What is a safe haven? Are they of any use to us?

The credit crunch era has seen not a few previously accepted tenets and sacred cows bite the dust. Unfortunately this has not stopped some from continuing to believe in them. For example my profession of economics has for a long time used the concept of a risk-less asset. Now, whilst in theory one may be able to grasp and define such a concept once you move into the real world problems always began to appear and these have mounted in the credit crunch era.

For example some argued that an asset is risk free if you have certainty of return such as a bank bond. I hope their money was not in a bank which failed! More commonly it was assumed that US Treasury Bonds were a risk free asset as the US Treasury could always print more money to pay them. Economists used them in their models as a risk-free interest rate too. The concept of a potential default by the US government must have seemed inconceivable to them whereas now it is certainly conceivable. Actually it also ignored the fact that governments more often default on their bonds than their bills. Also domestic investors had the problem of inflation which erodes the real value of their asset and overseas investors could add the exchange rate to the list as a clear risk. So we see that the theory was even in better days forced on reality and in these difficult times does not fit it at all.

Safe Assets

As we conclude above that there are no risk-less assets we find ourselves also concluding that true or pure safety has to be an illusion. There is no “safe asset” as the theory becomes a mirage once reality hits it.

This does not mean that there are no assets with elements of safety in them merely that they vary across a spectrum from less to more safe with no polar extreme to be found. As we consider the concept we also realise that safety means different things to different investors because it at least partly depends on their concept of safety.

What is a safe haven?

Investopedia defines it thus.

An investment that is expected to retain its value or even increase its value in  times of market turbulence

Actually I am not a fan of that as to me the concept of a safe haven covers countries as much as it does particular investments. Fortunately they do then throw in another sentence.

Safe havens are sought after by investors to limit their exposure to losses in  the event of market downturns.

Much better. What this now tells us whether intentionally or not that like beauty a safe haven is in the eye of the beholder. It depends on their circumstances wishes and needs. Let me give you an example of this.

It was only a few months ago that the Swiss Franc was considered to be such a safe haven by investors that they received negative interest rates on investments denominated in it. Some invested 100 to get back 99.6 in two years and this did at its peak extend out to the five-year maturity. But they did so and if we look wider we may be able to figure out why they did.

Inflation

In Switzerland under the current regime there is no inflation. The Consumer Price Index which was based at 100 in 2012 was at 99.3 on average in 2012 and had fallen to 98.9 in December 2012. So here is one reason why a nominal loss may have been accepted. Investors may well still have thought that there could be gains in real or inflation adjusted terms.

As ever we have another problem as the policies of the Swiss National Bank in capping the Swiss Franc against the Euro created a future inflation risk but let us park that one for now.

Exchange Rates

Here presumably foreign investors were hoping for a further appreciation of the Swiss Franc. They no doubt hoped that the negative rate of interest would be swamped by the capital currency gain.

Stability

Economic

What I mean by this is a country which has an economy which looks as if it is sustainable for the long-term and Switzerland would get quite a few ticks on such a list. As we peruse her balance of payments surplus and her national debt to economic output ratio of 35% we see an economy that looks stable. We have been taught by the credit crunch that apparent stability can go wrong quite quickly so even such apparent stability is only for a fairly finite period of time, but the new reality is that it is about as good as it gets.

Political

Here our idealised safe haven would have simply stability and certainty with anything like a revolution being extremely unlikely. Perhaps in the modern era we should add that it also has a political class which does not keep looking to foreign fields for wars either.

Price and value

This is something I so rarely hear being discussed or see being written about. I believe that you cannot measure safety or risk without also referring to the price of something which helps to give an idea of value. I have argued for something that the UK Financial Services Authority has imposed completely the wrong set of risk categories on investment advice in the UK for this reason.

Let me explain in the context of the UK government bond or Gilt market. The FSA have this as a low risk asset. Whereas in my opinion the rise in prices and fall in yields that we have seen in recent times have made them a riskier asset. For example as our benchmark ten-year Gilt yield  dropped from over 5% in the summer of 2008 to 1.46% in the summer of 2012 then the risk went up. Indeed those who bought at the low yield or price high will be mulling this fact right now as prices are falling again and our benchmark yield has hit 2.16%.

In a country regarded as a safe haven we need to consider the exchange rate on the sam basis.

The Currency Twins

If you look back over past updates on this blog you will see articles where I discussed the Swiss Franc and the Japanese Yen who via the backwash of the carry trade became the “currency twins”. Their surge saw them labelled as currency safe havens but it we return to our higher price leads to higher risk thesis we see that the outcome has meant that the status of the Yen in particular as a safe haven has been topedoed below the waterline.

