Why you should have a portion of your portfolio in gold

A World Gold Council study has concluded that a distinct allocation to gold within a portfolio including alternative assets such as private equity, hedge funds, real estate and commodities, can preserve capital and reduce risk without diminishing long-term returns.

The report, “Gold: Alternative investment, foundation asset”, analyses the effect gold has when included in a portfolio of mainstream and alternative assets. The research showed that portfolios with an allocation to gold of between 3.3 percent and 7.5 percent (depending on the risk tolerance of the investor and the currency of reference) show higher risk-adjusted returns while consistently lowering Value at Risk (VaR).

VaR is a measure of the maximum amount an investor could expect to lose in a given period of time.

The report also said that during periods of financial turmoil in which equity indices fall sharply and volatility increases, gold’s volatility remains much lower than that of equities.

From the chart below, we can see gold also tends to outperform other assets in times of economic and financial turmoil.Even in 2011, gold is up 20 percent even as equity markets struggle to hold on to their recent gains.

In India, of course, most of us are already fans of the precious metal and know all too well its merit as a hedge against inflation and as a store of value.India is largest consumer and importer of the shiny metal, accounting for 28 percent of global demand, according to data from the World Gold Council. Together, the Asian axis ofIndia and China accounts for about 45 percent of total demand.

Gold demand is broadly distributed between jewellery, technology and investment.

Jewellery is the biggest component of demand (approximately 50 percent), private investment and more recently central bank net purchases account for another 39 percent of demand and applications to technology and other fabrications make up another 11 percent.

A recent Citi reports predicts that the macroeconomic and financial drivers that sent gold prices to record highs remain firmly in place. The brokerage predicts that gold could rise to $1,950 per troy ounce in 2012. Gold is currently trading around $1,740 per ounce in the international markets, buoyed by news of an agreement over a eurozone debt bailout package. The precious metal is up 6.3 percent from a week ago - its biggest weekly rise since January 2009.

In the medium term, prices could go higher if, as expected, the European Central Bank and the Federal Reserve are compelled to inject more money to stabilise their respective economies (more liquidity will boost asset prices, including those of gold).

Given that the US dollar is also fundamentally weak, many countries will also be seeking to diversify out of dollars into gold. That trend is already being seen in the fact that central banks have become net buyers of gold from net sellers.

Troubled European central banks could also collateralise their gold, according to a report in Thestreet.com.

The PIIGS - Portugal, Ireland, Italy, Greece and Spain - collectively own 3,000 tonnes of gold, according to the report. Italy, which owns the most at 2,400 tons, has a history of using gold as collateral. “I don’t think the gold will come on the market but that it will be collateralised.”

So, for now, gold’s position as an investment-worthy asset remains intact.