Here's How Hungary Reduced Risk Without Forfeiting Returns

by Frank Holmes, CIO, CEO, U.S. Global Investors

Hungary isnā€™t known today as one of the worldā€™s top gold producing countries. There was a time, though, when it accounted for around three-quarters of Europeā€™s entire output of the yellow metal, if you can believe it. According to historian Peter Sugarā€™s A History of Hungary, the central European country was a ā€œveritable El Doradoā€ in the 14th century, and its gold pieces circulated widely across the entire continent, competing with those minted in Italy and England.

It was this rich mining heritage that Hungaryā€™s central bank evoked when it announced last week its decision to increase gold holdings tenfold, from 3.1 metric tons to 31.5 tons, taking goldā€™s share of total reserves to 4.4 percent. (Gold accounts for 73.5 percent of U.S. reserves, by comparison, the most of any country.) Hungarian central bank governor Gyorgy Matolcsy described the move as one of ā€œeconomic and national strategic importance,ā€ adding that the extra gold made the countryā€™s reserves ā€œsaferā€ and ā€œreduced risk.ā€ This is the first time since 1986 that Hungary has increased its gold holdings.

Hungary just boosted its gold reserves tenfold
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The country isnā€™t alone in its mission to diversify. This month we also learned that Poland became the first European Union (EU) member to increase its gold reserves in two decades. The Eastern European country added as much as 9 metric tons of hard assets between July and August of this year. Central banks in Russia, Turkey and Kazakhstan have also kept up their gold buying, representing close to 90 percent of the activity weā€™ve seen this year.

Meanwhile, the EU has continued to print paper money.

A Good Store of Value

So why should banksā€”or investors, for that matterā€”be interested in boosting their gold holdings? One reason is timing. Until recently, gold prices have been relatively affordable, trading at 52-week lows of around $1,180 an ounce in mid-August and at the end of September. Central banksā€™ investment was wisely made. From those lows, gold is now up more than 4 percent on stock volatility.

Check out the chart below. I think itā€™s fascinating to see the relationship between dramatic moves in the stock market and peopleā€™s interest in gold. When stocks sold off a couple of weeks ago, Google searches for ā€œgold priceā€ jumped to their highest in at least a month. This shows, I believe, that people recognize gold as a good store of value when market volatility reemerges.

Spike in Google searches for gold price corresponding with stock selloff
click to enlarge

Gold Has Helped Improve a Portfolioā€™s Risk-Adjusted Returns

Returning to what Hungarian central bank governor Matolcsy said about risk reduction, a certain amount of gold has been shown to improve a portfolioā€™s Sharpe ratio, according to the World Gold Councilā€™s (WGC) most recent Gold Investor. The Sharpe ratio, in case youā€™re unaware, measures a portfolioā€™s risk-adjusted returns relative to its peers, based on standard deviation. The higher the ratio is over its peers, the better the risk-adjusted returns.

Analysts at New Frontier Advisors found that an institutional portfolio with a 6 percent weighting in gold had a higher Sharpe ratio than one without any gold exposure. This means that volatility was reduced without hurting returns.

Although analysts were looking at Chinese portfolios in particular, the WGCā€™s Fred Yang believes these findings can just as easily be applied to portfolios that are invested in U.S.-, European- or U.K.-listed assets. The ā€œresearch indicates,ā€ Yang says, ā€œthat most well-balanced portfolios would benefit from a modest allocation to gold.ā€

Iā€™ve often advocated for a 10 percent Golden Ruleā€”with 5 percent in bullion, the other 5 percent in gold stocksā€”and so New Frontierā€™s research is illuminating. It also helps explain Hungary and Polandā€™s actions, as well as those of other net purchasers of gold.

Holding Firm Against Rising Treasury Yields

Iā€™ve shown many times in the past that the price of gold is inversely related with real rates. The yellow metal has especially struggled when Treasury yields have outpaced inflation.

Gold price has remained strong despite a rising 2 year treasury yield
click to enlarge

The two-year Treasury yield, for instance, is just under 3 percent today, a more-than-10-year high. Because consumer prices are rising at 2.3 percent year-over-year, according to the latest report from the Labor Department, the two-year has a positive real yieldā€”and this has historically weighed on gold.

You would think, then, that its price would be much lower than it is. Iā€™m impressed with how well itā€™s held up.

Get more of my thoughts on goldā€™s performance by watching the latest Frank Talk Live! View it by clicking here!

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. By clicking the link(s) above, you will be directed to a third-party website(s). U.S. Global Investors does not endorse all information supplied by this/these website(s) and is not responsible for its/their content.

Standard deviation is a measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher the deviation. Standard deviation is also known as historical volatility.

The S&P 500 Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies.

Diversification does not protect an investor from market risks and does not assure a profit.

This post was originally published at Frank Talk.

Copyright Ā© U.S. Global Investors

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