Gold News

Diversification Adds Nothing

The dumbest investing idea you'll read before the next stockmarket crash...
 
SO LAST WEEK's LBMA conference in Barcelona coincided not only with the city's split over independence for Catalonia, writes Adrian Ash at BullionVault.
 
It also saw the 30th anniversary of the 1987 stock market crash, the sharpest ever plunge in major world equities. 
 
You can catch up with the bullion market's latest news and views in our reports from last week's LBMA conference elsewhere on GoldNews
 
But that 30th birthday for October '87 came just as jitters over the current record-breaking bull run in stocks and shares are intensifying. 
  • Like 1987, some investors now think today's bull market in equities has run too long;
  • Others think major stock markets look over-valued. Very over-valued;
  • And some fear that central banks will burst the bubble by raising interest rates. 
As in any financial crisis, gold was seen as a core 'safe haven' asset during the October '87 crash.
 
Bullion jumped 3.5% against the Dollar on Monday the 19th, reaching 4.5-year highs as the Dow lost more than 22% in one day. 
 
But because the slump was so swift however, gold then held firm rather than pushing substantially higher... 
 
...and so it was investors who had bought gold before the stockmarket crash who benefited from its stability, not those flocking in once the trouble had struck. 
 
It's over the longer term that gold tends to do well when other assets struggle, as this table of US asset real returns to end-2016 shows. 
 
Table of US assets real total returns (ex. costs or tax) by decade. Source: BullionVault
 
Nothing is guaranteed. But the zig and zag looks pretty clear on the historical record.
 
The short history of Black Monday in October 1987 also says that anyone thinking they might need some investment insurance with gold should buy early, before a stockmarket correction or crash gets started. 
 
That, however, is exactly what the vast bulk of investors are NOT doing today.
 
"A little more than half of US investors anticipate a decline this year that will wipe out 'significant gains'," according to one recent poll. 
 
Ooh, sounds like a little insurance makes sense, right? 
"Yet just 18% said they're selling stocks to shield their portfolios from a downdraft, and only one out of five said they were buying bonds to limit their exposure to stock market risk." 
Gold, as history shows above, could be a more useful hedge. Yet money managers are staying shy...avoiding gold-backed ETFs and trimming their bets on Comex gold derivatives. 
 
Private investors meantime have cut their demand for US gold and silver bullion coins down to the lowest levels in 10 years.
 
Maybe they've realized coins aren't a very efficient way of buying and owning physical bullion. But lacklustre demand across the physical markets says not. More likely, and like most everyone else, they're putting money to work in super soaraway equities instead.
 
Why isn't anyone building their investment insurance alongside their fast-gaining stocks?
"Diversification hasn't added much over the last 5 years."
So said one hedge-fund advisory's client recently, apparently.
 
Read that again. Then unpick its stupidity.
 
Diversification cannot add anything on top of a super soaraway stock market. Only buying more stocks can do that. 
 
Instead, diversification seeks to limit your losses when the equities bull run goes pop and your stockmarket gains start to evaporate...without hurting your gains too much in the meantime.
 
You cannot predict when stocks will hit the wall. So unless blind luck helps you time it just right, you cannot avoid the crash.
 
But by spreading your risk – now more, now less, depending on how risky you think the wider outlook – you can at least hope and plan to avoid the costs which a crash or correction dumps on your savings and retirement.
 
"If you'd told me a year ago where equities would be today," said James Steel of HSBC at last week's LBMA conference, "I'd have said gold would be much lower than this." 
 
Gold's negative correlation with equities "grows stronger the longer a bull market in equities runs," reckoned another speaker at the LBMA conference, this time a money manager.
 
Most usefully, "Gold's negative correlation with equities is strongest against momentum stocks," said an ex-money manager also speaking in Barcelona, this time over a cigarette and a Cava.
 
Gold, in other words, zigs most against the zag of the hot money's hottest favourities. Which should appeal to anyone worried about US equities and the tech-heavy Nasdaq's recent surge in particular.
 
Chart of Nasdaq Composite vs. gold priced in Dollars
 
Looking back 10 years to just before the financial crisis broke home-buyers' hearts and retiree plans everywhere, global equities have since swollen 29% by stockmarket capitalization in US Dollar terms from what was then an all-time record high.
 
The Nasdaq has accounted for 27% of that growth, the same percentage as the shares traded on the bigger and more varied NYSE. All told, equities across the Americas as a region have grown 37% by market cap...the NYSE by 30%...but the Nasdaq by 110%.
 
So if you, like so many other investors, worry that this 9-year bull run in world stock markets is about to meet its end...led by the unbeatable and "impeccable" FAANGs...but you would actually like to do something about it...then the case for gold should look worth reviewing today. 
 
The fact that hardly anyone else cares only makes it more compelling.

Adrian Ash is director of research at BullionVault, the world-leading physical gold, silver and platinum market for private investors online. Formerly head of editorial at London's top publisher of private-investment advice, he was City correspondent for The Daily Reckoning from 2003 to 2008, and he has now been researching and writing daily analysis of precious metals and the wider financial markets for over 20 years. A frequent guest on BBC radio and television, Adrian is regularly quoted by the Financial Times, MarketWatch and many other respected news outlets, and his views from inside the bullion market have been sought by the Economist magazine, CNBC, Bloomberg, Germany's Handelsblatt and FAZ, plus Italy's Il Sole 24 Ore.

See the full archive of Adrian Ash articles on GoldNews.

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

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