Safe havens in times of crisis

As the sell-off in equity markets gathered pace in the fourth quarter (Q4), investors once again began to look for possible safe havens to shield them from the growing losses in stock markets.

Safe haven assets are defined as ones that hold or increase their value during times of volatility and uncertainty, or potentially ones that exhibit less volatility compared to stock markets. A number of assets have either held or continue to hold the title of ‘safe havens’, including gold, industrial commodities, treasuries and certain currencies such as the yen.

Havens need to be liquid. This means they need to be easily convertible into cash at any time, usually when the time of volatility is over. Houses and other forms of real estate have sometimes been viewed as a safe haven, but as anyone with experience of the UK housing market knows, it can take time to extract cash from a housing transaction. By contrast, government bonds or key currencies such as the Japanese yen provide this kind of liquidity.

A safe haven asset needs to have a purpose beyond that as a store of value. For example, while houses have low liquidity, they are clearly in demand, as is gold, whereas currencies are of limited use outside their home market (with the exception of US dollars).

Such assets also need to be permanent, the dollar and the yen are not going anywhere, while gold retains its allure for many people despite questions over how useful it would be in a truly disastrous scenario. By contrast, bitcoin or other cryptocurrencies may not stand the test of time.

Safe havens need to be relatively scarce, or at least a finite supply. This is why gold has achieved this status (and it also provides a hedge against inflation). By contrast, these days most industrial commodities are easily available, thanks to new sources of supply and the switch away from fossil fuels towards renewables, decreasing coal consumption.

For traders, times of volatility are not necessarily a bad thing, though they require careful use of risk management and position-sizing. Investors, by contrast, will look for ‘safe havens’ in order to protect the value of their existing portfolio. For example, they may look to switch away from small cap stocks which will suffer heavily in a downturn, towards safer names in the consumer staples sector that will likely decline less thanks to the regular demand for their products, or those with strong dividend payments that will help offset any capital decline.

Alternately, they will look for markets that are inversely correlated to stocks. During times of fear, the likes of the yen and gold tend to see inflows, pushing up the price of these assets. Gold is a safe haven in part because of its historic use as a store of wealth, while the Japanese government’s record as a reliable borrower, and the large domestic holding of the national debt, mean that investors can feel secure in putting their money in the yen when equities are falling.

Both traders and investors would do well to remember that, in the short term at least, cash is also a safe haven. While in the longer-term it suffers from the effect of inflation, short-term sell-offs are good times to hold cash, or increase the size of your allocation to it as part of your portfolio strategy. While it might not surge in value, it will also not decline particularly, and, whether for traders or investors, capital preservation is a sound principle to follow.