Almost 8 years ago I carried out a piece of research titled "Should you ever invest in gold? If so, how much?" and it's worth familiarising yourself with it. The research helped dispel some of the myths surrounding the precious metal, including whether it is a good hedge against volatility. The research is also one of the reasons why my own £50k portfolio has a 5% exposure to the price of gold.
The key findings from the original research article were that:
- Gold is a good diversifier and isn't correlated to bonds or equities
- Holding a small amount of gold reduces the volatility of your portfolio
- Gold is not a hedge against volatility as the more gold you hold the more volatile your portfolio.
- Holding gold reduces the size of your maximum losses to a point, yet holding too much will start to increase them again
- Holding more than 5% of your portfolio in gold starts to increase the frequency of your losses and reduces the frequency of your gains
The research conducted at the time was extensive and looked at performance data from the start of the millennium up until July 2015. However, in the intervening 8 years we've since experienced some extreme and unprecedented events and market movements. The pandemic in 2020 was a black swan event, the likes of which we've never seen before, which had a huge impact on investment markets and gave rise to the fastest bear market in history for a number of stock markets.
Then in 2022 the Ukraine war and spiralling inflation saw bond markets have their worst year ever, particularly in the US. During both time periods we experienced extreme levels of volatility in both bond and equity markets which is unusual. So how did gold perform during these periods?
In 2020 gold was a strong performer, only Technology funds, Chinese equity funds, North American Smaller Companies and European Smaller Companies beat the precious metal. Cash on the other hand only outperformed Commodities funds, property funds, UK equities and Latin American equities.
In November 2022 I published a research article titled "Diversifying with changing correlations" which showed that during 2022 gold was negatively correlated, or at least uncorrelated, to most other asset types. Gold was certainly a good portfolio diversifier in 2022 and made a profit of 12% meaning it was one of the best performing asset classes of 2022. In fact, only Commodities funds (which may invest in gold but mostly focus on other commodities such as oil) and Latin American Equities (which are a quasi-commodity play) outperformed gold. Interestingly cash also outperformed most other asset classes as only three other asset types made a positive return, as shown by the chart below.
In light of these outcomes, I thought it would be of interest to update the original research and look not only at whether gold is still a good diversifier but also whether the amount of gold exposure in a portfolio should be reconsidered. Also, I want to explore the benefits of holding gold versus cash.
Methodology
I kept the methodology the same as the original research article by recreating numerous portfolios assuming a different percentage of gold was invested in each, with the balance of each portfolio split equally between UK bonds and equities. This time around I also built portfolios that held cash instead of gold.
The table below shows key statistical measures for each portfolio for the 8 years since the original piece of research, ranked by portfolio volatility.
Max Drawdown determines the worst possible outcome you could have achieved during the period by buying at a high and selling at a subsequent low. Max Loss represents the worst running return over a period — for example, the longest running consecutive loss without making a gain. Max Gain is the opposite statistic.
Last 8 years (since the original research was published)
| Name | Max Drawdown | Max Gain | Max Loss | Negative Weeks | Positive Weeks | Average Annual Return | Volatility |
| 10% Gold portfolio | -17.02 | 9.34 | -12.56 | 186 | 231 | 3.62 | 7.53 |
| 15% Gold portfolio | -15.08 | 6.34 | -11.18 | 187 | 230 | 4.14 | 7.53 |
| 20% Gold portfolio | -13.37 | 7.58 | -9.98 | 186 | 231 | 4.6 | 7.8 |
| 5% Gold portfolio | -19.26 | 8.73 | -19.26 | 187 | 230 | 3.03 | 7.92 |
| 25% Gold portfolio | -11.87 | 8.57 | -8.93 | 190 | 227 | 5 | 8.21 |
| 30% Gold portfolio | -10.53 | 12.91 | -8.01 | 187 | 230 | 5.37 | 8.7 |
| 0% Gold portfolio | -24.72 | 9.69 | -24.28 | 186 | 231 | 2.62 | 10.13 |
| 100% Gold portfolio | -21.32 | 27.57 | -10.07 | 198 | 219 | 8.19 | 14.49 |
Since the year 2000
Meanwhile the table below shows key statistical measures for each portfolio since the year 2000 to date, ranked by volatility.
