Gold mitigates FX risk in emerging markets – WGC
Investors in emerging market assets can use gold to reduce the risks associated with exchange rate volatility and benefit from significant cost efficiencies, according to a new report from the World Gold Council.
Exchange rate risk is increasingly relevant as investors from developed economies look beyond their domestic markets to diversify their portfolios and pursue greater returns.
Given the significant changes in the global economic landscape over the past decade, conventional wisdom about exchange rate hedging has evolved.
The robust growth in emerging markets and aggressive monetary policies in developed markets have resulted in expanded interest rate differentials and, consequently, increased traditional exchange rate hedging costs.
Given the current trade-off between the costs of hedging and its benefits, many investors opt to leave their allocations un-hedged, exposing their portfolios to significant downside risks.
Juan Carlos Artigas, global head of Investment Research at the World Gold Council, said gold’s unique characteristics as an asset and currency hedge are particularly relevant to investors with emerging-markets exposure, where currencies and asset prices are more vulnerable to price swings and tail-risk events.
“Using a gold overlay can reduce currency-related losses, without increasing the opportunity cost or negating the potential benefits of investing in emerging markets,” he said.
Gold has a positive correlation to emerging market growth, and a negative correlation to the US dollar and other developed market currencies. It also has a low investment cost relative to traditional foreign exchange hedges, and is a proven hedge against tail-risk.
“Given these qualities, there is a strong argument for complementing existing exchange rate hedging strategies with gold.”
A World Gold Council report, Gold and currencies: hedging foreign exchange risk, explores the advantages and costs associated with hedging foreign exchange exposure.
The analysis demonstrates that portfolios with emerging market exposure hedged using gold, exhibited improved performance. Hedging with gold resulted in lower costs and levels of risk and higher returns, when compared with portfolios using a purely currency based hedge, or no exchange rate hedge at all.
The study focuses on emerging market investment and currency hedging from a US dollar perspective, but its findings are broadly compatible with other research from New frontier Advisors and Oxford Economics on the merits of gold as a foundation to portfolios.
The Gold and currencies: hedging foreign-exchange risk report can be viewed at: www.gold.org/media