Gold and yen are among the assets that have performed unexpectedly, revealing how market structures have changed
By Mike Bird
You only learn who has been swimming naked when the tide goes out, Warren Buffett famously wrote in a shareholder letter. As volatility has soared during the past two weeks, some asset classes have started to show a little more skin, and interesting wrinkles.
Perhaps the most notable anomaly of the latest selloff has been gold, which had been enjoying a strong year. As bond yields tumbled and equities plunged last week, the price of the supposed haven didn’t rally. Rather, it fell.
Forced selling is at the heart of most explanations for why the gold price slipped. As investors face margin calls for other investments, they sell gold to cover themselves. A similar theory advanced by Cantor Fitzgerald analysts is that the precious metal may be sold by central banks in emerging markets, which use the dollars received to defend their currencies.
Oddities are emerging in the foreign exchange market, too. The Japanese yen is often described as a haven, based on expectations that Japanese investors repatriate their overseas profits and even liquidate foreign assets during market tremors.
Recent market turmoil has led some asset classes to behave unpredictably. /Photo: kimimasa mayama/Shutterstock .
But the yen is barely up at all over the past month, having risen just 0.5% against the U.S. dollar.
Though it has moved more reliably in recent days, the yen’s increase has been barely more pronounced than the euro’s against the dollar, even though the eurozone currency isn’t traditionally regarded as a haven currency.
One reason the yen doesn’t react in a predictable way anymore is the sheer volume of overseas buying by Japanese pension funds. The latest data show mammoth purchases of foreign bonds in January, an emerging trend that may have changed the calculation of how the yen behaves.
The euro itself may have benefited from the unwinding of carry trades. Investors who borrowed cheaply in euros to invest elsewhere could be closing their positions during a moment of panic and buying euros in the process.
The equity market has perhaps behaved more predictably. The least creditworthy companies as measured by their Altman Z-score—calculated using a company’s earnings, retained earnings, working capital and sales relative to its assets, as well as the company’s market value relative to its liabilities—have performed worse than the average stock.
Those with an Altman Z-score of more than 3, judged to be relatively safe from bankruptcy, are down by less than 1.5% year to date. An investor who held only those stocks might barely know a market correction was under way. Those with a score of less than 1.8, judged to be distressed, are down by around 8%.
In a selloff, the creditworthiness of companies matters more, hidden pockets of leverage are revealed and established relationships can turn out to be broken. Keeping an eye on how market mechanics operate under stress teaches investors a necessary lesson in how to protect themselves against future panics.
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