Precious metals serve as an essential risk management tool for investors by providing effective diversification for risky assets, helping to limit portfolio declines when the stock market is volatile, and protecting against volatile markets.
Precious metals such as gold, silver, platinum, and palladium have gained increasing importance in recent years as a valid alternative to invest in. Despite being one of the oldest financial instruments, precious metals generally remain underused and many investors ignore this investment option. For many, this provides opportunities to further diversify and take advantage of the special features precious metals have offered in the past in portfolio structuring. It creates exposure to both the cyclical and non-cyclical drivers of gold, silver, platinum, and palladium as a whole. In addition, a basket allows you to take advantage of the diversification benefits of an asset class while exploiting the unique qualities of each individual precious metal.
An important advantage of investing in precious metals is its specific function as a risk management tool. Precious metals can fulfill different functions in risk management and therefore they are a dynamic and agile means of protection against many risks. In the past, they have also been able to protect investors’ portfolios against sharp stock market falls. This role as a risk management tool is particularly useful for long-term investors seeking permanent hedging against a wide range of known and unknown risks. In the past, the correlation between precious metals and most other asset classes, especially equities, has been low. Over the past two decades, the correlation between precious metals and the US and global equities has been lower than that of other alternative investments. The reason for this low correlation lies in the various drivers that drive demand for gold, silver, platinum, and palladium. Procyclical drivers of demand (jewelry, consumption, industrial applications) are increasing as growth and revenues pick up with the economy. By the way, if you are interested come visit this site ()
Counter-cyclical demand drivers, primarily investor demand, rebound in times of economic downturn and stock market declines as interest in value preservation and defensive investments increases. These pro-cyclical and counter-cyclical demand drivers occur at different times and result in a low overall correlation with the rest of the market and the economic cycle.
Precious metals also hold up well during extreme events and turbulent markets. A basket of precious metals performs prodigiously (with positive returns) during these tumultuous and volatile periods, while global equities have seen negative returns and large declines.
It is clear that precious metals are a unique and effective means of diversification, but the benefits of investing in precious metals are only really apparent when they are added to a diversified portfolio. By adding precious metals to a diversified stock and bond portfolio, the efficiency of the portfolio – with the portfolio’s risk decreasing while the return remains the same or increasing – can be increased compared to a diversified portfolio without investments in precious metals. This ratio can be increased by adding a basket of precious metals based on different scenarios and weightings. A 5% investment in precious metals where the exposure to equities is reduced from 60% to 55% results in a drop in volatility to 9.0%, with the portfolio return increasing slightly to 4.2%, and the Sharpe ratio increases from 0.22 to 0.26 (see Table 1). In addition, the annualized return and the Sharpe ratio rise to 4.4% and 0.29 respectively, while volatility drops to 8.7% when this precious metals position is raised to 10%.
These results demonstrate how efficient and effective precious metals can be as a diversification tool against equity risk. As the weight of the stocks in the portfolio was reduced and replaced by precious metals, the portfolio became more efficient over the long term. However, investing in precious metals does not only bring benefits if we reduce the weight of the shares. Indeed, with a 10% position in precious metals and a 90% position in equities and bonds (distributed according to the ratio 60/40), the volatility of the portfolio falls to 9.3% compared to 9.5% for a portfolio without precious metals. In addition, the Sharpe ratio increases to 0.26, as the portfolio’s return has increased slightly and the portfolio’s risk has decreased due to the addition of precious metals.