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The case for gold as an alternative asset class

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Gold was a long forgotten asset in 2001, trading at about a third of its price in 1980. But gold became a hot commodity by April 2011, when its price surged from $271 to $1,923 an ounce in roughly 10 years, and the State Street Gold ETF (GLD) became the largest ETF by asset size.

Those who bought gold out of a misguided presumption of the demise of the dollar and other paper currencies were merely exercising the predictably irrational human tendency to chase performance. This tendency is expressed in buy high/sell low behavior, as gold is currently trading at about $1,254 as of June 9, 2014.

Bought for the right reason, however, gold can be a good diversifier. To be considered a good alternative investment, gold would have to have a low correlation to U.S. stocks and a positive expected return.

According to my calculations from data derived from OnlyGold.com, gold has appreciated by 5.0% annually, over the past 40 years, besting the CPI annual increase of 4.0% annually, thus delivering a positive real return, though far lower than stocks.

The next criteria is to have a low correlation to traditional assets. According to Business Insider, the correlation between gold and the S&P 500 has averaged close to zero since 1965, never going above 0.5 or below -0.5. Thus, it meets this criteria as well. Gold also has a strong positive correlation with oil, meaning that it could be a good store of purchasing power.

Finally, author and financial theorist William Bernstein noted in his book Deep Risk that gold could have a limited role in a scenario where the government confiscates assets. It’s improbable however that, under a full collapse, we would be showing up at the grocery store to buy milk and eggs with gold.

It appears that a small amount of gold in a portfolio can act as a good alternative asset to diversify risk. It’s also clear that gold is a better deal today than in April 2011, but that doesn’t mean we know what the price will be three years from now. We at least know that adding gold to a portfolio today isn’t performance chasing.

Allan S. Roth, a Financial Planning contributing writer, is founder of the planning firm Wealth Logic in Colorado Springs, Colo. He also writes for CBS MoneyWatch.com and has taught investing at three universities.

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