As COVID-19 spread across the globe, the demand for safe-haven assets ballooned. A safe-haven asset is an asset that is expected to outperform during times when a market might experience turbulence. Generally, you might consider purchasing safe-haven assets when adverse market conditions occur which will negatively impact riskier assets such as stocks. Assets that are considered safe-havens might only outperform during certain market conditions. It’s important to understand when specific assets will outperform and the adverse conditions that might benefit these assets.
What is a Safe-haven Asset
A safe-haven asset helps you diversify your portfolio. This type of asset will generally underperform when a business cycle is on the upswing but will outperform during times of market volatility. The outperformance of a safe-haven asset will depend on market conditions. During short-periods of market turmoil, certain safe-haven assets will perform better than others. During long periods of prolonged economic malaise, other safe-haven assets will outperform. There are 3-categories of safe-haven assets including:
- Precious Metals
- Treasury Securities
The most widely held precious metal is gold. The yellow metal has been trading for thousands of years and was initially the benchmark. In the 1970s the United States removed a fixed value for gold conversion into US dollars to allow the greenback to float freely. Since that period gold has been considered a safe-haven as an alternative to sovereign currencies like the US dollar, as well as an asset that will outperform when inflation is on the rise. Gold prices are quoted throughout the globe in US dollars. Generally, when the value of the US dollar rises, it becomes more expensive to purchase gold in other currencies.
To adjust for this, the price of gold will generally decline. The reverse is also true. When the dollar declines it becomes less expensive to purchase gold in other currencies, allowing gold prices to rise. While you can trade gold as a safe-haven, if the dollar is rising against a basket of currencies due to the outperformance of the US versus other countries around the globe, then gold prices are likely to underperform and not act as a safe-haven would. Gold historically has experienced outperformance when inflation is on the rise, outpacing other safe-haven assets such as cash and bonds.
You might have heard the term, cash is king. This saying refers to the notion that cash will not lose its value based on market factors but can be influenced by rising inflation. Inflation is when the price of a basket of goods and services rises. If the price of goods and services that you normally buy increases and you are on a fixed budget, and only hold cash, the value of your cash will decline relative to the goods and services you can purchase. Cash can be a safe-haven and will outperform riskier assets when the markets are turbulent, but when inflation is on the rise, cash will lose its value.
When riskier assets such as stocks move out of favor, market participants will often look to bonds or treasury securities as a safe-haven asset. Treasury bills are short-term fixed income securities that provide the purchaser with a fixed coupon payment for lending money to the federal government. The value of treasury securities can be a risk, but most of the benefit comes from the fixed payments investors receive for loaning money to the government. Treasury security prices rise as yields on these securities fall. The reverse is also true. As yields rise, the price of Treasury securities falls.
Inflation can also be the enemy of treasury securities. Despite the market turmoil, if inflation is on the rise, it will erode the value of fixed coupon payments that are received by individuals who are relying on those payments to live. So, while treasury securities will generally outperform when markets are turbulent, they will underperform when inflation is rising.
The Bottom Line
The upshot is that there are several different assets, including precious metals, cash, and treasury securities that are considered safe-haven assets. These assets outperform during market turmoil. There are some caveats. Not every safe-haven asset will outperform during market turmoil as it will depend on economic conditions.