Gold as a Safe Haven Asset

Gold as a Safe Haven Asset
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Although gold has often been criticized as an imperfect and “obsolete” safe haven asset, the escalation of international conflicts in 2019-2020 has shown that many investors remain true to the “In gold we trust” mentality. Gold exchange rates were rising during the escalation of the trade war between the US and China, but kept the ground they gained as the relations eased. Now, during the conflict with Iran, the gold exchange rates are at a several-year high. The reasons for gold’s popularity are well-known: limited mining, independence from governments, and its time-honored role as a valuable asset. However, gold and other metals still have their own drawbacks that must be accounted for when one invests in them.

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Safe Haven Assets and Their Key Properties

A safe haven asset is an asset that is purchased for protecting one's funds during a crisis, rather than for maximizing one's profits. This role is usually served by gold and other precious metals, bonds issued by economically stable countries, specialized hedge fund shares, etc.

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A good safe haven asset must have at least some of the following properties:

  • Low volatility. A safe haven asset's price must remain stable even as the prices of other assets drop quickly.
  • A positive price trend that matches or exceeds inflation. The asset's price must not remain the same – it needs to grow over time, otherwise its actual value will gradually decrease.
  • High liquidity. A safe haven asset must be popular on the market, so that it can always be converted into other assets – such as when the threat of the crisis is gone.
  • Weak or inverse correlation with stock market fluctuations. In other words, a small or even negative Beta coefficient.

Beta determines how a specific asset's price correlates with general market fluctuations, such as those of the S&P 500 or Russell 3000 indices.

  • For Beta > 1 we have a risky volatile asset that gains value more quickly than other assets during a boom, and loses it more quickly during a recession.
  • For Beta = 1 the asset's price rises and falls at roughly the same rate as the market as a whole.
  • For 0 < Beta < 1 the asset's price rises less quickly than those of other assets during a boom, and drops less quickly during a recession. Typically, such assets include the shares of well-established companies whose goods have a stable demand (energy sources, food).
  • For Beta = 0 the asset's price is independent of market fluctuations. It may not be exactly constant, but its fluctuations follow their own laws. Gold is an asset with a Beta close to zero.
  • For Beta < 0 the asset's price changes inversely to the market trends. It typically drops during booms, and rises during recessions. This is, for example, how the so-called inverse funds work, whose issuers trade on bear markets.

All assets with Beta < 1 can be considered safe haven assets to an extent, but each of them has its own niche. Assets with Beta < 0 are the most effective immediately preceding a crisis, but if the market is booming, such an asset at odds with the market is going to lower the effectiveness of your portfolio greatly. The owners of safe haven assets with a zero or small positive Beta are going to have much better luck here.

Gold Exchange Rates: Advantages and Disadvantages as a Safe Haven Asset

Gold is the most well-known, classic safe haven asset. Its reputation reinforces gold's status on the market. During crises, investors try to get rid of their riskiest assets. Gold, however, is the asset that investors usually keep, thanks to the trust it enjoys worldwide.

This trust did not appear out of nowhere. Gold is not issued by any one national bank, it is mined in limited quantities due to natural reasons, and its total quantity worldwide is nearly constant. Nevertheless, gold does not perfectly meet all the criteria listed in the previous section.

First off, gold's volatility is not particularly low. Gold cost around $300 per ounce in 2000, almost reached $1900 in 2011, dropped to just above $1000 by late 2015, and reached $1550 in 2019. In other words, gold's price varied almost by a factor of two during the 2010s, which can be compared to the volatility of the average American stocks from S&P 500.

During the first two decades of the 21st century gold has shown an amazing result – a fivefold increase in value. However, most of the growth in gold's value took place during the 2000s, and those who were rash enough to buy gold in 2011 when its price was near its maximum are yet to recover their losses. The reason for that, as mentioned before, is gold's high volatility.

The liquidity of gold and precious metals in general has always been a complicated matter. The direct turnover of gold is very difficult due to the danger of counterfeiting. Certified gold bars are the safest, but their turnover is heavily taxed. It is true that the investor does not have to buy actual gold – there are precious metal accounts and other tools that allow one to track metal exchange rates. However, with these alternatives gold loses its independent status, and can no longer protect its owner from the most serious force majeure events such as wars or personal conflicts with the government (when there is a threat of having one's account frozen).

The independence of the gold exchange rates from stock market fluctuations is ensured to an extent by gold's low Beta coefficient, however, this is also just a statistical pattern. Due to its high volatility, the gold exchange rates may behave very differently during different market crashes.

For instance, gold nearly ignored the 1999-2000 Dot-com bubble, but the same was not true of the 2008 crisis. The stock index drop began during the fall of 2007 and ended in the winter of 2009. The indices recovered their old values by 2012-2013. As for gold, it grew in value until March 2008 inversely to the indices, but then gold's price started to drop along with the indices as everyone tried to buy US dollars. Gold's value resumed its growth in October 2008. Overall, gold fulfilled its role of a safe haven asset, but alarmed the investors considerably during the worst days of the recession.

Is Gold On Top of the Heap Again?

Although gold resumed its positive trend in 2016-2018 that it had lost in 2012-2015, that trend was fairly modest: by the end of 2018 gold cost about $1220 per ounce, which was a mere 15% increase over 3 years. However, the trade war between the US and China drew a lot of attention to this precious metal: by September 2019 its price had already risen above the $1550 mark, returning to its 2013 value.

The gold price was rising during most of 2019 as stock indices rose and fell. The détente between the US and China in the fall decreased the gold price slightly, but by the end of the year it started growing again. With the impending threat of a serious war during the Iranian crisis of January 2020 the gold exchange rates have reached a new high in many years as it exceeded $1580 per ounce.

But what about other assets that many people expect to replace gold? What about Bitcoin, which, like gold, has limited emission and is independent from governments? As strange as it may seem, after all the rollercoaster-like rocking that Bitcoin experienced during 2019 it still had a net increase in value, and even more so than gold – its value increased nearly twofold from $3000-4000 to $7000-8000. This is no surprise for a risky and highly volatile asset, but it still shares some traits with gold. Like gold, its value rose significantly in response to the Iranian crisis: from $6900 on January 3 to $8300 on January 8.

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