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What's The Right Amount of Gold for You?
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(October 13, 2001) Gold provides stability and cuts risk in an investment portfolio. Gold is useful as an inflation hedge and store of value. Gold insures against various disasters. Gold is the world's simplest estate-planning tool. Yet gold’s role over the past two decades has faded during an unprecedented economic boom. How much gold should you own in today's world?
Sunday, October 7th’s New York Times Mutual Funds Report section is headlined “How the Growl became a Roar - In a Worst-case Quarter, Bears Ran Wild." In this section, Mark Hulbert, editor of the Hulbert Financial Digest, penned an article under the Strategies heading entitled “Is Gold Relevant? Quiet, Please!”

The question he addresses is, What role should gold play in an investment portfolio? What percentage of your portfolio should be devoted to either gold stocks or gold itself? You’ll encounter a myriad of answers to that question.

A national financial planning group that we have worked with over the past few years encourages their clients to have six month's worth of living expenses as a family gold holding. Others in the U.S. commonly counsel that 5% of assets is a prudent holding of precious metals, with a much smaller number of advisors recommending more than that. In Europe, India, and the Middle East and Asia, gold is more naturally a part of their culture, and a larger component of family wealth, than is typical in the U.S.

One detailed study of portfolio performance cited by Hulbert was compiled by the World Gold Council. In what is described as an exhaustive study involving scores of economic variables, a number of economic situations were modeled and various portfolios were run through them to see which mix of financial instruments performed best under various circumstances. Their studies conclude that having 6% of an investment portfolio in gold optimizes an investment portfolio’s stability and minimizes the risk involved.

Hulbert compares the World Gold Council’s recommendation with a gold-neutral allocation scheme derived from a theory of rational markets. Under this portfolio plan, an investor simply owns stocks in various sectors proportional to their size. He writes, “If the auto industry represents 10 per cent of the market’s capitalization, for example, investors should allocate 10 per cent of their portfolios to auto company’s stocks.”

So let’s take as an example an average investor who owns no gold and has no interest in gold whatsoever. Even this person, under a neutral allocation scheme, should own gold stocks proportional to the weighting of gold and precious metals mining stocks in the U.S. market, i.e., a number which works out to about one half of 1% in the portfolio.

Hulbert’s point here us that a rational allocation of gold in one’s portfolio is a small amount, but by no means is it zero. Gold cuts volatility in a portfolio, and reduces its risk.

But what about gold’s most recent 20 years track record?

“Sure, gold has been a lousy investment for the past 20 years,” I was quoted in an article in Business Week magazine for October 15th entitled “After the Attacks, A Gold Rush. ” Kimberly Weisul’s article went on to say, “But most of the recent demand for gold comes from wealthy investors who are using the coins as a hedge.”….”(W)ith the stock market reeling, an investment that’s merely looking ‘lousy’ is starting to look pretty good.”

Of course, if you assume that the future will be like the last twenty years, you have very little reason to buy gold beyond the ˝% allocation in the gold-neutral portfolio that Hulbert discusses. But, rightfully in my opinion, he goes on to make the case that gold’s over all performance should not be judged by its dismal performance during the relatively calm period of the most recent twenty years.

Because, over a longer period, stuff happens.

Take the 1970s, for instance. Gold prices in 1970 were less than $50 an ounce, and by the end of 1979 were over $500 an ounce. This ten-fold increase came in a decade during which ‘stuff happened’ big time, including the U.S. fighting a protracted war on foreign soil, instability in the Middle East, a sluggish economy, and inflation born of accelerating federal deficit spending both domestically and abroad.

Has a familiar ring, doesn’t it? Sounds exactly like where we find ourselves today.

-Richard Smith, October 13, 2001.

 

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