Factors Driving Most Popular Safe Haven Asset, Gold

A good investor generally believes in diversifying the portfolio so as to mitigate the risk in tough economic situations. During the periods of market instability and crises, the investors invest in the safe haven assets that are likely to retain or increase in value. If the investors could identify the assets that would appreciate or decline in the period of market turbulence, they can take advantage of the price patterns by preparing a strategy to deal with the market movements.

Types of Safe Haven Assets

Although there are many safe haven assets available in the economy, finding the right one in the volatile market is a difficult task. Let us have a look at a few of the safe haven investment securities below:

  1. Gold - Gold is considered to be a most-popular and the ultimate safe haven asset by the investors. This is because the price of gold does not vary frequently by the monetary policy changes in the economy. It is also considered as a form of insurance by investors against adverse economic events. During the events of extreme market volatility, the price of gold tends to rise.
  2. Government Bonds - The financial instrument backed by the government like government bonds are also regarded as safe haven assets. For example, the US treasury bills, supported by the full faith and credit of the United States government, is termed as a safe haven because the investor gets repaid in full once the bill gets matured.
  3. Exchange Traded Products - The exchange traded fund or ETF is also characterised as a safe haven if invested in judiciously. The exchange traded fund is an investment fund that holds a wide range of securities. ETFs provide automatic diversification to shareholders and offer investors a way to express their views about the investment markets easily during periods of extreme volatility. ETFs are one way to gain an exposure to an underlying index in tough times.
  4. Defensive Stocks – The defensive stocks are stocks of the companies that provide goods and services like healthcare, utilities, food and beverages and consumer staples. These stocks can very well sustain the recession as the goods offered by these companies are necessary for daily life.
  5. Cash – The cash is the only safe haven that does not offer any real return. Clearly, keeping your money in cash form helps you avoid the turbulence in the market.

Gold – “The Ultimate Safe Haven”

The yellow metal has retained its status of being the ultimate safe haven asset as it protects the investors from sectoral and systemic risks. Investors generally buy gold in order to diversify their risk and hedge against the decline of the currency. Gold is not at risk of becoming worthless at times of financial or political uncertainty, unlike other assets bearing credit risk.

Factors Affecting Gold Prices:

The price of the gold can be influenced by multiple fundamental and psychological factors that are discussed below:

  • Monetary Policy - The changes in the monetary policy of any economy affects impacts the gold prices considerably. When the central bank of a country adopts expansionary monetary policy reducing interest rates, the gold becomes an attractive investment option because of the low opportunity cost of the forgoing interest-based assets. As a result, the gold price increases due to its huge demand. However, when the bank adopts contractionary policy increasing interest rates, the investors flock to fixed-income investments as they offer stable returns relative to gold, resulting in a fall in the gold prices.
  • Inflation – Gold is used as a tool by the investors to hedge against the inflationary pressures. People prefer to invest in gold during the periods of rising inflation, thereby raising the demand for gold. The higher inflation levels also lower the value of the currency, pushing the gold prices higher.
  • Currency Movements – The movement of the currencies affect the gold prices inversely. The fall in the value of US dollar pushes the price of gold higher as the other currencies across the world to become more expensive relative to the dollar. Conversely, as the value of the U.S. dollar increases, the price of gold tends to fall in the U.S.
  • Consumption demand – Gold is primarily used to make jewellery across the world. If the demand for gold jewellery increases, the price of gold automatically rises owing to its limited supply.

Relationship Between Gold Prices and Interest Rates

Usually, when the central bank decides to cut the interest rate, the gold prices jump higher as investors start looking for more viable safe haven alternatives. At the time when the Reserve Bank of Australia reduced the interest rate to a historical low level of 1 per cent this year, the prices of gold in Australia jumped higher, crossing the $2000 an ounce mark.

In contrast, when the interest rate rises, the incentive to hold assets in the form of storable commodities falls, and the interest-paying investments like Treasury bills become more appealing to investors. With a shift of funds towards other investments, the demand for gold falls, resulting in a fall in gold prices.

RBA’s Gold Holdings

The central banks of different countries also hold gold as one of their reserve assets. The commodity helps them protect the purchasing power of their currency during inflation.

The Reserve Bank of Australia also holds gold as a part of its official reserve assets. The bank has not undertaken any purchases or sales of gold in the last two decades. Around 99.9 per cent of the RBA's physical gold holdings are stored in the UK at the Bank of England (BoE) while a tiny amount is stored at the RBA’s head office in Sydney. Storing gold at Bank of England allows the central bank to easily access the market as London is the largest trading centre for gold in the world. The central bank claimed in 2018 that it has 80 tonnes of gold bars stored in an allocated gold account in a bailment arrangement at BoE vaults in London.

Gold Price Scenario

Gold spot price (XAU/USD) was recorded at US$1414.56 at the end of 15th July 2019. The price of gold has touched unprecedented levels in recent days as geo-political tensions have raised uncertainty, inducing a shift of the global investment towards the safe haven assets like gold. The turbulence resulting from the crumbling trade negotiations between the US and China have raised the spot gold prices in the US. Investors are also responding to the expectation of an interest rate cut by the U.S. Federal Reserve at the end of July 2019. The gold futures edged higher on Monday amid the anticipations of a rate cut. However, investors are now eyeing for the US retail sales data that could possibly raise little hope amid lingering concerns over a global economic slowdown.

The chart below demonstrates a rise in the gold prices witnessed in the last three months in the US:

Gold Price Chart, Source: Thomson Reuters

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