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All investment portfolios carry risk, but owning some gold can minimise credit and liquidity risks, and reduce market risks. The World Gold Council explains

Posted in Personal Finance
Owning gold can reduce risk in your investment portfolio

The reasons for investing in gold are varied. The World Gold Council lists five core reasons, and one of those is because it can help in managing risk in a portfolio.

(We have previously looked at diversification as a reason, here », and as an inflation hedge, here » )

Financial asset classes and instruments usually carry three main types of risk.

• Credit risk: the risk that a debtor will not pay

• Liquidity risk: the risk that the asset cannot be sold as a buyer cannot be found

• Market risk: the risk that the price will fall due to a change in market conditions

Credit risk

Gold is unique in that it does not carry a credit risk.

Gold is no one's liability.

When you invest in gold, there’s no risk that a coupon or a redemption payment will not be made, as there is for a bond.

There’s no chance that a company will go out of business, as with an equity.

Unlike a currency, the economic policies of the issuing country cannot affect the value of gold, nor can inflation in that country undermine it.

Liquidity risk

Gold benefits from demand among a wide range of buyers - from the jewellery sector to financial institutions, to the technology sector and manufacturers of industrial products and medicines.

A wide range of investment channels is available, including coins and bars, jewellery, futures and options, exchange-traded funds, certificates and structured products.

Worldwide markets trade gold 24 hours a day. The gold market is deep and liquid, as demonstrated by the fact that gold can trade at narrower spreads and more rapidly than most diversifiers or even mainstream investments.

Market risk

Gold, like all financial assets, is subject to market risk. However, it tends to have low correlations to most assets usually held by institutional and individual investors, which significantly enhances gold's attractiveness as a portfolio diversifier.

Research published in October 2010, demonstrated that gold can help to reduce the potential loss suffered when infrequent or unlikely but consequential negative events, often referred to as “tail risks”, occur.

Specifically, even a small allocation to gold, ranging between 2.5% and 9.0%, can decrease the Value at Risk (VaR) of a portfolio.

Volatility is a good indicator of market risk, measuring the dispersion of returns for a given security or market index. The more volatile an asset, usually the riskier it is.

The gold price is typically less volatile than other commodity prices.

This is because of the depth and liquidity of the gold market, which is supported by the availability of large above-ground stocks of gold.

Gold is virtually indestructible, which means nearly all the gold ever mined still exists today.

Much of it is in near market form, meaning sudden excess demand for gold can usually be satisfied with relative ease.

Adding to price stability, gold is mined all over the world. Unlike many other commodities, this geographical diversity reduces the chance of supply shocks from any specific country or region impacting heavily on gold’s price.

Consequently, gold is generally less volatile than heavily traded blue-chip stock market indices such as the S&P 500 or the FTSE 100.

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You can find detailed, up-to-date pricing for gold coins, bars/bullion, and gold scrap, all in both NZ$ and US$, here »

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