Nov 11, 2008

Gold As An Alternative Asset Class: 5 Reasons to Invest

IN the current financial turmoil – when the stock markets are down, property and commodity prices are weakening – gold is the only asset class that has seen a sharp rise in prices. It is the only financial asset that stands on its own during turbulent times. During the last one year, it has emerged as the strong option for investors.

Here is a list of five reasons why the yellow metal remains the most universally accepted and time-tested asset class:

# 1: Effective Portfolio Diversifier
Investment in gold is considered as best way to mitigate the risk and insure the portfolio. Small allocation (5 - 15%) of gold improves the consistency of portfolio performance.

The purpose of diversification is not to increase the returns, but to reduce the risk. The aim is to protect the value of portfolio against the fluctuations in any class of asset and this purpose is achieved when the different asset classes in a portfolio have either low or negative correlation with each other. Gold serves this purpose well.

The need for an uncorrelated asset classes to manage risk makes gold an ideal asset class for diversified portfolio. It can diversify and stabilize your portfolio and protect it against stock market fluctuations because there is low to negative correlation between returns on gold and those on stock and bonds.


# 2: Thrives under worst conditions
As an asset of last resort, gold is considered as a perfect hedge against uncertainties and financial crises. It never requires any economic or political stability to survive; rather in a crisis situation like this gold is considered as the best investment option.

During unstable times, most traditional asset moves together in the same direction which can lead to wild fluctuations in the portfolio. In such times, gold can prove to be an invaluable asset as it lends stability to the portfolio.


# 3: Hedge against inflation
Gold is considered as a perfect hedge against inflation. It has strong correlation with inflation. The purchasing power of gold (the real goods and services it can buy) remains same over long periods of time.

According to one study done a few years back by World Gold Council (WGC), a body that promotes the yellow metal, one ounce of gold would consistently purchase the same amount of goods and services as it would have done 400 years ago.


# 4: Linkage with oil and US Dollar
Gold prices are closely linked with two important factors: the USD and crude oil prices. While gold has an inverse relationship – strong negative correlation – with the USD (the prices of gold rallies as the dollar falls and vice versa), it has direct link with the oil prices.

Historically, gold has shown a higher correlation to oil prices. In general, higher oil prices tend to push up the inflation numbers and gold is considered as the best hedge against inflation. Thus, when oil prices shoot up, so does the price of gold.

Furthermore, in a global environment, with the weakening of the dollar, gold is likely to become more attractive to central banks (traditionally, the largest holder of gold), thereby further fuelling its demand and consequently its price.


# 5: Widening demand and supply Gap
There is ever widening gap between gold demand and supply due to ever increasing demand on the one hand and constraints on the other.


In a nutshell, gold must be made a part of your asset allocation because it is a great risk diversifier and considered as a safe haven during times of economic uncertainty, political strife, high inflation and wars.



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1. The Smart Way to Mutual Fund Investing: 10 Time-Tested Principles

2. Different Ways to Invest in Gold

3. Why Gold ETFs are Considered as Best Way to Invest in Gold?

4. FAQs about Investing in Gold ETFs

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