With rising risks across standard asset classes like stocks, bonds, and even real estate, many investors have been looking at new ways to add real diversification to their portfolios. As such, alternatives have become the buzzword of the moment. This has given rise to everything from options strategies to even cryptocurrencies. However, one very old-school diversifier could be the best to provide downside and inflation protection to a portfolio.
And that would be gold.
The precious metal is having a field day with strong returns amid all the uncertainty, inflation risks, and increased global volatility. All in all, this underscores its diversification benefits. With that in mind, there’s still time for investors to seriously consider the asset class for their portfolios and gain from its diversification powers.
True Diversification
Investors often overlook the primary objective of building a portfolio, which is to identify asset classes and funds that move in distinct ways. Modern portfolio theory (MPT) has become accepted canon when it comes to portfolio construction. Because, well, it works. Stocks, bonds, real estate, etc., all are supposed to move in different directions and magnitudes. This lack of correlation provides strong returns in both up-, down-, and sideways-moving markets.
Therefore, when stocks are down, bonds should rise. This provides a smoother and potentially absolute return for portfolios. We get a steady march higher.
The problem is that MPT only works when asset classes perform as they have historically done. And lately, that hasn’t been the case. Stocks and bonds have moved together, while other diversifiers haven’t performed as planned. For investors, this has created a whole different set of risks for their portfolios and long-term returns.
And yet, one classic diversifier remains functional just as it should.
Gold has continued to be an effective diversifier. According to asset manager State Street, gold’s multiple sources of demand and its cyclical nature have enabled it to exhibit low correlations with other asset classes. This fact, along with its safe-haven status, has helped it provide diversification benefits. Examining data from the past 30 years, gold has shown a correlation of 0.04 and 0.32 with the S&P 500 Index and the Bloomberg US Aggregate Bond Index, respectively. Expanded that further, gold has managed to provide low or even negative correlations to various other world markets and fixed-income sectors. 1
That diversification goes a long way in smoothing out the volatility of a portfolio and providing good returns over long periods. This is evident by gold’s ability to perform during market crashes, downturns, and other periods of heightened risk.
Examining the last 13 significant drawdown periods of the S&P 500, during which it lost 15% or more, gold has averaged a 5.83% return. This compares to an average negative return of 24.19% for the stock index. During the three drawdown periods when gold produced a negative return, the portfolio experienced reduced drawdowns and volatility compared to a portfolio with no allocation to gold or just the S&P 500.
This chart from State Street highlights these drawdown periods and gold’s returns versus the S&P 500. As you can see, its ability to hedge downside is unmatched.
Source: State Street
Given that many asset classes have become increasingly correlated with each other, it’s easy to understand that holding gold could provide the missing diversification benefits that investors crave.
A Golden Outlook
Investors may finally be getting the golden picture. As the world has continued to feel chaotic, gold prices have soared. Year-to-date, gold has seen its price surge by nearly 28% to reach a record high of $3,415 per ounce. That has shattered all previous records.
However, that surge highlights just how vital the asset class can be to a portfolio, particularly in terms of its outlook.
According to asset manager VanEck, while the future path of inflation remains unknown, various factors, including extreme government spending, debt, and money creation, as well as geopolitical risks such as trade wars, create an environment that is conducive to sustained above-target inflation. This provides gold with the ability to be used for wealth preservation. Thanks to concerns about the U.S. and its rising debt, gold purchases by foreign central banks have begun to increase. 2
Looking at various inflationary scenarios dating back to the 1960s, gold has performed very well compared to other asset classes, even outperforming commodities during periods of high, sustained inflation.
Adding to this wealth preservation factor is current demand from non-investment sources. Gold has many industrial uses and is found in various semiconductors, renewable energy products, and other high-tech equipment. As the world becomes increasingly tech-oriented, gold has a new base of demand. Likewise, in many parts of Asia, buying gold and jewelry remains a cultural phenomenon. With rising wealth in emerging nations, demand for gold jewelry has continued to surge.
When combined with investor demand, gold’s outlook remains very bright indeed.
A Golden Allocation
Given the portfolio and return aspects of gold, investors may want to consider adding the precious metal to their portfolios. According to Van Eck’s research, investors should allocate 18% to gold and 82% to a balanced stock-bond portfolio. However, the investment manager suggests that even a 5% allocation to gold can do wonders and provide support to a portfolio.
Getting access is easy. You can purchase gold bars, coins, and other physical gold. Some brokerages, such as Fidelity, allow for the purchase and storage of physical coins. The more modern approach is to use ETFs.
Gold ETFs can charge pennies for their exposure to the precious metal. An added benefit remains the liquidity of these ETFs. For many of the top gold funds, millions of shares are traded each day. This provides an instant source of liquidity, as opposed to having to sell bullion to other investors or pay fees to dealers.
Physical Gold ETFs
These ETFs were selected based on their ability to provide access to physical gold at a low cost. Their YTD total return is 5.5%, while their dividend yield is 0%. They have assets under management of $524M to $52.5B and expenses of 0.09% to 0.40%.
| Ticker | Name | AUM | YTD Total Ret (%) | Yield (%) | Exp Ratio | Security Type | Actively Managed? |
|---|---|---|---|---|---|---|---|
| GLD | SPDR® GOLD TRUST | $52.5B | 5.5% | 0% | 0.40% | ETF | No |
| IAU | iShares Gold Trust | $24.8B | 5.5% | 0% | 0.25% | ETF | No |
| GLDM | SPDR Gold MiniShares | $5.76B | 5.5% | 0% | 0.10% | ETF | No |
| SGOL | abrdn Gold ETF Trust | $2.58B | 5.5% | 0% | 0.17% | ETF | No |
| BAR | GraniteShares Gold Trust | $884M | 5.5% | 0% | 0.17% | ETF | No |
| IAUM | iShares Gold Trust Micro | $865M | 5.5% | 0% | 0.09% | ETF | No |
| OUNZ | VanEck Merk Gold Trust | $686M | 5.5% | 0% | 0.25% | ETF | No |
| AAAU | Goldman Sachs Physical Gold ETF | $524M | 5.5% | 0% | 0.18% | ETF | No |
Overall, gold remains a top diversifier and a way to reduce volatility in a portfolio. Thanks to its precious nature and inflation-fighting ability, gold remains a great way to hedge against unforeseen risks. By using a physically backed ETF, investors can instantly add an allocation to the precious metal and protect their portfolios for the long term.
Bottom Line
Gold has seen its share price surge over the last year or so. However, that just underscores its ability to perform during times of uncertainty. As an accurate diversification tool, adding a golden allocation to a portfolio is a necessity.
1 SSGA (March 2025). Invest in Gold: A Portfolio Diversifier With Staying Power
2 Van Eck (October 2024). Golden Rule: Gold Belongs in Every Investor’s Portfolio
