In a recent post, we outlined five types of potential safe-haven assets and their performance during the initial stages of the COVID-19 crisis in Q1 of 2020. We noted there, and note here again, that safe havens in general are a tricky topic, because how an asset performs during a crisis is very specific to the exact dynamics of that crisis, which can differ wildly and unpredictably from previous crises. Furthermore, often short-term technical or liquidity concerns can trump fundamentals1, causing even supposedly rock-solid, established safe havens to suffer. For example, gold suffered during the initial stages of the Global Financial Crisis (GFC) from March to September of 2008 before recovering.2 TIPS suffered a large 8% drawdown during the height of the GFC3 as investors dumped illiquid assets, whereas some might have thought that TIPS would have done well due to upcoming inflation arriving via fiscal stimulus plans and aggressive central bank action. More recently, we saw supposed safe-haven Bitcoin fall 27% on March 12, 2020, during the height of the COVID-19 crisis, and display a 0.7 correlation to global equities subsequently.4 This is hardly safe-haven behavior.
At this point, we should step back and consider why any of these assets are used as “safe havens” at all. Isn’t the best safe haven just cash? If you don’t want to lose any money, the safest of safe havens seems to be to just put it in the bank, or if you worry about bank failures, under the mattress. $100,000 in cash will be worth $100,000 in cash next week. Why would gold or Bitcoin, with their wild volatility and unpredictable behavior, ever be considered a better safe haven than that?
There are a few reasons for this. One is that when investors buy these safe-haven assets, they are not hoping for a “safe haven” of no volatility, but rather good old-fashioned price appreciation, similar to any other risky trade. Most people probably buy Bitcoin hoping it will go up in value, not because it “preserves” value. Also, for many institutions, liquidating entirely to cash is prohibitively expensive and impractical, so finding assets such as gold or bonds that moderate the volatility of their existing portfolio may be the only realistic way to reach for safety.
The other, more long term reason to invest in safe-haven assets like gold or Bitcoin is if you worry about the value of cash itself: that is, if you worry about inflation or the general solvency of the government. $100,000 under the mattress will still always be worth $100,000 nominally to a US based investor, but under a scenario of hyper-inflation or default, that $100,000 may not buy them very much. If paper money like the US dollar is in danger of losing value, then claims on hard assets like gold or other commodities (or an un-inflatable asset like Bitcoin) make sense as safe havens. For example, it would not have been a safe haven to invest in German marks under your mattress in 1923. If that is the future for the US Dollar, cash is not a safe haven.
So it turns out there is a point to non-cash safe-haven assets: currency devaluation and inflation fears. High levels of upcoming inflation are certainly a worry at this time, with the US government passing multi-trillion dollar stimulus bills.5 The Financial Times has written about inflation worries (twice!) in the past month.6 There is no real evidence of inflation yet, nor did predictions about inflation pan out after the GFC, but it is certainly a valid concern in the current environment.
If cash stays stable, cash is the best safe haven, otherwise non-cash safe havens have credence, but they can be volatile in the meantime. All this leaves the investor in a tricky spot. Investments like gold and Bitcoin may be safe havens during a real inflation crisis, but until then they represent a wild ride for the investor (again, Bitcoin down 27% on March 12, 2020) and are certainly apt to generate more sleep loss than pure cash in the bank. On the other hand, pure cash is steady now, but might not be after the next $2 trillion stimulus bill. It seems like the investor has no real safe haven. There is risk everywhere you turn.
So then what really is the ultimate safe haven investment? In a truly apocalyptic world, nobody wants your gold bars (especially your gold ETF) or your Bitcoins. To answer this we need to get back to the true purpose of investing. The point of investing is to eventually consume … not to consume gold bars or dollar bills, but to consume things that real humans need. When we invest, we typically hold things that are not directly consumable (like gold bars or dollar bills) and thus investing itself always entails the fundamental risk that our investments will lose value relative to the goods we eventually hope to consume. There is a basis risk in investing...a hedging risk. To be truly safe, you’d need to cut out that middle-man and just buy the consumption directly: the roof over your head and the food in your pantry (or bunker). Those will be valuable in any state of the world, as long as you have enough space for them, they don’t spoil, and you can protect them.
It’s therefore somewhat ironic that in the true crisis, the absolute safest investments are those we consume. So where does this leave the institutional investor? In reality, in the event of a major market crisis, a pension fund or university endowment is unlikely to liquidate its portfolio to stock up on food supplies and shelters. With this in mind, we believe the best option for institutions is to acknowledge that the financial safe-haven assets at their disposal (e.g., US dollars, Bitcoin, gold) might not outperform, maintain, or appreciate in value during every market crisis, as each crisis carries unique circumstances. Not only that, but it is difficult to know ex ante which safe havens will protect portfolios (and to what extent) in the next crisis. It is a non-trivial exercise, and one that should be made with lots of care, to select the safe havens that best meet a program’s needs and long-term objectives.
1 For more on this, read the Two Sigma Street View “Unwinds, Diversification, and Constraints: The Mechanics of Financial Panics.”
2 Sources: Bloomberg and Venn as of June 23, 2020. Gold suffered -23% cumulative returns from March 1, 2008 - September 11, 2008, and then recovered, posting 24% returns for the period September 12, 2008 - March 9, 2009.
3Sources: Bloomberg Barclays and Venn as of May 27, 2020. The Bloomberg Barclays US Gov Inflation Linked 7-10y Bond Unhedged Index suffered -8% over the GFC period September 15, 2008 - March 9, 2009. The dates for the GFC period were determined starting with the Lehman bankruptcy and ending at the peak MSCI ACWI Index losses. It is intended to represent the hardest and sharpest part of the market decline.
4 Sources: Bloomberg ticker XBTUSD, the Bitcoin / USD cross, and Venn as of May 20, 2020. The correlation was calculated using Venn’s global Equity factor for the period February 20, 2020 - May 6, 2020.
5Source: The Washington Post article “Trump signs $2 trillion coronavirus bill into law as companies and households brace for more economic pain” on March 27, 2020.
6 Sources: Financial Times articles “Investors warn Covid-19 crisis is paving the way for inflation” and “Why inflation might follow the pandemic” on May 14, 2020 and May 19, 2020, respectively.
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