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Is the end nigh for safe havens?

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Managing in a sea of uncertainty

Is the end nigh for safe havens?

A safe haven is the holy grail of investing. Assets that can hold their value – or even appreciate – in periods of market turbulence are highly prized by investors. Historically these have included gold, the Swiss Franc, the US Dollar and US Treasuries.

But, in today’s unusual investing world that includes unconventional measures such as quantitative easing (QE), political shocks such as Brexit and increasing tensions among western allies over trade balances; does such a thing actually exist anymore?

If we start off with gold, it is pretty evident that when equity market volatility – measured by the well-followed Vix index – spikes higher, the metal seems to get a boost.  

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However, the long-term chart does not necessarily give one a high degree of confidence that gold will necessarily hold on to its value in an equity market selloff. Certainly steep falls in UK equities seem to be associated with a rising gold price (in GBP terms), but the relationship is pretty noisy and there are times when weaker equities have been linked to a weaker gold price. This was particularly true during the financial crisis in 2008 when investors panicked and sold off all asset classes, including so-called safe havens as the money was needed to meet cash calls elsewhere.

Moreover, an environment of rising interest rates may also be a headwind for precious metals as it increases investors’ cost of carry. However much some investors consider it an insurance policy, gold will always be a non-yielding asset involving a cost in ownership.

We could run the same type of chart for the US Dollar, US Treasuries and the Swiss Franc with much the same (noisy) outcome. So, where does this leave us?

Well, hopefully in a better position than would appear at first blush.

One of the key features of the world of super-low interest rates and QE has been the high degree of correlation between asset classes and the constituent members of those asset classes. Intuitively this makes sense.

Central banks print money and use the cash to buy mainly government bonds and in doing so depress their yields. This, in turn, makes corporate and other higher-yielding bonds more attractive on a relative basis.

As investors switch into these assets, they in turn become more expensive. With the price investors are prepared to pay for a given income stream in the bond market now significantly higher, the price equity investors are prepared to pay for a given equity earnings stream is now similarly higher and this is felt in higher earnings multiples and share prices. It explains, incidentally, why shares were able to rally over the past couple of years without any corporate earnings growth. We can go on and include other asset classes such as property in this asset-substitution channel.

A result of this asset-price reflation, investment returns have been high, but so have correlations. This has had the effect of depressing risk-adjusted returns. It has been particularly true of the equity/bond relationship.