Gold As A Portfolio Diversifier

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GOLD AS A PORTFOLIO DIVERSIFIER:
THE WORLD GOLD COUNCIL AND INVESTING IN GOLD
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There was an audible buzz in the room as Juan Carlos Artigas, global head of investment
research at the World Gold Council (WGC), finished speaking. “The Strategic Case for Gold as
an Asset Class,” his presentation at the 2012 Bloomberg Precious Metals Conference in New
York, had attracted quite an audience. As a result of the market collapse in 2008 and the ongoing
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euro-area crisis, investors worldwide had safety and security on their minds, and many in the
room were wondering whether gold would provide capital preservation and improve the overall
risk-return tradeoff of their portfolios. At the same time, the sustained run-up in the price of gold
since 2001 that Artigas had talked about in his presentation was a cause for concern. Was gold
the safe haven that it had proved to be in 2008 and 2009, or was it an asset class at the peak of a
bubble? The investment case for gold deserved closer examination.
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The World Gold Council
Founded in 1987, the WGC is a market development organization that represents the
world’s largest gold mining companies. While many institutional investors were aware of the
WGC, it had obtained even wider visibility in recent years due to the 2004 launch of an
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exchange-traded fund (ETF) that tracked the price of gold.
The SPDR Gold Shares ETF (GLD) was sponsored by the WGC and had launched in
November 2004 in coordination with State Street Global Advisors (SSgA). SSgA was a pioneer
in the ETF market, having introduced the S&P Depository Receipts Trust Series (SPDR),
pronounced “spider,” a decade earlier. GLD was the first U.S.-listed gold ETF to be backed by
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the physical asset, and it was one of the fastest-growing ETFs in history, reaching close to 1,300
metric tons of gold under custody, making assets under management in the trust valued at over
$70.3 billion at the end of February 2012. GLD was the most successful commodity-based ETF
to date. While the focus of the WGC before 2004 was primarily on the use of gold in jewelry, the
This case was written by Assistant Professor Richard B. Evans and Associate Professor Pedro Matos. It was written
as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation.
Copyright  2012 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved.
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reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—
electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School
Foundation. The materials have been prepared only for educational purposes and not for any other purpose,
including as an offer to sell or the solicitation of an offer to buy any securities. By using these materials, you agree
that you will not display, reproduce, store in a retrieval system, or transmit these materials to any person for any
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launch of the ETF signaled a strategic shift to increase the visibility of gold as an investable
asset. The presentation at the Bloomberg industry conference was one element of the WGC’s
strategy to introduce gold to a broader group of investors.
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The Strategic Case for Gold as an Asset Class
Exhibit 1 provides selected slides from the WGC presentation, which can also be
watched online.1 Gold had a significant “bull run” in the previous decade, reaching a price of
over $1,530 per ounce at the end of 2011, and it had averaged an investment return of 17.4% per
year since 2001 (slide 1). In stark contrast, during the same period, the S&P 500 earned a meager
3% return. But the argument for gold was not just one of excess returns relative to other
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investments because gold had the potential to be an important source of risk reduction and
capital preservation (slide 2). Gold returns tended to be positive in periods of financial turmoil
and offered portfolio-diversification benefits. The correlation between the returns of gold and the
returns of other asset classes was very low (slide 3), and the volatility of the return on gold (slide
4) was lower than that of U.S. or emerging-market equities and real estate (as represented by
REITs) or commodities, two additional “real assets” that many investors would consider the
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closest alternatives to gold. Also with the prospect of significant inflation looming in the future,
the high real investment return on gold in inflationary periods (slide 6) could preserve the
purchasing power of investor capital.
Although the risk and return calculations in the WGC presentation characterized gold’s
overall behavior, as an investment, it exhibited unique properties in bear markets that made it
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particularly attractive to investors seeking security. The distribution of returns for many asset
classes exhibited negative skewness, whereas the returns on gold were positively skewed (slide
5). Put another way, this means that while the returns on gold that investors earned in a bull
market had volatility similar to that of equities, for example, in a bear market when investors
desired safety most, the returns on gold were less volatile. This combination of very low
correlation with other asset classes and positive skewness could potentially protect investors
against market crashes, which were often called “tail events.” During seven of the worst market
