Watch Out for the Hidden Risks of Safe Haven Assets
How can you smartly protect yourselves?
A safe haven is an investment that is expected to retain or increase in value during times of market turbulence. Safe havens are sought by investors to limit their exposure to losses in the event of market downturns. However, what appears to be a safe investment in one down market could be a disastrous investment in another down market, and so the evaluation of safe haven investments varies, and investors must perform ample due diligence.~ Investopedia
The Diverging Trends of Safe Havens Since March 1, 2023 (Gold and Yen were Up while the Dollar and Swiss Franc Fell)
The regulators shut down Silicon Valley Bank (SVB) in California on March 10 when SVB ran out of money due to a $42 billion deposit withdrawal request (about 25% of the total) the day before.
The irony is: SVB is sitting on good quality assets: long-dated U.S. Treasuries and Mortgage-Backed securities that SVB can sell to raise cash. Although these securities have no credit risks they have tremendous interest rate risks.
A bond is characterized by its duration: the sensitivity of its price to a change in interest rate. When the market interest rate increases, the bond price falls. Say, SVB has lots of 10-year duration government securities bought when the market interest rate was 1%. As the long-term interest is now 4% — the maths tells you SVB will incur a loss of (4 minus 1%) * 10 years, or -30% if they sell those securities (marked at cost)!
Look at another haven, the Swiss Franc. The U.S. Dollar, Swiss Franc, and Japanese Yen are traditionally safe-haven currencies. U.S. Dollar is the world’s reserve currency. The Swiss government and its financial system are stable. It has a high living standard and attracts a lot of foreign demand due to its tax haven status.
The recent Swiss banking crisis, characterized by the slow but sudden demise of Credit Suisse and the rapid take-over by its rival, has tarnished the Swiss Franc’s haven status, albeit temporarily.
You may ask: why did the U.S. Dollar decline right after the SVB collapsed?
First, there is a lingering impact, contagion, and regulatory tightening, which will dampen the U.S. economic growth, leading to a possible cut in interest rates by the Fed this year. When a country’s interest falls relative to another (note that currencies trade in pairs, e.g., Dollar-Yen, Dollar-Euro), its currency will likely depreciate against the other.
That leaves the Japanese Yen. The Japanese central bank is expected to hike its interest rate as its new governor may stop suppressing the yield level in government bonds. The country has no banking drama currently. The Yen has become the haven currency of the time.
What about Gold? Gold is a physical commodity and is a store of value. It performs well when there is economic distress or a threat of inflation. Gold has no interest rate risk, and it has become in demand. But what if risk appetite comes back to the market? Gold may not do that well. Besides, it costs between a third and half of the trading price to produce an ounce of gold.
Summarizing the Pros and Cons of the Various Haven Assets
In August 2019, JP Morgan Asset Management provided this helpful framework to analyze various haven assets.
Today, cash/money market funds/Treasury bills are a viable alternative as yield has approached 5%.
Core government bonds no longer have low yields. However, they now carry high-interest rate risks. On a positive note, as the interest rate falls, long-dated government bonds rise in price due to their long duration. Inflation-linked government bonds also have a positive yield.
What to Look for in Safe Havens?
High liquidity. An active market with many buyers and sellers with the asset converted to cash easily.
Low or no correlation with risky assets. This is helpful during times of market distress.
Continuous and certainty of demand. The asset should not decay in time or be replaced easily.
Final Thoughts
As a reminder from Investopedia:
… what appears to be a safe investment in one down market could be a disastrous investment in another down market, and so the evaluation of safe haven investments varies, and investors must perform ample due diligence.
Safe havens carry hidden risks in the clear case of the U.S. Treasury bonds. When cash yields zero, it has a huge opportunity cost.
Each haven asset is attractive for a different reason, and it works in one scenario but not in another.
Consider the macroeconomic environment and the risks in the system before piling onto any safe havens.
It pays to be nimble and maintain an open mind.
Thanks for reading!
This article is for informational purposes only. It should not be considered financial or legal advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.