When deciding whether or not to include an asset class in a portfolio, the most basic and fundamental test should be, “Does this asset class offer a positive real expected return?” In the case of commodities (which includes gold), the answer is no.
Purchasing a commodity in the hope that down the road someone else will pay you more than you paid for it is not investing but speculation, and the expected return from speculation is zero before costs and negative after costs.
Risk is the other side of the equation, and the risk of commodities is substantial. From inception of 1/1/1991 through 11/30/2012, the Dow Jones UBS Commodity index has had a standard deviation of 15%, almost the same as the S&P 500. Unfortunately, the return for the commodity index has lagged the S&P by 3.2% per year. Over the entire period, the growth of a dollar invested in the commodity index is 34% lower than the growth of a dollar invested in the S&P 500.
Furthermore, the majority of the return of the commodity index has derived from the fixed income investments that are held as collateral for futures contracts. A fixed income return can be obtained for about one-third of the risk.
It is worth noting that in a diversified equity portfolio, an investor would already have a substantial exposure to commodities via oil companies, mining companies, agricultural companies, etc. There simply is no compelling reason to double down on this exposure.
Return to Diversified Portfolios Examined