Gold stocks have historically ranked among some of the most volatile asset classes – about three times that of gold bullion – but despite this volatility, our research shows that investors can use gold stocks to enhance returns without adding risk to the portfolio. [Let me explain.] Words: 560
So says Frank Holmes (usfunds.com) in edited excerpts from his original article*.
Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!), has edited further below for length and clarity.
Holmes goes on to say, in part:
Wharton School finance professor Jeffrey Jaffe presented an academic study back in 1989 that illustrated the effects of portfolio diversification into gold stocks…On the risk side, gold stocks had greater volatility (measured by standard deviation) than the S&P 500 but Jaffe found that, because of their low correlation to U.S. stocks, adding a small percentage of gold-related assets to a diversified portfolio slightly reduced overall risk.
The Efficient Frontier
Here is an updated version of Jaffe’s results.
To find an optimal portfolio allocation between gold stocks and the S&P 500, the efficient frontier plots different portfolios, ranging from a 100% allocation to U.S. stocks (the S&P 500) and no allocation to gold stocks, and gradually increases the share of gold stocks while decreasing the allocation to U.S. equities.
Allocation of 85% to S&P 500 Stocks and 15% to Gold Miner Stocks
Assuming an investor rebalanced annually, our research found that:
- a portfolio holding an 85% allocation to the S&P 500 and a 15% allocation to gold equities* had essentially the same volatility as the S&P 500 (horizontal axis) but delivered a higher return (vertical axis).
In other words, the addition of a small allocation to gold stocks increased portfolio returns with no increase in the portfolio’s volatility.
Between September 1971 and November 2011, the S&P 500 averaged a 9.69 percent annual return.
- A 15% allocation to gold equities and an 85% allocation to U.S. stocks, with annual rebalancing to maintain the allocations, would have yielded, on average, an additional 0.82% per year.
How much is 0.82% per year? Let’s use a hypothetical $100 investment as an illustration. A $100 investment in gold stocks in 1971 would have grown to nearly $5,100 at the end of November 2011, while the same amount in the S&P 500 would be worth about $4,800…When you combine the two, however, assuming the same average annual returns since 1971 and annual rebalancing over 40 years,
- a hypothetical $100 investment in a portfolio with 15% gold stocks would be worth about $6,600 or 37 percent greater than the $4,800 for the portfolio solely invested in the S&P 500, while adding virtually zero risk.
Allocation of 90% S&P 500 Stocks and 10% Gold Miner Stocks
U.S. Global Investors consistently suggests allocating up to 10% gold in a portfolio, so we also looked at returns for investors at that level. In dollar terms,
- a hypothetical $100 investment in the 90-10 portfolio would grow to $6,022 over the ensuing 40 years (assuming annual rebalancing), compared to $4,820 for the portfolio solely invested in the S&P 500 [or 25% greater]…with no additional volatility.
Our research shows that the relationship among gold, outsized returns and volatility has remained consistent through the past four decades. If you haven’t already completed your annual portfolio rebalancing, this may be an opportune time recalibrate your portfolio with gold stocks.
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