Is there an “Optimal” Gold Allocation?

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It is common for investors to ask, “what is the right amount” when considering how to portion their investible cash across numerous assets. This question is especially common among gold investors because there has been an ongoing debate about what percentage of the total should be held in gold to Investments on White puzzle pieces backgroundgenerate the strongest possible return. The problem with this question is that it ignores the possibility that there can, in fact, be several “optimal” allocations.

How can this be? The word optimal seems to suggest that there is a best number to strive for. Research from Meb Faber, the co-founder and Chief Investment Officer of Cambria Investment Management, illustrates that this is not the case.

He examined the performance of several different asset allocation strategies. Each of the strategies represents an attempt to achieve optimal returns by allocation of investible funds across the right assets in the right proportions. Here is a sample of the portion of gold or commodities represented in some of the portfolios he examined:

Allocations

El-Erian Portfolio 7% Commodities
Arnott Portfolio 10% Commodities
Permanent Portfolio 25% Gold
Ivy Portfolio 20% Commodities
Risk Parity Portfolio 5% Gold

 

The exposure to gold varies greatly across the above list. Moreover, the selection and weighting of other assets like stocks, bonds, and real estate also vary considerably and can be seen in his analysis.

His conclusion: “they all performed pretty similarly.” The final performance figures reflect this similarity clearly.

Performance: Capital Asset Growth Rate

El-Erian Portfolio 10.39%
Arnott Portfolio 10.13%
Permanent Portfolio 8.88%
Ivy Portfolio 9.92%
Risk Parity Portfolio 9.48%

 

These results reveal an often unseen truth: a focus on finding the optimal gold allocation is irrelevant because when nearly any amount of gold is included in a balanced portfolio the investor is overwhelmingly likely to earn a return that is both strong and competitive with various other asset allocation models. In fact, a fixation on determining the perfect amount to allocate to gold may even hurt an investor’s portfolio because it will act as a deterrent from simply starting to invest. Moreover, seeking an answer to the question of “optimal” amounts may also encourage an investor to frequently re-balance which will decrease the long-term performance. The above results are based on portfolios that are treated as buy-and-hold strategies backdated to the 1970s.

Some might warn that while the returns are similar across different allocations, the risk profile differs significantly. This is also untrue as seen from the same data set. The Sharpe ratio is consistent across the portfolios. The Sharpe ratio is an equation that helps investors measure risk-adjusted return. Simply, the formula allows an investor to see what amount of an investment’s return is associated with risk-taking.

The Sharpe ratios in the above portfolios range only from a low of 0.44 (Ivy portfolio), to a high of 0.63 (Risk Parity portfolio). Here again there is little meaningful variation. An investor who selected the El-Erian portfolio, for example, took on the exact same Sharpe ratio as an investor who selected the permanent portfolio. Both clock in at 0.48.

The two pillars of a successful gold investment strategy are (a) to get started, and (b) to hold. Time spent trying to pinpoint a perfect allocation is unnecessary.  

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