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03/10/2016

Does gold deserve its reputation as a safe haven?

The price of gold has increased by more than 25% this year after rising rapidly during a tumultuous first quarter for equity markets.

This provides anecdotal evidence of the yellow metal’s oft-cited status as a ‘safe-haven’ asset, but how does that hold up under closer scrutiny?

Figure 1 shows the distribution of monthly returns of gold relative to the S&P 500 Index from 1975 to 2016. We have started from 1975 because that is when the restrictions on investors freely owning and trading gold largely elapsed. For the ‘safe-haven’ theory to hold, we would expect gold to rise when equities (the quintessentially risky asset class) fall.

Therefore, quadrant 2 is where we would hope to see most data points – where the monthly returns on the S&P 500 are negative and the returns from gold are positive. Slightly more observations (31%) fall in this area than we would expect by chance, indicating some evidence of gold’s protective properties.

Yet an investor who bought gold purely for its safe-haven qualities would be disappointed by quadrant 3. In this area, both gold and equity returns are negative, and a significant proportion of returns (18%) fall into this region.

Received wisdom

Does this analysis provide sufficient evidence to question received wisdom? The two asset classes are regarded as having an inverse relationship. In fact, gold and equities enjoyed a very low correlation of returns of 0.0045 over the period we examined – but not a negative one. More surprisingly still perhaps, gold has been a more volatile investment, with an annualised volatility of 19% compared with 15% for equities.

Another measure of investment risk is drawdown – the largest percentage price fall over the period. Since 1975 this measure is larger for gold at -62% than for equities at -53%. So while an investment in gold can help to diversify multi-asset portfolios, it does not come without risks.

We sold our allocations to gold in portfolios in 2013 because price momentum had turned negative. In May 2016, we dipped a toe back into commodities through a diversified basket on a compelling valuation case combined with positive momentum. Gold represents around 12% of this basket, a level with which we are comfortable given that it has not always offered the sanctuary sought by investors.

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