Gold Investor - SPDR Gold Shares
Gold Investor - SPDR Gold Shares Gold Investor - SPDR Gold Shares
Emerging-market investment incurs particularly hefty costs.This is due to structurally higher interest rates in emergingmarkets. 12 The current environment also accentuates this costas developed market rates are exceptionally low. The differentialbetween the two exerts strong downward pressure on hedgedreturns. For example, as of 31 December 2012, an investorwishing to hedge Indian rupee/US dollar exchange-rate riskwould have to commit to paying approximately 5% over thefollowing year. In other words, if an Indian equity investmentgenerates 11% over the coming year, around half of the returnwill be wiped away if the investor hedges the exchange-raterisk. On the other hand, the decision not to hedge exposes theinvestor to other unforeseen risks to the currency. The Indianrupee, as an example, has depreciated by approximately 20%between July 2011 and December 2012 on the back of a highcurrent account deficit and capital outflows.It is critical to note that our definition of developed marketsthroughout this discussion of interest-rate differentialsencompasses the four major currencies: US dollar, Japaneseyen, pound sterling and euro. However, it is conceivable thatother developed market currencies could face periods ofstructurally high interest-rate differentials and be subject todynamics similar to those of emerging markets.Chart 6 shows the costs of hedging for various developed- andemerging-market currencies as of 31 December 2012 from aUS investor perspective. While hedging the Indian rupee incursone of the highest costs, many other countries have costs inexcess of 1% per annum. Chart 7 details the historical cost ofcurrency-hedging a constructed proxy for the MSCI EmergingMarkets equity index. Calculations show that an investor wouldhave paid, on average, almost 6% per annum to hedge thecurrency exposure of this emerging-markets basket for the pasttwo decades.As a result of the costs of hedging, many of the returns in localemerging-market currencies illustrated above are unachievablefor foreign investors. Table 1 shows the returns on emergingmarketand global-equity assets using unhedged, hedged andlocal-currency indices. Results show that currency-hedgedreturns have been lower for emerging markets but higher fordeveloped markets over the 1987–2012 period. For example,for a US investor, a currency-hedged developed equity indexgenerated an additional 0.5% return per year over the returnon the local index. For an emerging-markets equity index, theannual return on a currency-hedged position was 6.4% lowerthan the local index.Thus, a common sentiment is that hedging foreign-exchangerisk undermines the very reason for holding emerging-marketassets. The persistent higher real yields in emerging marketsdrive up their currencies, but hedging exchange-rate risk of ahigh-yielding country reduces gains due to the relative cost ofborrowing in the foreign currency. It is precisely this dilemmathat highlights the case for gold as an effective complementto emerging-market investments. As will be discussed in thenext section, the depth and stability of the gold market ensureslow transaction and carry costs while also offering many ofthe benefits of hedging currency exposure including reducedvolatility. Gold can thus diversify currency risk while keepingcosts down, and reduce volatility without increasing theopportunity cost incurred by hedging.Table 1: Performance of global equity indices in unhedged, hedged and local terms*Annual returnAnnualised volatilityCountry Asset Unhedged Hedged Local Unhedged Hedged LocalUS MSCI World ex US 4.6% 4.0% 3.5% 17.5% 15.2% 15.1%US MSCI Emerging markets 14.9% 23.7% 30.1% 24.1% 23.1% 23.1%Europe MSCI World 6.0% 6.2% 5.4% 15.7% 17.3% 14.3%Europe MSCI Emerging markets 15.1% 24.2% 30.1% 24.8% 24.9% 23.1%UK MSCI World ex UK 6.6% 7.5% 5.4% 15.9% 14.6% 14.5%UK MSCI Emerging markets 15.7% 24.7% 30.1% 24.9% 24.8% 23.1%*MSCI Emerging Markets used for the emerging-market equities for all three countries. MSCI World ex US, MSCI World and MSCI World ex UK were usedfor US, Europe and UK respectively. Due to the lack of an MSCI World ex Europe hedged index, MSCI World was used as a proxy. Due to data availability,MSCI EM Gross Total Return (TR) was used for the unhedged calculation, while a portion of the currency-hedged index provided by MSCI is calculated usinga Net TR methodology. Index levels, not total returns, were used for developed-world equities. Monthly returns from December 1987 to October 2012 wasconsidered to compute annualised returns and volatilities.Source: Bloomberg, World Gold Council12 Emerging markets experience higher structural levels of interest rates due to higher natural inflation rates, stronger growth and economic inefficiencies.Gold Investor | Risk management and capital preservation
