US Corporate High Yield Bond Index: An index that measures the USD-denominated, high yield, fixed-rate corporate bond market.
Bloomberg Barclays US Treasury Bond Index: An index that measures US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury.
Bloomberg Commodity Index: A broadly diversified commodity price index.
Core Consumer Price Index: A measure of inflation that excludes goods exhibiting price volatility, such as food and energy.
LBMA Gold Price: The spot price of gold set by the London Bullion Market Association.
MSCI All Country World Index: An index that measures the performance of the large and mid-cap segments of 23 Developed Markets (DM) and 24 Emerging Markets (EM) countries. The index covers approximately 85% of the global investable equity opportunity set.
MSCI Asia PAC ex Japan Index: An index that measures the performance of the large and mid-cap segments 4 Developed Market and 9 Emerging Market countries in the Asia Pacific region. The index covers approximately 85% of the free float-adjusted market capitalization in each country.
MSCI Emerging Markets Latin America Index: An index that measures the performance of the large and mid-cap segments of 5 Emerging Markets (EM) countries in Latin America. The index covers approximately 85% of the free float-adjusted market capitalization in each country.
MSCI Europe Index: An index that measures the performance of the large and mid-cap segments of 15 Developed Markets (DM) countries in Europe. The index covers approximately 85% of the free float-adjusted market capitalization across the European Developed Markets equity universe.
MSCI Japan Index: Designed to measure the performance of the large and mid-cap segments of the Japanese market. The index covers approximately 85% of the free float-adjusted market capitalization in Japan.
S&P 500 Index: A market value weighted index of 500 stocks that reflects the performance of a large cap universe made up of companies selected by economists.
US Dollar Index: An index that measures the value of the United States dollar relative to a basket of foreign currencies.
The views expressed in this material are the views of George Milling-Stanley and Robin Tsui through the period ended March 31, 2018 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
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 Source: Bloomberg Finance L.P., SSGA, data from January 31, 1970 to March 31, 2018.