Gold Investor: risk management and capital preservation - Volume 1

Sectors: Investment

Aram Shishmanian
CEO World Gold Council

As we look forward into 2013, while hoping for stronger global economic growth, a few themes remain prominent: a low-interest rate environment stemming from concerted zero interest rate policies (or ZIRP) and expanded central bank balance sheets, stubbornly sluggish Western economies, and elevated sovereign-debt risk. Concern and uncertainty abound with respect to the effectiveness of the current policy mix to address these issues and put the global economy back on a sustainable course. Against this backdrop, demand is growing for high quality, liquid assets that can serve as a foundation for investor portfolios. Gold is one such asset that meets all three of the criteria.
In the prevailing low-interest rate environment, the search for yield is driving investors to look into more aggressive strategies, and some investors have begun to rotate into risk assets – notably equities, emerging markets and alternative assets, including commodities related to the growth cycle.
This approach requires the deployment of prudent hedging strategies, as a move into risk assets in the current environment leaves investors exposed. Such a strategy necessitates allocations to assets which offer diversification benefits, hedge currency risk and unexpected market turns. Hedging investments in foreign assets entails a cost, and gold can mitigate certain risks, in particular those related to emerging market currencies. In this edition, we explore some of the benefits gold can provide from a currency-hedging perspective.
We also examine the role of gold for emerging market central banks from a local-currency perspective and look at optimal gold-allocation ranges for foreign reserve portfolios.
Currently, these banks own on average approximately 4.6% of foreign reserves in gold, well below the 22% allocation of their developed-market counterparts. A shift towards higher allocations in the future could have significant impact on the long-term demand for gold.
Finally, we examine gold’s role in mitigating the impact of tail- risk events – unpredictable events that might be considered unlikely but nonetheless can cause considerable damage to investors’ capital when they do occur. The advantages of gold’s role in portfolio risk management have, over the past decade, become better understood in Western markets. In Japan, the role of gold in a portfolio context has only recently gained recognition, yet has advanced substantially in the past 18 months. This emerging trend is being driven by the continued weakness of the Japanese economy, deteriorating government fiscal conditions, unfavourable public and corporate pension reforms, growing concern over tail-risk events, regulatory changes in pension management, and the volatile performance of traditional assets. Gold is increasingly being considered by Japanese institutional investors as offering a solution that meets today’s needs.

Investors across the globe are concerned about the prospects for sustainable economic growth and the future of our financial and monetary systems. It is imperative that such systems evolve to manage the complexities of an increasingly intertwined global financial market, polarised by debt in the West and rapid growth in the East. In times such as these, gold becomes more and more relevant due to its universally recognised value and unique characteristics as a currency and monetary asset, thus providing a strong foundation to investor portfolios.


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