At a recent Investment Management Committee meeting we were discussing the importance that gold plays in our portfolios. Over the past year, many clients have asked if we had exposure to gold. To their surprise, we let them know that we have always maintained exposure to gold in our portfolios via investments in several mutual funds that have consistently maintained an investment in gold bullion (specifically the IVA Fund and First Eagle Global Fund). Recent events and our ‘Muddling Through’ strategy to hedge our portfolios have convinced us that this exposure is more important than ever and should probably be increased. This article, therefore, is not so much about our outlook for gold as it is about the importance gold plays in managing the risk of a portfolio.
Gold has been used as a medium of exchange and store of value since as early as 1500 B.C. and it continues to serve that purpose today. Many investment professionals believe that Gold serves two key functions in a well diversified portfolio; (1) as a direct hedge against inflation and (2) as a “shock absorber” during periods of severe financial stress.
Government debt levels in many developed countries (U.S., U.K., Japan, Spain, Italy, Greece, Portugal) are at unsustainable levels and growing. The recent financial crisis has been a significant contributor to this problem. Central banks have largely responded with solutions that involve the purchase of various debt securities with “money” that is simply created, often referred to as printing money. This is likely to be the continued playbook for dealing with the European debt crisis. Although the data is choppy, we are already seeing the impact on the general level of prices.
We are currently looking an opportunity to increase our portfolio allocation to gold through investment in a gold bullion ETF. While we recognize that gold has already risen steadily over the past decade, we believe inflation pressures are building and see the recent 15% pullback as an opportunity to add to our current exposure. We also recognize that Gold can be a volatile asset, but see the longer term inflation protection benefits worth the potential volatility that such an investment might add to the portfolio.
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Part of our ‘Muddling Through’ strategy is having flexibility, liquidity and the right balance of asset classes with low correlations, to each other, to help dampen overall portfolio volatility. Having the right amount of equities, fixed income, commodities (gold) and cash, for a specific risk levels, is what really controls the majority of the portfolio’s volatility.