An unexpected outbreak of the latest military conflict between Israel and the Palestinians on October 7, 2023 was once again sending investors in search of “safe-haven” assets.
But what are the historical characteristics of a safe-haven asset?
• Universal Acceptability of Value. The value of a safe-haven asset is universally accepted across all cultures and civilizations. For example, gold is recognized as a safe-haven asset in any culture and on any continent.
• Limited or Controlled Supply. The supply of a safe-haven asset cannot be increased by pressing a button on the central bank’s computer keyboard. Its supply is either limited or it rises in a controlled manner without exerting a debasement or devaluation pressure on its value.
• Stability and Independence of Demand. A safe-haven asset does not depend on the subjective will of controlling shareholders, issuers, or regulators. Its use can be banned. However, this is likely to lead to the emergence of a booming “black” market. In times of crises its price rises or remains stable, while the prices of other assets decline.
• Durability. A safe-haven asset does not burn like buildings. Equally, it does not depend on the benevolence of insurance companies and court decisions.
• Anonymity and Perpetuity. The ownership of a safe-haven asset is ideally anonymous. It also has no maturity date unlike government debt securities. A safe-haven asset can be sold without anyone knowing who its previous owner was. In turn, fiat or “paper” money is a government-issued security where the rules of circulation are mostly determined by the government itself.
In our real world it is quite difficult to find assets that would fully meet all these criteria.
Traditionally, such assets as gold, the Swiss franc, the U.S. dollar, and US Treasury bonds were used to be viewed as defensive. Can they still be viewed as safe-haven assets in the current geopolitical and macroeconomic environment?
To carry out this analysis, we can take a look at seven episodes of geopolitical and macroeconomic shocks starting with the Great Financial Crisis of 2007-2009.
1. The 2008 Lehman Brothers crisis: gold, the Swiss franc, and the U.S. dollar rise or remain steady (see Picture 1 below).
2. The 2011 U.S. credit rating crisis: gold and U.S. long-term Treasuries rise or remain steady (see Picture 2 below).
3. The 2014 Crimean crisis: U.S. stocks and the Swiss franc rise or remain steady (see Picture 3 below).
4. The 2018 market meltdown: gold, the U.S. dollar, and the Swiss franc rise or remain steady (see Picture 4 below).
5. The 2020 Covid-19 Crisis: long-term U.S. Treasuries and the Swiss franc rise or remain steady (see Picture 5 below).
6. The 2022 Russo-Ukrainian War: oil, bitcoin gold, the U.S. dollar, and the Swiss franc rise or remain steady (see Picture 6 below).
7. The 2023 Israeli-Palestinian Conflict: gold, oil, the Swiss franc rise or remain steady, while bitcoin eventually soars amid price volatility (see Picture 7 below).
As we can see, under different scenarios of geopolitical and macroeconomic shocks, different assets served as safe havens. However, we can still arrive at some general conclusions:
1. In almost all shock situations you can rely on gold as a safe-haven asset.
Gold has clearly benefitted from at least three thousand years of its use in the financial system. But taking a rational look at the situation, we must admit that there are many other objective factors that support gold’s continuing appeal.
First, gold prices are much more stable compared to most other assets (see Picture 8 below), particularly during periods of crisis, thus securing its status as a safe asset and a “stabilizer” of the investment portfolio.
Second, the demand for gold persists because during periods of instability and higher price volatility, the price of gold tends to have a negative correlation with the prices of other assets (see Picture 9 below).
2. In almost all shock situations you can rely on the Swiss franc as a safe-haven asset.
From a long-term perspective the Swiss franc has been the most stable “paper” currency. Certainly, it cannot compete with gold. Still, in the past 50 years the exchange rate of the Swiss franc against the U.S. dollar has appreciated by about 80% (see Picture 10 below).
How did Switzerland manage to become a leading nation in terms of wealth over the past hundred years? And how did its currency manage to achieve the status of “paper gold”?
Let’s dive into some macroeconomic theory. It states that a country’s foreign exchange rate depends on two factors, namely, its current account balance and its capital and financial account balance.
