Hedging Local Currency Risk: The S&P 500 Gold Hedged Index

Abstract

Efforts to hedge foreign currency risk via currency hedged portfolios are ubiquitous. Tools such as currency hedged benchmarks help an investor get exposure to foreign asset returns without getting exposure to changes in the value of foreign currency versus local currency.

Related to the concept of hedging foreign currency risk is the relatively novel idea of hedging local currency risk. An investor may have currency risk even if his/her investments are limited to home currency assets because if the home currency depreciates, then the investor’s purchasing power for real assets is diminished.

The local currency risk can be divested by taking an offsetting position in gold. Many consider gold to be the ultimate currency, while others see gold as simply a shiny metal with limited industrial usage. Nevertheless, gold continues to be an important reserve asset and currency hedge.

The S&P 500® Gold Hedged Index seeks to simulate the returns of an S&P 500 investment hedged against the fluctuations of the U.S. Dollar versus gold. It is calculated by hedging beginning-of-period S&P 500 Total Return index values with COMEX gold futures contracts.

All other things constant, the S&P 500 Gold Hedged Index will outperform an unhedged S&P 500 when gold prices appreciate against the U.S. Dollar. Conversely, the index will underperform the S&P 500 when the U.S. Dollar appreciates against gold. Looking over the last 10 years, the S&P 500 Gold Hedged Index has outperformed the unhedged S&P 500 by 9% per annum with higher volatility.

Keywords: Gold Hedged

JEL Classification: C3