Does the perfect hedge exist? Investors have long sought relatively stable assets that can help balance the more volatile asset classes in their investment portfolios. Gold, long woven into the commercial and cultural fabric of many societies around the world, has been a long-standing port of call for this purpose. Over time, though, modern finance has introduced several other options.

Across recent decades, high-quality bonds have offered a counter-ballast to equities, as have defensive currencies, such as the Japanese Yen and the Swiss Franc. Yet, instead of searching for a silver bullet for portfolio protection, we believe the answer lies in holding a safe-haven basket. To understand why, one must look at how individual safe havens have historically crumbled when investors relied solely on it.

Unmasking the cracks in safe havens

The year 2022 was, in many respects, the great unmasking. As the Fed embarked on one of its most aggressive tightening cycles in decades, equities and bonds fell simultaneously – an unusual breakdown of the negative correlation that had underpinned diversified portfolios for decades. While this was just one year, the failure of bonds to maintain a negative correlation with stocks raised important questions about their role in diversification. With the benefit of hindsight, 2022 illustrated that high-quality bonds may not act as safe havens when the volatility event is driven by rising inflation.

The failure was not isolated in the fixed-income market. Safe-haven currencies likewise failed to play that role in many specific instances. In 2022, as the Fed raised rates aggressively, the Bank of Japan maintained yield curve control. This meant that, instead of holding firm as a safe haven, the Yen fell sharply past 150 against the US dollar – its weakest level in over three decades. Instead of acting as a portfolio refuge, the Yen ended up being one of the worst-performing major currencies of the year. The Swiss Franc, too,has its own cautionary chapter. In January 2015, the Swiss National Bank abruptly abandoned its currency floor against the Euro, triggering a rapid surge in the Franc. While the currency strengthened in this instance, the scale of volatility in the pair was arguably more than a safe haven would normally display.

Gold, too, has had its episodic disappointments. Its long history as a safe haven asset notwithstanding, during the 2008 Global Financial Crisis, gold lost value. While its drawdown was more muted than the more dramatic fall in equities at the time, in this instance, gold only helped dampen volatility rather than provide the negative correlation often expected of safe havens.

Constructing a multi-layered shield

History suggests that the perfect safe haven does not exist. Bonds can struggle when inflation concerns dominate, while safe-haven currencies often falter when central bank policy overrides their defensive characteristics. Gold, meanwhile, underperformed when investors needed to raise liquidity. However, what stands out to us is that these vulnerabilities are not always correlated.

Just as one does not drive by only looking in the rearview mirror, relying on a single asset class risks defending against the last crisis rather than preparing for the next one. By holding all three asset classes (bonds, gold and defensive currencies) instead, one can stop trying to predict the exact nature of the next economic shock and ensure collective defence for portfolio protection.

Sifting through the short-term noise around gold

Historical context is vital when assessing the modern market, where, in recent weeks, questions have once again been raised about gold’s reliability as a hedge. The precious metal has experienced renewed volatility, pulling back from record highs as markets digest shifting rate expectations and a still-strong appetite for equities. The short-term weakness is consistent with gold’s well-documented sensitivity to real (net-of-inflation) yields, given most major government bond markets have witnessed considerable upside pressure on bond yields due to higher inflation.

In our view, though, this recent volatility is not a reason to abandon our Overweight stance on the asset class. Gold maintains an attractive track record as a safe haven in several possible risk scenarios. Today, one ‘worry scenario’ entails oil prices placing upward pressure on inflation and downside pressure on growth. Over the past 5-6 decades, gold has actually stood out as an outperformer when markets have worried about such ‘stagflationary’ risks. This arguably earns gold a place today in a basket of safe havens, even if short-term returns have been more volatile.

Crucially, gold’s modern appeal extends far beyond historical cycles. What makes gold’s case so much more compelling today is the continued evidence of structural central bank demand. World Gold Council data shows that central banks, particularly in emerging markets, continue to diversify reserves into gold. With the share of gold in emerging market central
bank reserves still at relatively low levels, we see little reason for this trend to reverse for the time being.

Gold, bonds and defensive currencies each possess distinct vulnerabilities, but they rarely fail with equal magnitude simultaneously. True portfolio resilience requires a blended approach so that when one defensive pillar is tested, the others stand firm.