Gold’s parabolic rise this year was a classic fear trade, driven by plunging global markets in January. Gold’s protective negative market correlation was especially strong as Chinese & Japanese equities fell. However, as we first highlighted in our March 9 post, Is Gold Losing Its Allure As A Flight To Safety Asset?, gold’s protective relationship has started to waver. Fig. 1 shows that Gold’s correlation to Japanese equities has weakened from -.63 to -.27 in March, making it a less reliable safe haven.
Fig. 1. Gold vs Japanese equities correlation
Fig. 1 also shows that gold is still negatively correlated to many equity markets (red links), although its negative correlation is now insignificant against MSCI Asia & Europe (red dashed lines).
The most reliable global safe haven asset continue to be US Government bonds ($TLT), followed by Japanese Yen. Both continue to show stable negative equity correlation in excess of -.6. Fig 2. shows that the US Gov’t 20+ bonds vs. Italian equities correlation has remained negative since the 29 June 2015 Flash Crash and currently stands at -.63 (we use the standard RiskMetrics .94 decay to calculate correlations).
Fig. 2. US Government Bonds vs Italian equities correlation
Finally, Gold’s persistent high volatility and strong link to Gold Miners and Silver is also dangerous. Indeed, we’ve recently observed an increase in negative surprises for commodity linked assets. On 23 March, the plunge in Silver, Gold Miners and Gold ranked as top outliers in our Cross Asset FNA Correlations dashboard. We discuss these outliers and recent correlation dynamics in the 4 minute video below.
Video: Gold losing luster as safe haven (4 min)
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Last week’s driving global market event was Fed Chair Janet Yellen’s March 16 announcement of delayed rate hikes in light of recent market turbulence. This dovish message broadly lifted global asset prices, while USD plunged against major trading partners. Fig. 1 shows a ranking of top cross asset surprises, which span fixed income, foreign currencies and gold.
Fig. 1. FNA Correlations ranking of cross asset outliers (95% confidence level)
US TIPS surprised with a +2.9 standard deviation jump, its biggest daily outlier in 12 months. In a deflationary environment, TIPS have underperformed the broader fixed income universe since 2013. Could this be a positive inflation tipping point? And could this be a negative inflection point for USD? Its recent increased negative correlation with USD could make TIPS an attractive portfolio diversifier. The 3 minute video below discusses key market dynamics arising from last week’s dovish Fed announcement.
Video: A tipping point for TIPS & USD?
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The synchronized global equities rebound comes with risk. Systematic risk remains highly elevated at 73%, implying that investors can’t count on global diversification. Any negative surprise, say weakness in China or a collapse in oil prices, would likely have global implications. Prudent asset allocation therefore, becomes key to building a robust portfolio.
Ideal flight to safety assets show reliable negative correlation to equities. Fig 1. shows Friday’s cross asset map. Red links to Gold, JPY, and US 20 Y+ Government bonds indicate a negative correlation to equity markets at the center of the network.
Fig. 1. Friday 11 March FNA Correlations cross asset map
US 20Y+ Government bonds ($TLT) have the strongest negative link to equities, with a -.71 correlation to US Financials ($XLF). JPY ranks 2nd with -.66 correlation to Financials. Gold ranks third with -.53 correlation to Chinese equities.
Fig. 2. 20y+ Gov’t bonds show strongest negative correlation to equities & negative systematic risk
Here’s a 3 minute video explaining these correlation dynamics.
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Global equities bounced broadly on Friday, following Mario Draghi’s ECB rate cut announcement on Thursday. We saw 8 positive surprises (at 95% confidence level) in Europe & Asia, as Fig. 1 shows. Was this just another one day wonder, or could this be a signal of a more sustained recovery in global equities?
Fig. 1. Ranking of positive outliers on 11 March using Global Equity FNA Correlations
Despite pervasive negative market sentiment, we’ve observed some interesting changes in outlier activity. After a rocky January which saw a synchronized plunge in global markets, positive surprises started to outnumber negative ones from Feb 3, and volatility started to decline in a synchronized rebound. Indeed, as Fig. 2 shows over the last 20 trading days, we’ve seen 20 positive surprises and only 1 negative one.
Fig 2. Summary of 20 day positive & negative outlier activity
Is the rebound sustainable? Positive surprises combined with moderating volatility bode well, and imply that risk parity and trend following strategies will continue to buy equities. However, systematic risk is still very high at 73% (about same level as the Aug 2014 Flash Crash, but with less coupling). This implies that we can’t count much on global diversification. Any surprise, for example a renewed China plunge, would likely have global repercussions. It therefore makes sense to remain cautious in position sizing. Asset allocation will be key to managing risk in markets with a high degree of systematic risk (e.g., in this case, balancing equity risk with US government bonds, which are the current preferred flight to safety asset with most reliable negative correlation to equities).
Here’s a short video where I review the global equities using FNA Correlations, and conclude by estimating the global impact of a China stress scenario.
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Fueled by global uncertainty, the resurgence of gold has been one of the biggest themes this year. To identify emerging themes, we look at phase transition signals. Changing correlations, as we saw between Chinese equities and Gold in January are a good example. Fig. 1 below shows how Gold became a favored flight to safety asset for Chinese equities investors in January as correlation turned negative.
Fig. 1. Gold correlation to Chinese equities turns negative in January
Chinese stocks ($FXI) remain the most negatively correlated stock market with gold, and yet the relationship is weakening.
As for global investors, we can see that more reliable flight to safety assets are US government bonds and JPY, which both show much more persistent negative correlation to risk assets than gold. Global investors prefer US government bonds as safe haven, as we can see by the strong negative correlation to US Financials ($XLF) in Fig. 2. below (currently at -.66).
Fig. 2. US government bond 20Y+ correlation with US Financials
It’s too early to tell whether the gold’s bubble is ready to burst, but monitoring correlations to equities will be key. The less negative its correlation becomes with equities, the less attractive it will be as a safe haven, as discussed the video below.
Video: Gold losing allure as a safe haven asset?
What do you think? Looking forward to your thoughts.
We live in an era of accelerating change. New technologies and behaviors disrupt markets like never before. While understanding a behavior of markets in isolation has always been a challenge, now the problem is much larger. Old methods of analyzing markets in isolation are insufficient, and an understanding of systemic dependencies has become critical. We need new tools and methodologies to view interconnected risks. Network science holds great promise by enabling us to detect hidden patterns in complex data.
Dynamic maps powered by network science can help us sense and respond to emerging risk, and to navigate a rapidly evolving landscape. Maps speak to two universal human superpowers: visual pattern recognition and communication. And indeed, ever increasing complexity calls for better communication and teamwork everywhere.
Furthermore, managing risks within the borders of our own organizations is not enough. This era of systemic risk calls for an evolutionary leap in collective risk management, taking into account ecosystems perspectives.
Our aspiration is to build a community around shared maps as a mass collaboration platform to spark social intelligence.
We look forward to your participation.
To start the conversation, here’s a short video discussing the elevated levels of systemic risk in current global equity markets using FNA Correlations.
Video 1: What happened to global diversification?
Thank you for watching. We look forward to your feedback and ideas in the comments section, or write me at firstname.lastname@example.org to get access to FNA’s interactive global equity dashboard.