Gold yields nothing. It actually costs money to own gold; insurance, a safe deposit box, and perhaps a gun if you keep it at home. Gold equities yield about 1%, so not much better.

Gold competes again bonds as a flight to safety. Like bonds, when inflation is rising, it erodes the value of your asset. When bond yields rise, they tend to attract money away from one of the worlds original currencies because of that lack of yield. If bond yields are rising because inflation is rising, gold will typically, but not always, rise in price as an inflation hedge.

When you build a portfolio, the most important consideration, for the vast majority of people is the cost of the ride. I’m referring to the emotional cost of investing, not the management expense ratio (MER). Learning when to add assets to your portfolio to help grow or diversify is one of the most important skills you can have.

Diversification should be the focus of most investors. Gold (and precious metals in general) is an ideal asset class because in the long run it tends to have a low correlation to traditional asset classes like equities and bonds. The table shows the weekly correlation of Gold (GLD), Global Equities (VT), and the Entire US Bond Market (AGG) from June 2008 to current.

Gold has a low correlation to both stocks and bonds. Adding gold to your portfolio helps reduce risk. Correlation explains the direction of price returns of one asset to another. A number closer to zero is better for diversification. The table shows GLD has had a 8% correlation to global equities and a 24.7% correlation to US bonds. Global equities has a -20.5% correlation to US bonds, which means price tend to move in opposite directions, but with low similarity.

The key thing is that it needs to be added at the right time because in the long run it yields nothing, so you are largely playing for capital gains (in other words, buy low, sell high).

The chart (in percentage returns) below shows that until recently, gold bullion (GLD) performed better than world equities since 2008. Gold equities performed poorly early in 2008 as gold prices fell too.

What we can learn from this analysis is that gold equities should be added when gold is weak and when gold is strong, you should swap out of gold equities and hold the bullion. We can see that gold equities have performed poorly since prior to the Lehman moment (Sept 15, 2008).

Last week we read a story that the Winklevoss twins see Bitcoin as an upgrade to gold.

They were trying to suggest that Bitcoin could replace gold. It is estimated that there is about 7 trillion US dollars worth of gold in the world and Bitcoin could exceed that. Cameron called Bitcoin a gold disruptor.

From an investment standpoint, not unlike gold, bitcoin has a different path of returns too and therefore has a low correlation with gold and other asset classes. The main difference is the cost of owning it; not the MER, the volatility.

The volatility of bitcoin would kill the average investor emotionally at this stage. So when adjusted for risk, bitcoin should not belong in your portfolio unless it’s the extremely speculative part and that you expect it to possibly decline 90% or more at some point.

Nevertheless, we could easily see the Bitcoin mania continue. It’s not for the faint of heart to be sure. I’m on record saying the intrinsic value of Bitcoin is closer to zero than any other number. I believe the world will only have electronic money within about 20 years, but that central banks will always control the supply of money. Giving that up would have disastrous economic results regarding their ability to control inflation. Assuming of course controlling inflation will be needed in the future.

Last week I was adding gold equities to my portfolios as they were falling. I have about half a full position now and would buy more if gold dips below $1200. Add gold to your portfolio when the upside potential is greater than the downside risk. Don’t get fixated on price targets or pie in the sky stories about central banks. Look at it as an asset that has intrinsic value and can help grow or protect your portfolio. I’m not sure if Bitcoin can do the job.

Watch Larry discuss this topic in a video segment on BNN.ca