This paper focuses on geopolitical risk (GPR) related to wars, terrorist acts, and tensions between states. Evidence is provided to demonstrate that GPR is different from other economic, financial, and political risks measured in the literature and that this research could therefore be helpful to investors with respect to geopolitical tensions in particular.

Precious metals are studied together with a variety of other assets (the US dollar, stocks, bonds) to provide an understanding of whether precious metals possess a unique hedging or safe haven property against GPR. Whether trading or hedging strategies can be formed in practice is also explored, and these findings could be more relevant to practitioners.

The authors proxy GPR using the GPR index, which employs textual analysis to reflect the proportion of news articles discussing GPR that appeared in 11 national and international newspapers between January 1985 and October 2018. The automated search identifies articles containing references to wars, terrorist acts, or tensions between regions. Actual adverse geopolitical events and pure threats are further disentangled via sub-indices.

The authors study the precious metals gold, silver, platinum, and palladium. Other assets, such as copper, the S&P 500 Index, the US dollar index, and the 10-year Treasury note, are added for comparison.

To examine the effectiveness of hedging political risk, the authors regress return data of each asset’s futures contract on GPR index moves with a set of control variables (credit spread, term premium, trading volume, and open interest). Assets with strong positive correlation to GPR index change are deemed as strong hedges to GPRs, or safe havens, if the positive correlation is statistically significant to extreme GPR index moves.

The authors focus on daily data, which allow them to capture geopolitical events in a timely manner. A one-day lag is applied to asset returns to understand market reaction to events, assuming that related news is published in the newspapers the next day. The authors then repeat this same analysis with monthly data and further incorporate other uncertainty measures for comparison. Other tests complementing the study include analyses of volatility clustering, lead-lag relationships, and the impacts of contango/backwardation.

At the end, the authors form hedging and trading strategies based on trading signals related to the GPR index. They analyze strategies based on concurrent and prior trading signals to demonstrate how portfolio performance could be affected by holding precious metals against GPR and to determine whether the strategies can be implemented in practice.

Precious metals respond primarily to threats but not to realized acts, and all precious metals show some ability to hedge GPR. Only gold and silver perform consistently; that is, both provide a strong hedge for normal GPR and a safe haven during extreme periods. Palladium responds to GPR in general but not in extreme periods (with the reverse being true for platinum). Mining locations might be one explanation for this, given that gold and silver are mined in many locations around the globe. Palladium and platinum are mined predominately in Africa and Russia and are thus less exposed to geopolitical tensions in other areas. Alternatively, demand characteristics differ across precious metals. Gold and silver have higher investment demand, while palladium and platinum have greater industrial demand related to the automotive industry, which is more dependent on economic growth factors.

In contrast, other assets are negatively related to GPR (though not in a statistically significant way), so they are not a hedge in general. The exception is the 10-year US Treasury note, which experiences price increases when GPR rises during periods of extreme political risk. One explanation is that news has become more globally relevant and attracts investors’ attention more broadly than do normal GPRs occurring in local areas that are more relevant to precious metal production.

The GPR index appears to capture a risk factor that is different from other uncertainty measures. Adding precious metals to an S&P 500 stock portfolio based on GPR trading signals appears to be a valuable hedging strategy. The hedging strategy based on concurrent GPR signals frequently outperforms the buy-and-hold stock strategy, though profits are not fully realizable. A more investable strategy that adds precious metals based on prior signal works only for daily frequency. Pure trading strategies that long precious metals based on GPR indicators generate positive returns but consistently underperform the S&P 500 stock portfolio in nominal terms.