What is a safe-haven investment?

Fans of bitcoin say it trumps gold as a safe-haven asset, so Morningstar analysts have created a framework to determine what a safe-haven investment is.

Kristoffer Inton 13 September, 2018 | 5:00PM
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Amid their meteoric price rises of 2017, bitcoin and other cryptocurrencies garnered mainstream attention and legitimacy as an asset class. Some went so far as to posit the idea that cryptocurrencies could replace traditional forms of currency or assets, including gold.

As a first step in determining whether cryptocurrencies should be considered safe-haven assets, we need to define what safe-haven assets are. For our purposes, we classify an asset as a safe haven if it holds, or even increases, its value during periods of market and economic uncertainty and downturns. The asset should preserve capital, withstand market volatility, and provide diversification across a portfolio.

Many asset classes have traditionally been considered safe havens. This list includes gold and other precious metals, industrial commodities, agricultural commodities, currencies, real estate, consistent dividend stocks, and US Treasury bonds.

Designing a safe-haven test

Based on our established definition, we've created a framework for assessing the viability of any asset class as a safe haven.

Liquidity How easily can investors buy and sell the asset? Investors should be able to convert the asset into cash easily at any time, requiring an active market that allows easy liquidation.

Examples: Currency is the most obvious liquid asset, as it can be used immediately. In comparison, real estate transactions can take months. Immediate liquidation of real estate can be challenging in certain scenarios.

Functional purpose Does the asset have any purpose other than as an arbitrary store of value? Additional uses create an anchor of demand for the asset, helping provide long-term demand stability. If there is no usefulness for the asset, then there's essentially no floor for demand, and the asset could easily be worth zero if sentiment on its investment viability changed rapidly.

Examples: Real estate allows the owner to develop assets on the land, and commodities can be processed into higher-value goods. Non-reserve currencies hold comparably weaker functional purpose, especially if only accepted in the issuing country.

Scarcity of supply Is there significant scarcity of the asset that limits potential supply growth in the market? Investors need some certainty that supply growth won't outpace demand growth. Otherwise, the asset value will probably erode even if demand is growing, likely leading to long-term price deflation.

Examples: Real estate and commodities hold some of the most obvious scarcity, as there is only a limited quantity of either asset. In comparison, cash and government bonds have weak scarcity, as there are virtually no limits to how much can be printed.

Future demand certainty Is there going to be demand for the asset in the future? Furthermore, if the asset has use now, is it possible that it can be replaced or disrupted in the future? Investors need to believe that there will be a future market for the asset. Without this confidence in a future market, then the asset can't store value.

Examples: There is almost no question that there will be demand for real estate in the future, especially when compared with certain commodities that may be disrupted or replaced. For example, coal's demand has fallen dramatically as alternative energy sources have gained adoption.

Permanence Does the asset's utility deteriorate over time? Will the asset be just as useful years from now as it is today? Investors need some certainty that the asset won't decay over time, which would otherwise erode its value.

Examples: Real estate and gold are virtually permanent, with no significant erosion of quality over time. In comparison, agricultural commodities' permanence is questionable, as most will rot in time.

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About Author

Kristoffer Inton

Kristoffer Inton  Kristoffer Inton is an equity analyst for Morningstar, covering gold, coal and cement companies. Before joining Morningstar in 2013, he was an investment banking associate for Guggenheim Securities in New York. He holds a bachelor’s degree in finance with high honours from the University of Illinois.

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