Gold as a Strategic Asset Class
Investors have often used gold tactically in their portfolios, with an aim to help preserve wealth with a relatively liquid asset that can potentially help navigate risk during market corrections, geopolitical stress or persistent dollar weakness. But in addition to gold’s tactical benefits, its function as a core diversifying asset during a variety of business cycles may demonstrate that gold can potentially play a more long-term strategic role.
Gold has the potential to enhance portfolio construction strategies on several fronts — providing broad benefits that can potentially support strategic investment efforts across multiple business cycles. Primary potential benefits include:
- Risk Management
- Capital Appreciation
- Wealth Preservation
Here we show how the key pillars and historical benefits of gold investing can provide potential support for these vital elements of investors’ portfolios.
1. Gold and Risk Management: The Potential Short-term and Strategic Benefits
Managing risks — both short term and unknown — is critical to optimizing portfolio performance. And gold’s historical benefits during a variety of market and business cycles can potentially provide a ballast for portfolios during good times and bad by adding:
- Portfolio Diversification
Gold has demonstrated a low and negative historical correlation to many financial indices over time, potentially helping to smooth out volatility and preserve wealth. For example, gold has shown a 0.00 and 0.08 monthly correlation to the S&P 500 Index and Bloomberg Barclays US Aggregate Bond Index, respectively, since the 1970s.1 This persistent and historically low correlation to many other financial assets is rooted in gold’s diverse sources of demand — both cyclical and countercyclical — which is illustrated during different phases of a full economic cycle.
Adding an allocation to gold may potentially provide diversification that can help mitigate portfolio drawdowns, increase portfolio efficiency through higher Sharpe Ratios and provide a potential store of value for investors over time.
- Managing Market Downturns
With a reputation as a perceived safe-haven asset,2 gold’s performance has the potential to shine during extreme volatility and market turbulence, growing less correlated to traditional equities and providing a potential ballast for portfolios that can help limit drawdowns.
As 2020 transformed asset markets, investors were faced with constructing portfolios that can weather the low interest rate and risk landscape. Gold’s historic benefits may potentially provide advantages to the modern-day portfolio that can help investors navigate these evolving risks.
Source: Bloomberg Finance, L.P., State Street Global Advisors. Data from August 25, 1987 to September 30, 2021. Date ranges for the time periods noted are: 2008 Financial Crisis: 08/11/08 - 03/09/09; Coronavirus: 02/19/20 - 03/23/20; Black Monday: 08/25/87 - 12/04/87; 2002 Recession: 03/19/02 - 07/23/02; Dot Com Bubble: 09/29/00 - 04/04/01; Gulf War: 07/16/90 - 10/11/90; LTCM & Asian Crisis: 07/17/98 - 08/31/98; US Credit Downgrade: 07/07/11 - 10/03/11; Subprime Meltdown: 10/09/07 - 03/10/08; September 11th: 08/24/01 - 09/21/01; Flash Crash: 04/23/10 - 07/02/10; Trade War/Recession Fears: 09/21/18 - 12/26/18. US Equity represented by S&P 500 Total Return. Gold = gold spot price. Index returns are unmanaged and reflect peak to trough returns for the stated period. Index returns do not reflect the deduction of any fees or expenses. Past performance is not a guarantee of future results.
- Low Correlation to Other Assets and Alternatives
Based on gold’s low correlation to many traditional markets, gold has historically provided positive returns during extreme bouts of volatility and market turmoil — earning it a “perceived safe-haven” reputation with some investors.
Unlike several other asset classes typically used as portfolio diversifiers, gold has historically been an efficient source of portfolio diversification, with its low correlation historically growing stronger over time, while many real assets have moved in an opposite direction,3 more closely aligning with movements of traditional equities and bonds.
Source: Bloomberg Finance, L.P., State Street Global Advisors. Data from 12/31/1993 to 09/30/2021. 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.