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events since 1987 (slide 7), even a small gold allocation of 5% would have reduced investor
losses substantially. Overall, even a small allocation to gold would have helped improve risk-
adjusted returns (slide 9).
The WGC admitted that global investment allocations to gold remained small (slide 15),
but it argued that the liquidity and aggregate dollar size of the gold market was comparable or
superior to other investment asset classes (slide 8). Using the stock of gold for private
investment, WGC valued the financial market for gold at $3.4 trillion, making it bigger than all
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sovereign debt markets except for U.S. treasuries and Japanese government bonds. Additionally,
the London Bullion Market Association estimated that the over-the-counter market for gold
1
Presentation is available at http://www.youtube.com/watch?v=THE8eBX3uk4.
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traded, on average, $240 billion a day with 90% of these transactions based on physical (not
synthetic) contracts,2 and the advent of the GLD ETF in 2004 made investment in gold more
accessible to a wider spectrum of investors.
In recent years, prominent hedge-fund managers such as John Paulson (who held over 4%
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of all GLD shares) and the Soros Fund had invested in gold as a store of value to protect its
capital as record-low interest rates eroded returns on currencies. Even some pension funds,
which were typically slower to diversify into new asset classes, had allocated portions of their
portfolios to gold. Public plans such as Texas Teachers and private ones such as the Lockheed
Martin Investment Management Co. had invested in gold through the purchase of GLD shares.
Other large endowments had invested directly in gold. The University of Texas Investment
Management Co. had converted its investments in gold producers and other gold-related
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securities into bullion in spring 2011. The company took physical delivery of the gold bars,
worth approximately $1 billion, and stored them in a bank vault in New York. The WGC
believed that as it spread the word about the benefits of investing in gold, other investors would
follow suit.
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The Decision
After the floor at the Bloomberg conference was opened for questions, there were a
number of issues raised that were clearly of interest to investors. Was gold a bubble asset? While
Artigas had argued in his presentation that gold’s recent price appreciation did not resemble
previous bubbles (slides 10 and 14) and that diversified and growing demand for gold (slides 11
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and 12) combined with limited supply (slide 13) suggested stable if not increasing gold prices in
the years ahead, opinions were divided. Some analysts questioned whether gold was losing its
luster as an asset of last resort and that the investment case for gold relied on the high historical
average returns it had experienced. While gold had an average annual return of 19% over the
previous 10 years (2002 to 2011), its average investment return for the last 25 years (1987 to
2011) was less than 6%. If investors expected lower returns for gold going forward, would it still
make sense to invest in gold?
No
Other questions were raised. Why should investors invest in gold if it did not provide
income as did dividend-paying equities or commodities with commercial utility (e.g., oil or
corn)? A participant pointed to a recent quote from the legendary investor Warren Buffett who
said, “If you own one ounce of gold for an eternity, you will still own one ounce at its end.” 3
Given the costs associated with owning gold (e.g., physical storage, insurance, and transaction
costs), the income stream from a gold investment could actually be negative. Should these costs
affect the decision of whether or not to invest?
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2
London Bullion Market Association, LBMA Gold Turnover Survey for Q1 2011, Alchemist 64 (August 2011).
3
Warren Buffett, “Why Stocks Beat Gold and Bonds,” Fortune, February 27, 2012.
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The most common question from the audience, however, had been about how much of an
investor’s portfolio should be allocated to gold? Many retail investors used a mix of equities and
bonds as core assets in their portfolios. Exhibit 2 provides annual returns for these major asset
classes and gold from 1988 to 2011. The more sophisticated institutional investors of pension
funds and endowments might consider gold as an alternative to other “real” asset classes such as
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commodities and real estate that also protected against inflation. Exhibit 3 provides historical
means, standard deviations, and correlations computed from monthly return data (6/30/1992 to
6/30/2012) for 11 asset classes more commonly employed by sophisticated investors when
structuring their portfolios, including these real assets. But even given all of this data, the
question remained, what fraction, if any, of an investor’s portfolio should be invested in gold?
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No
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Exhibit
E 1
GOLD AS A POR
RTFOLIO D
DIVERSIFIE
ER:
THE WORLD
W GOLD
G COUNNCIL AND
D INVESTIN
NG IN GOL
LD
WGC Presentation
n: “The Strattegic Case foor Gold as an Asset Classs”
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Wh
hat makes gold
g a long
g-term stra
ategic asse
et?
• Poortfolio risk management

