The Curious Case of Asset Correlations: Why are there No Safe Havens?
Global equity markets have fallen by 30% since the S&P500 plummeted from its all-time high in mid-February. This is already far worse than during the banking crisis on 2008/9.[1] But safe-haven assets like gold and bitcoin are falling too. What can explain this bizarre behaviour?
Historically, investors protect their returns during times of turmoil by switching into safe-haven assets, so-called because they normally have low or negative correlation with equities. For instance, between 15 September and 15 October 2008 the correlations between the S&P 500 index and gold, or the Swiss Franc, or US Treasuries were all around minus 40%.
US stocks have been crashing violently for the past five weeks, so much so that NYSE had to trigger ‘circuit breakers’ to halt trading for 15 minutes on several occasions when the S&P 500 crashed more than 7% in a few minutes. Why? The short answer is the ill-preparedness of the US against the COVID-19 pandemic. A longer answer includes significant decreases in the projections for global GDP, US company earnings, airline passengers, global supply chains’ capabilities all set against a backdrop of huge political uncertainty as President Trump makes unilateral decisions which send after tremors around the world.
As funds flow out of equities one would expect demand for gold and bitcoin to increase. But this time around, safe havens have behaved completely differently. Indeed, gold and bitcoin have all fallen at the same time as US equities, as can be seen from the chart at the top of this page. During the last month the correlation between the S&P 500 and the price of bitcoin has been plus 63% and with the price of gold the S&P 500 has a correlation of plus 20%. And the dollar was also falling (with a correlation of 17% with US equities) until it stopped (at least temporarily) amid the unprecedented repo operations of the Federal Reserve — of which we have much more to say below.
Quantitative Easing Doesn’t Work Anymore
Since 2008 most central banks have raised cash by issuing government securities (typically, long-term bonds) and selling them to other government agencies that have too much cash (e.g. tax-collection agencies) but mainly to domestic and foreign investors. For instance, given the latest information available from SIFMA the US government has about $19 trillion debt of which about $7 trillion is held by foreigners and of that over $2 trillion is held by China and Japan.[2]
To buy US assets one needs US dollars. So foreign holders of US debt help the US economy in another way too, by boosting the value of the dollar and making imports less expensive.
However, in 2019 President Trump escalated a trade war between the US and China and as a result the Chinese and other central banks started to diversify their reserves away from the US dollar.[3] In other words, foreign governments don’t want to buy US debt anymore. Many countries, such as Russia, would rather buy gold.[4] And, as can be seen from the figure below, during 2019 the People’s Bank of China increased their (already very large) gold bullion reserves by almost 6%. Bloomberg reports this as a direct consequence of Trump’s Trade War.[5]
Rambo Repo Rules
Given the lack of demand for US government securities, and hence also the US dollar, in September 2019 the Federal Reserve re-introduced repurchase (repo) operations for the first time since the ‘great financial crisis’. That is, they buy their own securities from banks, hedge-funds and any other financial institutions that have a lot of securities but not enough cash.[6] This way, they can inject some liquidity into the financial markets for a limited period.
The repo operations in 2019 had an initial value of about $200 billion and each repo was only for a very short period (overnight, or up to 14 days). But the Fed’s announcement on 12 March 2020 sent shock waves through the global financial system. In their Statement Regarding Treasury Reserve Management Purchases and Repurchase Operations the Federal Reserve announced: [7], [8]
“Today, March 12, 2020, the Desk will offer $500 billion in a three-month repo operation at 1:30 pm ET that will settle on March 13, 2020. Tomorrow, the Desk will further offer $500 billion in a three-month repo operation and $500 billion in a one-month repo operation for same day settlement. Three-month and one-month repo operations for $500 billion will be offered on a weekly basis for the remainder of the monthly schedule. The Desk will continue to offer at least $175 billion in daily overnight repo operations and at least $45 billion in two-week term repo operations twice per week over this period.”
Between 13 March and 13 April this year, numerous tranches of $500 billion cash will be injected to banks (and hedge funds and mutual funds and any holders of government debt) with repurchase dates up to three months ahead. That is, around 3 trillion dollars are essentially being printed so the Fed can buy its own debt for the sole purpose of injecting liquidity into US markets — that is giving the baying wolves of Wall street rather a lot of cash to buy US stocks.[9]
No Safe Havens!
Gold just had its worst week in 8 years, when it should have been its best, because somebody has been dumping huge naked shorts on COMEX gold futures … again (see our article on this). It is easy to bash gold this way, particularly because the futures are physically settled and so their price (which leads the spot price) needs bear no relation with the amount of bullion actually held. So far this month we’ve had two huge Friday-afternoon spoofs on COMEX aimed at selling high and buying back low the next week.
Trump doesn’t want the physical gold price to plummet because Fort Knox has almost as much gold as China.[10] However, Trump does not like bitcoin at all. This is not surprising because it is an existential threat to the dollar.
