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Investors place value at risk by not consistently holding gold, says WGC

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Investors who do not hold gold or view it purely as a temporary safe haven asset are failing to harness its full potential to protect wealth, according to a study published by the World Gold Council.

In its latest report, Gold: Hedging Against Tail Risk, the WGC shows that a modest, consistent holding of gold mitigates the potential for significant loss of value during extreme market events.

In the analysis the WGC shows that during the period between October 2007 and March 2009—the height of the global financial meltdown—an investor with a portfolio of USD10m experienced an additional USD500,000 financial loss simply by not maintaining a position in gold. The study used a composition similar to a benchmark portfolio, which included an 8.5 per cent allocation to gold, to show that total losses incurred during the period reduced by five per cent relative to an equivalent portfolio without gold. 

In 18 of the 24 tail risk scenarios analysed by the WGC, portfolios which included gold outperformed those which did not. The term tail risk refers to extreme events that may be considered unlikely, such as the “Black Monday” market crash of October 1987, but which tend to have a considerably negative effect on an investor’s capital when they do occur.

Juan Carlos Artigas, investment research manager at the World Gold Council and author of the research, says: “In previous studies, the WGC has shown gold to be a highly effective and consistent portfolio diversifier. We can now demonstrate that gold does not only help increase expected risk-adjusted returns, it can also considerably mitigate the potential for wealth to be eroded by extreme events.
“In the last decade we have seen two of the worst bear markets in the last hundred years.  As one might expect, sensitivity to risk still runs high for investors around the world, and as assets are rebuilt an ability to protect capital irrespective of market conditions is paramount.  Considering portfolio diversification is clearly important, but protecting against systemic risk can be an entirely separate matter. This research shows that gold protects against tail risk events, but equally in more positive times reduces the volatility of a portfolio without sacrificing expected returns.”

The analysis suggests that even relatively small allocations to gold, ranging from 2.3 per cent to 9.0 per cent, can have a positive impact. On average, such allocations can reduce the Value at Risk while maintaining a similar return profile to equivalent portfolios which do not include gold. Conceptually, VaR is a way of measuring the maximum amount an investor could expect to lose in a given period of time, with a certain degree of confidence, in the case of an unlikely, yet possible, event occurring.

Marcus Grubb, managing director, investment at the World Gold Council, says: “We now inhabit a world characterised by greater volatility and higher levels of investment risk. Robust asset allocation strategies are central to a return to financial stability. Gold’s ability to move independently of most assets usually held by institutions and individuals, and to hedge against inflation and currency fluctuations, all mean that it is highly effective as a preserver of long term wealth and should form a foundation of any long term investment portfolio. This report sets out how gold can protect against negative events, which are not easy to predict but can substantially erode wealth.”

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