- “True”
“ portfolio diversification
• Lack of correllation to most other
o asset classses
No
• Tail-risk hedging (negative correlation

c in pe
eriods of turmo
oil)
- Moderate
M volattility
- Deep
D and liquidd market
- No
N credit or cou unterparty risk
• Caapital preserva ation

- Inflation/deflatio
on hedging
- Currency
C hedging
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World Gold Council | The strategic case

e for gold as an asset class | 20
012 2

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Exhibiit 1 (continueed)
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No
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No
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Go
old tends to
o reduce lo
osses when
n tail events
s occur
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Impa
act of a 5% allocattion to gold in stan
ndard portfolio du
uring crises*
Basis points
30
00
25
50
20
00
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15
50
10
00
5
50
0
Black LTCM crrisis Dot-com September 2002 Greatt Sov'n debt Sov'n deebt
Monday bubble 11th recession recessiion crisis I crisis II
*Standarrd portf olio def ined as one having 55%
5 equities, 25% f ixed income and at most 5% cash with the rema aining weights optimally allocated in alternative
assets including gold, commodities and rea al estate. Gold's allocation when in
ncluded is 5%. Black monday: 9/87 7-11/87, LTCM: 8/98, Dot-com: 3//00-3/01, Sept
1, 2002 recession: 3/02-7/02, Grea
11th: 9/01 at recession: 10/07-2/09, Sov'n de ebt crisis I: 1/10-6/10, Sov'n debt crisis
c II: 02/11-10/11
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Source: Barclays
B Capital, Bloomberg, Hed ge Fund Research, J.P. Morgan, Thomson
T Reuters, World Gold Co uncil

e for gold as an asset class | 2012 7
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Sources of su
upply and demand
d arre diverse
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2011 deman
nd by source 2
2011 supply by source
* Includ
Source
Jewelry (1,9
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974 t) 44%
Investmentt* (1,613 t) 36%
Technologyy (453 t) 10%
Official sector (458 t) 10%
des bars, coins, ETFs, OTC pu
t: tonne
es
urchases and gold stock move
e: Thomson Reuters GFMS, World

W Gold Council
ements.
Mine supply** (2,83
M
R
Recycled
** Net of producer hedging.

t: tonnes
Source: Thomson
32 t) 63%
gold (1,665 t) 37%
n Reuters GFMS, World Gold Council

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Dis
sclaimer
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This presentation is provided solely

