Gold Continue to be a Safe Haven

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The term 'safe haven' has been synonymous with gold for ages now. The dictionary definition of a safe haven is "a place, a situation, or an activity which provides people with an opportunity to escape from things that they find unpleasant or worrying". From the perspective of investments, a safe haven is one that protects the overall portfolio returns when the prices of other risky assets in the portfolio fall. In other words, gold is expected to provide portfolio insurance during a crisis. Its unique properties make gold an ideal safe haven.

But over the last three months, the price action in gold in the international markets is threatening its status as a safe haven. Gold is down by about 18% from its recent peak and it has been moving more in tandem with other risky asset classes, especially the cyclical commodities. Its co-relation with risky assets and other cyclical commodities in the last few months has risen substantially as interbank liquidity has disappeared. Cyclical commodities usually rise when the risk appetite and the global economic confidence is higher and vice versa. And gold tends to do well when the risk appetite is low and a global crisis is on the anvil. The DJUBS commodity index has fallen by around 14% in last three months and gold's prices in US dollars have also fallen by 12%. The dollar's appreciation has helped gold's fall.

Gold usually competes with other global safe havens such as the US dollar, Swiss franc, Norwegian kroner, Japanese yen and US treasuries (bonds). The dollar derives its safe haven character from its status as a global reserve currency and US's dominating position in global trade, financial markets and GDP. US treasuries, too, enjoy the status probably for similar reasons. The other currencies are safe havens due to the strong economic strengths and the stable institutional framework of the countries concerned. Gold in the last three months has underperformed all the safe havens by reasonable margins, despite the rise in systemic risks and the possibility of a disorderly outcome of the European crisis.

So what's hitting gold now in international markets? A confluence of factors such as year-end squaring up of long positions and profit taking by hedge funds as interbank liquidity dries up in other markets; higher margin calls from exchanges (CME); a sharp fall in the Euro (rise in US dollar) in last few days, as the European crisis worsened and global risk appetite vanished; a general fall in commodity complex as global growth slowed; no further quantitative easing tranche's from the Federal Reserve or European Central Bank (ECB) as constitutional and political hurdles come in the way; the marginal improvement in macro data in the US; and the expected fiscal austerity on either side of the Atlantic.

Gold in Indian rupees (INR) has been able to minimise its fall due to the sharp depreciation of the rupee vis a vis the US dollar (USD). Gold in dollar terms peaked at 1,921/oz in September when the rupee was hovering around . 48. Gold in USD has since collapsed by 18% and in rupee by 13%.

Since most of the gold in India is imported, any changes in the value of the rupee is fully transmitted to the domestic gold prices, assuming no changes in duties, taxes or any other charges. So, gold prices in rupee are just lower by 9% from the peak, whereas in dollar it is down by 18% from its peak.

The rupee's weakness has become the white knight for gold prices in terms of the rupee. What if the rupee reverses its recent trend on positive policy triggers or RBI intervention? Gold as an asset class is unique as it enacts multiple roles at multiple times, such as being a proxy currency, safe haven, portfolio insurer, inflation hedge or just a commodity. But its recent move in tandem with risky assets such as commodities dilutes its safe haven status for the time being. Especially when almost onethird of the global gold demand comes with investment as an objective, more as a safe haven. Despite short-term headwinds, gold in the long run would continue to be a safe haven, till the global financial system remains fractured, sovereign crisis remains alive, real rates remain lower and central banks are expected to print money. Gold is a "real" proxy currency, which, unlike paper currencies, can't be printed at will and so they can't be safe havens on a sustained basis.

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