The Yen passed 80 versus the US Dollar in mid-November and as it is at 93 as I type this then it has proved to be a -16% safe haven over this period! Even the weak pound has not stopped the same being true for UK investors and of course the recent all conquering Euro means that a safe haven play out of it into the Yen will have investors wallets calling for the stretcher-bearers.

Also we note that the previous relative stability between the Swiss Franc and the Japanese Yen has now moved into the past.

Quantity

In a world where there is plenty of flexible and mobile capital we also have to face the issue of size or amount. What I mean by this is that at times the amount of capital looking for a (supposed) safe-haven can swamp the market it is going into. When we consider that such a large market as the Japanese Yen was swamped by such flows we wonder what markets could with stand and  sustain a genuine “safe-haven” rush? Not many if any….

Psychology

You may have noted that I have managed to get a long way into this post without mentioning the classic safe haven investment which is gold. This is because it is in my opinion a clear minefield. Some factors are there as for example its use for jewellery but against that you get no return. In fact in many ways its appeal relies on its durability which is another way of saying you get no return and uses are few. After all did not King Midas discover the problems created by being able to turn everything into gold?

So we end up with much of its appeal being based on psychology. If sufficient people believe in it then it will remain a safe haven although we return to the issue of at what price?

Zero sum games

More and more markets such as derivatives are in fact zero sum games. In fact if we allow for costs we see that they in fact in total give a net loss. This seems to take them out as being safe havens although as discussed above at a low price they may work.

Comment

So having considered the position we see that safe havens are in fact as Imagination put it some years ago.

It’s just an illusion,illusion,illusion

However we also know that there are times when human nature is such that safety is prized and we also know that in these times that a flood of capital will go that way. So anticipating such a move is perhaps where we will find the nearest to a safe haven trade. In which case we are likely to find our safe haven in an unexpected place as we reject what is strong now like the Euro and look for what is going to be strong going forwards. If Tom Petty was right about this.

Baby, even the losers, get lucky sometimes.

Should we be looking at something like the UK pound and anticipating a change of fortune? As I type that I have remembered something which I have not addressed fully so far and that is of the time-horizon which matters too.

As ever I await readers thoughts on this.

 

This entry was posted in Euro zone Crisis, General Economics, Gilts, Gold, Investing, Japan's Economic Situation, Psychology and tagged , , . Bookmark the permalink.
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  • Drf

    Hi Shaun,

    “What I mean by this is a country which has an economy which looks as if
    it is sustainable for the long-term and Switzerland would get quite a
    few ticks on such a list.” Well of course it will now get less ticks on the list because having agreed to end banking secrecy there is going to be a large outflow of wealth from their banks! Since a great part of the Swiss economy has always been based on international banking and banking secrecy that is going to weaken it considerably; I suspect it is because they knew they intended to comply with the EU and USA demands that was part of the reason for pegging the SF against the Euro?

    You mention that there is no return on Gold (as with all precious metals and commodities per se); but that is surely not the issue. Investors have been and are moving into precious metals not to seek any return; in most traditional “investments” at present it is not possible to achieve a real net return because of the erosion due to REAL inflation. It is all about real purchasing power and net yield; precious metals allow a hedge against the inevitable future latent inflation, and are likely at least to retain your purchasing power, although there is unlikely to be yield. However it is quite possible that with some commodities and some precious metals there actually may be an effective yield once hyperinflation sets in, because real consumables which humans need will escalate in price, but Gold will buy more of them. Gold and silver will become again the de facto real money. It is worth reading Adam Ferguson’s short book: “When Money Dies” again.

  • taurus

    Hello Shaun,

    I think it’s a case of ‘you pay your money you make your choice.” There are a good number of commentators predicting hyperinflation as the end game and for gold to rise to unparelled levels. Some boldly predict this will occur within twelve months while other litter their predictions with caveats. There are many sites whose devotees believe the end of the fiat money system is nigh(but cannot actually say when) and with the reset the introduction of the gold standard(but do not actually say how) All I know is whatever happens I will have backed the wrong horse.