2. Capital Appreciation and Gold’s Potential
Gold may merit consideration in more than just down markets, with its benefits potentially providing investors longer-term and strategic opportunities in terms of capital appreciation. Gold’s diversification and historically uncorrelated returns can potentially help limit episodes of portfolio drawdown, and that can help optimize portfolios by limiting impairments to capital. But gold is not just for managing the downside and may provide the potential opportunity to help investors grow their capital during certain market cycles, with some growth potential of its own.
- Historical Long-Term Returns
Gold has historically provided competitive long-term returns through a variety of business cycles — good and bad — adding longer-term diversification that can potentially help with optimizing portfolio returns.
Source: Bloomberg Finance, L.P., State Street Global Advisors. Data as of September 30, 2021. Gold = gold spot price, US Cash = ICE BofAML US 3-Month Treasury Bill Index, US Bonds = Bloomberg Barclays US Aggregate Total Return Index, Global Equities = MSCI World Total Return Index, Commodities = S&P GSCI Total Return Index. Past performance is not a guarantee of future results.
- Positive Risk-Adjusted Returns
Growing the value of portfolios and optimizing returns across business cycles is essential when constructing portfolios for the long run. Further, a low correlation between the asset classes in a portfolio can also potentially help lower portfolio volatility and therefore, all else being equal, increase diversification that can potentially improve Sharpe Ratios and enhance the overall risk-adjusted return of the portfolio over time.
As illustrated in our research article, Case For Constructing Portfolios with SPDR® Gold Shares (GLD®), we examined how including GLD in a hypothetical multi-asset portfolio – that also includes global stocks, various classes of fixed income, real estate, private equity, and commodities – may improve its risk-return characteristics. We found that holding between 2% and 10% of GLD between January 1, 2005 (GLD’s first year of operation) and the current period may have improved the hypothetical portfolio’s cumulative returns and Sharpe ratio and lowered its maximum drawdown, as compared to a portfolio without any gold-backed investments.
Illustrating the Potential Benefits of a Gold Allocation in a Portfolio
Defining the Hypothetical Portfolios
Asset Class Weightings for Hypothetical Blended Portfolios A, B, C and D
To read the full report, you can access the case study here.
GLD® Standard Performance Information as of September 30, 2021
3. Preserving Wealth: More Potential Strategic Benefits of Gold’s Diversification
Based on gold’s historical diversification and positive risk-adjusted returns during market turbulence, it has a track record of potentially helping to temper short-term volatility and limit drawdowns.
But an allocation to gold may support preserving wealth on a longer-term basis too, with its historical positive longer-term risk-adjusted returns during a variety of business cycles helping investors weather unforeseen risks and capital impairments that can erode a portfolio’s value over time. See the above chart for gold’s longer-term performance and how it can potentially influence portfolio construction during a variety of business cycles over time.
- Deep Liquidity
Gold’s liquidity may help with wealth preservation, providing investors a relatively deep and liquid trading market that may be a key benefit of holding gold strategically. With a historical trading volume on par with major debt, currency, and equity markets, the estimated average daily turnover of gold is more than US $183 billion, which is equivalent to US $44 trillion a year.
And even during turbulent markets , like those experienced during March 2020, gold market liquidity has stood the test of time, with gold trading volumes hitting US $237 billion in March during the initial COVID-19 lockdown,4 providing investors ready access to a liquid trading market— or access to cash — when many other assets were declining in value.
- Historical Store of Value
Longer term, gold can potentially provide a unique store of value for investors, helping to preserve purchasing power over time. Gold has kept up with rising prices by historically providing positive returns during periods of rising inflation, particularly during environments of extreme inflation.5
Additionally, gold has showcased its ability to hedge against currency debasement by historically maintaining a negative correlation to the US dollar.6 Taken together, gold’s ability to keep up with prices, in conjunction with currency depreciation, may potentially help investors maintain purchasing power and preserve value against inflationary pressures.
Investors may consider thinking about gold not just as a tactical asset to be used in times of crisis, but instead, as a long-term, strategic investment with unique and diverse potential benefits. See how a gold allocation contributed to performance in a hypothetical blended portfolio in our whitepaper The Role of Gold in Today’s Global Multi-Asset Portfolio.