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Gold investors, here are some good reasons you should also be holding Silver, Platinum and Palladium

I've never properly understood why people hold Gold (NYSEARCA:GLD) in an investment portfolio - and for full disclosure, that also includes me. That should prompt a few strong comments judging by other views around the SA site. But let me explain. As a (supposedly) rational individual with an investment and economics background, I'd like to think that I weigh up the fundamental value of different asset classes and on the basis of current price versus long-term fundamental value, make a decision whether to buy or not.

The problem with Gold is that it has no fundamental value. There are no cash flows, no coupons, no earnings, no principal value. It has almost no use for anything industrial, chemical, mechanical, etc. What is has going for it is that it is pretty to look at (or so my wife thinks), it doesn't decompose and you can't eat it.

Perhaps I've been scarred by a formative experience early on in my career. I was working at HM Treasury (the UK Finance Ministry) when the British Government made the (now infamous) decision to sell its gold holdings. I was working for a Junior Minister under Gordon Brown (then Finance Minister, later Prime Minster) and remember putting the proposal from a Treasury official into the Minister's bag for her approval. At that point gold was under $300, the UK government went on to sell every last ounce, and we all know what's happened since …

But back to the point. Trying to put a fundamental value on Gold is as good as pulling a number out of a random number generator. So, it's impossible to say whether it's a good thing to hold or not.

And yet I do hold just a little bit in my investment portfolio. So, why?

Ultimately gold is potentially the biggest Ponzi scheme out there. It goes up in value because everyone believes that everyone else will want it if (when?) things blow up. And, to level with you, I just don't want to miss out on this Ponzi bubble if (when) it happens. So that's why I hold my bit of gold.

However, if we like to think of ourselves as rational investors, it's time to put our feet on the ground and realize that exposure to all the 'Precious Metals' probably has more investment rationality than just holding Gold. Of the four metals known as the 'Precious Metals' - Gold, Silver (NYSEARCA:SLV), Platinum (NYSEARCA:PPLT) and Palladium (NYSEARCA:PALL), it probably makes more sense to think of the asset class as a combination of all four metals, and not just Gold.

Let's start by looking at the big picture. The following graph shows the historical returns over a 16 year time period, beginning with an initial investment of $100 at the end of December 1996. The numbers in brackets shows the value of the investment at the end of 2012. A summary is shown in the table that follows the graph.

(click to enlarge)

Precious Metals - a summary, 1997-2012

Gold

Silver

Platinum

Palladium

Total Return

350%

513%

311%

497%

Annualized Return

8.2%

10.8%

7.3%

10.6%

Annualized Volatility

17.1%

30.9%

23.1%

40.4%

Information Ratio

0.48

0.35

0.32

0.26

It's interesting to see that in return terms, Gold only takes third place, with Silver and Palladium substantially ahead. However, due to the staggering amount of volatility present in these metals, on a risk adjusted basis Gold outperforms all the other precious metals.

But the fact is that the other precious metals also have a pretty decent performance track record, which would argue for diversifying a bit of your risk if you're only holding gold. Obviously any analysis of returns will depend on the starting point - I simply took a reasonable time period that tried to account for a couple of economic cycles.

I thought that the table below made an interesting point. The table shows the annual returns - some of which are quite staggering in their magnitude and volatility. The best performer of every year is highlighted in yellow.

Annual Return of Precious Metals - 1997-2012

(click to enlarge)

An interesting point to note is that Gold has been the best performer in (and only in) the years when the returns of the three other precious metals have all been negative. Furthermore, the returns in the years when Gold has outperformed have been relatively modest compared to some of the annual returns of the other precious metals.

So, it may well be that a diversified portfolio could gain increased returns from adding some exposure to all the precious metals, rather than just holding Gold.

Source: Gold Investors: Some Good Reasons For Also Holding Silver, Platinum And Palladium