Why Stocks Are Rising While Investors Flood To Safe-Haven Assets

The Influence of Speculation & Hedging

From February 19th to March 19th, the S&P 500 fell 29% this year.

During that same time frame, the price of Gold fell 10%.

Why is that when investors are supposed to pile money into gold when the economy takes a turn for the worse?

Unless of course, gold no longer holds the same “safe-haven” appeal that it once did, and if that’s the case, the only winner is going to be volatility.

Economic Theory

I know that it sounds repetitive, but investing is nearly entirely about managing risk; and theory dictates that when risk rises, investors will move money from high-risk assets such as stocks and corporate bonds into gold, US Treasuries and the Japanese Yen (at least those are the big 3).

All 3 suffer from similar issues as we’re about to explore, but none have established the pop culture allure of gold. There’s nothing shiny about 10y Treasury Note with a 0.695% yield and while Japanese Yen notes are awesome and beautiful, there’s a reason movies love bank heists with gold.

Gold has been a store of value for centuries and is perhaps the longest existing safe haven for investors. Gold’s value has been recognized for thousands of years and used to mint coins in some of the earliest economies.

US History With Gold

From 1879 to 1933, the US Dollar’s value was evenly tied to the price of gold and one could redeem US Dollars for gold at any point in time. Economists quickly realized the faultiness in pegging a currency’s value to the price of a commodity; particularly in the 1930s where the Great Depression frightened Americans to begin hoarding gold coins and bullion.

President FDR rapidly acted, ordering all gold coins and gold certificates in denominations of more than $100 to be turned in for other money, which led to the US Government amassing $770 million in gold coins & certificates.

This led to a decision June 5th, 1933, which nullified the right of creditors to demand payment in gold.

Now, armed with a massive stockpile of gold, the US was able to inflate the money supply by, you guessed it, printing money that was no longer tied to the price of gold. In 1934, the US increased the government price of gold by 69%, effectively increasing the value of their reserves by the same amount and allowing the US to increase spending to jumpstart the economy out of the Great Depression.

We’re Not In Kansas Anymore

The Great Depression was literally a different era, and the increased investment in gold for speculative or hedging purposes has changed the safe haven property. Basically, it’s hard to argue that an asset can be both an investment and an effective save haven.

By their very definitions, an investment should grow over time, whereas the value of a safe haven asset should remain fairly consistent, increasing alongside inflation.

The Predicament

Two Australian researchers published a paper in 2012 posing the question: Does the belief in gold as a safe haven asset reinforce or weaken its safe haven properties?

As we’ll see, investors’ relationship with gold has transformed over the past half-century, as Commodities Trading Desks have sought more lucrative returns. The trouble is that when economic theory and reality diverge, there can be consequences; and the erosion of gold as a safe-haven asset could have multiple negative externalities for both the global economy & individual investors.

How Theory Plays In Reality

In the stock market crashes of 1987 and 2001, the price of gold showed an inverse relationship with global stock prices. This aligns with conventional theory that investors would flock towards safe haven assets during times of increased uncertainty or recession.

During that time, the price of gold was in a protracted Bear Market, while inflation continued to rise. Therefore, it’s hard to argue that gold was strictly a store of value, nor could one claim it was an entirely effective inflation hedge. Then again, gold did behave as expected in periods of market distress.

It was only after the recovery from 2001 that things change.

From 2002 to 2012, the price of gold soared from $300 to $1900. Similar 10-year growth is comparable to Japanese stocks in the 1980s and the Nasdaq’s Dot Com bubble in the 90s.

2008 Accelerated The Trend

In 2008, investors had already witnessed the rapid appreciation of gold in 1987 and 2001, leading to a bizarre occurrence: the price of gold displayed increased correlation with global stock prices after the initial market shock.

When the market crashed in 2008, the price of gold rose. So far so good right?

From November 14th, 2008 to September 9, 2011, the price of Gold increased 150% while the S&P 500 grew approximately 45% over a similar time frame.

During those years, the demand for gold in specialty electronics may have risen slightly, but that hardly accounts for gold’s price behavior. The demand for this alleged “safe haven asset” sky-rocketed, even as investors were willing to assume more risk by investing in stocks.

That’s because gold became detached from its sentiment as a safe haven asset; and that change in belief could have strong ramifications for global financial stability — particularly as we watch the price of gold skyrocket alongside Stock Indices once more these past few months.

Why We Want Gold To Remain A Safe Haven Asset

Many economists believe that that economic crashes and crises will be more extreme in the absence of safe haven assets such as gold, because investors will be forced to fully withdraw capital from the markets versus reallocating their portfolio.

The increased holdings of gold by many investors in recent years has the potential to undermine and possibly destroy the safe haven property of gold. This could:

Make It More Expensive To Hedge

As speculators drive up the price of safe-haven assets, including gold, this will increase the cost for investors who are actually looking to use safe-haven assets to offset risks in the stock-market.

Eliminate True “Safe” Assets

Efficient Market Hypothesis assumes that if investors recognize a trend, it won’t remain a trend for long, and as speculation drives up the price of other safe-haven assets, fewer and fewer assets will actually offer the elusive promise of “safety”.

More Bubbles

With speculation comes bubbles, except bubbles with gold produce particularly negative consequences due to its ubiquitous nature as a store of value.

The Bottom Line

In many countries with more volatile currencies and different cultural norms, gold truly does store value for families. It’s estimated that Indian families own over $2 Trillion of gold, not to mention the gold in their country’s reserves.

Clearly, nobody wins as we watch gold succumb to free market pressures, except speculators that time their exit and those who short GLD, I suppose. Unfortunately for most of us, such bubbles could eventually lead to a complete erosion of faith in the value of gold. This could in turn lead to a crisis in confidence with most major currencies that are backed by countries with vast gold reserves.

Fortunately, such a dire scenario seems unlikely.

When Wall Street drives up the price to $1900 an ounce with speculation, and the average individual purchases gold to store value at that price, what happens when the bubble pops and this “save haven” crashes back to earth?

Again, nobody wins with the erosion of safe-haven assets.