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How gold could help you hedge against a market downturn

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It's hard to turn away from risk assets when the market's hitting the all-time highs we've seen this year.

On the other hand, the current market run won't last forever. Valuations are stretched, and the central bank's shot off most of its ammunition as it approaches the effective lower bound on interest rates.

Increasing exposure to gold could be a way to hedge against a market downturn without giving up performance.

invest in gold

Normally, gold is negatively correlated with risk assets such as shares. When shares go one way, gold goes the other. Hence its reputation as a safe haven.

"This is a rare quality for an asset and it means that gold has the ability to reduce the risk of a portfolio and provide diversification," says Stockspot CEO Chris Brycki.

However this correlation has vanished recently, with gold and stocks both on the up. This doesn't mean gold is now correlated to stocks, but rather that it's not correlated to anything.

This is providing investors with an opportunity to lower their risk profile without sacrificing performance. Whoever said you can't have your cake and eat it too.

Case in point - Stockspot's best performing portfolio returned 21.7% net of fees despite having significant exposure to gold.

"Our portfolios have delivered similar return to the sharemarket but took half the level of risk," says Brycki.

"Defensive stocks like utilities don't have this characteristic. It's why gold is known as a safe haven."

Looking forward, gold could be a better bet to diversify than defensive stocks.

"Gold and gold stocks are likely to be very actively bid, along with most commodity stocks, over the next decade," says Barry Dawes from MPS Securities.

"Defensive stocks and bonds should now be major long term underperformers."

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David Thornton is a journalist at Money magazine. He previously worked at Your Money, covering market news as producer of Trading Day Live. Before that, he covered business and finance news at The Constant Investor. David holds a Masters of International Relations from the University of Melbourne.
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