Home' Trinidad and Tobago Guardian : November 20th 2014 Contents NOVEMBER 2014 • WEEK THREE www.guardian.co.tt BUSINESS GUARDIAN
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on trailing one-year of weekly data). This correlation was extremely high by
Today, with more differentiation in markets, the correlation has dropped back
down to near zero. While gold prices are struggling, at the very least the asset
class is once again offering some real diversification.
Refer to: Gold is a great diversifier
The correlation coefficient, which always lies between -1 and 1, is the extent
to which two securities move with each other. A correlation coefficient of 1
means that the two securities move in absolute tandem with each other. A coef-
ficient of -1 means the two securities are inversely related. A coefficient of 0
means the two move in random directions. It s the most desirable coefficient,
as far as portfolios are concerned.
The correlation between gold and the S&P 500 is 0.1. Between gold and junk
bonds, the correlation is 0.2. And between gold and emerging markets, it s
slightly above 0.3. The correlation between gold and the S&P 500 is much lower
than between the index and emerging markets. The latter stands at 0.8, surprisingly.
The former is also much lower than the correlation between the S&P 500 and
junk bonds, which also stands at 0.8.
This means that gold adds massive diversification benefits to a portfolio con-
taining the other three assets. So gold needs to be in your portfolio---at least
in a small amount.
Why real interest rates affect gold prices
4. All else equal, central bank buying is supportive of gold. Another consideration
is that while gold is hard to value, it has performed better in certain environments.
Historically, gold has done best when real or inflation adjusted interest rates are
low, as they are today. The reason is: when real rates are low there is less of
an opportunity cost, in the form of foregone income, to holding gold. To the
extent central banks, including the ECB and BOJ, maintain an accommodative
monetary policy; all else equal this should be supportive of gold.
Refer to: Gold tends to perform well when real interest rates are low
The graph shows real interest rates and gold prices in the last ten years. The
bank prime loan rate serves as a proxy for nominal interest rates. Nominal interest
rates minus the inflation rate result in real interest rates.
Gold prices have moved up when real interest rates remained low. With the
bond buying programme ended last month, the Fed could increase rates soon.
This will increase real rates if inflation remains constant---which seems likely,
given how inflation has remained below 2.0 per cent despite the Fed s efforts
to move it higher. The rising real rate decreases the attractiveness of investing
in gold since investors would rather invest in more attractive bank deposits.
But US and international equities may still provide better returns. The recovery
in major global economies should gain momentum over the next few years.
Keep gold in your portfolio to diversity
and hedge inflation
Investors, who include gold in their portfolio for diversification reasons and
as an inflation hedge, should maintain that position, and for long-term investors
a small allocation to gold could be reasonable. While there is no objective method
to deciding if gold is "cheap" or "expensive" at these levels, following the sell-
off the metal is obviously a bit cheaper to own.
Refer to: Gold prices are the lowest in over 4 years
The graph shows gold prices over 15 years. Gold saw a meteoric rise in the
2000s. After hitting an all-time high of around 1,900 in September 2011, gold
has been slipping. It s now sitting at a multi-year low.
Given low Treasury yields, gold is perhaps the "cheaper safe haven" at the
moment. Also, if inflation picks up from its current low levels, gold could shine
again. Equities could take a back seat in that case if the market takes higher
prices as a bad sign.
From Page 26
Gold still a
Investors, who include gold in their portfolio for
diversification reasons and as an inflation hedge, should
maintain that position, and for long-term investors a
small allocation to gold could be reasonable.
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