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Gold is the Optimal Portfolio Insurance

While a popular opinion contends that gold is volatile and thus risky, facts clearly prove the opposite. A look at the past few months as well as the long-term history shows that gold is substantially less volatile than shares (e.g. the MSCI World index) or commodities (oil, silver, copper). A study by the World Gold Council confirms this. In the past 20 years, volatility was significantly below that of oil, other precious metals, the GSCI commodity index, and most of the equity indices. Only the shares of junior explorers with low market capitalisations can be deemed “highly speculative”.

Volatility over 10 and 2 years

Volatility over 10 and 2 years
Sources: Bloomberg, Datastream, Erste Group Research

Precious metals have a low correlation with equities. The correlation efficient of gold (weekly correlation, 3 years) with the MSCI is -0.18. It is -0.17 with the DAX, and is practically uncorrelated with bond indices. Since 1990, the correlation of gold with the S&P 500 has been -0.15.

The traditional correlations have recently changed a lot. The correlation with the euro, which used to be 0.52 on a 12M basis, turned around to -0.187 in May. The correlation of the US dollar and gold during the same period was 0.042, whereas the 12M figure was -0.54. The correlation with the commodity sector has fallen as well; for example from 0.48 on a 12M basis to practically zero in May with the VRB commodity index. This suggests that gold has de-coupled from commodities and the leading world currencies, and it could mean that the monetary relevance of gold has increased and that gold is now traded like a currency again.

The following chart shows the 5Y correlation coefficients of the weekly performances with other commodities, equities, and commodity indices.

Correlation gold vs. other asset classes

Correlation gold vs. other asset classes
Sources: Bloomberg, Erste Group Research

The following graph highlights the fact that gold is an outstanding “event hedge”. In 20% of the weakest days of the S&P 500, precious metals and especially gold have clearly outperformed the other asset classes.

Performance on 20% of the weakest days of the S&P 500 index:

Performance on 20% of the weakest days of the S&P 500 index
Sources: ETF Securities, Bloomberg, Erste Group Research

Many studies show that gold, as part of the portfolio, reduces overall risk and improves portfolio performance. Especially in phases of high volatility, gold reduces the fluctuations. On top of that, gold and economic data show no statistically significant correlation with each other. This is probably due to the fact that gold contains no liquidity risk, is exposed to a lower market risk, and has no credit risk. Gold is not linked to any form of liability or promise – as opposed to shares or bonds. We therefore highly recommend gold for diversification purposes.

By. Ronald Stoeferle of Erste Group

Erste Group is the leading financial provider in the Eastern EU. More than 50,000 employees serve 17.4 million clients in 3,200 branches in 8 countries (Austria, Czech Republic, Slovakia, Romania, Hungary, Croatia, Serbia, Ukraine). As of 31 December 2010 Erste Group has reached EUR 205.9 billion in total assets, a net profit of EUR 1,015.4 million and cost-income-ratio of 48.9%.




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