I have previously suggested that a 10% gold position makes sense for many investors who want to generate attractive risk-adjusted returns in a diversified investment portfolio.
During my discussion, I spent little time talking about why a 10% position per se makes sense, as opposed to either a 2% position or a 50% position. Instead, my discussion focused on why it makes sense to own a meaningful position in gold.
For some people, a meaningful position is 11% in gold, while for others, it might be 20%. The correct allocation depends on each person’s risk tolerance, return goals, time horizon, and overall financial situation. That’s why my recommendation was “10%+” rather than 10%, or 12%, or 15%; I wanted to give room for the adjustments that must occur due to individual circumstances.
Yesterday, Incrementum published the 2018 version of my favorite annual gold report, “In Gold We Trust,” which I will discuss further in future posts. The extended version of the report is over 200 pages long, and I’m still in the process of slowly reading through the whole thing. Nevertheless, I want to share two tables I found which shed some light on the question of how much gold one should consider owning.
Risk/Reward Implications of a 10% Gold Position
The first interesting table, originally published by Goldman Sachs, analyzes the portfolio impact of adding a 10% gold position to a portfolio of 60% stocks and 40% bonds during the period since 1970. As you can see from the table below, adding a 10% gold position has enhanced returns and reduced downside volatility.
Goldman’s analysis also looks at the impact of adding a 10% position in GSCI (Goldman Sachs Commodity Index), in 30-year U.S. Treasuries, and in cash. Unsurprisingly, U.S. Treasuries and cash reduced risk, which is a good thing, but they also reduced returns. While cash and U.S. Treasuries certainly have a role in a diversified portfolio, these asset classes are not able to boost returns and risk in the same way that gold can.
Obviously, past performance is no indicator of future performance. That said, given how overvalued U.S. stocks are and given how leveraged the financial system is at the present moment, I expect the positive impact (on risk and return) of adding a 10% gold position to a 60/40 investment portfolio to be even more significant over the next ten years than it has been over the past forty years.
What are Central Banks Doing?
I also discovered that the world’s major central banks are on the 10%+ gold plan. To be more precise, central banks own a 13.73% gold position relative to all foreign currency reserves. For central banks, gold serves as a hedge against a decline in the rest of their foreign currency reserves, all of which are fiat currencies and most of which are U.S. Treasuries.
To be fair, the range is enormous, from China at the low end with a 2.25% gold position to Europe at the high end with a 42.64% gold position. While China’s gold position appears low, I suspect that China owns more gold than its official figures suggest due to the enormous volume of gold that has been imported into China over the past five years.
The key takeaway from this second table is that central banks understand the important hedging role that gold can serve in a portfolio of assets, and they have invested their own assets accordingly. Also, they are seeing that the need to hedge is increasing rather than decreasing because their gold positions have been rising year-after-year ever since 2008.
History suggests a 10%+ gold position makes some amount of sense. Central banks are acting accordingly. Furthermore, I expect that President Trump wants to see a weaker dollar, and any kind of a trade war will most likely result in accelerating inflation.
What are you waiting for?