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How The Academic Literature Says About Gold In Your Portfolio

|Includes: SPDR Gold Trust ETF (GLD)

With the price of Gold (NYSEARCA:GLD) surging, many investors are beginning to consider adding exposure to the precious metal in their portfolios. Often considered a "safe haven asset," the gold market is much more complicated than many lead on. It is important to carefully consider how this commodity should be best situated for your financial well-being. Let's use some of the tools not often considered by the at-home investors to get to know what moves the gold markets, the academic literature.

So as not to clutter your page with citations, I will simply put a number next to each source, and link to citation at the bottom.

It was found that there was not a correlation between the S&P 500 and the price of Gold over the long-term. [1] While correlations varied over the short term, sometimes negative and sometimes positive, as you move out the time horizon, the correlations disappear. This means that it is likely not best to buy Gold as a hedge against a long-term stagnant or declining stock market.

This same academic article found that Gold in fact did act as a safe haven during the financial crisis, and generalized this to all stock market "crashes." Nonetheless, this effect also goes away in the long-term.

In [2], it was found that the daily percentage change in the price of gold has especially fat tails compared to what would be expected from the normal distribution. This means that gold is more likely to move a large amount on any day than would expected from the idealized "bell curve;" i.e. it's volatile. Because this raises the risk of holding Gold, volatility is an important metric to keep tabs on.

As many would expect, gold was found to have negative correlation during stock market, as measured by the S&P 500, crashes; gold prices tended to rise during them. For this reason, or other plays on gold may be a good hedge if you believe stocks will move sharply lower in the near future. It was also found that volatility in gold prices were mean reverting. Current volatility now correlation with less volatility in the future.

[3] shows that oil and gold are correlated. This is believed to be because of oil's strong influence on inflation, which causes the price of gold to rise. This means that gold may be a hedge against rising prices.

Altogether, the generally accepted characteristics of gold are generally found to hold throughout the academic literature studying it. An important caveat to this, though, is that many of the correlations are not nearly as strong as many seem to believe. While gold seems to be a strong candidate for "safe haven" during short-term instability, this quality dissipates with time. Keeping all of these findings in mind, you can effectively use gold to further your portfolio.

[1] - ideas.repec.org/a/ebl/ecbull/eb-11-00754.html

[2] - www.uu.nl/sites/default/files/rebo_use_d...

[3] - mpra.ub.uni-muenchen.de/65484/1/MPRA_pap...

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.