Gold: Don’t Make This Critical Mistake
By Mark Hulbert
Many who invest in gold think the most important issue they face is timing—when to be in the asset class and when to be out.
They’re wrong.
Just as important, if not more so, is how they get their exposure to the gold market.
Not all gold and gold-related investments perform even remotely similarly, according to a study forthcoming in the Financial Analysts Journal titled “All That’s Gold Does Not Glitter.” Its authors are Robert Johnson, president and CEO of the American College of Financial Services, and Gerald Jensen and Kenneth Washer, both professors of finance at Creighton University.
Take the past decade. Over the 10 years ended Jan. 22, according to FactSet, the iShares Gold Trust exchange-traded fund (ticker: IAU) gained 45.1%, while the VanEck Vectors Gold Miners ETF (GDX) lost 49.3%. That’s a huge spread.
In this regard, gold is far different than equities. “If you’re going to put together a diversified equity portfolio, then the market-timing decision is far more important than the choice of individual stocks to put in that portfolio,” Johnson explained in an interview. With gold, by contrast, “the choice of vehicle is just as important, if not more so, than the market-timing decision.”
What factors should you take into account when choosing a particular gold-related investment?
Two Ways to Play Gold
How the iShares Gold Trust ETF and the VanEck Vectors Gold Miners ETF have performed over the past decade.
Source: FactSetOne is leverage. Many gold investors look to ETFs and funds that invest in gold-mining companies as a leveraged way of exploiting a rise in gold’s price. And, sure enough, the researchers found gold-related betas of between 1.5 and 1.8 for many of those funds (calculated when focusing on weekly volatility). That means that those funds are expected to gain or lose between 1.5 and 1.8 times as much as gold bullion in a given week.
Those high betas are attractive to aggressive speculators interested in getting more bang for their buck when investing in gold. But there’s an easier way of achieving the same result: Increase your allocation to gold bullion itself. If you otherwise were allocating 10% to gold, for example, allocating 15% instead would have the same effect on your bottom line as investing 10% in a gold-oriented investment leveraged with a gold-related beta of 1.5.
Another factor to keep in mind when choosing a gold investment is how good a job it does hedging against stock-market declines. The researchers report that the ETFs and funds that invest in gold-mining companies are far more correlated with the stock market than you’d expect. Gold bullion, in contrast, is not.
One revealing statistic is the correlation coefficient, which measures the extent to which gyrations in one asset are correlated with those of another; a coefficient of 1.0 would mean perfect correlation, while a zero reading would mean there is no detectable correlation. In contrast to a correlation coefficient of just 0.03 between gold bullion and the Standard & Poor’s 500 index, which is essentially zero, the gold-mining company funds had significant coefficients ranging from 0.3 to 0.7.
Yet another factor is one the gold-mining funds have in their favor—their ability to hedge against inflation. Confirming earlier reports, the researchers found that bullion itself is essentially uncorrelated with changes in inflation. The correlation coefficients with inflation for the gold mining company funds the researchers analyzed, in contrast, range from 0.2 to 0.4. Note carefully, however, that even though such coefficients are statistically significant, they nevertheless are still far from the 1.0 level that would indicate perfect correlation.
Regardless of where you come down on the bullion-versus-gold-mining-company-shares decision, the researchers’ broader point remains: A lot is riding on your choice, since in the future there is likely to be a wide dispersion of returns among the different investment vehicles traditionally used by investors to gain exposure to gold.
As Johnson and his co-authors conclude, investors should not be treating “precious metals as a largely homogenous asset class.”
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