The Best Way to Hedge Against Political Unrest

Any idiot can make money in a bull market.

You know the type of guy I mean… The brag at the dinner party who can’t stop yapping about how “X” sector is the hot new thing. The guy who keeps dropping references to the “fat profits” he just “bagged” on “Y” trade.

These guys are usually nursing fat losses before long. Eventually the market turns against them. And because they don’t know how to deal with losses, they panic and sell at exactly the wrong time.

Professional traders have a name for this kind of investor. They call them “weak hands,” because these dinner party brags don’t have the courage of their convictions. This makes them all too susceptible to shake outs in the markets.

Real investors are made of steelier stuff. They know that stocks go down as well as up. They know the market can have mood swings that make your average teenage girl look like an angel. And they know how to hedge for when things turn sour.

The biggest risk for emerging market investors has always been the political kind.

The reason there are such high returns on offer for investors willing to commit their cash to underdeveloped economies in far-flung corners of the globe is that these places have shakier political and economic foundations than back home.

Emerging markets are by definition growing into fully emerged markets. They are progressing toward being advanced economies like the U.S., Europe and Japan. But they’re not there yet.

Some common risk areas are:

1) Poor infrastructure – Roads, railways, ports and telecommunications networks still need work.

2) Currency volatility – Smaller, less liquid currencies are more susceptible to speculators than bigger, more widely traded currencies such as the U.S. dollar, the yen and the euro.

3) Limited equities markets – Often there are relatively few stocks trading on local exchanges. Plus, there are often barriers to entry for foreign investors such as capital controls. And many companies may still be state owned and therefore beyond investors’ reach.

But by far the most common risk is political risk. This is the kind of risk that investors in Egypt are experiencing now. It’s also what shook out many investors in Thai stocks last year.

Political risk—what’s sometimes known as “geopolitical risk”— is the risk that your return on your investments may get dragged down by political instability in the country you’re invested in.

It may take the form of a rigged election…a coup by the army…the death of a long-standing political leader…a civil war…or even just plain old corruption.

That’s not to say that investing overseas can’t be wildly profitable. It certainly can. It simply means that if you don’t hedge for this kind of risk, you’re asking for trouble as an overseas investor.

What the Top Performing Advisors Tell Us About Gold

Gold is one of the best ways to hedge against this kind of risk.

For centuries, investors have bought this shiny yellow metal when the going has gotten tough. That’s why it’s often known as a “safe haven” in times of trouble.

Given the current political and economic climate, it’s no surprise that the top investment advisors monitored by Hulbert’s Financial Digest (which tracks the advice of more than 160 financial newsletters) are focused on the gold market.

Hulbert’s defines a “top performer” as advisors who were among the top 25% for 12-month returns and who have beaten the market over the trailing decade. So it’s a fairly accurate sample.

Now, gold hasn’t exactly shone recently. In fact, many mainstream financial pundits are touting the idea that gold’s run is over.

But on the theory that the top performing advisors are likely to be more right than the bottom performing advisors (many of whom have piled into sectors like biotech, semiconductors and telecommunications equipment) gold’s recent weakness is more of an opportunity to buy than a reason to sell.

As unrest sweeps across North Africa and knocks on the door of the Middle East, consider hedging your overseas bets with some exposure to gold.