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Investing during uncertain times

02 december 2015, 11:24
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As we come to the end of the year and reflect upon what has come before us, this year will be looked back on as a year of high political instability and uncertainty.  From the violent conflicts in the Middle East, Syria and ISIS changing the landscape of war, to Russia’s dispute with Ukraine, and now Turkey, and of course the deadly terror attacks in Paris in November. While the tragedy and loss of life will always be top of mind, how do financial markets react to such periods of instability and what should investors do to protect their assets?

Looking at the most recent example, the growing conflict between Turkey and Russia in the wake of the Russian military jet being shot down by Turkish forces, has led to Moscow publically announcing economic retaliation steps which are expected to not only cause economic pain for  Turkey, but also for Russia.  Such measures include restricting the planned TurkStream gas pipeline, ceasing the plan to build the first nuclear plant in Turkey and restrictions of civilian flights to and from Turkey. The same day these restrictions were first announced, Turkish stocks fell more than 2 percent and the Turkish lira weakened against the US dollar.

Turkey is Russia’s second most important trading partner behind Germany, and if these threats by the Russian government to cut economic ties are followed through this will have a negative impact on the economies of the two nations. Over a longer period, it would be expected that these countries may suffer from weakening of both the foreign and domestic market, with major planned projects such as those listed above being halted and foreign partners choosing to outsource their production or business activities to other more stable markets.

Local investors will likely look to diversify into assets that are not impacted by such events, with many possibly turning to safe haven investments, those assets considered likely to retain their value or even increase in value during periods of market turbulence.

Gold is the most well-known safe haven investment as history has shown that it has preserved wealth across hundreds of years.  Compared to printed money that can have its value weakened by printing of more bank notes, gold is a physical asset that retains value over time.  It is also has a self-perpetuating reputation; as markets become volatile, investors rush to buy gold and this in turn pushes the price up.

Some notable examples of gold showcasing its safe haven status previously, include early 1980 when the combined events of the Soviet Union sending troops into Afghanistan and the Islamic revolution of Iran led to gold strengthening in value by more than 60%. Then of course there is the gold rally from October 2008 to September 2011 when we saw gold shoot up by 150% as investors rushed to invest in the precious metal in the wake of the global financial crisis in the West. 

However we have observed a change in gold in the past couple of years and now we are seeing that political crises, be those nationally or internationally, have had very limited (positive) impact on gold.  This summer when the collapse of the Chinese stock market sent tremors through international financial markets and the S&P500 dropped 11%, gold strengthened by just 5.9% before dropping back.  We also saw similar patterns earlier when Russia escalated their involvement in the conflict in eastern Ukraine.  This caused movement in the oil markets, but it had barely any impact on the gold price.

Even the oil markets have not reacted as we would normally expect this year.  We have seen various crises from Greece, the Paris terrorist attacks and escalating problems in Syria.  Despite all of these very serious and concerning events oil prices have tended only to be impacted if the trouble direct impacts a country’s ability to produce and export.  So far this year we have seen none of that apart from ongoing problems in Libya which has reduced the country’s ability to produce and export oil by more than 1 million barrels a day. 

Where does that leave investors?  Two other assets to consider include the US dollar and secure government bonds.  The US dollar is the world’s most liquid asset and also its performance is correlated to changes in interest rates; traditionally when interest rates are hiked, the US dollar strengthens, and vice versa.  Given that the US Federal Reserve is widely predicted to hike interest rates for the first time since 2006 in December, we are expecting dollar strength going in to the New Year.

However, even the US dollar is not immune from market disruptions.  The sell-off in Chinese stocks in August triggered a general risk aversion across all global stocks and currencies.  In a risk situation it is normal to reduce your positions and, as the euro had been a favoured short against other currencies, the market witnessed a period of euro strength which went against the grain of normal thinking.

Saxo Bank’s Chief Economist, Steen Jakobsen, says now emerging markets (EM) is the only asset class in stocks where both price and value is cheap. He points to China, Russia, Pakistan, Turkey, Hong Kong, Greece, Poland, Spain and Japan as markets that offer unique price and value.   Jakobsen says: “EM is ‘hated’ by most managers because of China and Asia overall. Big built in debt and lack of exports combined with low energy prices. But Asia and EM is now priced to imperfection, failure even, and with a monetary policy of stimulus from ECB and BOJ, plus a hesitant Federal Reserve will create carry-trades.”

As with all financial instruments, it is important that investors take the necessary steps to educate themselves on the product and ensure they understand all the pros and cons of trading an instrument. If the Federal Reserve do announce a change to interest rates in December as is widely predicted, the market may experience some volatility that can rapidly impact the value of investments.

 


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