Getting the Most Out of Gold

Gold is making a comeback. Quite a comeback. But think back a year. Bullion’s up about 4 percent over the past 12 months. Gold stocks, proxied by the VanEck Vectors Gold Miners ETF (NYSE Arca: GDX), have gained more than 19 percent since last May. Which exposure would have done your portfolio the most good?

For many people, the answer is painfully obvious. Who wouldn’t want a 19 percent gain rather than a 4 percent uptick? Other folks, though, would be concerned about the route taken to attain those gains. After all, gold stock prices are inherently more volatile than the cost of metal.

The chart above illustrates vividly the difference in returns and volatility. Clearly, the road’s been bumpier for gold stock owners on both the downside and the upside. On a risk-return basis, though, the volatility’s been worth it. Figure it this way: Gold miners have outpaced bullion, pricewise, 4 to 1. The stocks’ risk, measured by the standard deviation of returns, is only three times that of metal.

So mining stocks are better, right?

Well, that depends. Miners are equities after all; they’re imbued with stock risk. Just take a look the correlation of mining stocks and bullion to the S&P 500 in the chart below. Over the past 12 months, gold’s 30-day rolling correlation has averaged -0.13; the mean coefficient for mining stocks is diametrically opposite at 0.12.

Gold’s negative correlation to stocks is one of the primary reasons many advisors recommend a core holding in the metal—as a hedge against the vagaries of the stock market. The miners’ positive correlation, on the other hand, increases a portfolio’s stock risk.

If you’re looking for diversification out of your gold exposure, bullion (or a bullion-based exchange traded fund) is your pick. The leveraged returns of mining stocks are indeed tempting, but you’d be making a wager on both gold and equities with such an investment.