True Safe Havens Needed as Fed Monetizes Uncle Sam

A financial safe haven is generally an instrument that is expected to hold or increase its value in the face of market turbulence. It is used by investors to reduce exposure to declines resulting from downturns in the market or economy. What is considered a safe haven can change depending on market conditions, but a few asset classes typically come to mind. In the current financial landscape, there is a growing need for true safe havens.

U.S. Treasury instruments are widely considered to be a standard safe haven for investors, as they are backed by the full faith and credit of the U.S. government, for what that may be worth. The thinking also goes that if investors dump equity holdings, the money will flow into bonds. However, with central banks intervening in the marketplace more than ever, investors are not receiving a true demand and supply picture of the bond market, which distorts investment decisions and creates capital misallocations. Furthermore, investors who believe U.S. Treasuries are a safe haven and seek to purchase them, will have to compete with the Federal Reserve.

Jeffrey Gundlach, the well-known bond investor and chief executive officer of DoubleLine Capital, recently said, “I think it will be more likely that the Federal Reserve buys all the Treasury bonds that exist than starts selling them.” That idea is quickly coming to fruition. A Bloomberg article citing JPMorgan Chase explains that the Federal Reserve will likely add about $45 billion of Treasury purchases per month to its already existing QE-to-infinity-and-beyond program. This would bring the central bank’s total monthly haul to $85 billion. Even more staggering, the Fed will be “effectively absorbing about 90 percent of net new dollar-denominated fixed-income assets,” according to JPMorgan Chase, which is a member on the board of directors at the Federal Reserve’s New York Bank.

Uncle Sam has a new best friend…

With the Federal Reserve virtually monetizing all new debt coming from Uncle Sam, one might think there is a supply problem, but this is not the case. The U.S. budget deficit in fiscal 2012 came in above $1 trillion for the fourth consecutive year, while the national debt is firmly above 100 percent of the nation’s gross domestic product. According to Bloomberg and government data, gross domestic borrowing through Treasury sales increased to more than $2.1 trillion in each of the past three years. The national debt limit, which should really be called the national debt target at this point, is once again in the crosshairs. At the end of November, the U.S. was only about $63 billion under the $16.394 trillion debt target. Although, it will undoubtedly be raised again or even abolished altogether, as Treasury Secretary Timothy Geithner has suggested.

While a debt target of infinity would be a match made in monetary easing haven for the Fed’s QE-to-infinity-and beyond program, it is yet another example of a faltering economy. If the recovery story had any fundamental weight to it, central banks around the world would not have the need to print money like its going out of style. According to IceCap Asset Management and Goldman Sachs Global Economics, quantitative easing by the four major central banks over the past four years totals $6 trillion, enough to worry even the biggest bond bulls.

Investors looking for a true safe haven will have a hard time ignoring precious metals like gold and silver. Not only are they a medium of exchange, unit of account and a store of value, they also carry zero counter-party risk in the physical form. Additionally, they can not be printed out of thin and their benefits can be recognized with a modest allocation. A report by Oxford Economics last year recommends holding at least 5 percent of assets in gold, as it has a low correlation with other assets. Varying economic assumptions can imply higher allocations.

Gold still experiences dips from time to time, but the longer-term trend has been higher on the back of less volatility. The precious metal is on pace to finish 2012 with a positive gain for the twelfth consecutive year, while gold volatility, measured by the cost of options, recently hit its lowest level since 2008.

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