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The Case for Hard Assets

Frank E. Holmes
Chairman/CEO/CIO of U.S. Global Investors Inc

May 15, 2003


Summary: Compelling empirical data suggests portfolio performance can be improved with an asset class devoted to "natural" or "hard assets." Investors can effectively position this alternative asset class in their portfolios due to its low-correlated relationship to domestic stocks. A blended "hard asset" index was constructed by Ibbotson & Associates to prove this relationship. Returns from this index, the Global Hard Asset Index (GHAI), over the twenty-eight year period ending in 1998 bear out a compounded 8.6 percent versus 13.5 percent for the S&P 500 Index. The GHAI displays very low correlations to all the general categories of asset classes - U.S. bonds, large- and small-cap stocks, and international stocks. A hard asset allocation ranging 10 to 25 percent in a hypothetical portfolio since 1970 produced superior returns without increasing risk.

Defining Hard Assets
Most of the world's wealth is derived from natural (i.e., real or tangible) assets. Contrasted with financial assets, these nonfinancial assets tend to have an intrinsic value, usually in some manufacturing process or as a commodity. For our purposes, natural or hard assets will refer to the following: gold and precious metals, petroleum and coal products, industrial chemicals and metals, timber and paper products, and real estate. These sectors form the basis of the Ibbotson study. The related index (GHAI) will be the proxy for hard assets.

Return Comparisons - Hard Assets vs. General Asset Classes
Returns for the GHAI are displayed in Table 1 along with those of broad asset classes. For the entire period, the GHAI returned a compounded 8.6 percent. This performance compared favorably to the returns of small-cap stocks (13.9 percent), large-cap stocks (13.5 percent) and international stocks (12.7 percent). Notice further how different periods in the market produced a different ranking of these four asset classes. This "changing of the guard," with respect to performance leadership, displays the low correlation of hard assets to the other asset classes.

Table 1

Hard Assets - A Low-Correlated Solution
Asset allocation is a worthwhile concept for advisers and investors only when the chosen asset classes show sufficiently diverse risk and return characteristics. If various asset classes move in near-perfect sympathy or correlation with each other, the diversification benefits are lost to the portfolio. The hard asset class has an extremely low correlation to the general asset classes listed above. Table 2 shows the historical correlation coefficients for all these asset classes. Important observations can be made. Notice that hard assets enjoy a lower correlation to stocks than do U.S. treasury bonds. Additionally, hard assets have a negative correlation to treasury bonds. Compare these relationships to the high correlation of domestic large-cap stocks to small-cap stocks. These correlations can have an enormous consequence in a portfolio. Given the above relationships, an allocation of hard assets can potentially be more beneficial than an allocation of U.S. bonds when added to domestic stocks. Further, the negative correlation of hard assets to U.S. bonds argues that hard assets would be vital in smoothing portfolio returns of an "all bond" portfolio. Lastly, diversifying between U.S. large-cap and small-cap stocks as a "first step" in an equity mix is largely ineffective compared to combining hard assets with any U.S. stock class.

Table 2


Optimizing a Hard Asset Allocation
The implication of the hard asset class returns and correlations is clear. Investors should seek to allocate and rebalance their portfolios with a proper weighting of hard assets. As presented in a relevant Ibbotson study, Table 3 shows three separate asset allocation scenarios employing hard assets. In all portfolios, hard assets increased overall returns while decreasing or maintaining portfolio standard deviation.

Table 3

The Countercyclical Nature of Gold Stocks to the S&P 500
The chart clearly demonstrates significant rotation between Canadian gold stocks and the S&P 500 Index. The countercyclical nature of gold stocks to the S&P 500 Index make gold stocks an excellent asset class for a diversified portfolio.


Source: Bloomberg, Toronto Stock Exchange

Frank Holmes
Chairman/CEO/CIO of U.S. Global Investors Inc
May 15, 2003

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Distributed by U. S. Global Brokerage, Inc.

Performance data quoted represent past performance and investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost.The gold funds may be susceptible to adverse economic, political or regulatory developments due to concentrating in a single theme. The price of gold is subject to substantial price fluctuations over short periods of time and may be affected by unpredicted international monetary and political policies. We suggest investing no more than 3% to 5% of your portfolio in gold or gold stocks.

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