GOLDMAN: This is when gold actually works as a hedge

Myles Udland
Markets Reporter

A common refrain in the investing world is that gold is a must-have part of a portfolio because it acts as a hedge.

A hedge against what? Anything. Usually bad things.

But in a research note to clients out Tuesday, Jeff Currie and the commodities team at Goldman Sachs outlined what gold does and does not help investors hedge against. What it doesn’t — or hasn’t been — protecting investors against is a conflict with North Korea.

Currie outlines that the price of gold typically “doesn’t respond to geopolitical risk after controlling for other macro variables, such as real interest rates and the US dollar.” The recent rally in gold, for instance, has been attributed to the decline in the value of the U.S. dollar and lower real interest rates, not worries over a conflict with North Korea.

Gold is higher because the dollar is lower and interest rates are falling, according to Goldman Sachs (Source: Goldman Sachs)

But Goldman did find that there is one scenario in which the yellow metal lives up to its billing as a hedge: currency debasement.

“We find that gold can effectively hedge against geopolitical risk if the geopolitical event is extreme enough that it leads to some sort of currency debasement,” Currie and his team write, “and especially if the gold price move is much sharper than the move in real rates or the dollar.”

Goldman adds:

For these events, gold essentially serves as a call option and can therefore be thought of as a “geopolitical hedge of last resort.” For example, gold served as an effective hedge after the events of September 11, 2001 when the US Federal Reserve substantially increased dollar liquidity, debasing the US dollar. Gold also proved an effective hedge during the Gulf Wars as governments printed money. That said, it is interesting to note that the oil supply disruptions created by Gulf War I led oil to act as a better hedge than gold, which has been the case during several geopolitical events centered around oil-producing nations.

On Tuesday, gold was up almost 1% on the day to hit $1,343 an ounce, an 11-month high as stocks in the U.S. were getting slammed and other safe haven assets like U.S. Treasuries were rallying.

A mock money printing plate with US President Donald Trump face in place of Benjamin Franklin. (AP Photo/Pavel Golovkin)

In recent weeks, gold has also garnered increasing attention as its price has continued to rise.

Last week, analyst Michael Batnick of Ritholtz Wealth Management told Yahoo Finance that he was buying gold because simply because it is going up. “It’s pretty much the opposite of most investments — when prices are rising [they] become more risky, not less, but with gold it seems to be the opposite,” Batnick said.

Batnick added that gold is “really driven by sentiment” and as a result, when prices are rising they tend to keep going that way.

This position also stands in contrast with some of Batnick’s previous statements on gold, notably that gold often garners a position in clients’ portfolios because it will placate folks who have internalized gold’s use a “hedge” despite scant evidence that this is, in fact, an effective hedge.

Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland

Read more from Myles here: