Escolar Documentos
Profissional Documentos
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November 2014
Recent Gold ETF demand, spot price and S&P 500 trend; Long-term spot gold and S&P 500 movement (below)
1600
200
1400
100
1200
1000
-100
800
-200
600
-300
400
-400
200
0
-500
Q3'12
Q4'12
Q1'13
Q313
Q2'13
Q413
Q114
Q214
Q314
S&P 500
2,500
2,000
1,500
1,000
500
Jan-14
Jan-12
Jan-10
Jan-08
Jan-06
Jan-04
Jan-02
Jan-00
Jan-98
Jan-96
Jan-94
Jan-92
Jan-90
Jan-88
Jan-86
Jan-84
Jan-82
Jan-80
Jan-78
Jan-76
Jan-74
Jan-72
Jan-70
S&P 500
P a g e |1
Case for investors to leverage the fall in gold prices and go long its diversification benefits
First, what are these diversification benefits?
But divide your investments among many places; for you do not know what risks might lie ahead The Bible, in the book of
Ecclesiastes which was written in ~935 B.C., credits diversification as a method to cater to the uncertainties of life.
Coming back to our existence in Anno Domini, simply put, investors may improve the risk return profile of their portfolio by adding an
asset with lower than 1.0 correlation with the existing portfolio. Lower the correlation with the existing portfolio, better the risk reduction
potential. To substantiate, we illustrate the potential of diversification with mean-variance optimized portfolios holding US Equity, Global
ex-US Equity, Global Diversified Fixed Income, Global Real Estate and Gold. We start with Equity and build improved portfolios by
adding asset classes.
PORTFOLIO II
PORTFOLIO III
PORTFOLIO IV
Equity
Add Gold
Equity
100%
Equity
60%
Equity
50%
Equity
50%
US Equity
80%
US Equity
45%
US Equity
40%
US Equity
40%
International ex-US
20%
International ex-US
15%
International ex-US
10%
International ex-US
10%
Bonds
0%
Bonds
40%
Bonds
40%
Bonds
40%
Real Estate
0%
Real Estate
0%
Real Estate
10%
Real Estate
10%
Gold
0%
Gold
0%
Gold
0%
Gold
0%
Return
7.6%
Return
7.1%
Return
6.9%
Return
6.7%
Standard deviation
14.5%
Standard deviation
9.0%
Standard deviation
8.7%
Standard deviation
7.6%
0.79
0.80
0.88
0.52
16%
1.0
0.88
0.8
0.80
0.79
12%
0.6
8%
0.52
0.4
14.5%
4%
7.6%
7.1%
9.0%
6.9%
8.7%
6.7%
7.6%
0%
0.2
0.0
Portfolio 1
Portfolio 2
Return
Standard Deviation
Portfolio 3
Portfolio 4
P a g e |2
As we add a new asset class to the preceding portfolio, in an optimized allocation, we are able to demonstrate the risk-return improving
potential of diversification. Even though portfolio returns decline slightly, the standard deviation of the each subsequent portfolio
declines as well. At the extreme, we are able to increase the risk adjusted return (return per unit of standard deviation) from 0.52 for
Portfolio I to 0.88 for Portfolio IV.
Gold has put its hand up when needed the most: Income yielding assets v/s zero yield gold
As stated above, as long as the correlation of the added asset class with the existing portfolio is less than 1.0, diversification benefits
should follow. That said, why should an investor source diversification benefits from gold which yields no income versus other income
yielding assets?
Assuming our base portfolio of 80% US equity and 20% International ex-US Equity, for the period of our analysis, Gold had the lowest
correlation (0.02) with the base portfolio versus that of Fixed Income (0.04) and Real Estate (0.62). Lower the correlation, higher the
diversification benefits.
Correlation with Base Equity Portfolio
Asset Class
Overall
Credit Crisis
Dotcom Crisis
Jan 90 to Aug 14
Sep 07 to Oct 09
Mar 00 to Oct 02
Fixed Income
0.04
0.20
-0.24
Real Estate
0.62
0.55
0.88
Gold
0.02
0.11
-0.10
Furthermore, historically, correlations have tended to increase between asset classes in times of crises affecting all asset classes;
somewhat defeating the purpose of diversification. However, if we look at the period spanning the credit crisis, as a diversification tool,
gold was the most effective in terms of its correlation with the base portfolio, thus delivering when most needed. Furthermore, real
interest rates are still negative in majority of the developed world; further strengthening the case for gold as an effective asset class in a
portfolio.
Investors allocation out of gold, and into US equities, calls for a portfolio rebalancing
Portfolios may NOT be operating at an optimal asset mix. Sell-off in gold warrants an asset allocation relook
6,000
6.0
5,000
5.0
4,000
4.0
3,000
3.0
2,000
2.0
1,000
1.0
S&P 500
Ratio (RHS)
May-14
Jan-12
Sep-09
May-07
Jan-05
Sep-02
May-00
Jan-98
Sep-95
May-93
Jan-91
Sep-88
May-86
Jan-84
Sep-81
May-79
Jan-77
Sep-74
May-72
Jan-70
Average (RHS)
P a g e |3
P a g e |4
Physical Gold
Structured Products
Management Style
Potential Benefits
Potential Drawbacks
Passive
Large investment
required
Credit risk
Storage and insurance
costs
Active
Dividend potential
High liquidity
Potential for Alpha
Passive
Easy access to
investors
Protection of principal
Customizable to cater to
varied investors
Interest risk
Counterparty risk
Limited upside
potential
No alpha potential
Leverage
Standard contracts
Forward curves may be
in contango
Gold Futures
Active
High liquidity
No counterparty risk
Leverage potential
Active
Active
Low liquidity
Returns will differ from
those of physical gold
Not accessible to all
investors
Active
Low liquidity
Tax inefficient
Not accessible to all
investors
Hedge Funds
P a g e |5
Bears Case
Slow growth, deflation pressure and political chaos have put pressure
on the Euro (and other currencies). Any uptick in risk could drive
institutional & speculative money to an alternative currency; most likely
gold
Political risk
Tensions in the Middle East and Eastern Europe are still abound and
any potential breakouts represent upside potential for gold
Research Note by: Anant Wagh with contributions from Nitisha Pagaria and Anuj Goel
P a g e |6
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