The Handbook of Commodity Investing

CHAPTER 32

The Effect of Gold in a Traditional Portfolio

Thomas Heidorn, Ph.D.

Professor of Finance

Frankfurt School of Finance and Management

Nadeshda Demidova-Menzel

Equity Analyst

Equinet AG (ESN)

The price of gold has risen dramatically since 2000, making gold an interesting addition to a portfolio. One significant influence on the price of gold has been the decision that 15 European central banks made in 2004 to limit their gold sales over the next five years. Another influence may be the underperformance of many asset classes, which has forced portfolio managers to seek new investment ideas.

This chapter first outlines the main drivers of the price of gold, and examines both short- and long-term effects. We discuss gold's correlation with inflation, and with the U.S. dollar and Euro exchange rate. Building on these elements, we examine the contribution of gold to a traditional portfolio.

From a return and diversification standpoint, gold had a positive impact on euro (EUR) and U.S. dollar (USD) portfolios between 2000 and 2006 because of its high returns and low correlation with other assets. However, this time period is the exception. During most other periods, correlation with equity and bonds was low, but returns were small, overriding the positive diversification effect.

FACTORS DRIVING GOLD PRICES

Similarly to other markets, the price-determining mechanism in the gold market is supply and demand. More precisely, we mean “real” supply and demand, which does not include ...