Following our previous discussion piece on commodity fund taxation, this week we discuss the differences between a gold position financed in a (given) currency versus a gold position hedgedinto a currency. Broadly speaking the objective of a “currency financed” transaction is to give an investor the flexibility to choose the currency with which gold purchases are made. By contrast in a “currency hedged” transaction the objective is to protect the value of gold when expressed in a different currency. In reality in the US, there are few investment products available to US investors which offer the flexibility to choose a different financing currency other than the US dollar but there are many currency hedged products and as we show below, the two types of product are fundamentally different, offering investors quite distinct types of risk exposure.
We use the scenario of a gold purchase financed in Japanese yen to breakdown a “gold financed” transaction into its components but we take as the starting point a gold purchase financed in US dollars. This is typically the “financing method” which most investors in the US would utilize to make asset purchases of all types (including gold). In the diagram below we show the flow of funds resulting from the transaction:
Another way in which an investor might describe this transaction is LONG GOLD / SHORT USD. In other words by purchasing gold financed in USD, investors are in effect expressing the view that they expect the value of gold to increase relative to the value of the USD. By purchasing gold financed in USD an investor, whether by choice or not, is expressing a currency view on the USD.