People need to feel their money is safe, leading them to seek safe assets. How does gold function as a safe-haven?
The need for safety is one of the most important human needs. The same goes for money – people need to feel that their money is safe. That’s why they look for a way to protect their capital against financial turmoil, and assets that protect this capital are called safe-havens.
A safe-haven asset is an asset that is uncorrelated (weak safe-haven) or negatively correlated (strong safe-haven) with another asset orportfolioin times of market stress or turmoil. To put it another way, when the world and your portfolio are on fire, not everything you own loses value. Weak safe-havens do not lose value, and strong safe-havens are flourishing, thus protecting you against losses. So, a safe-haven protects investors during crises but not necessarily during normal times. Hence, a safe-haven asset is expected to retain its value or even increase in value during times of market turbulence when most asset prices decline.
It’s important to stress that a safe-haven is not bought to make additional profits. Safe-havens often do not pay any interest (e.g., gold, cash) or pay low interest on invested capital (US bonds). The main goal of a safe-haven is to protect you against downturns, systemic risks, and political turmoil. Thus, in the context of your portfolio, it’s used mostly as a portfolio diversifier which has no correlation or negative correlation with the rest of your portfolio.
A safe-haven can also protect you against financial system failure or political turmoil, when you can lose access to your accounts – bank or broker. If you have some precious metals or cash in physical form, you’re not yet stripped of your ability to pay your bills.
Gold as a Safe-Haven
Gold is commonly considered to be a safe-haven in times of financial or political uncertainty since it is not at risk of becoming worthless, unlike fiat currencies or other assets bearing credit risk. Gold works as a safe haven in a couple of ways.
Let’s start with the function of a safe haven during downturns. According to researchers Baur and Lucey (2010), gold is a hedge and a safe haven for stocks, but not for bonds – gold gains when stocks are falling, but not when bonds are falling (which makes sense, since lower bond prices equal higher interest rates). The authors also found that gold works as a safe haven only for a limited time, for around 15 trading days. This suggests that investors buy gold on days of extreme negative returns and sell it when market participants regain confidence and the volatility is lower.
Thanks to its safe-haven status,gold is used as a portfolio diversifier. Adding gold to your portfolio decreases your exposure to risk. However, adding gold to your portfolio does not mean higher returns – no boost there – but you can expect that unwanted events won’t hit your portfolio as hard.
Investors should remember that gold’s safe-haven features may change over time. For example, because the yellow metal becomes more popular as an investment to protect against equity market turmoil. Investors who hold significant amounts of gold in their portfolios may be forced to sell some or all of these holdings in times of equity market stress when they face borrowing or liquidity constraints in other portfolio holdings. This is what we saw in the aftermath of theLehman Brothers' bankruptcy, and later again in the aftermath of thecoronavirus pandemic, and the following stock market crash (see the chart below), due to the forced sales.
Generally, the perception of gold as a safe haven against crashes in any particular asset market is too limited.Gold is insurance against broader systemictail risks. In other words, gold is a safe haven that protects investors during crises but not necessarily in normal times of high confidence in the fundamentals of the economy. However, gold is not a safe haven against any particular asset class. Rather, it is protection against systemic risks – an insurance against the current monetary system based on thefiat U.S. dollar.
Mentioned above, Baur and Lucey (2010) calculated that gold goes up on average for two weeks during periods of strong downturns, but as we can see in the graph above, in some circ*mstances it can grow much longer when people are guided by the motive to run to a safe haven. When the coronavirus pandemic broke out, people were afraid that the financial system would collapse. The enormous amount of debt and the addiction to loose monetary policy were already scaring some investors before the pandemic. When firms were closing en masse, investors were expecting that stock markets around the globe would crash and central banks wouldn’t be able to do anything about it. So investors ran towards gold to protect themselves against systemic risk. Gold grew more than 30% during the year 2020.
FAQs
Acting as a strong hedge in 47% of the negative jumps helps explain why gold has been viewed as a safe-haven asset. Investors are often attracted to gold because they believe it provides hedging benefits and acts as a haven of safety in bad times.
