Diversification: Buying Gold as Investment Insurance

- May 03, 2016 -

I believe buying gold makes sense for investors wanting diversification for their financial portfolio. Only by owning a range of different assets can you reduce the cost of uncertainty on your savings and spending power. Spreading out risk over multiple asset classes including precious metals is a simple definition of diversification.

Diversification Can Reduce Financial Risk

Historical data shows that gold can act as “investment insurance.” Gold is a simple tool for smoothing out your risk and return, and reducing your overall losses when stocks, bonds or real estate fall sharply. As with all insurance policies, this protection comes at a cost, most typically during bull markets in equities and real estate. For investors holding gold for the long term, the “premiums” associated with gold as an insurance policy are “paid” in the form of occasional weaker precious metal markets.

Buying gold is a smart idea for investors who want to diversify their financial portfolio.

Why You Should Use Gold To Diversify

Gold’s power for diversifying risk comes from its unique mix of four attributes:

1. Non-correlation: Gold prices don’t tend to move in the same direction as other asset classes, helping reduce the impact of sharp losses elsewhere in a portfolio. Indeed, across a matrix of 17 major asset classes only the U.S. Dollar, 3-month Treasury Bills, U.S. government bonds and corporate U.S. debt show smaller week-to-week correlations with all the other assets than gold does over the last decade.

2. Liquidity: Physical bullion is one of the deepest, heavily traded asset classes. If gold were a currency it would represent the fourth largest FX pair in the world. Starting in Asia and ending in the U.S., gold trading runs nearly 24 hours a day Monday through Friday.

3. Global demand: Gold enjoys a uniquely wide and varied user base worldwide, from investors to electronic manufacturers, jewelry producers and central banks. A series of seasonal events spur consumer demand from the wedding season in Asia, Christmas in the Christian world and the Chinese New Year amongst others.

4. No currency risk: While we tend to think of gold being quoted in U.S. Dollars, it doesn’t rely on the U.S. currency for any of its value. Instead, gold holds value against all currencies directly, making it highly useful as a hedge against a currency crisis or hyperinflation.

The history of the world’s finances will support this hypothesis: The more physical gold one owns, the lower the risk for a catastrophic loss of one’s non tangible (a.k.a. “paper”) assets, which results in greater rewards when traditional asset classes underperform or collapse.

By Douglas Trinder, Precious Metals Analyst, Jack Hunt Gold & Silver