Should You Diversify With Gold?

by Sep 25, 2020Investment Strategy, Market Insights

Among investment assets, gold stands out in several ways. One feature of the precious metal is its ability to store wealth, and its track record of doing so is longer than any paper asset’s, such as stocks, bonds, or any government currency.

Gold’s supply is limited and cannot be printed or inflated at will by a government, and the cost of extracting gold is high. In fact, experts say we have reached peak gold, which means gold production will gradually decrease until there is no longer any gold left that can be feasibly extracted. Thus, gold will always have value.

All this would make it seem obvious that gold is a great long-term investment. While the most sophisticated investors in the world always hold gold in their portfolios, many financial advisors will say you should hold no gold at all. So, to provide you with hard facts for you to make up your own mind, let’s break down the question whether you should diversify with gold into two parts:

  1. Should you diversify at all?
  2. Should you diversify your portfolio with gold?

Should you diversify at all?

All investments come with risks, and if you invest in just one asset—for instance, stocks—you risk losing a large portion of your investment should that asset crash, in this case the stock market. You also risk losing growth opportunities in assets outside the stock market that may appreciate more than stocks. Diversification means that you spread your risk across different assets and reduce the impact on your portfolio of a stock market crash or other financial crisis. It also means that instead of placing a single bet on a single horse, you are betting on many horses participating in the race, allowing you to notch wins at many outcomes. This simple explanation will make more sense than complex economic papers by Nobel Laureate economists that diversification is key to the success of a portfolio. Putting your eggs in one asset class will lead you to poor results. Mathematically proven. So, you should diversify your portfolio.

Should you diversify your portfolio with gold?

In order to answer this question, let’s look at how gold stacks up in these three categories:

  1. Can gold preserve and grow wealth?
  2. Can gold hedge against stock market volatility?
  3. Can gold protect you during times of disasters?

Can gold preserve and grow wealth?

This is a simple question to answer. During the gold standard, the US dollar was backed by gold. Once that link was severed in 1971, we can measure gold independently from the dollar and see if it can grow wealth. A $100,000 investment in gold in 1971 when gold was $35/oz would be worth $5,428,571 in September 2020 (gold at $1,900/oz). Isn’t that incredible? 

On an annual basis, it reflects a growth of 8.49% a year. In other words, gold is doing a lot better than inflation, and we explained why here. Oh, and here’s the best part: Since you are holding the gold, forget about paying 1.5% in yearly fees to financial advisors that sweat from “managing” your assets and are advising you against holding the precious metal. So, not only can gold preserve wealth, gold also grows wealth with no effort or additional expense on your part. Just hold it and reap the rewards!

Can gold hedge against stock market volatility?

To create a well-diversified portfolio, you need to include assets that are inversely correlated, which means that when the price of one asset moves down, another one moves up. Is it possible to create an ideal mix of financial assets like stocks and bonds when diversifying your portfolio? Both economists and your own observations show that the answer is no. When markets collapse, stocks and bonds will collapse too—and many times simultaneously since they are correlated. Thus, if your portfolio consists only of these two asset classes, it may implode as well.

But one asset stands out: gold. This precious metal is one of the asset classes that are the least correlated with stocks and bonds, so it protects your investments when traditional paper assets crumble.

We’ve experienced a couple of significant stock market crashes in the past two decades. During each of them, gold soared. The metal acts as an insurance when the markets tumble, like we’ve seen earlier this year. The chart below shows how gold has acted as an effective safe-guard during the past five market corrections, and you can see just how valuable a role gold plays in protecting your entire portfolio.

During the past five market crises, gold has effectively hedge against market volatility.

Can gold protect you during times of disasters?

While true disasters on a national or global level are extremely rare, during all the ones that occured in the last 5,000 years—including hyperinflation, world wars, and national catastrophes—gold was the only asset people trusted as a store of value. 

Got gold?  

 From these three criteria, it should be pretty clear that you should diversify your portfolio to reduce risk and ensure growth and that gold is an ideal asset for diversification, providing a much better instrument than diversifying your stocks and bonds with other stocks and bonds. 

 With gold, you get the proven diversification benefits, but you also get an elimination of third-party risk. Since you hold the gold, there is no corporate management risk, like the one you have with stocks or bonds. Also, diversifying with gold is a much purer form of diversification. 

With gold, you are choosing to place a portion of your funds in a physical, tangible asset and not a paper asset like the ones in your current portfolio. To do so, you are removing the funds used to acquire gold from the banking and financial system completely. When getting the gold, you have diversification not just in a separate asset class but also from system, banking, and government risks. 

 With all these benefits, one question remains: If gold is so good to my portfolio, and large institutional investors, all central banks, and billionaire investors hold a position in gold, why do financial advisors rarely recommend holding gold? We’ll answer that in detail next week.

To acquire a position in gold does not mean you need to sell all your stocks and bonds and move to live in a bomb shelter. I live in LA, own a home, have investments, and owned gold prior to founding Gold Alliance. It just does not make sense not to. When asked by a financial market reporter in a televised event if he owns gold, billionaire investor Ray Dalio answered: “I own gold…it’s not sensible not to own gold…If you don’t own gold, you know neither history nor economics.” What about you? Got gold?

May you and your loved ones be safe in these trying times.

Joseph Sherman

Joseph Sherman

CEO, Gold Alliance