You’ve heard the ongoing debate on whether gold should be considered a true commodity or better classified as a currency. Although both sides of this argument may have merit, it is not the most critical question. The question is whether taking a position in gold alone, is the right means to the end that is low correlation, on the journey towards true diversification.
If you’re serious about diversification, and seeking better risk-adjusted returns across your portfolio, it’s essential to take full advantage of a broad spectrum of commodities including agriculture, energy, and metals.
A Diversification Reality Check
One of the primary reasons for investing in commodities is for the diversification benefits. As shown in the table below, individual commodity assets have historically had low correlation to even one another. Therefore, investing in a broader set of commodities beyond just gold may provide greater diversification.
10-Year Correlation of Gold to Individual Commodities
Source: Bloomberg. Date range: 01/01/02-12/31/11. The above listed commodities represent some of the individual components of the S&P GSCI. They qualify for inclusion in the S&P GSCI on the basis of liquidity and are weighted by their respective world production quantities. One cannot invest directly in an index. See index description below1.
All Commodities Are Not Created Equal
As evident from the chart below, individual commodities can perform differently over time, further making the case of allocating to a broad basket of commodities.
10-Year Performance of Individual Commodities (2002 – 2001)
Source: Bloomberg. Date range: 01/01/2002-12/31/2011. The above listed commodities represent some of the individual components of the S&P GSCI. They qualify for inclusion in the S&P GSCI on the basis of liquidity and are weighted by their respective world production quantities. One cannot invest directly in an index. See index description below 1.
So the next time a client brings up the subject of gold as a way to diversify, remind them that in reality they’re just trying to time the market or move into an asset class they hope will perform better in the near term.
As a professional, you know that the trick is to reap the potential benefits of more diversification and improving risk-adjusted returns over the long haul. The place to start is with a broader basket of commodities.