UNITED STATES March 26 2014 11:07 AM
LONDON (Scrap Register): Hedging EM risks? Think gold, one of a series of papers published by the World Gold Council, highlights how gold can be used by investors to mitigate systemic risks, act as a cost-effective currency hedge and reduce tail risks in emerging markets.
Over the past decade, the paper notes, investors have profited from exposure to emerging markets, owing to their strong economic growth, favourable demographics and industry deregulation. However recent volatility across Asia, Latin America and Eastern Europe - including developments in Russia and Ukraine - has significantly impacted investment portfolios, directly and indirectly.
The paper examines in detail gold’s role as an emerging markets hedge in a number of scenarios including:
Currency risk—Gold provides a cost-effective alternative to foreign-exchange hedging for investors seeking to reduce their risk from emerging-market currencies movements ;
Tail risk—Gold has historically performed well in response to systemic crises or systemic events;
Indirect exposure—Gold provides a useful hedge for investors not directly invested in emerging markets but nonetheless indirectly exposed given the interconnectedness of these economies to the global financial system.
The paper concludes an optimal level of gold allocation should be between 2% and 10% for a wide range of investors’ portfolios, depending on individual risk appetites.
Juan Carlos Artigas, Director of Investment Research at the World Gold Council, said, “While the long-term prospects for emerging market economies may justify including them in a portfolio, given recent market volatility, it is essential for investors to hedge their exposure. In our view, gold’s role as a portfolio hedge is critical. Its exceptional market liquidity provides a cost-effective alternative to managing emerging-market currency risk. The daily trading volume of gold – US$240bn in the London OTC market alone – far exceeds major currency pairs and surpasses all spot emerging-markets currency transactions combined.”
He continued, “Our research shows that even investors with little or no direct exposure to emerging markets would benefit from a gold-based hedging strategy. The world is much more intertwined and the risk of emerging-market contagion has the potential to impact portfolios that invest solely in developed economies.”
In addition, the latest Gold Investor includes two further papers Can gold replace bonds in balancing equity risk? which explores asset allocation at a time of historically low bond yields and A perspective on gold as a hedge in an expanding financial system, which discusses the role global gold holdings can play at a time when financial assets multiply, become more complex and increase the likelihood of tail risk events.