Diversifying risk to combat volatility in gold prices

Diversifying risk to combat volatility in gold prices

Few assets have the ability to divide opinion the way gold does. Once dismissed by John Maynard Keynes as a “barbaric relic”, the yellow metal has had rather mixed fortunes since the financial crisis hit in 2008.

One of the main arguments used by its critics is that gold has no yield, or purchasing power, and also incurs costs in terms of storage. The problem with this argument is that it could apply equally to a host of other assets, including currencies, as well as the valuations of a lot of companies that trade on the stock market.

Gold price hits record level

Earlier this year the gold price hit its highest levels against the US dollar since 2011, when it peaked at $1,921 an ounce before dropping sharply to lows of $1,047 in December 2015. Since then, it’s been a slow grind back, but we’ve slowly been closing in on the prospect of a new record high against the US dollar, and playing catch-up with a host of other currencies where gold prices have already set new record peaks.

These record highs against the Japanese yen, the euro, swiss franc and the pound, have come about as a result of central banks in these countries, and regions, cutting interest rates close to the zero bound, and embarking on large scale easing programmes.

Gold has often been touted as a safe haven in times of market uncertainty, either as a hedge against inflation, or as a hedge against financial repression. Over the last decade, the verdict has been mixed as to whether it has performed either function that effectively, particularly since inflationary pressures have been relatively muted.

Gold-miners mixed performance

The performance of US mining stocks has been similarly mixed over the same time period, not unsurprisingly when you consider that the price of gold almost halved from the record highs in 2011, before finding a base in 2015. For example, Barrick Gold, which is one of the world’s largest gold miners, has seen significant amounts of share price volatility over the last decade, and has struggled to even get close to the levels back in 2011, when gold prices hit record highs against the US dollar.

What this shows us is that just because you are a miner of one of the most precious metals on the planet, the fortunes of your share price aren’t always linked to the success or otherwise of the product you specialise in. For example, despite record gold prices, annual revenue since 2011 has been in decline. From a peak of $14.2bn in 2012, annual revenue in 2019 fell to $9.7bn, though this was an improvement on the $7.2bn recorded in 2018.

Take a broader view with the US Gold basket

Our US Gold basket offers the opportunity to take an alternative position on the popular metal. The US Gold basket comprises 15 US stocks with exposure to US gold mining, including Newmont, Barrick Gold and Franco-Nevada. These 3 stocks have the largest initial exposure in the basket, of 15% each. The ability to trade across the US gold-mining sector enables you to diversify your risk through exposure to multiple shares, as opposed to picking one specific stock to trade. Find out more about the US Gold basket

Share baskets offer a cost-effective way of trading, allowing you to take a view across a sector with a single trade, rather than opening multiple positions for individual shares. In addition, holding costs are 50% lower than trading on individual shares, while there is no commission involved. Learn more about share baskets

Gold’s breakeven price

One of gold’s many attractions has been its scarcity, as unlike money it can’t simply be conjured out of thin air. As gold becomes ever more difficult to extract, the breakeven cost of bringing it to market also rises, thus eroding profit margins across the sector and supply chain.

What this means is that while there is demand for gold, the price has an inbuilt floor, unlike the share prices of companies that extract it. This is called the breakeven price, and it currently sits at an average of around $1,200 an ounce, when spread across the sector. Of course, the downside to owning physical gold is the actual act of storing it; it’s heavy and bulky and costs a lot to keep safe, which is why central banks have vaults of the stuff.

In order to hedge against some of the volatility, as well as the costs of storing gold, and helping to spread risk and mitigate the various transaction fees involved in trading in and out of the market, a variety of different instruments have been designed in the last few years to help keep transaction costs down. These products can also be a hedge against price volatility, with a raft of different ETFs of varying degrees of complexity. The SPDR Gold ETF is a classic case in point, largely backed by physical gold it pretty much tracks the underlying gold price without the hassle of taking delivery of it.

The use of ETFs – like share baskets – allows investors to avail themselves of the need to diversify risk across a range of different stocks. As such, they can be one of the most powerful risk-management tools available to investors, but they can also be very risky products for the unwary.

Alternatively, you can choose to spread risk across a number of individual stocks, reducing the overall impact if one of them fails, or you can invest in a select number of well-established and larger companies, like the 15 stocks in our US Gold basket.

Leveraged ETFs are complex financial instruments that carry significant risks. Certain leveraged ETFs are only considered appropriate for experienced traders.

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