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I've come across a few ETFs that are currency hedged. At first, the "hedged" part in the name seems to imply that this is somehow a safer investment than an unhedged version.

However, take a look at this gold ETF: https://www.etfsecurities.com/retail/se/en-gb/products/product/etfs-eur-daily-hedged-physical-gold-gbse-xetra

The product enables EUR investors to gain exposure to the gold spot price with a daily currency hedge against movements in the EUR/USD exchange rate.

Consider what happens if the euro plummets versus the dollar one day (e.g. euro crisis redux): The price of gold in dollars would most likely go down (because a plummeting euro equals a stronger dollar), and since you are currency hedged with this ETF, the value of your investment in euros also goes down, exactly at the moment when you would want the gold investment to provide you a safe haven and to compensate the weaker euro.

Of course, in the opposite situation (dollar plummeting vs. the euro), you would reap massive profits with a hedged ETF. Hence, it seems to me that the name of this ETF should be currency "speculative" (not hedged) gold ETF. Do you agree with this?

Overall, since gold has value in any currency (and is sort of the ultimate reserve currency), why would anyone want to currency hedge it?

  • Most likely they are buying a one day currency swap, which they call a hedge. – ApplePie Oct 9 '17 at 11:02
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    You are making a lot of baseless assumptions in your prediction of how the prices of gold, EUR, and USD correlate. For example, you are assuming that a weakening EUR = a stronger USD = weaker gold. But in this simplified scenario, a "stronger USD" is only stronger relative to the EUR itself, not stronger relative to all currencies/commodities. Just because $1USD buys 10% more EUR tomorrow doesn't mean it will buy 10% more JPY tomorrow (and particularly it doesn't mean that $1USD will buy 10% more gold tomorrow). – Grade 'Eh' Bacon Oct 10 '17 at 13:15
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    This is not really an area of life where it is a good idea to theorize what numbers "should" do. You should test what they actually do. If your argument were correct, then how could you explain Victor's clear correlation shown below? Humility in this area might help you to learn something valuable - you are convincing no one here with hubris alone. – Grade 'Eh' Bacon Oct 10 '17 at 13:16
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    @ku9182 - No part of your question asks for "a comparison between the hedged ETF vs. an unhedged ETF". You just make baseless assumptions and then state that you think the hedged ETF should be called currency "speculative" (not hedged) gold ETF, and then you ask if others agree with you. The answer to that is no - we do not agree with you. You are incorrect in your assumptions and your understanding of what a hedge is. – Victor Oct 11 '17 at 5:16
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    If you want to know what a chart of an unhedged gold ETF would look like then you can see my first chart in my answer below - Gold: EUR 5 years. – Victor Oct 11 '17 at 5:19
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Currency hedge means that you are somewhat protected from movements in currency as your investment is in gold not currency.

So this then becomes less speculative and concentrates more on your intended investment.

EDIT

The purpose of the GBSE ETF is aimed for investors living in Europe wanting to invest in USD Gold and not be effected by movements in the EUR/USD. The GBSE ETF aims to hedge against the effects of the currency movements in the EUR/USD and more closely track the USD Gold price. The 3 charts below demonstrate this over the past 5 years.

EUR Gold Price

USD Gold Price

GBSE Chart

So as is demonstrated the performance of the GBSE ETF closely matches the performance of the USD Gold price rather than the EUR Gold price, meaning someone in Europe can invest in the fund and get the appropriate similar performance as investing directly into the USD Gold without being affected by currency exchange when changing back to EUR.

This is by no way speculative as the OP suggests but is in fact serving the purpose as per the ETF details.

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    That doesn't make sense. For the very reason that we are investing in gold here, the currency hedge makes the investment more volatile, not less. That is the whole point of my question. – ku9182 Oct 7 '17 at 21:11
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    Exactly, your understanding is incorrect and so is the basis in your question. – Victor Oct 8 '17 at 2:48
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    The whole point of a hedge is to protect against something. So being a currency hedge it means it aiming to protect against currency movements. – Victor Oct 8 '17 at 2:52
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    @ku9182 - I don't need to provide an example based on baseless assumptions - I have provided actual data which demonstrates that the ETF is actually doing what it is supposed to do - hedge against fluctuations in the EUR/USD. – Victor Oct 9 '17 at 8:04
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    @ku9182 - I think it is you fundamentally misunderstanding your own question as well as the meanings of hedging and speculation! – Victor Oct 11 '17 at 6:04
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The risk of any investment is measured by its incremental effect on the volatility of your overall personal wealth, including your other investments. The usual example is that adding a volatile stock to your portfolio may actually reduce the risk of your portfolio if it is negatively correlated with the other stuff in your portfolio. Common measures of risk, such as beta, assume that you have whole-market diversified portfolio.

In the case of an investment that may or may not be hedged against currency movements, we can't say whether the hedge adds or removes risk for you without knowing what else is in your portfolio. If you are an EU citizen with nominally delimited savings or otherwise stand to lose buying power if the Euro depreciates relative to the dollar, than the "hedged" ETF is less risky than the "unhedged" version. On the other hand, if your background risk is such that you benefit from that depreciation, then the reverse is true.