| Name | Max Drawdown | Max Gain | Max Loss | Negative Weeks | Positive Weeks | Average Annual Return | Volatility |
| 10% Gold portfolio | -22.04 | 14.78 | -17.6 | 512 | 708 | 4.85 | 7.29 |
| 5% Gold portfolio | -25.16 | 11.34 | -19.59 | 507 | 713 | 4.44 | 7.43 |
| 15% Gold portfolio | -19.71 | 14.16 | -13.02 | 514 | 706 | 5.23 | 7.53 |
| 20% Gold portfolio | -17.66 | 17.32 | -11.88 | 517 | 703 | 5.59 | 8 |
| 25% Gold portfolio | -16.62 | 17.22 | -11.57 | 536 | 684 | 5.91 | 8.59 |
| 30% Gold portfolio | -15.94 | 17.14 | -11.66 | 524 | 696 | 6.21 | 9.23 |
| 0% Gold portfolio | -35.34 | 13.72 | -24.28 | 506 | 714 | 4.05 | 9.56 |
| 100% Gold portfolio | -41.41 | 27.57 | -16.95 | 563 | 657 | 9.13 | 16.66 |
Findings
- Holding a small amount of gold (still) reduces the volatility of your portfolio
- A 10% allocation to gold was the optimum amount over both timeframes, followed by a 5% allocation over the long term.
- Gold's recent strong performance means that the higher the allocation to gold the higher the portfolio's annualised return
- Over the last 8 years the portfolio with the worst drawdown was the one with no gold exposure, however over the long term it was the portfolio with 100% gold.
- It remains the case that holding more than 5% of your portfolio in gold starts to increase the frequency of your losses and reduces the frequency of your gains over the long term
So the events over the last 8 years highlight the importance of gold as a diversifier in a portfolio. Over the long term the benefits start to be outweighed by the costs of holding gold if your allocation rises above 5-10%. But during volatile periods increasing your allocation to gold up to 15% doesn't increase the portfolio's volatility but could potentially boosts returns (see the first table above).
But what about just sticking with cash?
Another asset uncorrelated to equities and bonds is cash, as highlighted at the start of this piece. What would have happened if instead of having an allocation to gold you instead held an elevated cash position?
I have reproduced the earlier tables but this time included cash based portfolios, while focusing on the annualised return, max drawdown and volatility statistics.
Last 8 years (since the original research was published)
| Name | Max Drawdown | Annualised Return | Volatility |
| 30% Cash portfolio | -17.83 | 2.02 | 7.01 |
| 25% Cash portfolio | -18.65 | 2.08 | 7.36 |
| 10% Gold portfolio | -17.02 | 3.62 | 7.53 |
| 15% Gold portfolio | -15.08 | 4.14 | 7.53 |
| 20% Cash portfolio | -19.44 | 2.14 | 7.69 |
| 20% Gold portfolio | -13.37 | 4.6 | 7.8 |
| 5% Gold portfolio | -19.26 | 3.03 | 7.92 |
| 15% Cash portfolio | -20.19 | 2.2 | 8.02 |
| 25% Gold portfolio | -11.87 | 5 | 8.21 |
| 10% Cash portfolio | -20.9 | 2.25 | 8.33 |
| 5% Cash portfolio | -21.59 | 2.31 | 8.63 |
| 30% Gold portfolio | -10.53 | 5.37 | 8.7 |
Since the year 2000
| Name | Max Drawdown | Annualised Return | Volatility |
| 30% Cash portfolio | -21.73 | 3.46 | 6.03 |
| 25% Cash portfolio | -23.58 | 3.55 | 6.4 |
| 20% Cash portfolio | -25.4 | 3.64 | 6.77 |
| 15% Cash portfolio | -27.2 | 3.73 | 7.13 |
| 10% Gold portfolio | -22.04 | 4.85 | 7.29 |
| 5% Gold portfolio | -25.16 | 4.44 | 7.43 |
| 10% Cash portfolio | -28.98 | 3.81 | 7.49 |
| 15% Gold portfolio | -19.71 | 5.23 | 7.53 |
| 5% Cash portfolio | -30.73 | 3.9 | 7.85 |
| 20% Gold portfolio | -17.66 | 5.59 | 8 |
| 25% Gold portfolio | -16.62 | 5.91 | 8.59 |
| 30% Gold portfolio | -15.94 | 6.22 | 9.23 |
Cash vs Gold conclusions
- Without exception a portfolio that uses cash as a diversifier has a greater max drawdown than the portfolio with the equivalent percentage exposure to gold (i.e 10% cash portfolio vs 10% gold portfolio). That means your potential max loss if you were unlucky when you entered and exited the market was greater with cash as a diversifier over both time periods.
- Holding 5-10% gold reduces the level of volatility in a portfolio better than holding cash. The same is true for max drawdown
- Holding cash over the equivalent amount of gold dramatically reduces your annualised rate of return. The charts below show the impact this would have had over the long term
5% cash vs gold 
10% cash vs gold
