Gold Becoming a Common Allocation in Investment Portfolios and what we think about it

I was recently speaking to a businessman, Adam, who organizes events bringing together many different people from a particular sector to present their products to potential clients. Many of these programs include various banks and financial institutions sometimes as large as HSBC and Goldman Sachs. As you could imagine, Adam has a fairly good understanding of various investment ideas and their levels of interest in the current market.

When asking about the allocation of gold in current portfolios he explained that many growth fund managers are now suggesting a 5% allocation to the precious metals sector. Here’s why.

Oldest and Safest Asset Class
Gold is a unique asset class, possibly the first asset class ever. Sometimes referred to “real money”, as its supply can not be increased at will, gold has been a store of wealth, a currency and a commodity for thousands of years. Gold has intrinsic value that is not dependent on another factor, and has maintained its real purchasing power over time.

Greater Returns
Gold is negatively or insignificantly correlated with the major portfolio asset classes. An allocation to gold may thus increase the “efficient frontier”, or the returns for the level of risk taken. Some commentators believe gold is now in a secular bull market and could still rise significantly from here in price. Hence gold may be owned currently for its potential returns.

Use in Times of Market Volatility and as a Reserve Currency of Goodwill
Gold is most commonly used in portfolios as a form of insurance against extreme market conditions to lower the probability of an extreme outcome. The correlation between major asset classes commonly increases during “stressful” times, while the correlations between commodities including gold and the major asset classes usefully becomes more negative. This, and the concern about the timing of unpredictable shocks, means some risk aware investors constantly own a small percentage of gold in their portfolios. Others hold gold due to current concerns about the viability of the US dollar as a reserve currency. This includes a view that the US dollar is overvalued due to the US’s large current account deficit.

They say “Many times people don’t do things because people aren’t doing things”. In a ripe investors mind this is all too clear. The herd will follow those who dare to venture into a new idea or proposition of market-beating returns only after there has been a significant rise.

Gold and the Precious Metals have seen this rise. Now many analysts are saying that this great bull run may be about over. Although they may be correct on a short-term trading radar or technical basis the bullish outlook for the PMs remains intact. Remember that a bull run resulting from an under supply and increasing demand will not end until the supply factor exceeds demand. We are still quite some time away from from this event. Investor interest, supply of metal to the market, mining operations and stocks related must all rise significantly if we are to arrive at an equilibrium in the price of gold on the market. If you don’t own gold yet you’re late, but the party’s just getting started.

Profitable Gold (gold that costs less to mine than can be sold on the open market) has only been available to mines – many that have had deficits from lack of demand – are finally churning greater returns. On a historical basis it often takes as long as 8 to 10 years to get a mine running and operational. If so there’s still plenty of time for investors to go a little “irrational”.

Short Term Outlook (1 Month) – Bearish – Road Dips Ahead
Our short-term outlook for the PMs right now seems a bit hazy. On the one hand we have had a significant run bringing silver up almost a full dollar, while at the same time we don’t see any media hype that we have witnessed in previous gains.

Medium Term Outlook (6-12 Months) – Neutral – Commodity Corrections Probable
We would therefore not advise buying as of now, as there should be fairly better buying opportunities on the near horizon. During the bull run in the 1970s both metals had serious corrections sometimes declining 35-40%. This may currently be in the cards which is why you should have a solid mound of cash available – 10-15% – (in interest yielding funds or in foreign currencies) to buy with if and when the market heads south.

Long Term Outlook (5-10 Years) – Bullish Outperform – “I Told You So”s to be seen shortly
Silver should at the same time only be sold – albeit long or short – as a speculative trade alone and not as an investment alteration since we are in the midst of a bull market. Remember that not as many investors currently own gold and silver to enable them to sell it. The fundamentals remain in full force.

DISCLOSURE: We are selling our Gold and Silver positions in the Investor Sentiment Trading Fund (ISTF). Gold and Silver have locked 3.4% and 5.6% returns, respectively, over the past 21 Days.

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