"Hedging" means reducing the risk already present in your portfolio. In this case it does not refer to reducing the individual volatility of the ETF. It may or may not do that but individual asset volatility and risk are two very different things.

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    ""Hedging" means reducing the risk already present in your portfolio" - I don't think this is meaningfully correct. A hedge is simply something that offsets another risk. In this case, the intent of the 'hedging' is reducing the EUR currency volatility inherent in a USD gold investment. For someone living in the US who has all earnings / expenses in USD, then yes, hedging against the EUR volatility would increase risk, but the hedging itself is still being done as-advertised. – Grade 'Eh' Bacon Oct 10 '17 at 13:11
  • @Grade'Eh'Bacon I think farnsy's statement is correct. In a portfolio of gold futures priced in USD, held by an EUR-based investor, the investor is exposed to price risk of gold and FX risk. Currency hedging reduces the currency risk. A same portfolio held by a USD-based investor does not expose the person to any FX risk. So there is no "currency hedging" per se. If this investor take on some kind of currency swap, that's just a bet/speculation, not hedging. – xiaomy Oct 10 '17 at 20:29
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    @xiaomy You are completely correct, that was my error in understanding. Thinking it over again, there is no inherent fx risk associated with the USD-gold contract, there is only a risk associated with having a USD-denominated contract while having the rest of your financial life in EUR. Therefore this product is hedging only a specific risk that the holder may have, it is not internally hedging the underlying asset itself. Since I cannot change my vote on an unedited post I will attempt to edit to add clarity. – Grade 'Eh' Bacon Oct 10 '17 at 20:57
  • @Grade'Eh'Bacon Please don't edit my answers unless there are actual errors in them (like typos). While your edits may make something more clear to you, I don't necessarily agree with them. – farnsy Oct 11 '17 at 3:48
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Overall, since gold has value in any currency (and is sort of the ultimate reserve currency), why would anyone want to currency hedge it?

Because gold is (mostly) priced in USD. You currency hedge it to avoid currency risk and be exposed to only the price risk of Gold in USD.

Hedging it doesn't mean "less speculative". It just means you won't take currency risk.


EDIT: Responding to OP's questions in comment

what happens if the USD drops in value versus other major currencies? Do you think that the gold price in USD would not be affected by this drop in dollar value?

Use the ETF $GLD as a proxy of gold price in USD, the correlation between weekly returns of $GLD and US dollar index (measured by major world currencies) since the ETF's inception is around -47%.

What this says is that gold may or may not be affected by USD movement. It's certainly not a one-way movement. There are times where both USD and gold rise and fall simultaneously.

Isn't a drop in dollar value fundamentally currency risk?

Per Investopedia, currency risk arises from the change in price of one currency in relation to another. In this context, it's referring to the EUR/USD movement.

The bottom line is that, if gold price in dollar goes up 2%, this ETF gives the European investor a way to bring home that 2% (or as close to that as possible).

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I will just try to come up with a totally made up example, that should explain the dynamics of the hedge.

Consider this (completely made up) relationship between USD, EUR and Gold:

|              |      t0 |      t1 |      t2 |
|--------------|---------|---------|---------|
| USD          |   114.0 |   106.0 |   124.0 |
| EUR          |   100.0 |    98.0 |   102.0 |
| Gold (grams) |     1.0 |     1.1 |     1.2 |
|--------------|---------|---------|---------|
| EUR/USD      |  0.8772 |  0.9245 |  0.8226 |
| Gold/USD     |   114.0 |    96.4 |   103.3 |
| Gold/EUR     |   100.0 |    89.1 |    85.0 |
|--------------|---------|---------|---------|

Now lets say you are a european wanting to by 20 grams of Gold with EUR. Equally lets say some american by 20 grams of Gold with USD.

Their investment will have the following values:

|              |                t0 |             t1 |             t2 |  Return |
|--------------|-------------------|----------------|----------------|---------|
| Gold (grams) |               20  |            20  |            20  |         |
| USD          |            2,280  |         1,927  |         2,067  |   -9.4% |
| EUR          |            2,000  |         1,782  |         1,700  |  -15.0% |

See how the europeans return is -15.0% while the american only has a -9.4% return?

Now lets consider that the european are aware that his currency may be against him with this investment, so he decides to hedge his currency. He now enters a currency-swap contract with another person who has the opposite view, locking in his EUR/USD at t2 to be the same as at t0. He now goes ahead and buys gold in USD, knowing that he needs to convert it to EUR in the end - but he has fixed his interestrate, so that doesn't worry him.

Now let's take a look at the investment:

|              |                t0 |             t1 |             t2 |  Return |
|--------------|-------------------|----------------|----------------|---------|
| Gold (grams) |               20  |            20  |            20  |         |
| USD          |            2,280  |         1,927  |         2,067  |   -9.4% |
| EUR          |            2,000  |         1,782  |         1,700  |  -15.0% |
|--------------|-------------------|----------------|----------------|---------|
| EUR hedged   |            2,000  |         1,691  |         1,813  |   -9.4% |

See how the european now suddenly has the same return as the American of -9.4% instead of -15.0% ?

It is hard in real life to create a perfect hedge, therefore you will most often see that the are not totally the same, as per Victors answer - but they do come rather close.

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