In this week’s commentary we examine the performance of the price of gold expressed in the currencies of the world’s largest gold producing countries. In a number of previous commentaries we have investigated the currency like nature of gold investing.
When an investor buys a currency the transaction by its very nature involves the exchange of one currency for another at an agreed exchange rate (for example to buy euro in exchange for dollars). In effect, the investor is expressing a view on the relative value of one currency versus another currency.
Likewise in a gold transaction the investor is explicitly expressing the view that they expect the price of gold to increase relative to the financing currency.
For example, gold priced in dollars expresses the view that the price of gold will increase relative to the dollar – in market “speak”, the investor is said to be long gold, short dollars. We can see then that whether by choice or not the investor is expressing a directional view on the future value of the dollar. For gold investor s not wanting to take concentrated dollar risk in their gold holdings we have recommended a “basket” approach in which the investor makes gold purchases using a number of different currencies as a way to diversify some of the specific risks associated with the dollar.
We recommend this as a sensible approach for the medium to long term gold investor who has a view on the supply and demand dynamics of the gold market but may not necessarily have such a view on the currency markets.
In previous commentaries investigating the “gold basket” approach we provided an analysis of the performance of gold expressed in an equally weighted basket of the dollar, euro, yen and pound – these currencies being the four most liquid traded currencies. Here we extend this approach and present an analysis of the price of gold expressed in an equally weighted basket of the currency’s of the six largest gold producing countries – we call this the Gold Producers Basket (GPB). For comparison purposes we also include the price of gold expressed in the individual currency of each country and provide a comparison to the performance of the S&P 500. The results are presented in the table below.
Source: Bloomberg, LP; Treesdale Partners calculations.Gold Producers Basket – the price of gold expressed in an equally weighted basket of the currencies of the six largest gold producing countries (Australia, South Africa, Russia, Canada, USA and China); weekly rebalancing.
Past performance is not indicative of future performance.
At a high level it is notable that all of the countries listed here have significant commodity exposure beyond gold. In fact for all these countries commodities represent >50% as a proportion of total trade. This suggests that these currencies would be expected to exhibit a certain level of correlation with the price level of commodities on international markets. And a number of studies have supported this view finding a statistically significant relationship between the prices of commodities and foreign exchange rates1.
Looking at the results in the table, they show that all the local currency gold prices except gold in Canadian dollar terms exhibited higher volatility than gold in US dollar terms indicating that the foreign exchange rate component of the returns increased volatility.
We note however that the Gold Producers Basket while producing the same annual return as gold in dollars showed 1.3% lower annual volatility in addition to an 8.4% lower maximum drawdown over the ten year historical period. This nicely illustrates how a basket approach can help to reduce volatility and drawdown risk.
As discussed in previous commentaries the lower volatility of the basket approach is partly a benefit of the reduced exposure to the dollar which has tended to spike in value during previous periods of high market stress, pushing down the prices of assets priced in dollar terms. By diversifying financing currencies investors are able to reduce exposure to the some of the idiosyncratic risks that drive the individual currencies such as the dollar. More generally, this re-emphasizes the potential benefits for medium to long term gold investors of reducing exposure the use of any single currency when making purchases which always leaves investors with a concentrated short exposure to the currency.
Gold Producers Basket – the price of gold expressed in an equally weighted basket of the currencies of the six largest gold producing countries (Australia, South Africa, Russia, Canada, USA and China); weekly rebalancing.
Past performance is not indicative of future performance.
The other interesting result to highlight in the table is the strongly negative beta of the gold price in Australian dollars, South African rand, Russian ruble and Canadian dollar terms versus the S&P 500 index. Beta is a measure of an asset’s systematic risk – in effect how much of an asset’s volatility can be ‘explained’ (is caused) by the volatility of the broad market. A beta of 1 indicates that the asset’s price will move with the market. A beta of less than 1 indicates that the asset will be less volatile than the market. A beta of greater than 1 indicates that the asset’s price will be more volatile than the market. A beta lessthan 0 indicates that the asset’s price volatility will tend to move in the opposite direction to the broad market suggesting that reducing dollar exposure may help to enhance the “market defensive” characteristics of gold.
Source: Bloomberg, LP; Treesdale Partners calculations.
Gold Producers Basket – the price of gold expressed in an equally weighted basket of the currencies of the six largest gold producing countries (Australia, South Africa, Russia, Canada, USA and China); weekly rebalancing.
Past performance is not indicative of future performance.
Finally to get a better view of the portfolio effects of a gold basket strategy we chart the rolling two year drawdown of the Gold Producers Basket (GPB) and the rolling two year beta of the GPB versus the S&P 500 index. We note that in all instances the basket strategy showed lower or equal drawdown and lower beta versus the S&P 500, than gold priced exclusively in dollar terms.
1 “Can Exchange Rates Forecast Commodity Prices?” Chen, Rogoff and Rossi (2008), NBER Working Paper No. 13901
This article was written by Treesdale Partners, portfolio manager of the AdvisorShares Gartman Gold/Euro ETF (GEUR), AdvisorShares Gartman Gold/British Pound ETF (GGBP), AdvisorShares Gartman Gold/Yen ETF (GYEN) and AdvisorShares International Gold ETF (GLDE), share their thoughts about the gold space.