GOLD AS A UNIQUE ASSET CLASS
Asset allocation never goes out of style, but perhaps
its time to change your style
Frank E. Holmes
Asset allocation, discussed for years as an invaluable strategy for long-term investors, seemed to be the odd-man out in the equity run-up of the 1990's. Despite many new groundbreaking studies showing the critical role asset allocation plays in investors' portfolio returns, it is painfully clear many investors caught up in the equity boom were over-allocated to equity investments, in particular, telecom, technology and media companies, and paid a heavy price when equity returns soured.

With the prospects for equities in the next few years remaining historically dim in many experts minds, such as Richard Bernstein, Chief U.S. Strategist and Chief Quantitative Strategist at Merrill Lynch, many investors are responding to these heavy losses by selling their stock holdings or redeeming their equity mutual funds or switching to and over-weighting in bond funds. As your clients begin to deal with these issues, it is an excellent time to discuss with them how proper asset allocation (yes, including the very equity investments they may be selling right now) can go a long way in preventing the huge return gyrations they have experienced, and put them back on the path to long-term investment growth.

When asset allocation first became the subject of investment analysis, the types of assets broadly available to investors were relatively basic, mainly consisting of cash, bonds and domestic stocks. Studies done on mixing these broad security types into diversified portfolios showed such allocation, if properly constructed, could significantly improve the returns of portfolios, and leave risk levels virtually unchanged. It turns out this investment strategy worked so well because cash, bonds and domestic stocks had low return correlations with each other, meaning the returns on each asset class did not depend too much on the other; if one asset class did well, often times another did poorly, so over time each asset class's return balanced the others out for smoother, and higher, returns over longer time periods. Low correlated assets were (and still are) the key to having an effective asset allocation strategy.

As fund families proliferated in the 1990's, the new asset classes have focused on various U.S. stock classifications. These U.S. equity classes tend to split hairs between small-cap, mid-cap, large-cap, growth, core, value, as well as many other categories. These asset classes, while stimulating conversation among fund companies, rating services, advisors and the investing public, do not provide additional diversification in a broad bear market cycle. They are simply too closely correlated.

Each asset class has its own cycle, so it is important to have different asset classes that are counter cyclical to each other in order to have a portfolio that is balanced and has a low volatility. Key decisions are to diversify with different asset classes and to rebalance the portfolio in order to capture the opportunities and manage the risks.

What investors need today are more genuinely "counter cyclical" or low-correlated asset classes they can add to their portfolios to receive the benefits asset allocation offers. In fact, many such asset classes exist. These asset classes are sufficiently broad yet have attractive, low-correlations to the S&P 500 Stock Index (S&P 500), as shown by numerous recent studies. Gold is an especially interesting example. As an individual asset, gold and gold-related stocks can be highly volatile. On the other hand, gold's return characteristics clearly reflect a "safe harbor" aspect in bear markets. Of course, the ultimate measure of gold's usefulness is in its return correlation to other asset classes. When held up to many other asset classes, including domestic equities, gold shows excellent low correlation and hence is an ideal asset for use in a diversified portfolio.

Please note on the chart above, since 1971, when gold became free trading, the TSE Gold Equity Index outperformed the S&P 500. This period was also characterized by budget deficit spending. In 1996, a political commitment to balance the budget deficit created a strong dollar, a bullish stock market and a weak gold price. However, since September 11, 2001, the budget surplus has evaporated, the stock market has fallen and gold has risen.

The two most significant drivers to a gold bull market cycle are deficit spending and zero real rates of return on T-Bills. These two factors drive down the value of the U.S. dollar and lift the price of gold. With the cost of reviving the weak economy and fighting the war on terrorism, the budget surplus has reversed itself and will only worsen over the next several years.

Given the poor domestic equity performance of the last few years, now is the perfect time to help your clients reassess their asset allocation with an eye towards low-correlated assets to give them true long-term diversification. U.S. Global Investors is a strong proponent of using a complimentary mix of asset classes to construct an effective investment portfolio. With an asset allocation approach dedicated to the proper use of low-correlated asset classes, and supported by decades of investment research, your clients will soon be back on the path of long-term investment growth.


Frank E. Holmes, Chairman/CEO/CIO of U.S. Global Investors, Inc.
June 2, 2003

For a more in-depth analysis on how to use gold in asset allocation, please visit www.usfunds.com/gold. There you will discover the benefits of gold as a portfolio diversifier.

For more complete information about any U.S. Global fund, including charges and expenses, obtain a prospectus by visiting us at www.usfunds.com or call 1-800-873-8637. Read it carefully before you invest or send money. Distributed by U. S. Global Brokerage, Inc.