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Safe Haven - Look no Further than Gold

May 16, 2012, 5:51 PM

Markets are skittish and the pace and force of financial crises have taken a frightening turn for the worse. It seems like the fuse gets shorter between each crisis. We barely catch our breath from one when confronted with the next. Looking back three decades a crisis had taken place, on average, every three years. But a scant 18 months after the 2008 meltdown, Europe's Greek sovereign debt crisis hit with full, fulminating force. Then we got Spain, Ireland, Italy etc. One crisis begets another and it seems like the world's economy is on a treacherous bumper-to- bumper course where any misstatement from politicians can cause a multiple car pile up. Still, the fact worth keeping in mind is that the main stock indices lead, not follow the main economic indicators, such as the GDP growth.

Therefore, when one reads something about the unemployment, GDP, import/export dynamics etc., in the vast majority of cases this information is something that has already been factored into prices. Let's just say that the realistic assumption here is that the institutional investors / specialists have better access to information / research teams. At the same time they usually control large amounts of capital and their investment decisions can influence the value of the stock indices. So, if these investors' research suggests that the economic statistics are going to be grim in the future, they are likely to sell stocks right away, before everyone else gets the same information - without waiting for the official numbers to be released. Consequently, prices of stocks are to lead economic statistics.

Naturally, a move in either direction might accelerate after a particular piece of news is released, but the overall trend will most likely be in place much before that.

Moving back to gold - more and more often we hear talk of investors searching for "Safe Haven," as if it's a quest for a Holy Grail.

Take a look at these headlines:

"Bullion Sales Hit Record in Stampede to Safety." (Financial Times)
"Gold is Safe Haven for Looming Crash." (Seeking Alpha)
"Gold Ticks Higher On Safe Haven Buying." (AP)
"Gold Rush: This is a new round of safe haven buying." (Bloomberg)

Safe haven is defined as a currency, stock or commodity favored by investors in times of crisis because of its stability and/or easy liquidation. Gold is a universally recognized currency carrying no counterpart risk, easily portable and unlike fiat currencies, it is nobody else's liability. Early civilizations equated gold with gods and kings, and gold was sought in their name and dedicated to their glorification. Humans almost intuitively place a high value on gold, equating it with power, beauty, and the cultural elite. And since gold is widely distributed all over the globe, we find this same thinking about gold prevalent throughout ancient and modern civilizations.

Sometimes safe haven is mentioned in connection to gold, other times U.S. treasuries, the Swiss franc and the Japanese Yen. In 2010 when financial markets plunged in "flash crash" mode, there was talk of capital flight from countries like Germany and Britain to perceived safe havens like Switzerland. Across the globe, investors fled from risky currencies, bonds and stocks to gold, the dollar, the Japanese yen and U.S. bonds.

When there was intense pressure on the euro, we witnessed panicking German dealers and banks desperate to get their hands on Krugerrands, the world's most popular gold coin. At times like that the phone does not stop ringing the Rand refinery in South Africa with people wishing to buy gold coins. The Austrian Mint, which produces the popular Philharmonic gold coin, sold more gold in the two weeks from April 26, 2010 during the euro crisis than in the entire first quarter of the year because of soaring European demand.

Gold has a solid reputation as a safe haven when markets are gripped by fear and as an inflation hedge. Is the reputation justified?

It is useful to look back several decades to see gold's performance during some of the major crises that gripped the world.

When the news of the Bear Stearns collapse became public in the last week of June 2008 there was a flight to quality as investors became more risk averse. When in July 24th news came out that the subprime fiasco had extended to Australia, there was mass flight into Treasuries and gold fell almost $30 under liquidation and technically induces sales. It was after the interest rate cut by the Federal Reserve that investors returned to gold and it emerged as the strongest asset class, other than oil, in all the major currencies. At the end of September the U.S. Mint was forced to suspend sales of the American Buffalo 24-carat gold coins because it had run out of inventory. Only a month earlier, the Mint had also temporarily suspended sales of the American Eagle one-ounce gold coins, and had later made them available again through an allocation program to specific dealers.

If we go further back to the 9/11 terrorist attack crises, in the immediate aftermath gold prices fell under panic selling, dropping from $287 to $279. Then came the flight into safety and gold shot up from $279 on September 12, to $293 on September 17th, a five percent increase.

The Dot.Com bubble burst on March 10th, 2000. The NASDAQ dropped 34 per cent from that date until April 14th. The S&P and gold fell 3 percent during this time. The biggest beneficiary of a flight to safety was the bond market, mostly due to a strong dollar. Another reason for gold's feeble performance was the British gold sales during this period initiated by Gordon ("Golden") Brown, who sold on the open market 60 per cent of Britain's gold reserves.

Gold's performance was relatively bullish during the Russian ruble crises of 1998 and the collapse of hedge fund LTCM, although gold did not do as well as the bond market.

Gold found itself under pressure during the Asian currency crisis of 1997-98. However, if we need proof of gold's safe haven status, there is the fact that the South Korean government bought gold from its population, sold it on the international market and raised hard cash to pay its debt service obligations.

In the short term, gold can move any way, because the enormous amount of speculative capital out there (that's one of the reasons we pay a great deal of attention to the charts.) It is not at all uncommon for gold prices to have a delayed reaction to a crisis. For instance - in the 2008 credit meltdown, gold at first plunged along with main stock indices as hedge funds were forced to liquidate their gold positions to offset losses in other markets. The most extreme example was the fall in gold prices following the Asian currency crisis, but also evident to a lesser extend during the credit and 9/11 crises. Going back further, the same phenomenon took place in the 1987 stock market crash.

There are two reasons why gold has retreated on each of these occasions. The first, gold, as a part of some commodity indices, is automatically subject to liquidation along with the others. The second, gold is sold in order to raise cash or meet margin calls from other sectors. Once nervous investors and distress sellers had been flushed out of the market, sentiment towards gold returned in most of the major crises as well as its status as a safe haven.

The bottom line is that gold has been valued throughout history and fiat currencies have always failed sooner or later. So, gold may not always move in the direction that one would expect it to move, but it is reasonable to expect gold to retain its purchasing power over the long run, while the fiat currencies do not.

Throughout history and in all civilizations gold has been valued and cherished. It has offered security in times of political or economic crisis. In extreme situations a few gold coins hidden in a coat lining could mean the difference between life and death. Gold is almost indestructible and does not corrode or rust. The amount available changes slowly and the quantity of newly-mined gold added each year is a small proportion of the existing inventory.

Gold has been a "reserve currency" and a safe haven for thousands of years, and those who understand history know that it will always remain one.

However, in order to make the most of investing in gold and trading it, it is imperative to conduct through analysis and dedicate a lot of time and resources to it... Or to read the professional analysis written by experience authors. This is where we can help. In our Gold & Silver Trading Alerts we provide detailed analysis of the precious metals market in a daily basis and in our Market Overview reports, we conduct monthly fundamental analysis of the gold market. Regardless of which is of the above seems more appealing to you, the best course of action at this time is to sign up for our free gold newsletter. In this way, you'll be up-to-date with our free analyses and at the same time, you'll receive 7 days of access to our Gold & Silver Trading Alerts as a starting bonus. Again, it's free so all it takes to sign up is just several seconds of your time. Sign me up!

Shula Kopf
Sunshine Profits' Contributing Authors

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