Hedging local currency risk with precious metals

Precious metals are popular instruments for hedging local currency risk. Most precious metals are priced in US dollars, which is a single-currency numéraire. The numéraire of a precious metal can easily be changed, which allows investors to choose their own local currency as the precious metal’s numéraire and subsequently use it to hedge their own local currency risk. In this paper, we decompose the standard hedge ratio into two parts, namely, a precious-metal hedge ratio and a local-currency hedge ratio. We consider three main precious metals, namely, gold, silver and platinum, from the beginning of 1990 to the end of 2019 to hedge local currency risk for individual G10 currencies. Over the full sample, we find that all standard hedge ratios are negative for all combinations of currencies and precious metals. However, the negativity is driven by the precious metal’s numéraire, rather than the precious metal.