Why is gold known as a safe haven? ›
These precious metals can surely be a safe investment asset when there is instability in the global economic markets, because in fact, the value of gold tends to rise every year and then remain stable even after recession or inflation strikes the markets.
Is gold a safe haven currency? ›
In the ever-changing landscape of finance, where the eroding effects of inflation can quietly erode the purchasing power of money, gold stands as a steadfast guardian against this monetary threat. Gold is a proven hedge against inflation as it is said to preserve the real value of assets when other prices rise.
What are the best safe haven assets? ›
Safe havens tend to retain value or even appreciate during market downturns. The lower risk of safe havens usually translates to lower potential returns. Some traditional safe havens historically include gold, government bonds, defensive stocks and cash.
Is gold good to have during a depression? ›
Gold is consistently in demand around the world, so a recession in any one region is unlikely to skew its international value. In the case of a global recession, gold is still seen as a valuable commodity because of its liquidity, and it is an easy asset to cash in on when the markets are down.
What is the downside of gold? ›
Cons of Investing in Gold
There is no stream of income associated with the investment. Other investments provide income in addition to gains from price appreciation. For example, stocks can earn dividends, bonds can earn interest and investment real estate can earn rent. Extra costs.
Why was owning gold illegal? ›
Rationale. The stated reason for the order was that hard times had caused "hoarding" of gold, stalling economic growth and worsening the depression as the US was then using the gold standard for its currency.
Why does gold not lose value? ›
Fluctuations in financial markets can also cause volatility in the price of gold. However, because so many investors purchase gold as a safe-haven asset, its value remains relatively constant. Long-term investments in the precious metal are unlikely to experience losses.
What is the safest asset in the world? ›
The concept of the "safest investment" can vary depending on individual perspectives and economic contexts. But generally, cash and government bonds—particularly U.S. Treasury securities—are often considered among the safest investment options available. This is because there is minimal risk of loss.
Should I keep all my money in gold? ›
The bottom line
It's probably not a good idea to convert all of your cash savings to gold. After all, doing so could make accessing cash a challenge if and when an emergency arises. On the other hand, chances are that you could benefit from allocating at least some of your investment assets to the precious metal.
Safe haven currencies typically strengthen or hold their value in times of global economic uncertainty caused by conflicts, political turmoil, or economic downturns. The Swiss franc, Japanese yen, and US dollar are common examples of safe haven currencies.
What are the most valuable assets in a time of crisis? ›
Typically at the onset of a crisis, investors usually decide to move their investments to sectors, industries, and asset classes that are considered to be “safe”. These include technology, utilities, consumer staples, and gold.
Who funds Safe Haven? ›
Half of SafeHaven's funding comes from government funding, while private donations make up 28 percent.
What happens to gold in a recession? ›
These unique characteristics make gold an ideal asset to hold during recessions as inflation rises and currency devalues. In fact, gold has yielded higher returns than the stock market in six of the past eight recessions. In total, investors saw 37% greater returns from this precious metal when compared to the S&P 500.
What happens to gold if the stock market crashes? ›
The more common pattern in a stock-market crash is for gold to drop as equities sink. But it falls less and from higher ground before finding its floor sooner.
What will gold be worth if the economy collapses? ›
A US dollar collapse would likely cause the price of gold to rise. Rising inflation, a common result of a falling dollar, would increase gold prices. However, the rising demand for gold would likely increase the amount of gold mined in the U.S. This could offset the rising price caused by inflation.
Is gold really a safe haven? ›
Their findings led them to conclude: “Gold's strong safe haven status is not unconditional, but conditional on the specific catalysts driving stock market downturns. We find that gold's role is a strong safe haven during market contractions triggered by macroeconomic news and developments, terrorism or trade policy.
Is gold a safe haven status? ›
Gold as a Safe-Haven
Gold is commonly considered to be a safe-haven in times of financial or political uncertainty since it is not at risk of becoming worthless, unlike fiat currencies or other assets bearing credit risk.
Why is gold considered high risk? ›
Moreover, an investment in gold carries unique costs. As it is a physical asset, it requires storage and insurance costs. And, while gold is traditionally thought of as a safe asset, it can be highly volatile and drop in price.
