Using Gold to Protect a Portfolio

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...while gold has never been proven to be a statistically viable inflation protector, it has a significantly correlated 10 to 1 relationship with interest rates and bond prices which, as you know, react to inflation. Therefore, if interest rates rise by 1%, the face value of bonds should fall 10% but gold should rise by 100%...

One of the things people don’t understand about buying gold for diversification is that it doesn’t work all the time. It works over time.

That means that you can’t simply switch from one asset class to another when the going gets tough and expect miracles. Nor can you expect higher returns.

And that’s the really cruel part.

Many so-called alternative investments, gold being the most notable, are being sold right now on the basis of recent high returns to salivating investors desperate to stop the bleeding in their portfolios.

No question, the yellow metal offers diversification; but near all time highs, its “protection” is debatable at best, when viewed against the harsh light of historical data...

Does this mean that gold is worthless when it comes to riding out tough markets?

No. Not for a New York minute.

Gold remains a powerful hedge and one that every investor should think about… but for reasons that are not commonly understood.

You see, while gold has never been proven to be a statistically viable inflation protector, it has a significantly correlated 10 to 1 relationship with interest rates and bond prices which, as you know, react to inflation. Therefore, if interest rates rise by 1%, the face value of bonds should fall 10% but gold should rise by 100%.

Which suggests that 10% of the value of a bonds ought to be put in gold… as a hedge.

Here’s how such an example would work.

If we allocate $10,000 to this strategy, $9,000 would go into bonds and $1,000 into gold. If rates rise by 1% (as they’re likely to do and then some), the bonds should fall 10% to $8,100 and the gold should rise by approximately 100% to $2,000. Overall, my portfolio would be worth $10,100 (give or take), which is right about where we started.

That suggests a portfolio of bonds and gold is safer than either bonds or gold in isolation.

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