MARKETS SPECTATOR: The great migration

The end of the safehaven slumber has come, and money is flowing back towards higher yielding assets with equities set to be the big winner.

It’s always good to take a step back and look at the bigger picture, both from a domestic and global perspective.

Starting on a global level, the last three to five years have all been about safehaven assets. Yes there have been risk rallies here and there but overall, there was a huge inflow of money into perceived safehavens. These included precious metals, bonds, cash and safehaven currencies like the Swiss franc, Norwegian krone and the Australian dollar.

As the world continues to recover from the GFC and eurozone debt crisis, I believe, alongside many others, that we’re beginning to witness a big rotation back towards riskier asset classes, of which equities is the most popular.

This series of charts gives us an insight into where money is currently flowing and what that likely means looking into the future.



Source: Iress

Gold has been in a large consolidation range for the best part of 18 months now, although it did gain 8 per cent in 2012. Last year was the 12th consecutive annual gain for gold bullion, meaning the bull market is considered mature. From a contrarian point of view, I argue that it’s a very crowded trade and that anybody who was considering a position in gold would have bought a long time ago.

I think there are a lot more potential sellers of gold than buyers at these levels and some of the potential target prices so-called experts are bandying around quite frankly frighten me. I saw $US2500/oz within two years the other day!

It reminds me of Goldman Sachs $US200 per barrel oil call in early 2008; it was trading near $US147 per barrel and less than six months later is bottomed out at $US33 per barrel.

Nonetheless, the consolidation over the last 18 months indicates that money flows towards gold are in a relative state of equilibrium.

10-year US bonds


Source: Iress

10-year German bonds

Source: Iress

The two charts above show that the US and German 10-year bonds are in a bottoming phase where yields have hit their lows and prices have peaked.

In my eyes, many so-called safehaven assets relied on capital gains to be safe, which worked really well during the panic of the GFC when everyone rushed towards them, driving prices higher. Now, with extraordinarily low yields or no yield at all, investors are beginning to realise that these ‘safehavens’ might not be so safe after all and that they can actually fall in price.

As the US Federal Reserve slowly becomes more hawkish, it wouldn’t surprise me one bit to see price falls accelerate in the above safehavens.

Australian dollar

Source: Iress

The Australian dollar is a very interesting beast and has acted like a chameleon over the last few years. It’s traded as both a ‘safehaven’ and ‘risk’ asset.

When commodity prices pushed higher and China was strong, the Australian dollar was very well bid. However, when these two factors reversed, the dollar was bought aggressively thanks to its incredibly high yield relative to the developed world.

Today, after 18 months of consolidation and aggressive interest rate cuts, it is still underpinned by a strong yield differential.

Nonetheless, I believe it shares many of the same characteristics as gold in that it’s a very crowded trade and that there are likely to be many more sellers than buyers around current levels. With economies in Europe and the US slowly recovering and further interest rate cuts expected domestically, I think the floor supporting the Australian dollar will be slowly eroded over the coming years.

Alongside the above safehavens, cash as an asset class has never seen higher levels. There’s no way to chart this but it’s common knowledge that the amount of money kept in cash products reached record levels over the last three to five years.

So with perceived ‘safehaven’ assets, including cash, either in a state of equilibrium or slow decline, we’ll turn our attention to the major indices.

S&P 500 index

Source: Iress

The broad-based S&P 500 is firmly established in a long term uptrend, having just broken out to five-year highs. In fact, it looks likely to test all-time highs over the coming months as money continues to flow towards the asset class.

The US equity market has been steadily trending higher ever since the bear market lows of March 2009, meaning the bull market is nearing three years of age. It’s had a very strong run and as it approaches the all-time highs around the 1550 level, I would expect to see some serious selling pressure develop.

A significant pullback from those levels is an almost certainty in my mind before a renewed breakout attempt.

S&P/ASX 200 index

Source: Iress

When compared against the S&P 500 above, one can easily see that the domestic market missed out on much of the US gains. It’s only the last six months or so that the ASX 200 has begun to rise and outperform its US peer.

In my mind this is due to two main factors. Firstly, money is being forced out of low yielding cash products and towards high, sustainable dividend paying equities. And second is the Chinese economic recovery that began approximately six months ago. This means increased demand for Australian mining companies that are so heavily reliant on Chinese growth.

The big four banks, which are arguably Australia’s best dividend paying bluechips, and BHP and Rio make up more just under 40 per cent of the ASX 200 index. If these six stocks are moving higher, then so is the index.

Shanghai Composite

Source: Iress

The above chart of the Shanghai Composite shows the abrupt turnaround witnessed over the last two months. In fact, it’s up more than 18 per cent in less than two months.

With the Shanghai index closed to foreign investors, the large China facing ETFs have outperformed significantly as foreign money flooded in.

The bulk of the global investment community got China completely wrong. They forecast a hard landing for the world’s biggest developing economy that just didn’t eventuate.

Instead, they were caught very underweight or even short in the case of the hedge fund world. This has resulted in a sharp snapback rally as everyone tried to close their losing positions and reestablish new ones.

So in summing it all up, as it stands it looks like money is flowing from safehaven assets into equities. Across the different equity markets, it looks like the rally in the US is the most mature, and therefore the likeliest to see a period of consolidation or pullback.

Locally, given the best part of two years' relative underperformance, the ASX 200 looks to have plenty of upside potential left, especially considering the unique dynamics of superannuation and the demand for high yielding assets.

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