Investment Update: Using gold to hedge emerging market risk

Published 10th May 2018

Categories: Market insights, Investment

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Over the long run, economic growth is a key driver of gold demand, especially in emerging market countries where there is high affinity for gold as jewellery and investment. At the same time, gold tends to perform well in period of crisis.

Having a strategic position in gold helps improve EM portfolio performance as it can be used to:

  • capture EM upside through gold’s link to rising incomes
  • protect against systemic risks, which reduce portfolio volatility and losses – producing gains in some systemic sell-offs
  • hedge foreign-exchange risk at a lower cost than traditional currency hedges

Gold pairs well with EM

Dual nature of holding gold

Gold has performed well over time with returns on pace with the S&P 500 over multiple time periods (see chart below). It is not simply a hedge that eats into net returns, but it also provides the diversification for investors during strong and weak market environments.

Emerging market growth and potential

EM investments have a tremendous amount of potential to continue growing and play an ever-important role in an investment portfolio. This is supported by global economic growth, which tends to have an incremental effect on performance in emerging versus developed countries.

Additionally, nearly two-thirds of global gold demand comes from emerging markets. Over the long run, income growth is a key driver of gold demand, especially in EM countries where there is an affinity for gold. Having gold exposure in an EM portfolio therefore couples with the EM exposure itself.

 

Gold’s long-term performance compared to other financial assets*

long term performance of gold vs other financial assets

*Based on total returns indices including MSCI US, MSCI EAFE, JP Morgan 3-month US cash, BarCap US Bond Aggregate, Bloomberg Commodity for the 10- and 20-year average, and S&P Goldman Sachs Commodity since 1971 due to data availability. Gold performance based on the LBMA Gold Price. Data between Jan 1971 and Dec 2017.

Source: Bloomberg, NBER, ICE Benchmark Administration, World Gold Council

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Gold is a strategic asset in EM portfolios

Adding gold to an EM portfolio produces higher absolute and risk-adjusted returns than a fully hedged or unhedged EM portfolio.

Because gold gives a US investor’s EM 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 a US investor. Regardless of the decision, having some gold exposure provides a clear advantage for risk-adjusted returns compared to a portfolio with no gold exposure.

Analysis on using gold to hedge emerging market risk:

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