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March 27, 2014 at 10:56 AM
With stocks and bonds rising ever upward on a path that cannot endure, currency funds manager Axel Merk suggests that now may be an appropriate time for investors to think about adding gold to their portfolios.
In a new white paper called “The Case for Gold,” the chief investment officer of Merk Investments says that success in investing depends optimizing risk-adjusted return over the long term, and by that measure the forlorn metal deserves more respect than it’s currently getting.
Merk’s white paper looks at three investing periods. In the last 10 years, gold had an exceptional run (until its dismal 28% loss last year).
But since this period also included the peak of the financial crisis, Merk also considered a period stretching back to August 1971, the point at which President Richard Nixon ended the dollar’s convertibility to gold.
And to counter any arguments that gold’s price was artificially depressed prior to that point, he also looked at a time horizon stretching to the beginning of 1934, when the Gold Reserve Act boosted the nominal price of gold from $20.67 to $35.
For all these periods, Merk compared the performance of gold-only and stocks-only portfolios with combined gold and stock portfolios optimized to have the highest Sharpe ratio (meaning that the portfolio would yield the highest risk-adjusted return).
Over the past 10 years, the highest Sharpe ratio over the “efficient frontier” (to cite the modern portfolio framework he employs) accrued to the investor who put 68% of his portfolio in gold and just 32% in stocks.
Such an investor would have enjoyed an annualized return of 11.28%, but at far lower risk (15.51% standard deviation) compared to an all-gold portfolio (returning a higher 12.84% but with 20.05% volatility) or a S&P 500 all-stocks portfolio (returning 7.16% with 20.38% volatility).
“Does this mean an investor should have more than half of their investable assets in gold?” Merk asks. And he answers no, because historical returns do not guarantee future results and because the investment universe offers more choices than just stocks and gold.
But this first portfolio test offers the first demonstration that one can improve risk-adjusted return by adding an uncorrelated asset to a portfolio of U.S. stocks.
