During periods of heightened stress investors have often sought to swap assets into dollars as a way to seek protection from rising uncertainty in other markets. But ironically it is this defensive surge in demand for dollars that has often worked to reduce the effectiveness of holding gold as a defensive asset. As the dollar strengthens on currency markets this has the direct effect of pushing down the value of gold priced in dollars – put differently the number of dollars that an investor would expect to receive from selling an ounce of gold, all things being equal, would be expected to fall. For this reason, an investor seeking to hold gold for its diversification and defensive qualities can potentially enhance these desirable characteristics by having an allocation to gold in non-dollar denominated currencies in addition to their dollar denominated allocation.
Historically Gold Financed in Non-Dollar Currencies Outperforms During Stress Periods
To show this effect the analysis below looks at the performance of gold priced in dollars, euro and pounds during periods in which there was a sharp rise in risk aversion. For the purposes of the discussion a “sharp rise in risk aversion” is defined as any period from and including the 2007 credit crisis in which there was a peak-to-trough fall of 5% or more in the S&P 500 index. The results are presented in the table below.
There are two main patterns to observe. Firstly, in every period other than the May-June 2013 period gold priced in euro and gold priced in pounds outperformed gold priced in dollars. This was driven by the fact that during these periods the US dollar showed broad based strength as investors concerned about the heightened level of uncertainty swapped assets into dollars. And as the dollar strengthened from the rising demand, as might be expected, the price of gold in dollars was adversely affected. In contrast gold priced in euro and gold priced in pounds by not being exposed to the dollar were less impacted by dollar strength during these stress periods. In the last column in the table a broad measure of the value of the dollar is shown using the Intercontinental Exchange Trade Weighted Dollar Index (USDX) as a proxy. In every period other than May-June 2013 the dollar as measured by USDX strengthened which contributed to the underperformance of gold priced in dollars relative to non-dollar financed gold. But in the period in which the dollar was weak we see that the gold price in dollars outperformed the other currencies.
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).