Chart 6: The expected loss from hedging FX risk for 1 year*Return (%)10-1-2-3DM currencies-4-5-6EM currenciesJPY EUR GBP CAD AUD CNY KRW MXN BRL RUB INRCurrency/US$*The expected loss is the percent difference between the spot rate and the 1-year forward rate as indicated by futures contracts or non-deliverable forwards.Source: Bloomberg, World Gold CouncilChart 7: Estimated annualised cost of hedging currency exposure in an emerging-markets equity index*Cost (%)1816141210864201987 1990 1993 1996 1999 2002 2005 2008 2011Annualised costAverage annualised cost*Cost is computed by multiplying a constructed proxy for the MSCI Emerging Markets Index respective country weights by the corresponding interest-ratedifferentials. Please see Appendix II for methodology. Computations are made from a US$ perspective, but results are similar for euro and pound sterlinginvestors given the relatively similar domestic interest-rate environments investors have experienced.Source: Bloomberg, Global Financial Data, Thomson Reuters, World Gold Council22_23
- Page 6 and 7: Macroeconomic events: support andch
- Page 8 and 9: In US dollar terms, prices fell dur
- Page 10 and 11: Volatility: low levels belie nervou
- Page 12 and 13: The interaction of all assets on av
- Page 14 and 15: • Strong global equity market per
- Page 16: • The Fed’s preferred measure o
- Page 20 and 21: The impact of foreign-exchange expo
- Page 23: Chart 4: Emerging market equity cor
- Page 27 and 28: Chart 8: Regional distribution of g
- Page 29 and 30: Chart 9: Gold consumption per capit
- Page 31 and 32: Chart 11: Performance of emerging-m
- Page 33 and 34: The second period, between 2002 and
- Page 35 and 36: Table 3: Summary of portfolio perfo
- Page 37 and 38: ConclusionExchange-rate risk is a s
- Page 39 and 40: Gold is also used to lower the cost
- Page 41 and 42: Currency-hedged index constructionD
- Page 43 and 44: III: Tail-risk hedging:an internati
- Page 45 and 46: Unlike other assets, gold tends to
- Page 47 and 48: Chart 3: Research findings for opti
- Page 49 and 50: Chart 5: Improvement in performance
- Page 51 and 52: Chart 6: Performance of portfolio a
- Page 53 and 54: The role of gold during possible fu
- Page 55 and 56: ConclusionGold helps investors dive
- Page 57 and 58: IV: Foreign-reserve diversification
- Page 59 and 60: Optimal allocations to goldMethodol
- Page 61 and 62: Chart 1: US dollar as numéraire -
- Page 64 and 65: ConclusionGold should form an integ
- Page 66 and 67: DisclaimersThis report is published
- Page 68: World Gold Council10 Old Bailey, Lo
Chart 6: The expected loss from hedging FX risk for 1 year*Return (%)10-1-2-3DM currencies-4-5-6EM currenciesJPY EUR GBP CAD AUD CNY KRW MXN BRL RUB INRCurrency/US$*The expected loss is the percent difference between the spot rate and the 1-year forward rate as indicated by futures contracts or non-deliverable forwards.Source: Bloomberg, World <strong>Gold</strong> CouncilChart 7: Estimated annualised cost of hedging currency exposure in an emerging-markets equity index*Cost (%)1816141210864201987 1990 1993 1996 1999 2002 2005 2008 2011Annualised costAverage annualised cost*Cost is computed by multiplying a constructed proxy for the MSCI Emerging Markets Index respective country weights by the corresponding interest-ratedifferentials. Please see Appendix II for methodology. Computations are made from a US$ perspective, but results are similar for euro and pound sterlinginvestors given the relatively similar domestic interest-rate environments investors have experienced.Source: Bloomberg, Global Financial Data, Thomson Reuters, World <strong>Gold</strong> Council22_23
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