  • ernie

    Interesting post Shaun. I have been wrestling with this since the period in early 2008 when I began to see how it was going to unravel. I have never actually come to an answer though! Of course, it critically depends on two things. Firstly, your age, which will affect the course of action that seems right to you. A person of or about to be at pensionable age will be much more risk-averse anyway, whereas a younger person may be able to take a longer view.
    Secondly, it depends on your overall assessment of the situation – the famous deflation/inflation debate. This is very difficult to resolve as the ridiculous printing of money vies with the strong likelihood of grossly-inflated asset prices collapsing at some point as the leverage comes out (again as per 2008). I don’t pretend to know the answer but I do feel that not enough people look at the possibility that we have lived through inflationary times through the provision of massive amounts of credit to enable leveraged activities. Maybe the other side of this coin is significant deflation as the laws of arithmetic cannot be denied – that is constantly increasing debt/leverage is impossible. I put it out there just as a thought, since I have to agree no-one could have foreseen the absurd lengths to which governments have gone to avoid prices reaching clearance levels and debts being reduced sufficiently to allow growth to resume.

  • Justathought

    Hi Shaun,

    Based on those wonderful and uncertain times we are
    presently living in, where economic theory has been thrown out of window, where governments are no longer governing but are simply curators and where many moral standards are failing. To assume the worst of the situation and to return on some fundamentals in order to not only protect ourselves but to sustain a decent living standard would be of a prime concern.

    It appears to me that we might be living a replicate of the 2006/2007
    UK’s years … While in the streets an uneasy “feel” was blatantly perceived regardless of the pretence entertained by the media, news manipulators and governments’/official’s propaganda.

    Gratefully we have some accurate and trustable bloggers such
    as yourself to shine some lights within this maze of data’s and misinformation.
    Unfortunately, nobody would know with certainty what would be in three years’ time, nonetheless within six month.

  • Anonymous

    Shaun,
    Are the CB’s not still buying gold hence self supporting prices?

    Also Cyprus appears to be exposed to extra austerity with the EU wanting to punish Russian inflows?

  • Noo 2 Economics

    Gold’s been in a downward trend since last September – abiout 8% down, which, imo coincided with an increasing positive perception of the future (although I don’t share it) of investors. If CB’s are buying gold they aren’t doing a very good job at supporting it’s price.

  • Noo 2 Economics

    Hi Shaun,

    Glad to see you respond to readers requests as I’ve been waiting for this since someone requested it a while ago.

    Are we not in a position of oil steadily increasing as the Fed gets into it’s stride with QE and speculators buying oil in anticipation of the BOJ printing activities?

    Maybe oil is the current “safe haven” with all the bonhomie I see on the bourses until they realise the markets are massively out of sync with the real economies and then will come the correction in markets and oil (down) and gold (up) as imo investors continue to see gold as possessing intrinsic value.

    I would suggest another potential short term “safe haven” of China as it’s economy has grown (albeit at a slower pace) last year whilst it’s stock market collapsed only starting to recover last November/December.

    So maybe it’s as I guess you are suggesting, the “safe haven” nowadays keeps moving around and to find it you need market timing. Who can time markets accurately?

  • Rods

    Hi Shaun,

    An excellent article again.

    Once a safe haven has been identified and written about, due to investors herd instincts it is probably much less of a safe haven, with early adopters making money and late arrivals not! Six months a go investors were talking about shares looking cheap on a price / yield basis and if you were an early investor this was probably true, but now there is considerable scope for a share correction and losses on a run of bad news.

    I look at derivatives as a bit like insurance using them to quantify risk, by turning an unknown risk into a known cost. It makes perfect sense for say a airline to hedge their fuel costs and accept the cost of the derivatives when they are booking flights at fixed prices up to 12 months in advance. Although I never costed this, could it make sense to use of dividends from shares to protect your capital when you have purchased shares in a rising but volatile market? A bit like we have had over the last 5 years and we could easily have a correction again with bad news later in the year with a Sterling crisis brewing and I’m sure many more issues in the Eurozone. It looks like the next tipping point maybe political rather than economic in Italy and Spain.

    It is my understanding that holders of shares like Insurance companies use derivatives to make extra money (hopefully!) by using their shares in derivative deals.

    If I had money to spare at the moment I really don’t know where I would invest it. Shares are still probably the best long term bet against inflation but that is going to depend upon the companies exposure in different countries and how those economies perform? I think I would be steering clear of the UK and Europe.

  • forbin

    Hello Noo 2

    a little on oil – it doubled in price between 2002 and 2005 and then doubled again – forget the supa spike that prob was computer trading plus a lot of hot money ….

    currently oil is at around 110-117 mark

    current chines growth in oil import suggests that by 2027 they will be taking all of the current available exported oil – now I don’t believe that will happen for various reasons.

    factor in the high decline rates of all the “old resource” tight oil thats become a reserve because of the high oil price

    and we get the picture that baring a major economic collapse , that oil is only going to go up.

