There are three ways in which investors can use gold for long term strategic allocation. The first of these is to boost the diversification of their investment portfolios. The second is to use gold as a hedge for tail risk and the third is to utilize it as a hedge against inflation. Below is a deeper analysis of these three methods and how to use them most effectively.

Using Gold To Boost Portfolio Diversification

When constructing a portfolio that consists of multiple assets, investors must understand the potential risk return attributes of each asset class and how the classes behave in comparison to other investments. The most desirable asset types are those which have returns that are risk adjusted and high forecast, but investors may also choose to expand their search for assets that behave differently in comparison in relation to others.

When a lower correlation exists between different asset types, this means a portfolio will have reduced volatility with greater diversification. Its risk adjusted return will thus be enhanced. History has shown that including gold in one’s portfolio can bring a number of diversification benefits over the long term, especially in relation to bonds and equities.

Using Gold As A Hedge For Tail Risk

Gold can also be used to mitigate tail risk, particularly at times when the markets are under significant stress. History shows it often rises when markets fall back. Gold will deliver returns which are competitive, often surpassing other asset types during “black swan” scenarios. By making gold a key part of one’s portfolio, investors can lower their exposure to market volatility while lowering drawdowns within their portfolios.

Using Gold As A Hedge Against Inflation

Many economists and statesmen have defined inflation as a form of governmental theft, and it is hard to argue with this analysis. Money supply expansion gives governments around the world an alternative to direct taxation, which would force citizens to pay up front for government ventures and in most cases would be extremely unpopular and prove the undoing of many political figures.

This is why governments expand the money supply either digitally or through physical printing. This allows them to get the needed funds without having to tax citizens directly. However, citizens ultimately pay, in the form of inflation which translates into higher prices for goods and services which result from the expansion of the money supply. Over time, the purchasing power of savers is eroded, if their savings are primarily in paper/digital currency.

An analysis of gold has shown that it can preserve the purchasing power of savings when it is present in one’s portfolio. As the rate of inflation increases, the price of gold and silver will increase correspondingly. In the worst case scenario, where a country enters a stage of hyperinflation similar to Zimbabwe or Venezuela, where the currency becomes essentially worthless, the savings of those who hold only cash will be wiped out completely, whereas those who have at least ten percent of their savings in gold will preserve their wealth since gold will increase in price to account for the loss in value of their paper money.