Gold Investor - SPDR Gold Shares

The case for gold as a foreignexchangehedgeInvestors in developed markets are increasing their allocationto emerging markets, motivated by the prospects of higherreturns and portfolio-diversification benefits. In this context,foreign-exchange hedging is an important strategy. However, itcomes at a substantially high cost to investors. Furthermore, asTable 2 shows, analysts strongly believe that emerging-marketcurrencies will appreciate over the next few years due to higherrates of income growth, increased investment and higher realinterest rates – a scenario which may undermine the case forhedging exchange rate risk.Investors consequently face a dilemma. The impact ofexchange-rate hedging, as proven historically, might not beas relevant or clearly beneficial in the future. The marginaldecrease in volatility, weighed against potentially large losses inreturns, may not be attractive to all investors. However, havingno currency hedges in place exposes the investor to harmfulcurrency swings and tail-risk events in emerging markets.Gold offers a potential solution to these issues. Gold exhibitsa number of characteristics that allow investors to hedgepart of the currency-related risk while reducing costs, addingdiversification and protecting against tail risks. These includegold’s positive correlation to emerging markets’ growth, itsnegative relationship with the US dollar and other developedmarket currencies, its low correlation to most developedmarketassets and its ability to protect against tail-risk events.Consequently, investors can benefit from including gold intheir portfolios as part of their currency-hedging strategy foremerging-market investments.Gold’s economic relation to emerging markets growthAn important part of the rationale for using gold as a solutionto foreign-exchange risk hedging is the increasing relevance ofemerging markets in the gold market, particularly over the past12 years. In fact, the correlation between gold and emergingmarketequities is significantly higher than that of gold anddeveloped-market equities. For example, in the period between2001 and 2012, gold had a correlation of 0.28 to emergingmarketequities in US dollar terms (compared to a much smaller0.11 correlation to developed-market equities).This should not come as a surprise to those familiar withgold-market fundamentals. Countries like India, China, Turkey,Vietnam and the entire Southeast Asia region have a culturalaffinity to gold. 13 Physical gold demand coming from developingcountries has contributed to over 60% of annual demand since2000 and represented more than 70% of global demand in2011 (Chart 8). 1413 A detailed analysis of gold demand in these countries can be found in the following World Gold Council reports: India: heart of gold, May 2011; China goldreport: The year of the tiger, April 2010; Gold Demand Trends Q2 2011; Gold Demand Trends Q1 2012; and Gold Demand Trends Q2 2012.14 Source: Thomson Reuters GFMSGold Investor | Risk management and capital preservation