Gold Still a Standard for Appreciation, Portfolio Diversification

Something unusual is taking place in the commodities complex this year. Broadly speaking, commodities are performing well. Gold, not so much.

Check out this tale of the tape. The WisdomTree Continuous Commodity Index Fund (NYSEARCA:GCC), a diversified commodities fund, is up nearly 14% year-to-date while the SPDR Gold Shares (NYSEARCA:GLD), the world's largest gold-backed exchange traded product, is off 5.44%.

Alone, gold's performance this year is disappointing and it's even more so when considering the arrival of inflation – an economic condition that's historically efficacious for bullion. Advisors that have been in business awhile are to be forgiven. They were practically programmed to believe gold is a premier inflation-fighting asset.

And with bitcoin, despite its recent price weakness, commanding more attention and framed as a digital alternative to gold, it's reasonable to expect that more clients are wanting to know if gold is even worth the hassle anymore.

Short Answer Is 'Yes'

Advisors often hear about and discuss the roles of liquid alternatives, of which gold is one, in standard 60/40 portfolios. Typically, the roles of liquid alts, which also include infrastructure, real estate, natural resources and other commodities, among others. While good lacks the income offered infrastructure and real estate, it is the original portfolio diversifier and one with a well-deserved reputation for adding downside protection to traditionally structured portfolios.

“Each time equities dropped more than 10% over the last decade, a 10% portfolio allocation to gold would have reduced portfolio drawdowns by 161 basis points (bps) on average compared to a traditional 60/40 portfolio, while the same allocation to most other liquid alternatives would have had the opposite effect — increasing average drawdowns,” according to State Street research.

Said another way, the hypothetical portfolio with gold performed less poorly during periods of significant weakness than portfolios including bitcoin, hedge fund strategies, infrastructure, REITs, natural resources and 60/40 portfolios. That's some pretty compelling evidence for advisors to remind clients that even modest allocations to bullion, despite the yellow metal's recent lethargy, is beneficial.

Adding to gold's luster is that it's supported by its own fundamentals and frequently displays lower correlations to equities than rival diversification instruments.

“Gold’s performance is explained by more than just the vicissitudes of global equity and debt markets. Gold is driven by its own market’s fundamentals — gold demand in the form of jewelry, technology, central banks, and investment along with changes in gold supply globally,” adds State Street. “Compared to gold, other liquid alternatives and Bitcoin have higher betas to global stock/bond portfolios; this shows that their performance is determined by these markets. This may result in a less effective source of portfolio diversification.”

Favorable Volatility Profile

Another benefit of gold is that it's volatility profile stacks up well compared with some of the other liquid alts mentioned here.

Alright, so that's not surprising regarding bitcoin, but over the past decade, gold's annualized volatility was below that of broader baskets of commodities, natural resources and REITs.

Bottom line: A case can be made that gold is a cut above other liquid alts when it comes to diversification and downside protection.

“However, not all alternative assets offer the proper amount of diversification. Overall, whether an investor is considering adding alternatives to their asset allocation, has already done so, or is primarily focused on traditional assets, gold — the original liquid alternative — may be a potentially strong complement to traditional asset allocation models and potentially enhance portfolio performance over time,” concludes State Street.

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