From the March 2010 issue of Investment Advisor • Subscribe!

What the Research Found

Sidebar to the Expert's Corner "The Use of Gold in Portfolios"

The research paper, Can Precious Metals Make Your Portfolio Shine, cited in this article was authored by C. Mitchell Conover, The Robins School of Business, University of Richmond; Gerald R. Jensen, Professor of Finance, Northern Illinois University; Robert R. Johnson, Deputy Chief Executive Officer & Managing Director, Education Division, CFA Institute; and Jeffrey M. Mercer, Associate Professor of Finance, Rawls College of Business, Texas Tech University.

The authors analyzed numerous studies that have explored the investment benefits of adding precious metals to portfolios of U.S. equities, including a 2006 study ("Do Precious Metals Shine? An Investment Perspective." Financial Analysts Journal 62 March/April 2006 by David Hillier, Paul Draper and Robert Faff) that examined the relative benefits of supplementing an investment in the S&P 500 with gold, silver, or platinum over the period 1976 to 2004, and found that portfolio performance generally improves regardless of which precious metal is added, with gold offering the greatest incremental benefit and silver the least benefit.

In its summary and conclusion, the paper offered the following insights:

"First, we find that adding a 25% allocation to the equities of precious metals firms improves portfolio performance substantially. Portfolio returns increase by 1.65% and the standard deviation drops by 1.86%. While smaller allocations improve portfolio returns and risk, the benefits are less prominent. Second, our evidence indicates that an indirect investment in precious metals, via the equities of precious metals firms, dominates a direct investment in precious metal commodities. Both direct and indirect investments improve portfolio performance; however, the benefits of an indirect exposure are considerably larger. Third, relative to platinum and silver, gold has better stand-alone performance and appears to provide a better hedge against the negative effects of inflationary pressures. Fourth, the benefits of precious metals are strongly tied to monetary conditions. The benefits of adding precious metals to a portfolio are rather small during periods when Fed policy is expansive; however, the benefits are substantial when monetary policy is restrictive. Finally, while the benefits of adding precious metals to an investment portfolio varied somewhat over time, they prevailed throughout much of the 34-year study period. Furthermore, the benefits have been quite pronounced in recent years.

"Overall, our evidence suggests that investors could improve portfolio performance considerably by adding a significant exposure to the equities of precious metals firms. The improvement can be attributed to the ability of precious metals to mollify the poor market performance that tends to afflict many equities during periods when Fed policy is restrictive.

"While a strategic allocation to precious metals equities captures most of the benefits; our results suggest a tactical approach offers some additional benefits. Specifically, using monetary policy shifts to guide investment in precious metals, and particularly gold bullion, achieved slightly higher return and lower risk than that achieved with a strategic allocation."

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