Using gold to mitigate currency gyrations affecting emerging
markets can partly resolve a dilemma in how to cost-effectively control risks,
the World Gold Council, the industry group, has said in a new research paper.

The WGC has carried out research indicating that had
investors used gold to spread some of their risks in emerging markets between
1987 and 2012, they would have enjoyed generally higher returns at around the
same level of volatility.

An un-hedged emerging market index (in dollar terms), held
between 1987 and 2012, would have delivered annual returns of 8.4 per cent; if
the index exposure is hedged with a 50/50 split of currencies and gold, the
return would have been 8.96 per cent and the volatility 7.95 per cent, the
report said.

The WGC’s paper, entitled, Gold and Currencies: Hedging Foreign Exchange Risk, said that the
yellow metal can improve the impact of currency hedging strategies, especially
where emerging market equities are concerned.

The report said gold has a positive correlation to emerging
market growth, a negative correlation to the dollar and other developed market currencies,
and has a low investment cost.

“Results show that compared to traditional foreign-exchange
hedging, a strategy incorporating gold has distinct advantages. First, it
lowers portfolio drawdown risk: adding gold to an un-hedged emerging market investment
achieves a lower drawdown than a 100 per cent currency-hedged strategy,” the
report said.

“Second, a gold overlay has lower costs than traditional emerging-market
currency hedges. Consequently, while gold is not a perfect substitute to
emerging market currencies, adding gold produces higher risk-adjusted returns
than either a fully hedged or an un-hedged foreign-exchange position,” it said.