1. The current account balance reflects the balance of cash flows generated by the real sector of the country’s economy in its dealings with the outside world. The lion’s share of the current account balance is usually generated by the trade balance. For example, if the volume of exports of goods and services of some country significantly exceeds the volume of its imports then it accumulates a surplus in terms of foreign exchange or foreign currencies. In turn, this has a strengthening effect on the exchange rate of its national currency.
Switzerland’s current account balance and trade balance have been substantially positive for many years (see Picture 11 below). And their sizes are significantly larger than those in other countries. In other words, the volume of goods and service sold by the Swiss to foreigners substantially exceeded the volume of imported goods and services.
2. The capital and financial account reflects the balance of cash flows generated by the financial sector of the economy resulting from its transactions with the outside world. If the surpluses generated by the real sector of the economy are invested abroad, then the country has no reserves left. On the contrary, if funds invested by foreigners in the country are added to the surpluses generated by the real sector, this leads to the accumulation of huge foreign exchange reserves. This is exactly what Switzerland was experiencing for a long time. Foreigners were happy not only to buy Swiss goods and services, but they also were quite happy to invest their money in Swiss companies or deposit it into Swiss bank accounts. As a result, the country with less than 9 million inhabitants has accumulated gold and foreign exchange reserves amounting to 924 billion USD (see Picture 12 below).
3. Bitcoin remains too volatile. Therefore, it cannot be viewed as a safe-haven asset yet. But can it become “digital gold” in the future?
What are most cryptoassets striving to achieve? Ideally, they are striving to achieve the status that gold and, to a certain degree, silver (the “poor man’s gold”) have historically occupied by becoming new safe-haven assets but at a more advanced technological level.
Tentatively, we can say that so far most cryptocurrencies and cryptoassets have been able to provide their investors with anonymity under conditions of limited supply at a more advanced level of technology. However, their value is not yet universally accepted even among younger generations. There are also multiple question marks regarding their perpetuity, stability, independence of demand, and durability.
In a pre-pandemic world bitcoin, the world’s largest cryptocurrency, was a useful investment instrument in terms of its portfolio diversification potential. This is because its price, despite being very volatile, exhibited low correlation with the prices of most other assets (see Picture 13 below). However, in a pandemic and post-pandemic world the price of bitcoin was used to correlate with the prices of U.S. technology companies.
Most importantly, to become a safe haven any asset must pass its real-life test in times of political, economic and social instability. Cryptoassets were prone to widespread panic sell-offs. And, in general, they are still acting more like highly speculative technology assets rather than safe havens.
Does it mean that cryptos have no chance of becoming safe-haven assets? Not necessarily. As long as there is a monetary policy framework that leads to a systemic debasement and devaluation of “paper” money, the search for new “safe- haven” assets will continue. The introduction of digital “paper” money will not be able to prevent this search from happening in any way. This is because a fast and reliable transfer of constantly depreciating electronic money will not make them a safe-haven asset.
There have recently been some signs pointing to the fact that the most popular cryptocurrencies (bitcoin, ethereum, and others) are finally starting to behave like safe-haven assets:
1. The price of bitcoin is becoming less volatile compared to other assets (see Picture 14 below).
2. The price of bitcoin is becoming less volatile in times of crises. At least, it is no longer obvious that during geopolitical and macroeconomic shocks, it will necessarily fall (see Picture 6 and 7 above).
3. Bitcoin’s correlation with U.S. technology stocks has declined substantially from highs seen in 2022 (see Picture 15 below).
4. An increasing number of institutional investors acknowledge that cryptoassets, in one form or another, are here to stay. It is enough to recall Black Rock CEO Larry Fink’s change of heart. In 2017, he claimed that bitcoin was an “index of money laundering.” In 2023, he insisted that bitcoin “could revolutionize finance” with the world’s largest asset manager filing for a spot bitcoin ETF (see Picture 16 below). “The times change, and we change with them.”
Are we finally entering an age when the limited supply of an asset determines its safe-haven status? Time will tell. However, it is worth remembering that “Scarcity, as we’ve seen, is the secret to value,” as Seth Godin put it.
