Let’s talk shelters. Because I’m officially paid to be a bit contrarian and therefore gloomy, you might think I’m constantly bearish. Overall, though, I’m actually quite optimistic, and in my investing I’m probably a mix of aggressive tech bull and cautious bargain hunter. But the default position is usually risky.
It hasn’t been a bad tactic for a long time, but as we enter a new regime of monetary and political policy, it’s important to think about what might be safe havens in a potentially more volatile world. I ask this question because I am struck by the fact that many of the classic safe havens no longer make as much sense as they once did. Cash, for example, doesn’t seem too popular in a time of high inflation and still low (even if rising) interest rates.
Most bonds also seem a little flimsy, and I wouldn’t want to be caught arguing that the vast majority of corporate bonds are a diversifying element within a portfolio. They are not.
Government bonds – especially US Treasuries at the longer end of the maturity curve – and I guess TIPS (if you’re a true inflationist) might make sense; However, ask yourself this question: how high do you think government bond yields can reach before government bonds in Washington and London start to feel under the collar?
In the UK, high inflation is already being used by the government to cut spending on the public health budget due to the rising cost of past indexed bond issues. If all new conventional bonds started to cost Treasuries, say, 4-5%, how quickly do you think we would see an all-powerful fiscal crisis and drastic austerity budgets? All of this leads me to assume that the upper bound for 10-year US Treasury yields is probably 3-4%, in which case I suspect government bonds might start to look like a decent bet then. But we have to hit those rates first, which potentially means more losses for conventional government bonds.
Specifically, there is also a significant amount of research that suggests that the old positive relationship/correlation between US Treasuries and US equities is about to reappear after the past decades of negative correlations. Until the late 1990s, the correlation between the S&P 500 and US 10-year Treasuries was actually mostly positive, and on many occasions beginning in 1969, this correlation metric was above 0.5. , that is, not closely correlated, but correlated enough not to provide much diversification benefit.
In recent decades, however, this relationship has reversed and the correlations have turned negative. That could change.
Vincent Deluard, global macro strategist at Stone X, said: “The one-year correlation between long-term US Treasury yields and those of the S&P 500 Index is [now] close to zero. Long-term US Treasuries have lost a cumulative 1.7% on S&P 500 index down days since March 2020, and they have lost an average of 20 basis points on stock sell-off days in 2021. »
So, a haven of peace? May be. Let’s quickly skip over the ridiculous argument that bitcoin and other digital currencies could be a safe haven – they are not and never will be anything resembling a safe haven given the exorbitant levels of volatility we are experiencing. currently. They could be a bet against the collapse of the Western fiduciary order, but right now that’s not on the cards!
This leaves us with two final relatively liquid asset classes: gold and currencies. Let’s start with gold. Gold’s volatility has indeed been low for a year, as shown in the chart below. Gold prices have certainly remained stable, although it should be noted that US equity volatility has been lower than gold for a few weeks in 2021.
So if a safe haven is defined simply as a low volatility asset class, then gold looks solid. But my definition of a safe haven is one that: a) is negatively correlated with stocks and also bonds; AND b) one that over time does not lose much value.
The practical challenge here is that gold has many cross-relationships between asset classes, which makes instantaneous analysis very difficult.
The best-known relationship is between the US dollar and gold – a strong dollar is usually bad news for gold prices. The next, more tenuous relationship is between oil and gold. According to Shahbaz et al. (2017), there has been a positive correlation between gold and oil prices more than 80% of the time over the past 50 years – except of course when there was none such as in the middle of the COVID-19 crisis.
For me, the most interesting relationship is between gold prices and real returns. Charlie Morris, CIO at ByteTree, pioneered this research – he treats gold as if it were a 20-year zero-coupon US Treasury inflation-protected security (TIPS).
As he said, “Gold is a store of value, so inflation is driving prices long term. But the bond model explains medium-term price movements because real interest rates influence the current value of gold.