    Forbin

  • forbin

    Hello Shaun,

    Whats a safe haven – land and property – seems to have lasted millenia

    needs some type of stable government – oh you mean short term!!!

    nimble of foot I think – still land and property though ! ;-)

    Selling some London flats to the French emigree might be worth while

    indeed Shaun I understand that the companies are holding onto wads of cash waiting for something to invest in – why is that ? how long can they hold on ?

    perhaps we need our Governments to have more balls and tax those holding on!

    yeah right , no hope there …..

    Forbin

  • Anonymous

    Hi Forbin,

    Property isn’t necessarily safe – just look at the houses the Spanish are bulldozing due to lack of planning permission. Lots of money has been lost in Spanish apartments too. I think this property market has further to fall and is being held artificially high by forbearance on foreclosures.

  • DaveS

    Actually Shaun – I constantly read that UK companies are awash with cash – we just need business confidence to improve and they will invest,.

    I had a few questions around this topic – maybe more of a subject for a future blog….

    1. Also read that SME’s are being starved of lending so I assume that means only big UK companies are awash with cash.

    2. Was wondering which big UK companies exactly ? If I look down the FTSE its hard to see what sectors would be awash with cash – maybe big miners but they are essentially foreign companies that are domiciled here – they are hardly going to start digging holes in the UK. The big supermarkets perhaps but then they are “investing” – we are awash with express stores these days.

    3. Before the crash I thought a lot of UK companies where highly leveraged in the boom e.g. private equity deals, property developers – surely they are having to de-leverage.

    So it it more a case that they are paying down debt rather than building up cash piles ?

  • Justathought

    Hi Shaun and others participants, out of topic however some relevance embedded within this vid might appears… http://www.youtube.com/watch?v=oby0ZdDYwiI

  • Anonymous

    Hi Drf
    Actually there was quite a change in the recent pattern of the Swiss Franc today as it rallied strongly to Euro 1.228. With the Spanish Prime Minister having slush fund problems and Silvio Berlusconi apparently back on the scene it will be interesting to see what happens next.
    I am neither a gold bug nor a denier but if pressed the more I read about the antibacterial qualities of silver those who favoured it in the past may have been right all along!

  • Noo 2 Economics

    Thanks Forbin, So are you saying that, accepting volatility along the way, maybe oil is a long term safe haven? And what about popcorn?

  • Anonymous

    Hi Ernie
    I have suggested often in the past that we can see disinflation in some things and inflation in others at the same time. I have not come back to it recently so I will put it on my list!
    It sounds illogical but for example we have had commodity based inflation whilst the price of labour has seen falls in real terms. An uncomfortable situation to say the least.

  • Anonymous

    Thank you.

    With Prime Minister Rajoy in Spain in trouble over slush fund payments and Silvio Berlusconi coming back lazarus like in Italy it has not been a good few days for officialdom. And that is before we get to Chris “I am innocent of all charges” Huhne…

  • Anonymous

    Hi Chris
    Yes they have been buying and the World Gold Council estimated that it amouted to 500 tonnes last year. Noo 2 is right to point out that the price has fallen but if they are buying for the long-term they may see it as a dip to buy into.
    Mind you care is needed as central banks (not only Gordon Brown) sold at the lows and are buying at near the highs or #toppedandtailed

  • Anonymous

    Hi Rods
    Derivatives were my living for quite a few years! But whilst for some they can be a safe haven trade as for example selling call options against a shareholding someone has to take the other side. Also I suspect that say like zeroes in the UK some things which are badged as safe turn out to have been very risky…

  • Anonymous

    Hi DaveS

    I note the request and can already help on question or point one.

    Lending to UK businesses by UK banks fell by £2.5 billion in November and by £2.1 billion in December which is not exactly auspicious for Funding for Lending. And yes SMEs seem to be getting the worst of this as net lending to them has been negative since the second quarter of 2011.

  • james

    Hi Shaun,

    I am convinced that banks are not lending :the rates of interest on savings are dropping all round which makes me think that they do not need to attract deposits because they won’t lend

  • JW

    Hi

    Just plot CPI/RPI indices ( not annual variations) in US/Europe/UK over the last 30 years. The western world is completely and utterly in an inflationary situation. Deflation is a figment of CBs imaginations.

  • tam

    can you explain clearly about safe haven and hedge (can you give me an example)?