The following article is for information purposes only. New, inexperienced and most retail investors should consult a financial professional.
So many investors point to the volatility of precious metals as a major reason to avoid taking positions in precious metals. This makes sense. Why invest in an asset class that could experience rapid price swings when one could easily add their money into a money market account that pays a whopping 0.9%, but is guaranteed not to fluctuate? In a bubble this argument works. When one does not take into consideration that even modest inflation of 2% makes the real return on the money market account an actual negative return. However, one of the best kept secrets of precious metals investing is that for many professional investors volatility is good. Really good. In an oversimplified look at this method, when investors take a position in precious metals, they also take an alternate opposite position to protect their overall downside risk. Therefore if the value of their position goes up they see profits that are reduced by the costs of their hedge positions. Yet conversely if their portfolio goes down their total position has more protection at the hedge offers an insurance that limits the downside risk.
Let’s look at the world of precious metals hedging, a strategy that we recommend for serious precious metals investors to understand (via VisualCapitalist).
WHAT IS HEDGING?
In a nutshell, hedging is the process of playing both sides of a market to provide protection against the market’s fluctuations.
For bullion dealers and seasoned precious metals investors, hedging means that the dealer/investor has to offset all of their long positions with short positions, and vice versa. By ensuring they never have a long or short overall position in the market, the dealer ensures they are immune to market movements, and lock in their margins between their purchase premiums and sale premiums.
Long positions: Any inventory the bullion dealer/investor holds or has priced/ordered from a supplier. The dealer benefits from upwards price movement in the gold or silver price.
Short positions: Any orders that the bullion dealer/investor has yet to fulfill or is holding in their portfolio. The dealer/investor benefits from downwards price movement in the gold or silver price.
Net house position: Equal to the bullion dealer’s long position minus short position.
