NEW CONKERS3 FEATURE : The Analytical Surveyor

Analytical Surveyor has worked for over 40 years in the City and West End of London as a real estate investment manager, an equity analyst, a multi-manager, a fund manager and as a researcher and strategist. In his area of expertise, he is highly regarded and currently works as a consultant.
There is an enormous amount of academic research that provides insights into the functioning of investment markets. Rarely will this help with stock selection, but much of it will help in understand how and why the market functions the way it does. The Analytical Surveyor trawls through the work that is available in the public domain and summarises the work into useable notes for investors.

Playing the emerging markets’ cycle:

I suspect that few UK investors have a substantial proportion of their long-term core holdings in emerging markets.  More likely, investors treat emerging markets as high-beta cyclical or opportunistic assets, taking advantage of what are perceived of as growth-pricing entry points while continually monitoring for changing economic or political risks to trigger the exit decision.

But if investing in such stocks is not an obvious whole-of-cycle holding, the obvious question is where to place the capital when it is out of the market.  A recent academic paper[1] addresses the question by seeking to identify whether gold and/or the US dollar can be considered (safe) havens for emerging markets.

The authors adopt a definition that the role of an asset as a safe haven with respect to another asset depends on the link between the two assets in times of extreme market movements. If one asset is unrelated or negatively related to the other asset under extreme market circumstances, then the safe haven property is verified.

MSCI data for nine emerging economics (Brazil, Chile, the Czech Republic, Russia, South Africa, China, India, Malaysia, and Thailand) are used, together with the world gold spot price, and the corresponding exchange rate of the US dollar for each local currency.

The paper finds that both gold and the US dollar can serve as a safe haven for emerging stocks, identifying the US dollar is a superior safe haven asset to gold in most cases, while its superiority in hedging infinitely extreme risks (implied by the low-high tail dependence) is weakened in the subsample of the global financial crisis and in the out-of-sample analysis, and that the US dollar provides attractive downside risk gains for China and Thailand, followed by India and Brazil, while offering relatively less attractive gains for Chile, South Africa, and Russia.

The authors do not explore the reasons why gold and the US dollar are havens for emerging markets, but offer a few possible explanations.  First, investors switch to gold as a behavioural reaction.  As an aside, they note that gold was a superior haven to the US dollar in slightly more countries during the 2008/9 global financial crisis, although they make no argument to suggest that it will be a superior haven in times of extreme stress.  Second, the US dollar plays a role in emerging markets’ trade and is regarded as highly stable.  Finally, gold prices are more correlated with stock prices than the US dollar, and this makes the latter a superior haven.

The immediate result from exiting an emerging market investment is, of course, the generation of cash.  For UK investors, this is almost inevitably going to be sterling cash, but this paper suggests that it might be better to park or reallocate the monies to US dollars or even gold before re-entering the market or at least pending the next investment decision.

[1] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3000134  Which is the safe haven for emerging stock markets, gold or the US dollar?, Xiaoqian Wen, Hua Cheng


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