Gold In A Global Multi-Asset Portfolio
March 4, 1988 - Morgan Stanley

Lewis E. Lehrman

Since gold is uncorrelated, rather than negatively correlated, with financial assets, it is not surprising that the addition of gold to a financial portfolio can have very different effects on the portfolio depending upon when the gold is added.

Robert A. Jaeger
Vice President
Evaluation Associates, Inc.


SUMMARY AND INVESTMENT CONCLUSION

Much subjective input goes into the construction of a global, multi-asset portfolio, and while such influences are inevitable, emotion and impulsiveness may dominate analysis when objective standards are not applied across asset classes.

In fact, just as objective standards (such as price-to-book, price-to-earnings, price-to-value ratios) figure importantly in equity portfolio theory, so, too, can they be applied across asset categories that may at first seem incomparable. Let us consider an oversimplified case -- a fully invested portfolio restricted to two asset classes, U.S. equities and gold.

From the standpoint of a price-to-hook evaluation, for example, one would start by ascertaining the replacement cost or true hook value of the underlying real assets represented by a new common share unit of equity and the cost of producing a new weight unit (or ounce) of gold.

Comparing U.S. equities and gold on the basis of their respective market values, one can determine the divergence of the market price of each asset from its average and marginal (or replacement) cost of production. On March 4, 1988, the difference was approximately minus 12% for U.S. stocks based on replacement cost. It was minus 4% for U.S. gold, based on marginal costs, and close to plus 50% on an all-in average-cost basis. The degree of divergence of market price from cost over the long term can yield an estimate of the relative under/overvaluation of gold and equities. But divergences will also be influenced by radical movements in interest rates because equities exhibit special characteristics as financial claims, the present values of which are in part a function of the market rate of interest.

Also, gold has special characteristics that tend to influence its price movements. The immense scale of the market is shown by the value of the most recent year's mining output, which equaled approximately $24-billion -- greater than the stock market capitalization of Denmark. The current value of above-ground gold in the world is about $1.25-trillion -- more than one-quarter the market capitalization of all the stocks in the Morgan Stanley Capital International 21-country index. The daily value of physical and futures gold trading is $3- to $5-billion. Surely, this is a liquid investment market too large to ignore.


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