The Benefits of Diversifying the Funding of a Gold Position

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The recent sell off in gold has sharpened the focus of even the most committed gold bugs, and has highlighted one of the key risks that many investors face when they access the gold market. Do you purchase Gold in dollar terms or something else? How do you look at Gold, as a currency or something else? For the purposes of this analysis, Treesdale Partners took a look at a gold transaction in foreign exchange terms.

Any transaction in the FX markets implies an exchange of one currency for another. For example, if I buy the euro versus the US dollar this implies that I receive euro versus pay US dollars in exchange. Gold is no different - if I buy gold this implies a receipt of gold in exchange for delivering an agreed amount of currency to the seller and in most gold related transactions the currency used is US dollars (a widely used US dollar benchmark for gold ETFs is the London Bullion Market Association PM Fixing Price/United States dollar (USD)). Whether by choice or not, the gold investor is explicitly expressing the view that they expect the value of gold to increase relative to the US dollar. Conversely an investor that sells their gold is expressing the view that they expect the value of gold to decrease relative to the US dollar. In fact in broad terms, we can say that as the value of the US dollar falls in currency markets, the value of gold as measured in US dollars tends to increase.

Therefore by holding gold an investor is not only exposed to risk factors that impact the supply and demand for gold but are also exposed to the many idiosyncratic factors that might impact the value of the US dollar on international currency markets. For investors that only buy and sell gold in US dollar terms this potentially creates a concentrated (undesired) exposure in the US dollar. This exposure can be quite acute particularly during periods of stress in financial markets when there tends to be increased demand for US dollar assets.

A representative period we can use to look closer at this effect is the year-to-date performance of gold as of 3/29/2012. The period has been characterized by a strong demand for US dollars driven by a number of factors including strength in the US economy and higher US interest rates, yen weakness driven by Japanese monetary policy and rising concern about the state of the European economy. In Chart 1 we compare the performance of an investment in gold that is financed in each of four currencies, US dollars, European euro, Japanese yen and British pounds. An observation that might come as a surprise to US investors is how different the performance of gold has been depending on the currency in which the investment was funded. Unsurprisingly gold financed in yen has been the best performer given the weakness in yen over this period. Conversely, gold financed in US dollars has shown the worst performance given the strength of the US dollar since the start of the year. We do not make the case here about which specific currency in which an investor should finance a gold investment but rather wish to emphasize just how different returns can be depending on the funding currency. Investors holding ETFs that track a USD financed benchmark (for example, the London Bullion Market Association PM Fixing Price/USD) must always keep in mind that they are expressing a bearish view on the future performance of the US dollar in addition to a bullish view on gold.

Gold Financed in each Currency:

US dollars, European euro, Japanese yen and British pounds

12/31/2012 – 3/31/2013

Chart 1

One simple strategy that can be used to mitigate the US dollar risk would be to fund the position across a number of currencies thereby providing some diversification away from the US dollar. In Chart 2 we show the relative performance of a Gold/USD investment versus gold financed with an equally weighted basket of US dollars, European euro, Japanese yen and British pounds. Since the start of the year gold financed in USD has lost about 4% of its value while the gold “USD diversification strategy” is broadly unchanged.

Gold/USD vs. Equal Weight of US dollars,

European euro, Japanese yen and British pounds

12/31/2012 – 3/31/2013

Chart 2

Ade Odunsi, Managing Director of Treesdale Partners, LLC


The Foreign Exchange (FX) Market is a market in which participants are able to buy, sell, exchange and speculate on currencies. Foreign exchange markets are made up of banks, commercial companies, central banks, investment management firms, hedge funds, and retail FX brokers and investors. The FX market is considered to be the largest financial market in the world.

The London bullion market is a wholesale over-the-counter market for the trading of gold and silver. Trading is conducted amongst members of the London Bullion Market Association ( LBMA), loosely overseen by the Bank of England. Most of the members are major international banks or bullion dealers and refiners.

One cannot invest directly in an index.

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