Source: ByteTree Asset Management
The chart above shows this ratio and suggests that gold is now roughly at fair value. Logically, this report makes sense. If real rates are high, gold is much less attractive. But if real rates are at rock bottom, what do you have to lose by holding gold? But again, the actual relationship between real rates and gold is probably a bit more complicated.
Earlier this year, the World Gold Council released its latest analysis accompanied by forecasts for 2022, and the following passage stood out: “The short to medium term performance of gold tends to respond often to real rates which combine two important drivers of gold’s performance: “opportunity cost” and “risk and uncertainty”.
In addition, low interest rates – both nominal and real – are shifting investment portfolios further into risky assets. And this, in turn, increases the need for a high quality liquid asset such as gold.
“Gold has historically underperformed in the months leading up to a Fed tightening cycle, only to significantly outperform in the months following the first interest rate hike. Gold may have been partly helped by the U.S. dollar which showed the opposite trend. Finally, U.S. equities posted their best performance before a tightening cycle, but generated weaker returns afterwards.”
This last point about the importance of the US dollar is also worth considering. All of these complex relationships depend on the country in which you hold your wallet. Joachim Klement, investment strategist at Liberum, reminds us that what might work for someone in Germany or the US, for example, might be a complete loss of space in the UK.
“Dirk Baur from the University of Western Australia did a nice little exercise measuring the correlation of gold with the local stock market in 68 countries. He did it using gold prices in dollars US and local currency gold prices.
“The chart below shows the correlations between local stock markets and gold in local currencies. Note how Venezuela has the highest positive correlation.
It will not be a big surprise to see that in Venezuela there is a very close correlation. In a hyperinflationary environment, anything vaguely resembling a real asset – buildings, cash-generating businesses and gold – looks attractive. But the protective qualities of gold increase dramatically as we go down the list.
“For countries starting with Oman and the United States all the way to Israel or Taiwan, gold has essentially zero correlation with the local stock market and therefore offers quite good diversification.
“But if you find yourself in the countries at the bottom of the list which includes pretty much all the Eurozone countries, Sweden, Norway and Australia, then you are in luck. Gold has a correlation significantly negative with the local stock market and is therefore an excellent protective asset.”
So, one can probably conclude that gold still has significant diversification benefits for many investors in the developed world, but probably not all of them, and certainly not all of the time!
But there is another even more rewarding asset class: currencies, two of which particularly stand out – Switzerland and Japan.
At this point he is back to Deluard, a devoted polemicist. He recently published an article that argues that the Swiss franc is the most liquid and obvious safe-haven asset.
In a hymn to the landlocked mountainous republic, Deluard lists the big macro positives for Switzerland:
- Each Swiss has $85,000 in net foreign assets, $106,000 in foreign exchange reserves and $17,400 in US stocks (!).
- The latest Form 13F filed with the SEC reveals that the Swiss National Bank holds a staggering $157 billion in US stocks, or $17,444 per capita. Thanks to the SNB’s mostly passive purchases of US stocks, each Swiss owns around $1,000 of Apple stock, $890 of Microsoft, $680 of Alphabet and $670 of Amazon.
- Real GDP is soaring, inflation is contained and the government’s budget should be in surplus this year. Real GDP increases by more than 4% and consumption by only 2.8%. The unemployment rate fell to 2.5%. Despite the pandemic, the public deficit is only 2% of GDP and should be in surplus next year.
Deluard’s net result? “The Swiss franc should benefit from increased volatility in 2022 and the inability of US Treasuries to hedge equity risk.
“Due to inflation, the Swiss National Bank should tolerate a higher Swiss franc next year and the Swiss economy can handle a strong currency. Swiss francs are already expensive but may become much more overvalued in 2022.”
So what’s on my short list of safe havens in 2022? Probably gold, definitely Swiss francs, probably Japanese yen and maybe US Treasuries.
David Stevenson is Founder and Strategic Advisor at ETF Stream
This article first appeared in ETF Insider, ETF Stream’s monthly ETF magazine for professional investors in Europe. To access the full issue, click here.