Asset allocation is an important aspect of any investment strategy. By balancing asset classes of different correlations, investors hope to maximise returns and minimise risk. However, while many investors may believe that their portfolios are adequately diversified, they typically contain only three asset classes - stocks, bonds and cash.

To counter adverse movements in a particular asset or asset class, many investors now strive to achieve more effective diversification in their portfolios by incorporating alternative investments such as commodities.

While gold has shown strong returns over recent years, its most valuable contribution to a portfolio lies in the fact that it is not correlated with most other assets, as shown in the chart below. This is because the gold price is not driven by the same factors that drive the performance of other assets. Similar data and charts covering a range of countries can be downloaded from our investment statistics page.

ENLARGE

The sources of demand for gold are far more diverse - both geographically and sectorally - than those for many other assets, which helps to explain the independence of the gold price as well as why identifiable demand has remained robust in the face of a rally that has spanned several years. The value of gold demand increased by 75% between 2003 and 2006, and by 101% between 2001 and 2006. Moreover, most spending on gold is discretionary. 74% of total identifiable demand over the five years to December 2006 came from the jewellery sector, with a further 14% from investment and 12% from industrial demand. This is, in itself, unusual for commodities, where demand is typically driven by non-discretionary spending and is consequently more exposed to the vagaries of the economic cycle.

Gold offers enhanced diversification opportunities relative to many alternative assets. Independent studies have shown that while alternative assets and traditional diversifiers often fail during times of market stress or instability, even a small allocation to gold may significantly improve the consistency of portfolio performance during both stable and unstable financial periods.

Research papers

• Gold as a Strategic Asset
  by Richard Michaud, Robert Michaud, Katharine Pulvermacher, 2006
• What sets the precious metals apart from other commodities?
  by Rhona O'Connell, 2005
• Why is gold different from other assets? An empirical investigation
  by Colin Lawrence, 2003