Why gold shines as a portfolio diversifier?

Middle East geopolitical uncertainty has significantly escalated.

This follows a US missile attack on Iranian nuclear facilities, which Iran retaliated against with a missile attack on an American airbase in Qatar late on Monday.

Meanwhile, gold prices have struggled to hold above $3,400 an ounce, indicating that the metal is not attracting a significant safe-haven bid.

Safe-haven demand for gold has been constrained, with some analysts attributing this to the conflict remaining localized. Similarly, oil prices are struggling to maintain gains despite the ongoing instability.

“Gold’s inability to hold early gains could suggest that traders don’t expect hostilities to escalate further,” said David Morrison, senior market analyst at Trade Nation. 

Alternatively, it could simply be profit-taking in an otherwise well-supported market. More broadly, prices continue to consolidate, and are currently little more than 4% below April’s record high of $3,500.

Gold in diversified portfolio

Market analysts at UBS highlight gold’s value within a diversified portfolio, emphasising that its strength is not primarily as a hedge against geopolitical events, despite its lackluster performance as a safe haven, Kitco.con said in a report.

“Investors, though, might benefit from thinking about gold from the perspective of portfolio diversification, rather than as a discrete trade that hinges on the price level,” Julian Wee, Investment Writer at UBS was quoted in the report.

Wee highlighted that portfolio managers see gold as a versatile asset, citing data from the World Gold Council’s Annual Central Bank Gold Survey. 

The survey indicated that the primary reasons for holding gold are its ability to perform well during uncertain times, its effectiveness as a diversification tool, and its role as a reliable store of value.

Wee said:

The current geostrategic environment supports all these factors, albeit to varying degrees. The Trump administration’s unpredictable policy-making contributes to an erosion of confidence, which may remain a key driver in the near term. Investors should be mindful of the indicators pointing to a sustained move out of the USD, and gold is likely to play a crucial role in this transition.

Bullish outlook remains

UBS maintains a bullish outlook on gold, reiterating its $3,800 per ounce upside target despite the yellow metal’s current sideways trading pattern.

Wee further stated, “We anticipate continued strong demand from central banks and ETFs. Gold also functions as a politically neutral, liquid store of value, replacing the USD in this regard.”

However, Wee highlighted alternative avenues for investors to leverage gold’s value, even amidst price consolidation. 

He proposed exploring corporate debt from gold miners, with some bonds offering yields of approximately 6%.

Despite record-high gold prices, the mining sector has struggled to attract consistent investor interest.

However, producers have maintained significant margins in recent years due to stable production costs.

Wee noted that these companies have successfully reduced net leverage and bolstered their balance sheets, thanks to robust free cash flow generation.

We expect M&A activity to continue in a lower-risk manner, helping preserve the strength of their financial metrics.

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