The dollar has rallied this week and that was bad news for gold. While the US Dollar Index is up 2%, the yellow metal is down 3%. But, while the metal is down nearly 22% year-to-date, the leading gold advocacy organization says investors shouldn't give up hope on it just yet.
Juan Carlos Artigas, Head of Investment Research at the World Gold Council, says gold is a necessary part of a diversified portfolio. In fact, he believes the average portfolio doesn't have enough gold in it.
"Even though many investors think about gold as a commodity, I think that gold behaves far more as a currency," says Artigas. "It has a dual nature to it, part of it is consumption and part of it is investment. The best way to describe gold in a portfolio is that of a very consistent diversifier that actually mitigates risks, whether it is stemming from currency devaluations or pressures based on an expansionary monetary policies or inflation as it materializes."
One big example of expansionary monetary policy has been the Federal Reserve Bank's "quantitative easing" ("QE") program. The Fed has been buying US Treasury and mortgage bonds since the start of the financial crisis half a decade ago. This past December, it raised the dollar amount is has been buying to $85 billion each month.
This bond-buying raised bond prices and thus lower interest rates because bond yields move inversely to price. The bond-buying also added dollars into the economy in the hopes that some of that money would be loaned out to people and business, thereby stimulating growth. The Fed was expected to taper the policy back in September but decided against it, saying that the economy isn't quite out of the woods yet.
All these extra dollars in the economy would have been expected to be inflationary. But, the official inflation rate has generally stayed below 3% on a yearly basis since 2008. On the other hand, the US stock market, as measured by the S&P 500 index, is up 160% since its 2009 lows and up nearly 24% in 2013 alone.
According to Artigas' research, gold has little or no correlation to such things as the US stock market, corporate bonds, US Treasury bonds, or REITs. Its strongest relationship among a series of assets he studied was with global government bonds and commodities. It has a correlation coefficient of close to 0.3 with each of those two classes. A coefficient of 1.0 means a direct relationship, while a -1.0 signifies an inverse relationship. A coefficient of 0 means no observable relationship at all.
"Gold has very little correlation with assets," says Artigas. "That basically means that, looking at the movement on the stock market or looking at the movement of other assets, it's not necessarily going to tell you what gold is going to do because the correlation is very low. That's what makes gold such a good diversifier."
Artigas says that the typical portfolio has been vastly underweighting gold. To hear what portion of a portfolio Artigas says is optimal, and to hear other reasons why he thinks gold should be in a portfolio, watch the video above.
More from Talking Numbers: