Gold Stocks Can Add Returns with No Extra Volatility


"The judicious use of gold stocks as part of an investment portfolio can add to returns without significantly adding to risk."

Gold stocks are among the most volatile asset classes, but old and new research shows that their judicious use can enhance investor returns without adding portfolio risk.

U.S. Global Investors has updated research on gold stock investing by Jeffrey Jaffe, a finance professor at the Wharton School, that was published in the Financial Analysts Journal in 1989. Prof. Jaffe's study covered the period from September 1971, just after President Nixon ended convertibility between gold and the dollar, to June 1987.

The Jaffe study concluded that adding gold and gold stocks to a large portfolio increases both risk and return, but that the additional return from these non-correlative assets more than compensates for the additional risk.

During the study period, gold bullion saw an average monthly return of 1.56%, considerably better that the 1.06% average monthly return for common stocks represented by the S&P 500. Gold stocks shone even brighter, returning an average of 2.16% per month.

On the risk side, gold and gold stocks had greater volatility (measured by standard deviation) than the S&P 500. But Jaffe found that, due to their non-correlative qualities, adding gold-related assets to a diversified portfolio would likely reduce overall risk.

Between September 1971 and May 2009, the S&P 500 averaged a 9.34% annual return. A 15% allocation to gold equities, with annual rebalancing, would have yielded on average an additional 0.89% per year.

How much is 0.89% per year? Assuming the same average annual returns since 1971 and annual rebalancing over 25 years, a $10,000 investment in the portfolio with 15% gold stocks would be worth about $114,000, 22% more than the 100% S&P 500 portfolio, while adding virtually zero risk.

U.S. Global Investors consistently suggests up to 10% gold in a portfolio allocation, so we also looked at returns for investors at that level. A 10% allocation to gold equities, with annual rebalancing, would have yielded on average 0.63% more than an exclusive S&P 500 portfolio.

More than two decades and many ups and downs have passed since Prof. Jaffe published his study, but our follow-on research shows that the relationship between gold, investor returns and volatility has remained pretty much the same.

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