S&P launches Gold Hedged index; UBS signs up, other banks may follow

By Emma Trincal

New York, Dec. 7 - Standard & Poor's announced the launch of the S&P 500 Gold Hedged index, saying that it has licensed UBS to create and launch investment products based upon this new benchmark.

The new index seeks to simulate the returns of an investment strategy that is long total return of the S&P 500 index and long gold futures contracts, according to a press release. It will allow investors to participate in the returns of the U.S. equity market while hedging against a decline in the value of the dollar versus gold.

"This new index is for investors exposed to the S&P 500 who want to hedge the U.S. dollar," Liz Taxin, director of strategy indexes at S&P Indices told Prospect News in an interview. "More specifically, it's a hedge against the dollar depreciation. If gold goes up, the hedged index would outperform the S&P 500. But the flip side is that if the dollar appreciates and gold is down, then the hedged index underperforms the S&P."

Investors stand to gain when the dollar loses value because they hold long gold futures contracts, which are priced in dollars.

While investors are protected against a declining dollar, there is no hedge against stock market risk and dollar appreciation, said Taxin.

Gold bugs

At the origin of the index was the bullish momentum around the precious metal.

"There is a heightened interest in the market for gold due to the weakness of the dollar and inflation concerns. The market right now has an interest in this type of strategy," Taxin said.

Another factor for the creation of the new index was S&P's strategy to develop its existing brand.

"It was a natural expansion of our family of indexes. We have a series of currency hedged indices. And we are always looking to expand our products," she said.

S&P already has versions of this product available for the euro, the Japanese yen, the British pound and the Canadian dollar.

The results of a gold-hedged index strategy, versus that of an unhedged strategy, vary depending upon the movement of the gold futures contract and the dollar. "Usually the hedge is used against a foreign currency, not a local currency. But this index is used to hedge a local currency because U.S. investors still have currency risk," Taxin said.

Bankers' inquiries

S&P creates indexes that it can then sell to banks for use as benchmarks and to underlie structured products and exchange-traded funds.

The index provider has already signed up UBS, which will use the index for future structured products. S&P is talking to other financial institutions also interested in using the index for the construction of derivatives instruments.

"We have received a lot of inquiries from a number of different clients. UBS is one. We have received a good amount of interest from banks and others," she said, declining to comment further.

"This investment works for you if you believe that the gold rally is going to continue and you also want to be invested in the U.S. stock market but are concerned about the U.S. dollar depreciation," a source said.

"You can be in the U.S. equity market as well as gold. The bottom line is: If the dollar appreciates relative to gold, you lose. If the dollar depreciates relative to gold, you win."

Because the index establishes a long position in both U.S. stocks and gold, it offers a hedge against a declining dollar, simply because "being long gold is the equivalent of being short the dollar," this source said.

On the other hand, "if the dollar is up, then gold is down. In that case, you lose and you're better off with the S&P 500," he noted.

A new tool

One of the catalysts for the new index and the demand for future products that may use it is the impact of a lower dollar on stock gains.

Investors in U.S. stocks are looking for ways to protect their return against the declining moves of the dollar because "the decline in the value of the dollar erodes your returns in stocks," this source said, as it gives you only "a fraction of your gains."

As a result, money has poured into commodities and other asset classes that offer a hedge against a declining dollar, he said, "to a point where people are wondering - do I invest in stocks or do I invest in commodities? This new index allows you to do both. Now they're going to be able to invest in stocks and hedge against a potential decline in the value of the dollar, something they couldn't do with the S&P," he said.

"Traditional tools to hedge equity against a dollar decline were commodities or being short Treasuries. Now you can do that in a different way, I think it's a very big deal for investors," this source said.

Directional bet

However, the risk of this investment is to "put on the wrong hedge" and to see gold prices decline instead of rallying, said this source.

"This product is not for you if you're bearish on gold. Gold prices have certainly soared of late. But gold has only gone up by 100% in 30 years. It's a very low inflation-adjusted return, and many think that there is more upside looking forward," he said.

Past performances

This source compared the historical performance of the S&P 500 with the back-tested return of the S&P Gold Hedged index.

The S&P 500 "made no money" in the past 10 years, he said. "But in the last 10 years, the S&P Gold Hedged outperformed the S&P by 9% per year," he said.

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