Buying gold in local currency is usually the more effective investment

Issuers of gold certificates usually offer two versions of these instruments: on the one hand a certificate which securitizes gold as a commodity, measured and priced exclusively by its weight. The second kind of gold certificate securitizes gold in its capacity as a financial instrument. Here, the gold price is usually determined in US dollar per fine troy ounce. On markets where the local currency is not the US dollar, this kind of certificate will be offered exclusively currency-hedged as so-called Quanto certificates. In this particular case, the certificate reflects not only changes in the value assessment of gold as a commodity but – to the same extent – exchange rate fluctuations of the US dollar. As a consequence, buyers of currency-hedged gold certificates will be betting both on the US dollar devaluation as well as the appreciation of gold as a commodity. However, this combination of simultaneous gold and exchange rate betting comes at a price – in the form of higher fees for the investor – and may diminish the returns in case of wrongly assessed exchange rate developments, as a performance comparison of plain and Quanto gold certificates in the light of the stronger US dollar over the course of last year clearly shows: numerous Quanto certificates performed significantly weaker than plain gold certificates which simply reflect the commodity gold.

From early 2014 to 5 May 2015, the price of a fine troy ounce of gold in euro had risen by 16.4 per cen, while the gold ounce in US dollar had decreased in value by 4.3 per cent. During the same period, Quanto certificates on gold slipped by 5.7 per cent – a result of the higher fees due to the need for currency hedging (see chart below).

Therefore, investors should carefully consider whether or not to buy gold in US dollar at all, since the foreign currency component only becomes part of the product through its denomination, thus making a return-diminishing hedge necessary in the first place. After all, gold is by no means linked to the US dollar – the price development is largely autonomous. Gold is accordingly independent when priced in the investors’ local currency, which has the monetary sovereignty. Those living in the EU simply have to buy gold in euro in order to eliminate the foreign currency component most effectively. However, investors wishing to express their market view of both the prices of gold and the US dollar will usually act more cost-efficiently by purchasing two separate certificates – one on gold and another on the US dollar.

Arnulf Hinkel
Financial journalist