Gold Hedging

Investment markets are inherently unpredictable, with volatility driven by factors such as economic downturns, inflation, and geopolitical unrest. To protect against potential losses during turbulent times, many investors turn to hedging strategies. Once choice for hedging is gold, a timeless asset known for its resilience and desirability during periods of uncertainty.

By understanding how hedging works and the unique qualities of gold, investors can create a balanced portfolio that minimizes risk while maintaining opportunities for growth.

What Does Hedging Achieve?

Hedging is a strategy designed to reduce the impact of negative market movements on an investment portfolio. Instead of relying on the performance of a single asset class, hedging involves diversifying across assets that behave differently under various conditions.

While hedging doesn’t eliminate risk entirely, it acts as a form of financial insurance. For example, during a market downturn that negatively impacts stocks, an asset like gold can help stabilize returns and protect wealth.

Why is Gold a Popular Hedge?

Gold’s reputation as a “safe haven” asset makes it an integral part of many hedging strategies. Its value is not directly tied to corporate performance or government policies, setting it apart from stocks, bonds, and fiat currencies. Over centuries, gold has consistently served as a reliable store of value during economic turmoil and market volatility.

Protection Against Inflation

Inflation erodes the purchasing power of currencies, reducing the real value of savings and investments. Gold, however, has historically maintained or increased its value during inflationary periods. As prices rise, gold becomes an attractive alternative to cash or fixed-income assets, providing a hedge against the diminishing value of money.

Stability in Times of Crisis

Gold’s appeal as a hedge is particularly evident during periods of financial or geopolitical crises. When market confidence falters and traditional investments lose value, gold’s stability often attracts investors seeking security. Its role as a universally recognized store of value makes it a go-to asset during uncertain times.

Portfolio Diversification

Adding gold to a portfolio enhances diversification by reducing overall risk. Gold tends to have a low, zero, or negative correlation with stocks and bonds, meaning it often performs differently than these assets. This uncorrelated behaviour makes gold an effective counterbalance in a portfolio, helping smooth returns over time.

The Market Price of Gold

The market price of gold is determined by supply and demand, and many different factors can have an effect. Below, we will take a look at a few factors involved in gold demand and gold supply, respectively.

It is important to understand that the world market price of gold can be very rapidly influenced by speculation, and a seemingly minor factor can cause a substantial change in the gold price if investors act on it.

Gold Demand

In an average year, roughly 50% of newly extracted gold goes to the jewellery sector and about 40% is used for investments. Gold is not just pretty; it has many characteristics that make it desirable for certain types of manufacturing and for medicinal use.

Gold characteristics

• Gold is a bright, slightly orange-yellow noble metal, and it is solid under standard conditions.
• Gold is soft and highly malleable.
• The ductility of gold is high. This means that gold can be drawn into very thin wires or hammered very thin without breaking.
• Gold is a good conductor of electricity.
• Gold is very resistant to corrosion and most other chemical reactions. It is one of the least reactive chemical elements (it is the second-lowest in the reactivity series).
• Gold is resistant to most acids, but can be fairly easily dissolved in aqua regia (a mixture of nitric acid and hydrochloric acid). Nitric acid alone can not dissolve gold, even though nitric acid can dissolve silver and all base metals.
• Gold will dissolve in alkaline solutions of cyanide and this characteristic is important for electroplating.

Examples of how gold is used

• Gold jewellery
• Gold bars and bullions for investors. They are sough after by many different types of investors, from small-scale private investors who might own a few bullions to Central Banks and funds that keep large amounts of gold bars.
• Gold leafing
• Production of coloured glass
• Art and crafts
• Corrosion-resistant electrical connectors. The chief industrial use for gold is to make corrosion-resistant electrical connectors for computerized devices.
• Infrared shielding.
• Gold salts are included in certain anti-inflammatory medicines.
• Dental gold

Gold Supply

Gold is a relatively rare element. It often occurs in a free elemental state (native metal) as grains or nuggets. In nature, gold can for instance be found in rocks, veins and alluvial deposits. Gold often occurs in a solid solution series with silver, or naturally alloyed with metals such as copper and palladium. It is also fairly common to encounter it together with the iron sulfide known as “fool´s gold” (iron pyrite).

As of 2020, the largest gold supplied in the world was China, followed by Russia and Australia. Historically, gold was chiefly extracted from alluvial deposits (e.g. gold panning in rivers), but today most of the extracted gold comes from the mining of ores that are not on the surface. These operations are large and complex, and carried out by large corporations. Nowadays, roughly 80% of the gold supply comes from large multi-national corporations, including giant corporations such as Newmont and Barrick Gold.

In addition to the extraction of gold, gold also re-enters circulation through gold recycling.

Incorporating Gold into Your Portfolio

To use gold effectively as part of a hedging strategy, investors can choose from several options depending on their goals and preferences.

Physical gold, such as bars or coins, provides direct ownership and a tangible store of value. However, storage and insurance costs can be considerations for holding physical gold. Alternatively, gold exchange-traded funds (ETFs) and mutual funds offer convenient exposure to gold’s price movements without the need for physical possession.

For those seeking indirect exposure, investing in gold mining companies can align a portfolio with the broader gold industry. However, it’s important to note that mining stocks come with their own set of risks, as they are influenced by operational and market factors in addition to gold prices.

Experienced investors may also explore gold futures and options, which provide leveraged opportunities to speculate on gold prices or hedge other investments. These instruments require careful management and a deep understanding of the market.

When to Hedge with Gold

Hedging with gold is particularly relevant during periods of economic uncertainty, rising inflation, or declining market confidence. Central bank policy shifts, geopolitical tensions, and financial market corrections are all scenarios where gold’s stabilizing properties shine.

Even during stable economic conditions, maintaining a modest allocation to gold in a portfolio can provide long-term risk management. Its role as a consistent store of value makes it a reliable choice for protecting wealth.

Using Gold as a Component of Broader Strategies

Hedging investments is a vital strategy for managing risk in an unpredictable market, and gold can be a cornerstone of effective hedging. Its ability to act as a safeguard against inflation, a stabilizer during crises, and a diversifier for portfolios makes it an invaluable asset for both seasoned and novice investors. While gold is an essential component of many hedging strategies, it works best when integrated into a diversified portfolio. Pairing gold with other defensive assets, such as bonds or low-volatility stocks, can provide comprehensive protection against a range of risks. A balanced approach ensures no single asset dominates, reducing exposure to concentrated losses.

By thoughtfully incorporating gold into a wider portfolio, investors can protect their wealth, reduce volatility, and build a foundation for financial resilience. Gold’s enduring value and versatility ensure its place as a critical tool in the art of hedging investments, but it should not be your only tool.