Gold: The Most Liquid of All Liquid Alts?

Gold - The Most Liquid of All Liquid Alts?A report from the World Gold Council asserts that gold is “the most liquid of all liquid alts,” with lower correlation to other assets classes and risk-adjusted returns that are superior to other alternative investments. The report titled Gold Investor: Risk management and capital preservation, Volume 6 was published in June, 2014, and is comprised of three distinct articles:

  • How gold improves alternative asset performance
  • Gold: metal by design, currency by nature
  • The most liquid of all liquid alts

Each article makes the case for gold from a different angle. The first, How gold improves alternative asset performance, demonstrates how gold has the lowest levels of correlation to the stock and bond markets among alternative assets. The second article, Gold: metal by design, currency by nature, explains why this is the case. And finally, the third article asserts that gold is not only the most alternative investment with the least correlation to other investments, but also the most liquid of liquid alternatives.

How Gold Improves Alternative Asset Performance

Demand for alternative investments has grown substantially since the turn of the century. The World Gold Council reports private equity investments have grown from less than $400 billion in 2001 to more than $3.5 trillion in 2013. Investments in “liquid alts” have reportedly tripled since 2009 and are projected to reach $1.3 trillion by 2017.

But while alternative investments are designed to have low levels of correlation to the “traditional assets” of stocks, bonds and cash, most alternatives’ correlations have increased during times of financial stress – which is exactly what alternative investments shouldn’t do.

Gold is an exception, though; as it is the only alternative asset that has a lower level of stock-market correlation since 2009 than it had from 2000 to 2007. Its correlation to equities was roughly 0.15 from 2000 to 2007, roughly 0.18 in 2008, and has fallen to around 0.12 since 2009. Hedge funds, by contrast, have seen their correlations to equities stay roughly in the 0.8 range over the period – that’s an 80% correlation to equities, compared to gold’s average level of about 15%. The correlations to global equities are shown in the chart below.

correlation of gold to stocks

An alternative investment portfolio with at least a portion of its holdings in gold clearly reduces its correlation to other asset classes, and this should work to improve risk-adjusted returns.

Gold: Metal by Design, Currency by Nature

The report’s second article explains why gold’s performance has such limited correlation other asset classes. In brief, it has to do with gold’s traditional role as a store of value.

Investors typically group gold with other commodities, but it behaves more like a currency. This is because while demand for gold’s use in jewelry is stimulated by bullish economic conditions, demand for it as a hedge against economic uncertainty is stimulated by bearish economic conditions. What’s more, gold’s production and demand are geographically diverse, greatly reducing geopolitical supply risks.

Gold is a virtually indestructible metal, and it’s roughly accurate to say that all the gold ever mined in the history of the world is still available for use today. Gold is scarce: all of the gold ever mined could be housed in a cube with sides measuring less than 70 feet, but because gold essentially can’t be destroyed, about 35% of the annual supply is recycled and redeployed. This keeps the supply stable and contributes to alternative investors’ low-beta objective.

The Most Liquid of All Liquid Alts

The idea behind “liquid alts” is to provide the strategies of alternative investments with the liquidity and transparency more similar to traditional investments. The definition of “alternative investments” is anything other than stocks, bonds, and cash – so gold clearly qualifies. And since gold is the sixth-most heavily traded financial asset in the world – behind three currency pairs involving the U.S. dollar, U.S. Treasuries, and  Japanese government bonds – gold is clearly the most liquid of all liquid alts!

In terms of monetary value, more gold is traded each day than all stocks, worldwide. Demand for gold is diverse and widespread, and the ways to buy and sell gold – ranging from physical coinage to options on gold-tracking ETFs – are just as variant. Having gold as a component of an alternative investing strategy enhances liquidity while diversifying returns, and while many other forms of alternative investments have limited track records, gold’s history as an investment predates recorded history itself.

Conclusion

The World Gold Council’s report makes three separate but equally convincing cases for gold’s role in any diversified alternative investment portfolio. When the three angles are synthesized, gold’s role as an enhancer of risk-adjusted returns becomes even clearer. While alternative investments are a relatively new marketplace innovation, gold is eternal – and that’s another reason why it deserves consideration from all investors.

For more information, visit the World Gold Council website and request a download of the report.

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