Negative correlation stands out on portfolio diversification

This article is part of
The Guide: Precious metals

Negative correlation stands out on portfolio diversification

Though there is little consensus on whether gold is a worthwhile investment, or where its price may go from here, in my view, an allocation to the precious metal can be a valuable way of hedging and diversifying a portfolio.

Evy Hambro and Tom Holl, managers of the BlackRock Gold & General fund, expect to see a relatively range-bound gold price over the next 12 months, although they believe it could surprise on the upside.

They say: “Global economic growth appears to be improving, which is likely to be supportive for broader equity markets and could act as a headwind for gold. However, we see a lot of uncertainty, given events such as Brexit, the new US administration and unrest in the eurozone, and this does not appear to be being priced into financial markets today. With broader equity markets at all-time highs after an extraordinary bull run that has appeared to have been fuelled by monetary policy, we continue to believe in the importance of an allocation to gold.”

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It is also worth considering the US dollar, which has a relatively robust outlook. The US has now embarked on a tightening cycle while monetary policy elsewhere is loose – the gold price and the dollar has historically been negatively correlated.

Over the longer term, rising incomes in emerging markets should increase retail demand for gold and help to be supportive of the price. The future supply of physical gold is also likely to be constrained as ore body discoveries are becoming increasingly scarce. This is an important supply-side factor in the market, and could contribute to higher prices for gold in years to come.

Despite coming under pressure in the fourth quarter of 2016, gold and gold equities rose significantly over the course of last year and have proved their worth as a diversifier and an important source of portfolio insurance.

At a time when political uncertainty remains relatively high, given unrest in the eurozone and the controversial Brexit and US election results, and with global markets becoming increasingly positively correlated, an allocation to gold or gold equities should continue to be an important portfolio diversifier. Although it does not offer any yield, unlike some other so-called “safe haven” assets such as government bonds, the fact these assets are currently trading with very low or even negative yields has reduced the opportunity cost of holding gold. 

If the US Federal Reserve were to raise interest rates more aggressively than expected this year, global growth exceeded expectations and financial markets performed well, the gold price would undoubtedly come under pressure. But it still remains a very useful portfolio hedge given its negative correlation to other assets, and in this scenario any losses incurred from an allocation to gold would be offset by the performance of other assets in an investor’s portfolio.

The best way to gain exposure to gold is via a dedicated fund which invests in primarily in gold mining companies, or if you want to invest in physical gold you can do so via a gold exchange-traded fund (ETF).