Adding Gold to Your Portfolio

Unless you’ve been in a coma, you know that gold has been the hottest commodity of the last decade, quadrupling in value since 2000. That’s in US dollars, but even measured in loonies gold is up more than 164% over the last ten years.  Those are impressive returns during a period when investing in stocks often felt like feeding cash into a paper shredder.

Claymore’s Gold Bullion ETF (CGL) began trading on the TSX on Tuesday, giving even Couch Potatoes an easy way to invest in physical gold. Is it time to add some of the shiny metal to your portfolio?

Let’s consider the main arguments in favour of investing in gold:

  • It’s a hedge against inflation, and it retains its value even if a nation’s currency becomes devalued.
  • Unlike stocks and bonds, gold has virtually no risk of becoming worthless. That makes it a safe haven in the event of financial Armageddon.
  • Gold is not highly correlated with stocks, bonds or real estate, so it plays a diversification role in a portfolio.
  • Gold’s price tends to move in the opposite direction of the greenback. This can protect Canadian investors who hold securities denominated in US dollars, such as the Vanguard ETFs recommended in many of our Model Portfolios.

The arguments against gold in a portfolio are also compelling:

  • Gold purchased from a dealer will have a large mark-up, and it is expensive to store and insure.
  • There are more precise ways to hedge against inflation. Real-return bonds are specifically designed so that their interest payments and principal value rise in lockstep with the Consumer Price Index.
  • Investments in “paper gold” — including Horizons’ COMEX Gold ETF (HUG) — do not offer the safety of physical bullion.
  • Gold pays no dividends or interest and has no potential for growth: its long-term inflation-adjusted return is approximately zero. According to Jeremy Siegel, “One dollar invested in stocks in 1802 would have grown to $8.8 million in 2003, in bonds to $16,064, in treasury bills to $4,575, and in gold to $19.75.”
  • Canadians already have significant exposure to gold through the stock market. Of the 60 companies in the S&P/TSX 60 Index, at least eight are gold miners — notably Barrick, Goldcorp, Kinross and Teck Resources — and they make up more than 13% of the index.

The Claymore ETF overcomes a couple of these drawbacks: rather than tracking the price of gold with futures contracts, CLG holds honest-to-goodness bullion in a Scotiabank vault (although you can’t exchange your shares for gold bars). It also makes buying gold bullion inexpensive, with a management fee of just 0.5% and no need to rent a safe deposit box.

At the same time, both the Claymore and Horizons gold ETFs negate one of the potential benefits: they are both hedged to Canadian dollars, so they offer no protection against a falling US dollar. If you don’t hold any US-denominated stocks, this may be a good thing. But if you do have greenbacks in your portfolio, consider a US-listed ETF such as iShares COMEX Gold Trust (IAU) or SPDR Gold Shares (GLD). Both hold physical bullion, not paper gold, and are priced in American dollars.

So, should you add some gold to the stocks, bonds and real estate in your Couch Potato portfolio? It’s not essential, but a small allocation of 5% or 10% can be good diversifier, and perhaps some insurance against factors that can derail other asset classes. Whether you should buy gold now—with the price near its all-time high—is a question I’ll leave to the market timers.

4 Responses to Adding Gold to Your Portfolio

  1. westislander February 17, 2010 at 11:56 pm #

    If inflation really takes off, there will be a lot of pressure to backtrack on the rate of interest paid on “real return” bonds, which ultimately are still paper. Its one thing to issue these instruments when interest is at historically low rates, another to back them when the real economic pressure is on. I’d feel safer with the Gold.

  2. Canadian Couch Potato February 18, 2010 at 8:41 am #

    Real-return bonds have the full backing of the federal government. Once investors start asking whether Canada will default on its bonds, they’re worrying about the wrong things.

    Note also that the idea of gold as an inflation hedge is not universally accepted. See for example:
    http://www.forexblog.org/2009/03/is-gold-a-hedge-against-inflation-and-currency-weakness.html

  3. Doug Morrow February 20, 2010 at 12:48 pm #

    hi can you please help me understand the benefit of holding a gold ETF in USD rather than CAD? if USD and gold are inversely correlated, won’t any increase in the value of gold be negated in part by declining USD (relative to CAD)?

  4. Canadian Couch Potato February 20, 2010 at 3:46 pm #

    Doug: This a great question and one I have not been able to find much commentary about.

    As I understand it, the important idea is that correlations are never tidy, they’re just tendencies. A drop in the US dollar does not always coincide with a rise in the price of gold. The degree of movement matters, too: gold is more volatile and may go way up when the US dollar goes down just a little. So there is some negative correlation (as there is with stocks and bonds), but they don’t cancel each other out.

    It’s important to look at an asset class in the context of the whole portfolio, not in isolation. Let’s say you have 20% of your portfolio in a Vanguard ETF that holds stocks in USD. Adding 5% in a gold ETF (priced in USD) may provide a cushion when the US dollar falls. Other times both assets will rise or fall at the same time. Over the long term, however, you should experience less volatility.

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