Safe Haven Assets in Volatile Times
A Look at Dollar and Gold
During periods of market volatility, investors often turn to safe-haven assets as a way to reduce their overall risk. To better weather market swings, investors can plan ahead by determining which assets will rise in value while others fall.
A safe-haven asset is a type of investment that usually holds or even increases in value when the economy is in a bad spot. In the case of a market recessions, these assets may rise in value since they are either uncorrelated with the economy or negatively associated with it.
It is up to investors to determine which safe haven is best for the current economic scenario, as not all safe havens will share these features. Because of this, investors need to know exactly what they hope to gain from safe-haven assets before making any decisions.
In this article, we take a closer look at two of the most popular safe haven assets amongst investors – namely gold and the dollar – and show you how to trade with safe haven assets.
The dollar as a safe have asset
During times of economic uncertainty, the US dollar has been one of the most widely used safe haven assets for almost 50 years. It has many features that make it a safe haven, the most important of which is that it is the most actively traded currency in the foreign exchange market. The 1944 Bretton Woods agreement established the fixed currency system and established the US dollar as the world’s principal reserve currency, establishing its credibility in the eyes of the investing public. The US dollar continued to be seen as a safe haven even after the system was disbanded since it represented the strongest economy in the world.
Although many predicted that increasing volatility due to US President Donald Trump’s contentious politics would hurt the dollar’s standing as a safe-haven, it appears that the currency is still benefiting from safe-haven flows.
The US Dollar Index, for instance, rose by 5.29% between January and August of 2018, despite trade tensions’ impact on financial markets and commodities generally.
Gold as a safe haven asset
Gold is commonly associated with the concept of a safe haven. Gold’s price is unaffected by interest rate decisions made by central banks because it is a tangible good, and its supply cannot be artificially increased or decreased by means such as printing, a policy also known as quantitative easing.
Gold’s role as a safe haven asset after the 2008 financial crisis is illustrative. As an example, gold’s price increased by over 24 percent in 2009 due to an increase in investment, and it has continued to rise steadily since then, all the way into 2011.
Gold’s historical role in supporting currencies and as a store of value has led many to conclude that the decision to purchase gold is influenced by irrational beliefs.
According to the conventional wisdom, when investors see warning indications of a major market crash, they rush to buy gold because of its reputation as a haven in times of uncertainty. Investing in gold as a haven has turned into a self-fulfilling prophecy.
What makes an asset safe in times of market volatility?
An investment in a safe haven can reduce overall portfolio risk and protect you from market fluctuations. Safe haven assets typically do better than other markets during market downturns.
Many of the features of safe haven investments are the same:
- High liquidity
- Stable demand
- Relevance and assurance that it won’t be replaced
- Expected to retain or rise in value during times of economic turmoil
In the event of a financial crisis, it is crucial for investors to know which assets are viewed as safe havens.
This allows them to better anticipate the price movement of other decreasing assets and employ the most appropriate risk management technique, such as closing long holdings or initiating short ones.
Negative effects on an investor’s portfolio value from events like stock market bubbles, crashes, and economic recessions can persist for years.
How to trade safe haven assets
The wisest course of action for any investor is to take as many precautions as possible to ensure that they are ready for a market downturn, which is a normal and expected part of the market cycle.
Safe-haven investments typically outperform the bulk of markets during times of financial crisis.
Traders need to be able to recognise safe-haven assets and use this knowledge to foresee price fluctuations and apply their own strategies, even though investors often utilise safe havens to shield their portfolio’s value.
You may want to consider closing out any open long positions or opening new short ones if you anticipate a dramatic decrease in the market price as investors flee ‘riskier’ assets for safer ones.
Yet, you might benefit from price increases if you are confident in your ability to determine which assets will serve as safe havens in the near future.
Safe-haven asset trading patterns are very subjective and cannot be predicted. In order to profit from price changes or hedge against price declines, knowing how the market feels about safe-havens at any given time is essential.
Trading gold and the dollar
The European economy shifted its minting system from silver to gold between the thirteenth and fourteenth century.
This evolved as people realised that gold’s intrinsic durability and appeal made it a more reliable standard for establishing the prices of items in exchange.
The agreement to peg the world’s currencies to the dollar has heightened the importance of the inverse relationship between gold and the dollar.
The price of gold is a barometer of the health of the US economy; a rise in gold prices indicates economic distress.
When gold prices are low, however, other investments like equities, bonds, or even real estate tend to do better.
Investors acquire gold as a hedge against economic crises and inflation, with the gold price serving as a barometer for economic success.
Traders’ faith in the commodities market is reflected in the gold price, making it a credible barometer of market sentiment.
To hedge their bets against a possible economic downturn, these investors will buy more gold, and vice versa when times are good.
A stock market correction occurred in 2016 in the United States as an illustration of this mechanism in action. Gold prices increased as the Dow Jones Industrial Averages declined.
When the market looks hazardous, gold is a safe haven.
The wartime suspension of the Gold Standard eroded faith in that system and prompted calls for a more malleable currency.
As the world economy expanded and the gold supply shrank, the British pound and the American dollar rose to prominence as the world’s reserve currency.
In turn, the dollar may be exchanged for gold at a set rate of $35 per ounce. Although the dollar is currently only tied to gold through indirection, the global financial system still operates on a gold standard.
Given that the United States maintains significant trading relationships with countries in Asia, Europe, and North and Central America, the dollar continues to enjoy safe-haven status.
Nonetheless, the United States still has not entirely recovered from the past economic calamity, as seen by persistently high unemployment rates (approaching 10%) and sluggish economic growth (which has persisted for a considerable while).
And the fact that investors can trust the United States Treasury to make good on their investments is what gives the US dollar its status as a safe haven currency. Investors fleeing the last financial crisis flocked to US Treasuries and the US dollar.
Treasury bills and notes are examples of government bonds. They are effectively a “I owe you” from the government with a defined maturity date and interest payments.
The only distinction between the two is the length of time you’ll have to wait to get your money back in full. In contrast to government bonds, which might have maturities of ten years or more, treasury bills mature in one year or less.
Government bonds from developed economies are more trusted by investors; US treasury bills are the most widely held of these bonds.
Their status as a safe haven stems from the United States’ stellar credit rating and the excellent quality of income denominated in US dollars. Investors view government bonds as a risk-free safe haven because of the consistent income they generate and the guarantee of full repayment upon the bonds’ maturity.
During times of market instability, the aforementioned assets’ values may fluctuate. Also, the definition of a safe haven evolves throughout time.
Even if an entire economic sector is doing poorly, the stock of one company operating inside that area that is doing well may be seen as a safe haven.
Investors wishing to put their money in safe havens would be well to complete their research ahead of time, as an asset that is viewed as such during a market slump may not be such a good investment during a market upturn.
That said, the dollar, and gold in particular, have shown dependable longevity as safe haven assets.