And so, bitcoin, originally termed ‘digital gold’ because of its safe-haven asset properties, has been bashed to within an inch of its life. Its price fell from over $10,000 in the middle of February to less than $5,000 in the middle of March. It remains hugely volatile, regaining ground as the bulls return, only to fall again 50% in the space of a week. The 7-day bitcoin VIX even reached 200% recently (see our article on this). Trading is being driven by some pretty obvious manipulation bots on the main bitcoin derivatives exchanges, especially BitMEX (see our article on this).
It is not that easy to bash COMEX gold futures which are, after all, supposed to be under the watchful eye of the CFTC. But bashing bitcoin is simple. Child’s play for the wolf cubs. The exchanges aren’t even regulated. Officially, US investors are banned from trading on them, but it is actually possible to trade on the biggest bitcoin derivatives exchange under the radar and there is evidence that this has been happening recently on quite a large scale (see here and here for our articles on this).
Why?
Large US asset managers (and the other wolves) may have become complacent from the decade-long almost linear upwards trend in the US equity market.[11] But now they must find returns some other way. I hypothesize that they started bashing US stocks to, effectively, hold the Federal Reserve to ransom until it came up with the cash the only way it knew how — repo — and on a scale never seen before.
Now that the wolves have their cash there is a huge temptation to get up to their old tricks. The unprecedently widespread market turmoil keep the CFTC very busy, so it is much easier for their antics to remain below the radar of regulators. Could it be that bashing gold and bitcoin is their way of saying thank you for the cash? Whatever the reasons, it seems abundantly clear by now that there is no alternative. There is no safe haven. Only by holding the US dollar and US assets will global investors make positive returns.
Watching Out for the Wolves
The CryptoMarketRisk team need a break. We have been writing 12 hours a day for two weeks to produce 8 articles about what is actually happening in gold and bitcoin markets now. And I’ve been burning the candle at both ends to get my new book on Corruption and Fraud in Financial Markets ready to go to press today.[12]
We are all getting fat from lack of exercise, especially me. So, we shall stop writing for a while, except for keeping up the commentary. Hey, the bitcoin price has just jumped again, this time +25%! And gold is up since 00:00 UTC from $1,460 to $1,510 at 11:30…..
So, we anticipate another battle with the wolves. Especially since it is almost Friday afternoon. But we are watching. Looking for the naked COMEX shorts, and the signals from the option traders, and for the whales to surface, and for the funds to appear on BitMEX, and for the bots to appear in the order books.
Carol Alexander
@CryptoMarketRisk, QFIN, University of Sussex
[1] The MSCI world equity index was at 2,431 points on 14 February 2020, falling to 1,702 one month later by 16 March (down 30%). By contrast it was at 1,236 when Lehman Bros. filed for bankruptcy on 15 September 2008, reaching 950 points by 15 October (down 23%).
[2] https://www.sifma.org/resources/research/us-treasury-securities-holders/ and https://ticdata.treasury.gov/Publish/mfh.txt
[3] https://www.reuters.com/article/us-usa-treasury-securities/china-holdings-of-u-s-treasuries-in-april-skid-to-nearly-two-year-low-idUSKCN1TI2RA
[4] https://www.ft.com/content/8148a8f0-2479-11e9-8ce6-5db4543da632
[5] https://www.bloomberg.com/news/articles/2019-10-07/china-s-gold-buying-spree-tops-100-tons-amid-prolonged-trade-war
[6] But only for a short period such as one day (i.e. overnight repo) or 14 days. At the end of the repo period the bank (or hedge fund) repurchases it. Repos were originally an operation to sell short, by borrowing the asset (via an intermediary called a repo broker) and then selling it on the market, hoping to buy it back at a lower price before returning it to the original owner, via the broker, on the agreed date. Repo rates are charged so that the broker and the owner receive a small fee. The operator hopes that the fall in price of the asset will cover the repo rate, so he makes a profit.
[7] https://www.newyorkfed.org/markets/opolicy/operating_policy_200312a
[8] Here is a good explanation of how repo works, what happens when the repo rate dislocates from the benchmark Fed funds rate and how this new repo operation differs from standard QE .
[9] https://www.brookings.edu/blog/up-front/2020/01/28/what-is-the-repo-market-and-why-does-it-matter/
[10] https://en.wikipedia.org/wiki/United_States_Bullion_Depository
[11] For instance, after the banking crisis of 2008–2009, the value of the S&P 500 on 19 February 2010 was 1,109 points and its all-time-high value exactly one decade later was 3,386. That’s an average annual return of 13%. The risk-adjusted return (information ratio) was a whopping 0.92 based on weekly data over these 10 years. It would be little wonder if they did get complacent, if a little bored perhaps.
[12] https://www.amazon.co.uk/Corruption-Fraud-Financial-Markets-Manipulation/dp/1119421772
