By Samuel Harrison (UK), Current Student Master in Finance 2011

There is no doubt that the current macro environment remains resoundingly weak. Continued unpredictability continues to push investors to the sidelines. Whilst recommending specific investment strategies remains problematic, extensive market dislocation from traditional valuation metrics may provide savvy investors with an opportunity. Markets are increasingly being driven by fear and sentiment rather than logic. A prime example of this is the soaring levels of correlation between asset classes, as investors no longer discriminate between different assets in their panic-fuelled buying and selling.  

For example, correlations between the 10 main sectors of the S&P 500 are at ~95% (1), and furthermore, the directional difference between investments in EM and DM has also become negligible. As a consequence, true diversification is almost impossible to achieve within equities, and using beta strategies is the only simple way to manipulate returns. This is a rare phenomenon, as correlation usually resides around the 80% range for these assets. Defensive stocks are being indiscriminately sold off, where one would expect them to be outperforming. It stands to reason that this correlation surge will correct back to historical levels when traditional rationale returns. Therefore, right now, robust, quality names are available and they are trading at a steep discount. (2) IMT.L and AZN.L are two cash-generative, high-yielders that are worth highlighting.

Another potential opportunity brought about by irrational market behavior has been observable on and off since early August this year. That is: gold trading above the price of platinum. Some may argue that this is unsurprising given that gold has always been a relative outperformer in weak macro periods, and continues to be seen as the preeminent safe haven. Furthermore, gold is less industrial/cyclical than its denser cousin and is more of a proxy currency, which is also advantageous whilst confidence in paper currency dwindles.  

However, we must not forget the fact that platinum is considerably rarer in the earth’s crust than gold. This is absolutely crucial, as no more of either metal will be formed in any of our lifetimes, once the accessible metal has been mined, platinum will have supply dynamics in its favour. Also, from an economic standpoint, platinum is more expensive to mine and refine than gold, due to its rarity. As well as being an equal store of value, platinum also performs better in recovering market conditions, due to its wider industrial properties and is also broadly uncorrelated to equity returns. Indeed certain manufacturing outputs are totally reliant on platinum, without alternative. Therefore, for the price of gold to be significantly above platinum makes little long-term sense. 

Platinum has typically cost double that of gold, per ounce. History shows us that the current price spread is unlikely to continue indefinitely and as soon as confidence in industry returns, the traditional status quo will re-emerge. Growing structural trends in Asia for platinum jewelry will likely aid this transition. Whether or not the recent pullback in gold prices marks the beginning of this process, will remain to be seen.


 [2] Dylan Grice. Soc-Gen Global Strategy Research. 29th September, 2011.

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2 thoughts on “Opportunity amidst chaos? – An insight by our student

  1. Antonios Kypreos

    Interesting post. I agree with you that typically defensive names are being sold off , as you said “indiscriminately” as the daily risk on, risk off trade lingers on. I do believe there are many good bargains out there now at firms that pay high dividends and are set for future growth. Unfortunately, due to the volatility in the market place, it is very difficult right now to look out more than a day or two in advance. European debt crisis is still lingering and it is tough to predict what type of market correction we could have if more negative news continues to come from the Euro zone.

    Also, your gold /platinum debate is interesting. I agree with you that platinum does have more industrial uses than gold. That is one reason why I do not like gold, is that its lack of real life day to day uses. At the same time, gold does seem to be a proxy for global dysfunction (however not in the recent month). It is tough to predict the movement of gold price in the short term. Due to the gold miners under performance related to the bullion price this year, I am in favor of many gold miners, vs the gold bullion, who can benefit from a high gold price, even if gold prices continue to correct. The one negative with gold miners however is that sometimes when the market corrects, gold miners go with the market, alas not always in lock step correlation.

    Thanks for posting the article. Would be interested to speak more one day.

  2. Samuel Harrison

    Thank you Antonios. I definitely agree with your points, especially those on gold, and gold miners. One thing I have noticed is that playing gold through buying gold miners equity can be equally as tricky as trading the commodity itself. Some interesting comments in the Economist a few months back talked about the cost of gold extraction sky-rocketing (all easy to mine gold has been used up, carbon costs increasing and also rising execution risks), which combines to explain the dislocation between the miners and the metal this year. Of course, the whole mining sector has had a torrid time as you insinuated, which also helps to explain the underperformance. Thanks again for your comment.

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