Gold in your investment portfolio still glitters

Gold. For the layman the classic safe haven; for the aggressive investor the last few years have been in the "good" column but doubts arise on its ability for continued performance. "Remember you cannot eat and sleep well at the same time or all the time. So, we try to sleep well first — and all the time — but still have the occasional gourmet dinner," so says our Schadenfreude investor "The Poisonous Pen" writing in Mondial Money. Mr Pen's penchant is to eat very, very well on high returns gained from a mix of traumas caused by simple events and tracking trends. Readers will remained impressed with his tenfold return on the VIX Index covered in this space last month. This week, however, his focus turns to the need to "sleep well", and almost reluctantly, accepts that there is a role for gold within his overall portfolio at somewhere around "3 per cent to 5 per cent of the total". Most readers would be more conservative than Mr Pen, and might interpret this as a suggestion that exposures of around 10 per cent would suit the more balanced portfolios. For Pen, gold is difficult to take a view on because "for us gold does not exhibit characteristics that we desire — no malaise, no apparent disaster news — simply no trend to jump on yet great uncertainty in outlook." No trend, no friend for Pen, who says the situation has been similar: "since we were born [assuming we are all under 90 years of age]". "That is exactly one of the temptations of buying gold since we cannot remember the last time it was a bad medium-term investment choice. The puzzle to solve is whether this view holds true analytically." So it's the numbers and stats Mr Pen is looking for and he gets them in the pro-gold World Gold Council research which, while written by its members, provides for Pen compelling research into justifying a portfolio role for gold. Pen adds: "It is not because we like gold — we do not like gold — but it seems we may need a small portion of gold as insurance both for tail risks and possibly for diversification." Unusually for Pen it is downside protection he seeks because high risk portfolios can be skewed to the downside. There is a simple explanation why financial markets changes in value are skewed towards the negative. Catastrophic bad news can occur but there is no equivalent ‘catastrophic' good news. Companies can be wiped out, but there are no positive developments of equivalent value. So gold becomes a proxy hedge. The Gold Council research compared a standard portfolio with 3 per cent gold content with the same portfolio without gold. Over the period 1987 — 2010 and across all crisis, the annualised return of the "with 3 per cent gold" and the "without gold" portfolio was highly similar. However, in almost all cases, the portfolio with a 3per cent gold content fared much better during extreme crisis. Gold portfolios had lower losses at crisis time and/or increased gains during the subsequent portfolio recovery. Aggressive In short, the 3 per cent to 5 per cent exposure will not detract from average portfolio gains but is good in a crisis and acts as a parachute. The more aggressive your portfolio, the more useful this insight might be. Finishing with a picture-story: Pen says: "It is like placing one chip on zero at roulette in the casino — zero is one that is outlying [comes less often than a number and is not included in combination bets] but when it comes everything else is lost and all strategies are void. We still do not like gold as an asset but it seems that others like it so much that they will insure our losses by driving gold prices in times of crisis. Now we like gold a little."