Safe Haven Investments: Only One Remains

The April 18 announcement by Standard and Poor's that it downgraded its outlook for U.S. debt to "negative" from "stable" was unsurprising.

At the same time, though, it raised questions about safe haven investments.

Principally, if U.S. Treasuries are no longer an investment safe haven, then where can cautious investors safely store their capital?

The market's initial reaction to the S&P announcement was typical of its trader-dominated nature. Stocks dropped and gold rose - but U.S. Treasury bond prices actually rose, as well.

Traders took the view that S&P's action had increased the chances that Congress would come together and produce a compromise solution to reduce the budget deficit and restore the U.S. credit rating to a sound footing.

I can see how that might happen, but I wouldn't bet on it. Certainly, such an outcome is not likely before the 2012 elections.

Given that belief, it is clear that U.S. Treasuries are no longer a safe haven. And in my view, they haven't been for some time. The monetary policies of former U.S. Federal Reserve Chairman Alan Greenspan and current Federal Reserve Chairman Ben S. Bernanke have been tending towards the inflationary since 1995.

For more than a decade, the inflation those policies should have produced has been suppressed by the deflating effect of the second wave of globalization, which has reduced the cost of innumerable imported goods.

However, as we look at Chinese wage inflation of 20%, it is becoming clear that this benign suppression of the inflation we deserve is coming to an end. Hence, U.S. Treasuries fail as a safe haven for two reasons: They are vulnerable to default in the long term and a loss of purchasing power in the short term.

If that's obvious to us, it must be equally obvious to the Asian central banks and Middle Eastern oil billionaires that have been propping up the U.S. Treasury market for the last three years. It's also probably obvious to the U.S. Federal Reserve, which has been propping up the Treasury market through its quantitative easing programs. Thus, an awful lot of money is currently looking for a new safe haven.

The conventional safe haven from the travails of the dollar has long been gold.

Those that have trusted in the yellow metal so far have done very well. Its price has risen from around $250 an ounce a decade ago to its current level of more than $1,500 an ounce. The same is true for silver, which has experienced an equally impressive surge. These two metals continue to be a safe bet for investors going forward.

Traditionally gold has been limited to 5% to 10% of a portfolio's holdings, but today's conditions of monetary uncertainty warrant higher proportions - perhaps up to one-third is justified.

But be warned: To go any further than that would transform gold from a safe haven to a risky asset, because the world's monetary authorities will at some point get serious about the rising level of inflation, and gold prices will crash.

Remember, it took former Federal Reserve Chairman Paul Volcker less than four months - from October 1979 to January 1980 - to stymie gold's record-setting advance after he decided to squash inflation. Gold's fallback thereafter was both swift and massive, as the metal lost two-thirds of its value over the next five years.

Safe Haven Investments Around the Globe

Outside of gold, safe haven investments are few and far between.

Japan, which used to be considered a haven, has an even worse debt problem than the United States. Australia and Canada, the rich countries with substantial commodity economies, will suffer if commodity prices fall, and both have succumbed - at least in part - to the global mania for fiscal and monetary stimulus.

They all are also on the small side for Asian central banks and oil billionaires, and their government bond markets are somewhat illiquid by People's Bank of China standards.

However, there is one country that has refrained from stimulus - whose finance minister described stimulus as "crass Keynesianism" as early as December 2008. It has a strong economy based largely on manufacturing, steady growth, and a balance of payments surplus based on the success of its exporting industries.

Yes, I'm talking about Germany.

You may object on the basis that Germany is tied to a bunch of economic losers through the European Union (EU), and more particularly the euro. However, as the strongest economy in the Eurozone, Germany's assent is essential for bailout deals, and it has already become clear that German politicians and taxpayers will not allow any deals that threaten Germany's own fiscal stability.

Also remember that not all the other EU countries are basket cases. In addition to traditionally strong economies such as France and the Netherlands, the EU now includes a number of rapidly growing Eastern European countries, such as Poland and Slovakia.

Politically too, Germany is not alone in objecting to massive bailouts. Finland (another strong economy) last month gave a record share of the vote to the True Finn party, which opposes all EU bailouts and greater EU spending generally speaking.

So unlike the United States and Japan, Germany has no need to impoverish itself, and is likely to remain strong.

Infuriatingly, there is still no mutual fund or exchange-traded fund (ETF) devoted to German government bonds available in the U.S. You can buy the bonds directly through a German bank, but the minimum investment is large - about $70,000 (50,000 euros).

There is an exchange-traded note (ETN) devoted to bund (German government bond) futures, the Power Shares DB German Bund Futures ETN (NYSE: BUNL). However, that's not the same thing as buying bunds directly; you have a credit risk on its sponsor, Deutsche Bank AG (NYSE: DB), a basis risk between futures and bonds, and a U.S. government credit risk because the ETN invests in futures contracts and U.S. T-bills - getting you right back where you started in terms of credit risk.

So, on the whole, you should avoid this.

In terms of shares for an individual investor, I'd recommend the iShares MSCI Germany ETF (NYSE: EWG). You might also look at the iShares MSCI Singapore ETF (NYSE: EWS) - that's probably the safest haven of all, since the country has hardly any government bonds outstanding!

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