Market Minute – April 22, 2013
Last week was another one of those moments in the market which reminds us that we are in troubled times. Taking a completely agnostic, statistical perspective on last Monday’s events in the gold market, we again had an event that demonstrates the unstable foundation of the market. In this case, gold dropped by 5.8% on Friday, April 12 and then 7.7% on the following Monday, for a combined two-day drop of 13.5%.
For perspective, using the prior 1,000 days of trading data as a baseline, gold typically moves around 0.5% per day. A 2% move is big (once every couple of weeks). 3% is rare (three times a year). A bigger move than 3% is statistically remote. A two-day move of 13.5%, under these conditions, has a probability of one-in-a-trillion or roughly once every four billion years. So maybe my assumptions are wrong (that market returns are normally distributed), but then you would have to discredit an entire generation of financial theory and models.
So where does this leave us? In the span of two days, gold prices (and a host of other commodities) moved in a way that is not supposed to happen unless we are facing the most dire of global circumstances. In effect, something snapped in commodities. There are a host of explanations as to why (Cyprus might sell all their gold, Goldman Sachs starting bad rumors, North Korea did it, Paulson did it…. and so on), but the result is rather simple. We are in an investing world in which market mechanics are evolving into a dynamic that is both unpredictable and challenging to comprehend.
[To emphasize the volatility problem, yesterday someone hacked the AP twitter account and sent out a false report of an attack on the White House. The Dow dropped 140 points in a few seconds, then recovered. Someone made a small fortune on their put options.]
My suspicion regarding gold is that the Exchange Traded Funds (ETFs) which hold a large percentage of the World’s gold supply are causing distortions in the market and led to the market dislocation. It is a rather nuanced explanation based on the way that ETFs are created, but the theory also helps to explain the Flash Crash of 2011. Whatever the answer is, since 2008 we have been in a new world of investing and markets. Gold is supposed to be a safe haven, stable asset with limited volatility. While it still may be safe in the long term, it is now subject to the same randomness as the rest of the market.
I will later elaborate about other such events during the past three weeks, but the conclusions are the same. Under the veneer of a bull market in US stocks, there remains tremendous unpredictability and dislocations continue to manifest.
As an investment manager, we have mitigated these risks through our asset allocation strategy and the manner in which we use specific securities. And in all likelihood, the dislocation in gold is temporary. But time will tell, as always.
David B. Matias, CPA