August 30, 2011 at 14:15 PM EDT
The World’s Last Risk-Free Investment
Gold will eventually replace U.S. Treasuries as the world's last risk-free investment. Here's why.

It wasn’t long ago that U.S. Treasuries were considered a “risk-free” investment. But the financial crisis, hulking budget deficits, political gridlock and the Standard & Poor’s debt downgrade have changed that perception — forever.

Now there’s only one safe-haven investment: gold.

Since surging to a record high $1,917.90 per ounce earlier this month, the price of gold has slipped on profit taking. But don’t let that minor correction fool you into thinking gold’s bull run is over. The yellow metal’s best days still are ahead.

How do I know? Because, unlike U.S. debt, gold can’t be downgraded. It has inherent value that’s more reliable than the word of even the most powerful country on earth.

Gold was used as currency for centuries. In fact, it’s still being used for transactions in places such as China, India and much of the Middle East — regions that are eager to diversify away from the beleaguered U.S. dollar.

But now gold’s also usurping the role U.S. Treasuries have played for the better part of a century — that of the ultimate investment safe haven.

Just take a look.

The World’s Real Risk-Free Investment

From July 21, 2009, to mid-July of this year, the correlation between Treasuries — as represented by the iShares 20-Year Treasury Bond ETF (NYSE:TLT) — and gold — as represented by the SPDR Gold Trust ETF (NYSE:GLD) — was 0.5, meaning that only half the movement of one coincided with the other.

However, in the period ranging from July 21, 2011 to Aug. 16, 2011, the correlation jumped by 78% to 0.89. That means gold and 20-year Treasuries are moving in near-perfect lockstep.

What’s the catalyst for this shift? I believe traders are using gold to hedge their holdings against the systemic solvency risk of a global banking failure. Simply put, they’re looking to cover their bets should the worst happen.

Far-fetched? Not really.

If the banking system crashes, it will take the developed world’s financial system down with it. And when that happens, it’s very likely that cash withdrawals or cash transfers will be frozen, as will the credit markets.

Thus, gold might be one of the few assets that’s still actively traded, meaning there’s still an independent pricing mechanism in place.

You will, for example, be able to price gold at the local pawnshop — just as easily as you’ll be able to cut a deal on the corner of the street (though hopefully not at gunpoint).

At an institutional level, this already is happening, albeit with a slightly different twist.

ICE Clear Europe Ltd. — a unit of IntercontinentalExchange Inc. (NYSE:ICE) and one of Europe’s top derivatives-clearing companies — is accepting gold as trading collateral. Earlier this year, JPMorgan Chase & Co. (NYSE:JPM) and the Chicago Mercantile Exchange also started accepting gold as trading collateral.

The advantage gold offers is incontrovertible. Bonds — be they U.S. Treasuries or other types of securities — are limited by their sovereign backers. That means they are only as solid as the country that’s backing them.

But that’s not true of the yellow metal.

The lesson here is clear: You can’t downgrade gold; and that makes it the world’s only risk-free investment.


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