Monday, July 18, 2011

Safe Haven Trade

By Scott Silva
Editor,  The Gold Speculator

Gold is showing its true colors as the ultimate safe haven asset. Gold has been trading at all-time highs as national economies in the European Monetary Union teeter on bankruptcy, threatening the legitimacy of the Euro as a legitimate currency. Adding to global economic uncertainty is the US debt crisis, which has forced the major credit rating agencies to place US sovereign debt on negative credit watch for potential downgrade.

It seems inconceivable that the US would lose its AAA credit rating. US Treasurys have been considered the riskless asset compared to all others. That is, the probability that the United States would default on its debt has been considered zero, up until now. Moody’s has stated that the chances of US default in the next 90 days are 50-50. That’s a long way down from “riskless”.

The US Dollar and US Treasurys have been traditional safe-haven assets. US Dollar denominated assets surge in price when investors sell risky assets such as stocks and high-yield bonds in the so called “risk-off” trade. We saw the Dollar climb at the height of the global financial crisis, right after Lehman Brother’s bankruptcy in September 2008.  US Treasurys also surged. In January 2011, the Arab Spring followed by the Libyan oil shock in February put pressure on the Dollar as commodity prices, led by oil, spiked. Also in January, fears of a Euro-zone debt crisis began to take hold. Investors piled into gold, in a flight to safety, driving the price above $1400/oz.

Traditionally, the Dollar and gold are negatively correlated, which is to say gold prices tend to rise as the Dollar declines, and vice versa. We have seen gold prices, measured in Dollars, rise steadily since 2009. Over the same period, the US Dollar has seen an overall decline. This is not to say that one caused the other. Contrary to popular belief, correlation is not causation. The US Dollar has declined in value primarily due to Fed increases in the money supply. Gold prices have increased because there are more buyers than sellers. The price of gold is a good measure of economic uncertainty.

Another measure of investor sentiment (fear or uncertainty) is the CBOE Volatility Index, or VIX. It measures market expectations of near-term market volatility conveyed by S&P 500 stock index option prices. Since its introduction in 1993, VIX has been considered by many to be a reliable barometer of investor sentiment and stock market volatility.

We can see in the chart above that the VIX and the S&P 500 are negatively correlated. Stocks tend to fall when the VIX rises. This makes sense. When investors expect the markets to be volatile, fear of losses drives them to sell. Of course, for most investors, selling begets more selling. Many flee to US Treasurys, considered the safe trade.

But that relationship is now breaking down. Today, stocks are selling off; the Dow is down more than 150 points and S&P500 is down 1.3% to below 1300. Price action in the VIX predicted the sell-off by moving up from 16 on July 11 to 21.78 today. The Dollar index, however, is trading slightly lower than the last week’s levels (75.85 vs 76.31) and, the 10-Year Treasury is trading at the same level as nearly a month ago. So proceeds from the stock sell-off are not flooding into US Dollar denominated assets.

Instead, funds are flooding into gold and gold stocks. COMEX gold has broken through $1600/oz, and the gold mining stocks are breaking higher. The NYSE Arca gold BUGS index (HUI) is up 17% over the last 30 days.  The Philadelphia Gold/Silver index is up 11% for the same period.

Clearly the ‘safe-haven’ asset is gold. Right now the flight to safety is away from stocks and away from the Dollar and Treasurys and into gold and gold stocks.

Subscribers to The Gold Speculator have owned gold and silver (metals and mining stocks) since early in 2010. Specific portfolio recommendations produced 66% profit in 2010 and gains of 40.5% year-to-date for 2011. In comparison, the Dow is up 7.10% year-to date, and the S&P 500 is up 4.09% year-to-date.

Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

The question for you to consider is how are you going to protect yourself from the vagaries of the fiat money and economic uncertainty?  We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio gained 66.7% in 2010, and 55% for 1Q2011. Subscribe at our web site  with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055

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