A Two Pronged Case for Holding Gold

Includes: GLD, IAU
by: Russ Koesterich, CFA

I've been advocating gold as a long-term investment and also as a risk management tool for some time now. Today, I remain bullish on the metal for two reasons – the monetary climate and gold's diversifying qualities. Gold is up nearly 6% year-to-date, underperforming most equity indexes but outperforming fixed income. Gold – more than any other commodity – is a natural beneficiary of the current monetary regime, which is characterized by negative real interest rates. (Note: This is based on the London Gold PM Fix price as of July 31, 2012 year-to-date. The London Gold PM Fix price is for illustrative purposes only and does not represent actual iShares ETF performance. The London Gold PM Fix price does not reflect any fees, transaction costs or expenses.)

Most of the world's central banks are trying to hold interest rates at or below the level of inflation. This strengthens the argument for buying gold because it means there is no opportunity cost for holding gold— in other words, investors aren't going to be missing out because inflation is so low to begin with. Over the past two decades, this relationship between real interest rates and the return to gold has been exceptionally strong, explaining roughly 60% of the variation in the annual return to gold.

While gold's price might be high by historical standards, I still believe that investors should strongly consider maintaining their allocation. Investors should also consider gold as a diversifying asset. In an environment in which correlations are elevated, gold continues to march to its own drummer. Since 2010, gold's correlation to the S&P 500 has been 0.06, a remarkably low correlation in an environment in which most assets, apart from Treasuries, tend to move together.

The bottom line is that I continue to advocate a strategic allocation to gold, in addition to investing in a broader commodity benchmark.

Source: Bloomberg

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