Gold Reduces Risk

Nobel Prize-winning economist Paul Samuelson famously quipped that the stock market has predicted 9 of the last 5 recessions! He understood that stock investors can be anxious, very anxious when they smell just a whiff of economic trouble that could bring a malodorous stink to corporate earnings. Typically, they will rush for the exits.

This is what we witnessed in late February and early March, as President Trump alternated between threatening, imposing, cancelling, and then again imposing tariffs, causing great uncertainty for businesses, consumers, and trading partners.  

Even though most economic indicators were not yet indicating a significant contraction, the stock market didn’t care. It’s a forward-looking mechanism that is focused on what may happen in the near future, usually about three to six months from the present, which led many investors to dump shares.

This is why it is so important to keep a portfolio diversified. Gold, in particular, is an excellent way to reduce investment volatility because the precious metal has a low correlation with risk assets during downturns.

This was absolutely the case in March. As stocks sank, gold held above $2,900 an ounce, and on the day the Standard & Poor’s 500 Index was down 10 percent from its high—what Wall Street calls a “correction”—gold set a new high, breaking through $3,000 an ounce in New York futures trading.

Gold has consistently lowered the overall volatility of investment portfolios. A widely-used Wall Street metric is the Sharpe Ratio, which measures how much more return an investor receives for taking on additional risk. On average, the Sharpe ratio increases by 12 percent when 2-½ percent of an investment portfolio is allocated to gold, according to a World Gold Council (WGC) analysis. Over the course of 3, 5, 10 and 20 years, the WGC found portfolios with 5 percent gold had lower volatility and better performance than those holding no gold.