Banks often advise investors to buy gold products that are hedged against currency risk. But what is supposedly for the benefit of the customer is more of a disadvantage for them. As is so often the case, the product provider who profits from the protection benefits in particular.
When European investors buy gold, they are also taking a currency risk. Because the precious metal is traded worldwide in US dollars. Exchange rate fluctuations between the euro and the US dollar can reduce or increase the return.
The media and banks regularly point out possible exchange rate losses in gold investments . The latter would like to sell investors protection against this risk, just as an airline wants to persuade its customers to take out travel cancellation insurance at the end of the booking.
The banks argue with the negative relationship between the US dollar and gold: if the gold price rises, the US dollar tends to fall, which reduces the profit of euro investors, according to the rationale. This linear statistical relationship is only weakly pronounced. It was stronger in the 1970s and 1980s. But since the 1990s, the negative relationship between the US dollar and the gold price has either no longer been statistically verifiable or is only very weak.
This means: On a monthly basis, it happens only a little more often that the US dollar depreciates against the euro when the gold price rises. In the other months, however, the two prices move in the same direction. For this reason alone, hedging the currency risk does not make sense.
Currency hedging can increase risk
In addition, an exchange rate hedge for gold can lead to higher risks and lower returns. That may not seem at first glance, but it cannot be dismissed out of hand: If the gold price falls and the US dollar rises, the losses for gold investors from the euro area are dampened. You benefit from a more or less natural risk diversification that reduces the risk of loss. This beneficial effect is eliminated when the exchange rate is hedged.
This can have fatal consequences, especially in a crisis. Because when the financial markets crash, many investors flee to the US dollar, which they consider a “safe haven”. As a result, the US dollar rate rises sharply.
For example in 2008. Those who hedged the exchange rate back then did not benefit from the currency gains of the US dollar against the euro. The efficiency of a Goldman Sachs credential obtained was, for example, just under 35 per cent untill the end of 2007, the end of 2010, relative to the unknown variant.
Hedging costs reduce the return
Another argument against currency hedging is its cost. They cannot be higher than the currency losses that would arise without hedging for it to be worthwhile. However, the exchange rate fluctuations are not particularly high over longer periods. Since the euro was first listed in 1999, the common European currency has only fallen from 1.1789 to around 1.1177 US dollars per euro by June 2020 – albeit accompanied by sharp fluctuations.
Accordingly, European gold investor made a small exchange rate gain of a good 5 percent during this period . A currency hedge over 20 years, on the other hand, would have cost a lot of gold and depressed the gold yield. The costs result from the difference between the short-term interest rates in the USA and in the euro area. Investors would pay their difference to the euro interest rate if interest rates in the United States are higher. You gain money for insurance if it’s the other way around. The basis for a good return, and investors should always take this to heart, is avoiding losses. The supposed currency risk with gold actually tends to lower the risk of loss. The implicit possession of US dollars is also an additional safeguard against unexpected crises.