You might have noticed that since the beginning of the year,
all prices have been only going up, from commodities like oil, iron, copper,
coffee and natural gas to stocks, indices, and bonds. This is also true for the
prices of finished goods, real estate, services and gas at the pump.
اضافة اعلان
In financial markets, like all other markets, there are
correlations between different asset classes, some are positive (when the price
of one goes up the second follows) and some are negative (prices of correlated
assets move in the opposite direction). For example, the prices of precious
metals like gold and silver are usually negatively correlated to the prices of high-risk
investment instruments like the S&P500, while the prices of gold and silver
are usually positively correlated meaning when one goes up the second usually
follows.
Correlations are greatly important when building an
investments portfolio — the less correlations between assets you are invested
in, the less risk your portfolio has. Put simply, there is smaller risk for
your entire portfolio to go down, because when one side of it goes down,
another side would go up and balance out your portfolio. The process of
investing in different asset classes is known as diversification, a primary
rule for all investors across different markets to spread out risk and reduce
the effect of different market crashes on the overall portfolio.
That being said, it is safe to say investors are always on
the look out for different areas they can diversify their portfolios with and
more assets within a single area to diversify with, so the demand for
diversification is continuous.
Correlations exist in the real economy as well, not just in
financial markets. For example, when people’s income grow so does their
spending, and vice versa. In other words, as people make money they spend more,
therefore, the GDP is positively correlated to spending, and in turn, demand is
growing, and if the pace of demand grows faster than supply, prices go up.
Recently however, something weird has been happening;
everything has been going up, which either means that there is demand across
the board and people just want everything: They want to save and they want to
spend, they want risk and they want safety. That sounds unreasonable, how can
you want two opposite things? Well, the answer is simple, you don’t.
The price of gold going up in parallel with the S&P500
means that there is demand for both risk and risk aversion, which is outright unrealistic.
What is happening in fact is that the prices are being reflected in a much more
inflated lens, and the reason is something known as “FUD” (fear,
uncertainty & despair). Governments are pouring money into their financial
sectors, and in many cases, into the pockets of people, who are really afraid
of the future and really want to save up for a rainy day. Nonetheless, they are
witnessing rallies in the prices of stocks and commodities that are so big,
they are begging for “FOMO” (fear of missing out). This causes
people to take uncertain investment decisions, leading them to
either jump in or jump out of investments prematurely, creating rapid changes
in the prices (volatility).
Increased volatility causes weird things to happen, such as
negatively correlated instruments moving in a parallel direction (gold up =
S&P500 up). It is in human nature to want to have rules and principles,
even if they are made up ones with no substance, and I’m not saying gold and
stocks aren’t correlated, I am just saying humans need buffers to reduce doubt
to as little as possible, after all, we did invent the zero, because we needed
its nothingness to make us just a little more confident that a two is really a
two and a three really is a three! When humans see rules and principles on
which their beliefs are built break, they begin to feel a huge sense of despair; they feel lost and confused, making them less rational and more prone to
mistakes. This reduced confidence in investment choices usually leads people to
slow down and gradually begin to take less steps forward, making prices (demand
vs supply) much more elastic.
In closure, people have developed huge demand for safety, but they also don’t want
to miss out; they behave like a child playing hot potato, which leads to the
magnification of both price rallies and price crashes. Given historical
incidents in humanity where FUD was this high, the crash is usually the most
likely and most intense outcome, so be weary of unjustified price rallies.
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