Gold as a refuge from a recession

 In times of economic uncertainty like the one we are experiencing, investors tend to lose their appetite for risk and one of the favorite safe haven values ​​is usually precious metals. Gold, in particular, has appreciated almost 20% so far this year, and is expected to continue to appreciate if fears about a global recession are confirmed gold ira company.

While this behavior in financial markets is common during turbulent times, how effective is it in the long term? And, how well can this investment strategy work in emerging markets such as Latin America?

Let us remember that, although it is advisable to generate diversified investment portfolios , a deep knowledge of the different investment instruments is required to reduce risk and improve returns.

During the last decade, various financial innovations have allowed commodities , whether agricultural, metals or energy, to become part of investment portfolios along with other traditional financial assets, such as bonds and stocks. Commodities are considered today as a way to diversify risk and hedge against inflation .

Several studies have shown that a portfolio that includes commodities has lower risk as it has better diversification coupled with higher returns than a portfolio that does not include them. Additionally, using precious metals such as gold, silver and platinum protects against share price volatility .

Financial portfolio theory establishes the basic concept of hedging . A hedge is the most used strategy to eliminate or mitigate possible losses on financial assets. An effective hedge is one in which changes in the price of a financial asset offset changes in the financial asset to be hedged. In other words, this strategy allows you to reduce the risk of a position in the market.

In my most recent research , titled “Estimation of optimal coverage levels for static, dynamic and conditional variance investment portfolios. Evidence in emerging countries” , I analyzed the behavior of different methodologies for determining an efficient coverage ratio. To confirm the above, I used gold future data as a hedging tool for an investment portfolio in emerging countries.

Gold is an investment instrument that has low correlation and makes it an attractive instrument in periods of economic mismanagement or financial crises, the main characteristic of emerging markets. In other words, I sought to expose different methodologies to determine an efficient hedging ratio that compensates for volatility shocks in emerging markets through a very safe instrument: gold.

The methodologies used were the following:

In a first model, least squares regression was developed for the construction of a static portfolio. Under the profile of an investor, it would be one who invests his funds and is not aware of the changes in the market by not making adjustments that optimize it.

The second model represented a dynamic portfolio whose characteristic was the use of moving windows with 6-month time slots for fund rebalancing. This means that every 6 months regressions were prepared considering these time windows with monthly dynamics. The above exemplifies an investor profile that is more aware of market movements, who continuously monitors their portfolio, making adjustments and optimizing it.

The third model was the construction of a portfolio with conditional variance using the GARCH (1,1) model. A main characteristic of financial time series is the presence of volatility over time. This volatility is not constant, there are periods with high and low volatility which indicates the presence of heteroskedasticity. That is, the variance is not homogeneous (homoscedastic), but varies over time. Hence the importance of establishing a model that captures these changes and allows establishing a better coverage ratio. This is the approach of GARCH models that try to capture and model the movements of variance over a time series.

The results of the study contributed to expanding our knowledge on the subject, allowing three conclusions to be drawn: 

It was shown that gold is a very noble instrument that represents a good hedging strategy for emerging countries with high volatility.

The three models presented confirm the financial theory that having any level of coverage is better than having none , since it reduces volatility by 96.17% unlike a static strategy.

Although the GARCH model efficiently models the movements of the conditional variance, a least squares model with moving windows proves to be an accessible and easy-to-implement tool in determining optimal coverage levels.

In this sense, emerging countries represent investment opportunities due to their attractive returns and high volatilities, but it is necessary to establish mechanisms that allow for optimal coverage levels in portfolios with the aim of minimizing their risk exposure.