s for general informa ation and educational purposes. It is not, and should not be construed
as, an offer to buy or sell, or ass a solicitation of an offer to buy or sell, gold, anyy gold related products or
o any other products,
securitties or investments. It do oes not, and should not be construed as acting to o, sponsor, advocate, enndorse or promote any
gold re
elated products or any otther products, securities or investments.
This presentation does not purrport to make any recommendations or provide any a investment or other advice
a with respect to
the purchase, sale or other dissposition of gold, any gold related products or anyy other products, securitties or investments,
includiing without limitation, anyy advice to the effect tha
at any gold related transaaction is appropriate for any
a investment
objectiive or financial situation of a prospective investorr. A decision to invest in gold, any gold related products or any other
produccts, securities or investmments should not be made e in reliance on any of th
he statements in this pressentation. Before
making g any investment decisio on, prospective investorss should seek advice from m their financial adviserss, take into account
their in
ndividual financial needs and circumstances and carefully consider the rissks associated with such h investment decision.
While the accuracy of any information communicated herewithh has been checkked, neither the World Go old Council nor any of
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its affilliates can guarantee succh accuracy. In no eventt will the World Gold Cou uncil or any of its affiliatess be liable for any
decisio on made or action taken in reliance on the inform mation in this presentation or for any consequentiial, special, punitive,
inciden ntal, indirect or similar da
amages arising from, rela
ated to or connected withh this presentation even if notified of the
possib bility of such damages.
Expresssions of opinion are tho

ose of the author and are
e subject to change witho
out notice.

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Source: All slides in Ex

xhibit 1 are from
m the World Goldd Council; used with permissionn.
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Exhibit 2
Annual Return Data, 1988 to 2011
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U.S. Large U.S.
Date U.S. Bonds Gold
Cap T-Bills
1988 15.72% 7.68% 6.36% -15.26%
1989 10.63% 13.92% 8.38% -2.84%
1990 4.51% 8.88% 7.84% -3.11%
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1991 18.86% 15.43% 5.60% -8.56%
1992 7.34% 7.36% 3.50% -5.73%
1993 9.76% 9.88% 2.90% 17.68%
1994 -2.32% -2.48% 3.91% -2.17%
1995 35.20% 18.42% 5.60% 0.98%
1996 23.61% 3.79% 5.20% -4.59%
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1997 24.69% 9.66% 5.25% -21.41%
1998 30.54% 8.80% 4.85% -0.83%
1999 8.97% -0.56% 4.69% 0.85%
2000 -2.04% 11.64% 5.88% -5.44%
2001 -17.26% 8.67% 3.86% 0.75%
2002 -24.29% 8.50% 1.63% 25.57%
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2003 32.19% 4.20% 1.02% 19.89%

2004 4.43% 4.45% 1.19% 4.65%
2005 8.36% 2.60% 2.98% 17.77%
2006 12.36% 4.48% 4.81% 23.20%
2007 -4.15% 7.12% 4.67% 31.92%
2008 -40.09% 5.26% 1.68% 4.32%
2009 30.03% 6.17% 0.09% 25.04%
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2010 19.76% 6.65% 0.09% 29.24%

2011 2.04% 7.79% 0.04% 8.93%
Data sources: The U.S. large cap equities returns are calculated from the St Louis Fed’s S&P
500 Index return series (http://research.stlouisfed.org/fred2/series/SP500?cid=32255). The
U.S. bond return series is calculated from the annual returns with dividend reinvestment on
the Vanguard Total Bond Market index funds gross of expenses. The U.S. T-bills return
series is calculated from one month of T-bill returns from Ken French’s website
(http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html). The gold return
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series is calculated from gold price data (U.S. dollars per troy ounce, source: LBMA taken
from the WGC website http://www.gold.org/investment/statistics/gold_price_chart/).
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Exhibit 3
Asset Class Return Statistics for 11 Asset Class Portfolios
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Panel A: Averages and Standard Deviations (monthly return data, 6/30/1992–6/30/2012)
Fixed Income Equities Altern. Real Assets
U.S. U.S. Developed Emerging Hedge
U.S. U.S. Global Commodities Gold
Small Large Market Market Funds U.S. REITs
T-Bills Bonds Bonds (GSCI) (dollars/oz.)
Cap Cap Equities Equities (HFRI)
Avg. 3.78% 6.29% 6.38% 10.44% 9.12% 7.16% 11.00% 9.93% 13.07% 5.50% 8.80%
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Std. Dev. 0.64% 3.69% 8.14% 19.66% 15.24% 17.11% 24.11% 7.12% 20.97% 21.69% 15.97%
Panel B: Correlations (monthly return data, 6/30/1992–6/30/2012)

