Gold: A Distinct and Independent Asset Class
While many investors classify gold as a commodity, gold stands out from other commodities and alternatives, potentially offering more efficient diversification — a benefit that may support treating gold as a unique asset class, with a distinct and independent allocation of its own.
As portfolio construction evolves beyond the traditional “balanced” 60/40 stock and bond portfolio, investors are increasingly looking to add exposures with less traditional assets that can potentially add both diversification and uncorrelated returns. Based on gold’s historically low correlation with many traditional asset classes, an active allocation to gold may help to potentially improve strategic allocations and portfolio construction strategies for a wide range of portfolio risk profiles across a variety of full market cycles.
A commonly cited motivation to invest in broad commodities is to combat inflation, with commodities historically providing unique diversification and, generally speaking, positive average returns across various inflation environments. But, not all commodities have performed similarly across all business cycles, and the extent of a commodity’s ability to offset inflation is more nuanced and dependent on the current or projected inflation regime.
Turning to today’s market, investors are contending with a high level of macro risk, low interest rates and high stock valuations, but in a relatively subdued inflationary environment. Based on historical data, this backdrop may be positive for gold, with gold’s historical returns during periods of low inflation outperforming a basket of broad commodities.1 Moreover, as the chart below illustrates, certain commodities, such as oil, copper, and even silver, have historically been more cyclical than gold and have tended to have a higher correlation to market and economic cycles because their demand depends more on pro-cyclical consumption, meaning they may capture more of the upside movements in global equities, but they may also experience more of the downside when equities fall.
Source: Bloomberg, State Street Global Advisors. Data from January 31, 1990 to August 31, 2020. BCOM = Bloomberg Commodity Total Return Index. GSCI = S&P GSCI Total Return Index. Past performance is not a guarantee of future results.
Understanding How to Compare Gold With Other Asset Classes
In conversations with investors, we are frequently asked how to compare gold with other commodities, liquid alternatives, and currencies. We often hear investors classifying gold as a commodity alongside other diversifying asset classes, such as oil, real estate, currencies, private equity and even a broad commodity index to gain exposure to gold. But gold frequently stands out from the pack of other commodities and alternatives, potentially offering more efficient diversification than many other sources — a benefit that may support treating gold as a unique asset class, with a distinct and independent allocation of its own.
Broad Commodities
Investors commonly access the commodity asset class by using broad commodity indices and passive strategies. This approach, however, should not be viewed as a substitute for an independent allocation to gold. In fact, based on three of the more prominent broad commodity indices, the gold allocation within a broad commodity index can range from 4% to 14%.2 This potentially leaves a portfolio underexposed to gold and some of its beneficial investment characteristics. Practically speaking, gaining gold exposure via a broad commodity index may offer investors access to some of gold’s diversifying and inflation-fighting benefits, but the relatively low exposure to gold may leave some potential benefits untapped.
When we compare gold with a major broad commodity index, we see that historically, gold has outperformed with less downside.
Source: Bloomberg Finance, L.P., State Street Global Advisors. Data from 04/30/1991 to 08/31/2020. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Past performance is not a guarantee of future results. Gold is measured by LBMA Gold Price PM (USD/oz)
Liquid Alternatives
When discussing gold’s diversification benefits, the conversation often turns to other “liquid alternatives” that are frequently leveraged for their daily liquidity and low correlations to stocks and bonds. But broadly speaking, gold has historically maintained a lower correlation over time and has provided a more efficient source of diversification than many of those other assets, including REITs, liquid hedge fund strategies, and private equity proxies.
Since 2008, gold’s correlation to equities has trended lower, while other alternative asset classes have experienced a rise in their correlation to equities, potentially reducing the diversification benefits they provide to investors’ portfolios.
Source: Bloomberg Finance, L.P., State Street Global Advisors. Data from 12/31/1993 to 08/31/2020. Gold = gold spot price. Commodities = S&P GSCI Total Return Index. Hedge Funds = Hedge Fund Research HFRI FOF Diversified Index. REITs = FTSE NAREIT All Equity REITS Total Return Index. Private Equity = LPX50 Listed Private Equity Index Total Return. Past performance is not a guarantee of future results.
Bitcoin
Currencies are another way that investors can manage volatility and inflation. With the evolution of technology, investors now have digital currencies, such as Bitcoin, to consider as an alternative for gold. But in our opinion, Bitcoin is not gold. In fact, Bitcoin’s extremely limited track record, exceptional volatility and speculative nature have yet to demonstrate that it can effectively transfer and preserve wealth like gold has the potential to do. And most central banks and other institutions still do not accept cryptocurrencies — such as Bitcoin — as a medium of exchange, further diminishing some of Bitcoin’s benefits relative to gold.
On a diversification and risk-adjusted return basis — especially during market downturns — Bitcoin historically is not comparable to gold, as seen in the following chart:
Source: Bloomberg Finance L.P. & State Street Global Advisors, date as of August 31, 2020. Gold is measured by LBMA Gold Price PM (USD/oz)
While innovation in the market is inevitable and welcomed, our stance is that both history and data have provided testament to gold’s historical store of value and virtues of diversification and liquidity — especially when compared with commodities, other alternative asset classes and cryptocurrencies, such as Bitcoin.
Based on today’s changeable markets and risks, gold’s role in a modern-day portfolio may be extending its reach, redefining its uses and benefits among the list of known portfolio diversifiers and traditional fixed income assets that investors have historically relied on to navigate risks and grow portfolio values.
As the investment landscape evolves, our SPDR gold strategy team continues to monitor market trends and investor demand. You can read their latest commentary here.