Investors with an additional 10 per cent allocation to gold would have successfully avoided the harshest market falls of the past decade and made a handsome excess return, research by FE Trustnet shows, although they would be more than 10 percentage points behind a typical balanced portfolio on a five-year view.
Gold appears to be very much back in favour in 2016 after nervousness around the global growth outlook, shaky equity markets and, more recently, the UK’s vote to quit its membership of the European Union sent investors scrambling for perceived safe havens.
As the graph below show, the yellow metal gained 37.10 per cent in the first two quarters of the year in sterling terms and outpaced both UK equities and gilts. Its outperformance became more pronounced after 23 June, when it was revealed that the British public had voted in favour of Brexit.
Performance of gold vs indices between 1 Jan and 30 Jun 2016
Source: FE Analytics
Of course, gold has had its difficult days. After reaching a record of high $1,921 per troy ounce on 6 September 2011, the metal started to sell off and made a close-to 30 per cent loss in 2013; this compared very poorly with the FTSE All Share, which was up 20.81 per cent.
Given the differing returns that have been made by gold and the importance that some place on it as a safe haven, we thought it would be interesting to see the impact it would have had on a typical balanced portfolio. To do this, we used the Wealth Management Association’s balanced portfolio (allocation on the right) and added an extra 10 per cent to the S&P GSCI Gold index.
Rob Morgan, pensions & investments analyst at Charles Stanley Direct, said: “Gold tends to show little correlation to other asset classes, which means it adds a layer of diversification to investors’ portfolios.”
“It is also regarded as a ‘safe haven’ investment and a long-term store of value over time, tending to come into its own in times of global economic uncertainty – e.g. at the start of the year when concerns about the health of the Chinese economy resulted in an equity market sell-off and in the days following the referendum result.”
“It is therefore something of an insurance policy against financial cataclysm or indeed a loss of faith in central bankers keeping the global economy on a steady course.”
Our data shows that holding gold has been a prudent move over past 10 years to the end of June 2016. According to FE Analytics, the FTSE WMA Stock Market Balanced index has made an 81.04 per cent total return over this period but the additional of an extra 10 per cent in gold has boosted this to 95.47 per cent.
Performance of balanced portfolio, balanced portfolio plus gold and gold over 10yrs
Source: FE Analytics
The graph above shows that gold on its own has made a much higher return than both portfolios. However, it must be kept in mind that the ‘safe haven’ has been more than twice as volatile over the past decade (with annualised volatility of 20.40 per cent) and has given investors a 38.97 per cent maximum drawdown – which is only 2 percentage points behind the one that hit the FTSE All Share in the financial crisis.
But the portfolio with extra gold has also been less volatile than the balanced portfolio alone (although only by 58 basis points, annualised) and has had a much lower maximum drawdown, at 16.7 per cent versus 27.26 per cent.
Ben Seager-Scott, director of investment strategy & research at Tilney Bestinvest, says investors have to be mindful of the fact the precious metal can give a rocky ride.
“Funnily enough, we’ve turned rather positive on gold of late, initiating a position at the back end of last year and more recently increasing our position, though it is still at a lower level overall – around 3 to 5 per cent. Now don’t get me wrong, I’m naturally very wary of gold, given it lacks any intrinsic value of note – and certainly shouldn’t be considered a safe haven, as the dramatic swings in the price over the last few years has shown,” he said.
“However, in the current environment it does have a number of attractive characteristics – for a start, it is generally lowly correlated with broad equity and bonds markets, which have been moving together recently, a paradox fuelled by central bank liquidity. It could also benefit from investors looking for a store of wealth at a time when faith in unconventional monetary policy is falling, and there is the potential for debasement in a number of currencies. Another risk is that fresh fiscal stimulus could impact the bond market, even sovereign bonds, which are typically viewed as risk-off assets.”
At look at the peak of the global financial crisis in 2008 shows how effective gold can be in dampening down falls in challenging markets. In 2008, the portfolio with additional gold was more than 10 percentage points better off than the standard one.
Performance of balanced portfolio and balanced portfolio plus gold in 2008
Source: FE Analytics
The addition of gold has improved the risk characteristics of the portfolio over the past decade: the Sharpe ratio goes from 0.28 to 0.39 when an extra 10 per cent of gold is put into the portfolio while the Sortino ratio moves from 0.26 to 0.39.
However – as the falls in 2013 might suggest – gold doesn’t always lead to improvements in the balanced portfolio. For example, 2013’s drop means that the 90% FTSE WMA Stock Market Balanced / 10% gold portfolio’s 32.26 per cent return over five years is 10 percentage points behind the balanced model alone. 
Charles Stanley Direct’s Morgan concludes that a small allocation to gold could be a good idea for some investors, although they could be better off blending it with other defensive assets, so long as they understand its particular risks.
“While it comes into its own in difficult times, and is a natural hedge against inflation, it produces no income, tends to be volatile and is heavily affected by strength in the US dollar. As a safe haven it is far from perfect for these reasons, but keeping a small amount in a portfolio just in case is no bad thing in my view,” he said.
“I would do so on a permanent basis rather than try and time exposure because predicting movements in the price is extremely difficult, and I would look to combine it with other lower volatility investments such as absolute return funds and perhaps some conservative bond funds to provide a blend of investments that offer diversification from equities - the longer-term ‘engine’ of the portfolio.”
However, Coram senior fund manager James Sullivan notes that gold is an asset that “divides opinion” among investors and argues that nothing should have a guaranteed place in a portfolio.
“We don’t believe any asset class should be ever present in a portfolio. But we have been in unusually uncertain times for an extended period now, and the end game still isn’t obvious. One could argue, with political and union instability across Europe (Turkey et al), the end game is as far away today as it was eight years ago at the height of the financial crisis,” he added.
“In this environment, gold is as good a hedge as any – priced in dollars it offers the sterling-based investor an additional opportunity to add exposure to the world’s reserve currency. Arguably the two most desired currencies in one trade which pays out handsomely when ‘risk off’ is back in play.”
“We all have buildings and contents insurance – that’s how we view our gold. If it doesn’t pay out, then we can assume the rest of our portfolio is performing, yet when that trend goes into reverse for whatever reason, we can sleep a touch easier knowing our hedge is most likely to offer some significant downside protection.”
“When a sense of stability and normality returns to economies and markets, then we move on from gold.”