U.S. U.S. Developed Emerging Hedge
U.S. U.S. Global Commodities Gold
Small Large Market Market Funds U.S. REITs
T-Bills Bonds Bonds (GSCI) (dollars/oz.)
Cap Cap Equities Equities (HFRI)
U.S. T-Bills 1.00 0.16 0.02 -0.06 0.02 -0.04 -0.09 0.09 -0.11 -0.05 -0.12
U.S. Bonds 0.16 1.00 0.46 -0.04 0.05 0.03 -0.02 0.03 0.13 0.02 0.16
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Global Bonds 0.02 0.46 1.00 0.07 0.10 0.34 0.13 0.08 0.21 0.20 0.35
U.S. Small Cap -0.06 -0.04 0.07 1.00 0.80 0.72 0.72 0.82 0.63 0.30 0.09
U.S. Large Cap 0.02 0.05 0.10 0.80 1.00 0.79 0.73 0.74 0.54 0.25 0.00
Developed Market Equities -0.04 0.03 0.34 0.72 0.79 1.00 0.77 0.74 0.53 0.37 0.16
Emerging Market Equities -0.09 -0.02 0.13 0.72 0.73 0.77 1.00 0.82 0.46 0.34 0.22
Hedge Funds (HFRI) 0.09 0.03 0.08 0.82 0.74 0.74 0.82 1.00 0.42 0.39 0.18
U.S. REITs -0.11 0.13 0.21 0.63 0.54 0.53 0.46 0.42 1.00 0.22 0.09
Commodities (GSCI) -0.05 0.02 0.20 0.30 0.25 0.37 0.34 0.39 0.22 1.00 0.25
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Gold (dollars/oz.) -0.12 0.16 0.35 0.09 0.00 0.16 0.22 0.18 0.09 0.25 1.00
Panel C: Baseline Optimized Portfolio

Portfolio weight
U.S. T-Bills 1.20%
Fixed Income U.S. Bonds 19.40%
Global Bonds 11.30%
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U.S. Small Cap 14.30%

U.S. Large Cap 12.60%
Equities
Developed-Market Equities 1.60%
Emerging-Market Equities 13.00%
Alternatives Hedge Funds (HFRI) 13.70%
U.S. REITs
Real Assets Commodities (GSCI) 12.90%
Gold (dollars/oz.)
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Note: Calculations by authors based on monthly returns from 6/30/1992–6/30/2012.

Data sources: Ken French’s website (U.S. T-bills); Barclays Capital US Aggregate (U.S. bonds); Barclays Capital
Global TSY AGG ex US (global bonds); Russell 2000 TR (U.S. small cap); MSCI US TR (U.S. large cap); MSCI
EAFE TR (developed market equities); MSCI EM TR (emerging market equities); HFRI fund-weighted composite
(hedge funds) DJ US Select REIT TR (U.S. REITs); S&P GSCI TR (commodities); and London PM Fix (gold). All
series are total return except hedge fund index and gold.
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exchange-traded fund (ETF) that tracked the price of gold.

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• Poortfolio risk management

• Tail-risk hedging (negative correlation

• Caapital preserva ation

World Gold Council | The strategic case

World Gold Council | The strategic case

e: Thomson Reuters GFMS, World

** Net of producer hedging.

n Reuters GFMS, World Gold Council

This presentation is provided solely

Expresssions of opinion are tho

World Gold Council | The strategic case

Source: All slides in Ex

2003 32.19% 4.20% 1.02% 19.89%

2010 19.76% 6.65% 0.09% 29.24%

Panel B: Correlations (monthly return data, 6/30/1992–6/30/2012)

Panel C: Baseline Optimized Portfolio

U.S. Small Cap 14.30%

Note: Calculations by authors based on monthly returns from 6/30/1992–6/30/2012.

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