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How Do Index-Based Gold-Hedged Strategies Work?

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Index design and construction 

The S&P 500 Dynamic Gold-Hedged Index seeks to track an investment strategy that is long on the S&P 500 and hedged against the fluctuations of the US dollar versus gold. The index is calculated by hedging the beginning-of-period S&P 500 (TR) index values using gold futures.

The designated set of COMEX-listed gold futures used in the S&P GSCI is also used in the S&P 500 Dynamic Gold-Hedged Index. The index rolls to the next gold futures contract in the first five trading days of the month prior to the expiration of the current contract. On each day, 20% of the gold futures contract is rolled into the new contract, and the index equalizes notional exposure to equity and gold.

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The index is also rebalanced to equalize notional exposure to equity and gold after the close of the first business day of September, if the difference between the values of the gold futures exposure and the equity exposure is more than 10% above or below the value of the index as of the last rebalancing, or if the sum of the equity return and gold futures return since the last rebalancing is more than 20% or below -20%.

The S&P 500 Dynamic Gold-Hedged Index Market Realist’s View

The increasing use of gold (IAU) as an alternative asset class has prompted Standard & Poor’s, the world’s leading index provider, to launch the S&P 500 Dynamic Gold-Hedged Index. In a dynamic gold-hedged index strategy (GLD), investors aim to eliminate the risk of dollar fluctuations. By employing this strategy, investors sacrifice any possible currency gains against gold. Because of the inverse relationship between gold (GDX) (GDXJ) and the US dollar, investors holding long gold futures contracts are likely to gain if the value of the dollar declines against the dollar price of gold.

Performance

In the past, the S&P 500 Dynamic Gold-Hedged Index has outperformed the S&P 500 (SPY) by a wide margin. Year-to-date, the S&P 500 Dynamic Gold-Hedged Index has risen by a staggering 37.2%, as compared to the mere 6.6% gain seen by the S&P 500.

Notably, the S&P 500 Dynamic Gold-Hedged Index has been beating the S&P 500 on a long-term basis as well. In the past ten years, the S&P 500 Dynamic Gold-Hedged Index has provided annualized return of 14.3%, as compared to the 5.5% return seen by the S&P 500.

Now let’s go deeper into the benefits of this kind of gold-hedged investment.

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