Gold News

Diversifying with Liquid Gold

Marked against alternative investments, gold has unique investment benefits...
 
JUAN CARLOS ARTIGAS is director of research at market-development organization the World Gold Council.
 
Here he speaks to Mike Norman at Hard Assets Investor about the Council's latest quarterly report on investment returns and trends.
 
Hard Assets Investor: The Gold Council just came out with your new Gold Investor quarterly report. You highlight specific areas where gold is different from other alternative assets, and you also talk about the distinction between outperformance and diversification. A lot of investors may not even understand that.
 
Juan Carlos Artigas: This is really key. We were trying to explore gold in the context of alternative assets. Anything that is not a stock or a bond is going to be an alternative. Hedge funds, private equity, real estate commodities. What we find is that gold brings something new to the table, even for investors who have exposure to hedge funds and private equity and commodities and real estate. Considering gold as part of the allocation can bring very positive results. And as you were saying, it really has to do with two things: partly outperformance, but more than anything, diversification. 
 
Many alternative assets bring outperformance to portfolios. And that's why investors like them. They want to get better risk-adjusted returns, and they do get good results from investing in many of these strategies. However, in terms of diversification, alternative assets – in particular, hedge funds, real estate and private equity, and to some extent commodities – have a higher correlation to stocks, in part because they are more leaning not only to the stock market but also to the business side. 
 
When it comes to gold, it is truly the one alternative asset that has the lowest consistent correlation to the stock market. And more than anything, actually it keeps that correlation through periods of systemic risk, which is particularly important when it comes to balancing risk in a portfolio.
 
HAI: The other area you spoke about is that gold acts most of the time more like a currency. So you get the dual benefit of having some commodity exposure, but you also have that currency effect, which is again not correlated to the commodities.
 
Juan Carlos Artigas: Absolutely. And that lack of correlation comes from the fact that gold is less exposed to the business cycle. In many respects, a good portion of gold demand is countercyclical. So as you were saying, many people consider gold in the context of commodities. 
 
But when you look at the characteristics, it behaves much more as a currency. So thinking of gold as a currency is not really too outlandish. It's actually closer to what in reality gold behaves like. And part of the reason is, in terms of demand and supply, you can see from the demand side on one hand you do have consumption, whether it's jewelry or applications in technology and other industrial uses.
 
HAI: Volatility in gold prices has fallen sharply this year.
 
Juan Carlos Artigas: I think this is not a gold-specific problem, it's industry-wide in the commodity sector. It's a cycle. Volumes are quiet. People are waiting for something to happen. But to break out of these ranges, one needs a catalyst. It could be a geopolitical catalyst. It could be on the supply side. It could be on the financial crisis side, which would mean down movement for both equities and oil prices in general. Where it comes from, in which direction, that's the hard part. But it looks like we're going to have to have some event to break us out of the ranges at the moment.
 
HAI: Jewelry is very, very important. It's the biggest demand factor, isn't it?
 
Juan Carlos Artigas: It is the largest share of demand. But you also have the investment side of gold.
 
HAI: Which is growing very rapidly...
 
Juan Carlos Artigas: Exactly. And it's also an important and consistent part of the world, whether it is in the West or the East. But you can see that the consumption side is going to be procyclical, but the investment side is more countercyclical. And you don't have that really often in any asset. So that's one side. 
 
On the other side, in terms of the production, not only is gold production very well diversified in terms of the region of production – so it's not concentrated in a particular region – you also have gold already above the ground that can come back into the market. And it's not really consumed; it's not like oil, where once it's used you can't use it again, or agriculturals, or any other type of commodity. 
 
It's really an asset you can reuse. And that part of the characteristic of gold – in terms of its permanency in the system – is also one of the important characteristics of a currency. It's something you can rely on, something you can get your hands around. And because it's a large market, it has a lot of liquidity. So investors can access it fairly consistently.
 
Gold actually dampens volatility in many respects if you think about it, because if there is a disruption to production in one area, gold production is well diversified, it's not concentrated in one region.
 
HAI: There's a buffer stock there at all times.
 
Juan Carlos Artigas: Exactly. And that's one reason why gold is one of the least volatile components of these commodity indices.
 
HAI: Now, there was a third point – that gold is the most liquid of all alternative assets. Nothing comes close.
 
Juan Carlos Artigas: This is key. And not only those traditional alternative assets, but also the new liquid alts, the new strategies that are accessing hedge funds and private equity and so on, but in a more mutual-fund sort of a structure that are supposed to provide more liquidity and daily pricing, and so on.
 
HAI: The GLD, the gold ETF...?
 
Juan Carlos Artigas: Well, what I'm trying to say is that there's a trend for liquid alts, but even those liquid alts that are more liquid than the traditional alternatives, if you compare that to gold, it really dwarves, like gold dwarves any other market. In part through ETFs, gold-backed ETFs that are very liquid when you compare it to any stock that is traded, but especially on the futures and the over-the-counter market that are very large and provide a ton of liquidity of the market. And you actually create fewer disruptions in terms of pricing.
 
HAI: Has gold always exhibited these three characteristics – diversification, outperformance, and non-correlation to traditional assets? Or is that becoming stronger now because more and more people want to own gold?
 
Juan Carlos Artigas: What I can tell you is that most of our analyses are based on data going back to 1971 when gold started to freely trade in the market, when the Gold Standard and Bretton Woods ceased to exist or collapsed. So it really goes throughout times. It's not only about a particular aspect.
 
I think that what is interesting now is that you get more diversification, in part because the market is not so concentrated on Western investors or consumers. But really, the emerging markets, as they have taken a bigger role in all aspects of the global economy – but very much in particular with gold – creates bigger diversification. You are less tied to what is happening only in one part of the world. It's really a global asset.

Hardassetsinvestor.com is a research-oriented website devoted to sharing ideas about investing in the natural resources sector. Published by Van Eck Associates Corporation, the site offers an educational resource for both individual and institutional investors interested in learning more about commodity equities, commodity futures, and gold – the three major components of the hard assets marketplace.

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