Jan Skoyles: When asked why we invest in gold the standard answer often involves, ‘because it is a safe haven,’ or, ‘because it is a hedge against financial collapse.’ Often people base these statement on historical examples many hundreds of years old, but what about in recent history? Has gold proved itself in recent years? And when we talk about a safe haven, do we realize that it is not the same as a hedge?
I look at a paper that answers these very questions. As is so often the case in gold investment, the answers to above questions are not clear cut but the overall message remains the same: gold is both a hedge and safe haven.
Is gold a safe haven everywhere?
Baur and McDermott (2009) examined the role of gold in the global financial system and asked ‘Does gold act as a safe haven against stocks of major emerging and developing countries?’
Looking at data between 1979 and 2009 the study finds that gold is both a hedge and a safe haven for both the US and major European stock markets. However it is not shown to be so for Australia, Canada, Japan and the BRIC stock markets.
They find that ‘gold was a strong safe haven for most developed markets during the peak of the recent financial crisis.’ The authors argue that ‘gold may act as a stabilizing force for the financial system by reducing losses in the face of extreme negative market shocks.’
Interestingly, looking at daily data the authors ‘find evidence of the strong-form safe haven’ for Canada, France, Germany, Italy, Switzerland, the UK and the US.’ This finding, they believe, ‘suggests the potential for gold to act as a stabilizing force for financial markets by reducing losses when it is most needed.’
When and why we invest in gold
Traditionally we refer to gold priced in dollars, many investors (particularly at the moment) choose to invest in gold as a hedge against inflation and a falling dollar. Should the dollar lose value then theprice of gold (as priced in dollars) will rise. This theory, of using gold as a hedge against exchange rate risk, has been shown in previous academic work.
The authors believe that investment demand is ‘counter-cyclical’, i.e. demand rises as the global economy ‘enters a recession.’ In contrast, jewelry and industrial demand both follow the business cycle.
Since the financial crisis gold investment, according to the World Gold Council, has continued to reach new highs. Demand in bar, coin and ETFs appears to outstrip jewelry demand on an annual basis. This phenomenon had not been seen prior to the financial crisis.
Frequently the mainstream financial media use the phrases ‘hedge’ and ‘safe-haven’ to mean the same thing. This is not the case and the authors offer up definitions:
Hedge: A weak (strong) hedge is defined as an asset that is negatively correlated (uncorrelated) with another asset or portfolio on average.
Safe haven: A strong (weak) safe haven is defined as an asset that is negatively correlated (uncorrelated) with another asset or portfolio on average.
The authors believe that the key difference between the two is the ‘length of the effect’. ‘The important property of the hedge is that it holds on average whilst the key property of the safe haven is that it is only required to hold in certain periods.’(...)Click here to continue reading the original ETFDailyNews.com article: Is Gold A Safe Haven?You are viewing an abbreviated republication of ETF Daily News content. You can find full ETF Daily News articles on (www.etfdailynews.com)
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