Hedging Risk With Gold

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Hedging Risk With Gold

Economic growth is a key a driver of gold demand, especially in emerging market (EM) countries where there is a high affinity for gold (for example: cash for gold) and investment.

At the same time, gold tends to perform well in periods of crisis. Having a strategic investment in gold tends to help in improving the portfolio of emerging market countries and their respective economic performances as it can be used to:

  • Protect against systemic risks, which reduce portfolio volatility and losses;
  • Hedge foreign-exchange risk at a lower cost than traditional currency hedges.

Dual in nature

History has shown us, that gold has performed well with returns on par with stocks over multiple time periods. It is not merely a hedge that eats into profits, but it also provides diversification during bull and bear market environments.

Emerging markets potential

EM investments have a tremendous amount of potential for growth supported by economic trends. EM continues to play an ever-important role in asset allocation as a source of return, but it usually carries higher volatility.

Lofty valuations, market downturns and correlation

Lofty valuations in developed markets, as well as low bond yields across most developed economies have led to a more significant proportion of investment growth in new markets like emerging ones. Cheaper funding in the US has allowed better access to EM. However, expectations of rising interest rates in the US could cause uncertainty and hurt the attractiveness of EM exposure.

There is a higher beta of 1.26 in emerging markets versus the MSCI World Index. Systemic risks that impact global economies have an even more substantial effect on emerging markets. As gold often acts as a haven and hedge against systemic risks, it can provide an appropriate hedge to EM exposure.

And while EM stock performance is often linked and correlated to commodity performance, this does not hold true with gold, especially in market downturns. Gold has a negative correlation with risky assets during extreme market sell-offs yet provides returns during market strength. EM jewellery demand typically falls during market downturns, but this is generally offset by the increase in investment demand worldwide.

An asset in portfolios

Adding gold to a portfolio generally produces higher absolute and risk-adjusted returns than a fully hedged or unhedged portfolio. Gold is different than traditional hedges because gold gives an investor’s portfolio positive correlation in a rising market and negative correlation in a falling market, gold has a dual nature for investment purposes – this quality is not seen in other traditional hedges.

Choosing whether to hedge the foreign currency or systemic risk of an EM portfolio is a crucial decision for any investor. Regardless of the choice, having some gold exposure can provide an advantage for risk-adjusted returns compared to a portfolio with no gold exposure.


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