How Safe Havens Works
When the seas are turbulent, the captain steers his vessel into a safe haven – a part of
the sea deemed calmer and therefore, secure.
Similarly, investors seek investments that are expected to retain or increase in value
when the markets are turbulent as they are right now.
These classes of assets are referred to as safe-haven assets.
Market downturns are unavoidable, and are part of the natural market cycles.
As an investor, you must prepare yourselves as much as possible.
You must find a way to keep your money safe till the storm calms.
Safe havens help investors reduce their risk of losses in the event the market goes down.
They can prepare for a market movement if they can identify the assets more likely to
appreciate or retain their value when others are depreciating.
But there's no guarantee that what served as a safe haven in a market downturn could
be just as secure in the next recession.
Investors, therefore, must weigh their options carefully before choosing a safe haven.
So, how do you know an asset will be a safe haven?
The assessment of an asset's safety in times of economic uncertainties is hinged on its
correlation with conventional assets, amongst other criteria.
Here’s is a rundown of what makes an asset a safe-haven.
So, lets look at some characteristics of safe-haven assets.
You see; the desirability of an asset as a safe haven is based on certain features which
include: 1.
Correlation The asset is uncorrelated or negatively correlated
with the general economy and conventional assets.
In other words, it could even appreciate when the market crashes.
2.
Liquidity The asset must be easily converted to cash
at any time.
This will help you enter and exit positions at your price, thereby avoiding slippage.
Slippage refers to the difference between the expected price of a trade against the
price it was actually executed.
3.
Supply and demand A safe-haven asset must have a limited supply.
There should also be a stable demand as well to keep the price stable.
If the asset has a supply that exceeds demand, the asset tends to lose value.
An excellent example of such an asset is gold, which has a supply deficit.
And whenever there is more demand, it gains in value.
4.
Permanence The asset should not decay or, in any way,
decrease in intrinsic value over time.
It should also not become too expensive to maintain.
5.
Functionality The asset should not easily be replaceable
in the long-term.
It should provide a function that will keep up a long-term demand for it.
Types of safe-haven assets When you are shopping for a safe-haven asset,
always remember that you are not buying them to make a killing on your investment.
Instead, the idea is to purchase assets that will retain their value and reduce your exposure
in massive, extended market downturns.
Here are some of the most common safe-haven assets and ways they can help to protect your
capital during periods of insecurity and uncertainty.
1.
Cash Cash is said to be the real safe haven in
times of market downturn.
You know exactly how much it's worth and what it can buy.
It’s major advantage is it’s liquidity and can be readily used to meet any immediate
obligation.
But it earns little or no returns, and when you factor in inflation, a cash investment
steadily declines in value.
2.
Currencies
Historically, the currencies investors look to for safety in times of trouble are the
Japanese Yen, the Swiss Franc, and the U.S. dollar.
For instance the Japanese Yen often appreciates against the U.S. dollar when U.S. stocks and
government bonds face instability.
Therefore it's considered to be a safe haven.
After World War II, the Japanese economy recovered reasonably quickly and caught up with the
rest of the world.
Their highly respected central bank, the Bank of Japan, worked to establish the Yen as a
major world currency.
Despite the occasional government intervention, the Yen has retained its attractiveness to
investors during a financial crisis, due to its liquidity.
The Yen owes its reputation as a safe-haven to Japan's high trade surplus against its
debt.
This means that the value of foreign assets held by Japanese investors is far more than
Japanese assets owned by foreign investors.
So, when markets become quote on quote ”risk off” money flows out of other currencies
back into the Japanese market, which strengthens the Yen.
And since everyone believes that the Yen is a good safe-haven, it continues to be one.
A kind of self-fulfilling prophecy, if you will.
The Swiss Franc The swiss franc has been known to appreciate
whenever the global markets become shaky.
This was confirmed in an extensive study by German's Central bank, Deutsche Bundesbank.
The Swiss franc gained the reputation of being a safe-haven currency because of the famed
political neutrality of the Swiss government, their advanced stable banking sector, and
their strong economy.
Furthermore, the country's independence from the E.U. ensures that adverse economic and
political events that shake the region leave it unaffected.
Which makes it a popular haven for capital in times of financial crisis.
The U.S. Dollar: Investors have always regarded the U.S. Dollar
as a safe haven.
Because of it's liquidity.
It's actually the most liquid currency on the forex market – which is it's most significant
safe-haven characteristics amongst several others.
The U.S. dollar gained its reputation from the 1944 Bretton Woods agreement, which made
it the world's primary reserve currency.
After the system was discarded, the U.S. dollar was still regarded as a safe haven because
it represented the world's largest economy.
Even the increased volatility caused by the current U.S. president's controversial politics
has not damaged the U.S. dollar's reputation as analysts expected.
Even as the stock and commodities market experiences fluctuations due to rising trade tensions,
the U.S. Dollar index increased by 5.29% from January to August 2018.
3.
Government Bonds Government bonds are fixed-term debt securities
issued by a government to support their spending and other obligations.
They pay a periodic interest to investors and are considered low-risk because of government
backing.
Bonds issued by more developed economies are more desirable.
Thus, the U.S. treasury bills are the most popular and are supported by the full faith
and credit of the U.S. government.
Government bonds, like cash, have low yields and some even have a negative yield.
4.
Gold Historically, gold has always been considered
a safe-haven asset.
The price of gold is not affected by the decisions of the Central Banks of governments, and its
supply can not be controlled by printing like currencies.
Gold has maintained its value over time and, therefore, is used as a form of insurance
against adverse economic events.
In the event of an extended unfavorable economic event, investors move their funds to gold,
which drives up the price.
For example, the financial crisis of 2008 saw investors seeking safety in gold.
This caused the price of gold to rise by 24% in 2009 and continued climbing into 2011.
Gold is relatively liquid and can be easiy converted to cash unlike other precious metal.
On the downside, gold will not offer you any yield.
Infact, there are storage costs to contend with.
5.
Defensive stocks Defensive stocks are the shares of companies
that are into the provision of essential goods and services such as utilities, healthcare,
consumer goods, food, and beverages.
They are thought to be safe-haven assets because regardless of the economic situation, their
products are still going to be in steady demand.
Additionally, during times of economic downturns, the companies in the defensive sector will
tend to perform better as investors increase demand for their shares.
So in Conclusion; Safe haven assets offer safety during an economic
downturn.
You should familarise yourself with the advantages and disadvantage of each asset considered
as a safe-haven and the best to use in any particular circumstance.
Safe havens in an era of market volatility may behave differently in another.
So, the only consistent safe-haven is a diversified portfolio.
This makes it necessary that you carry out due diligence when looking for a safe haven
investment.
Also, consider that a safe haven in an economic crisis might not necessarily perform well
when the markets recover.
That’s it for today.
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