What to do if markets fall in step

AFTER a tempestuous time in the markets last week, the good news is that things could be worse. The bad news is that they are probably going to get worse. The markets look set to turn very ugly in the coming weeks – Eurozone sovereign debt worries, European banking equities and increasingly dire macroeconomic indicators are all coming together in troubling times. And with this, investors are rapidly running out of safe havens.

For most of the year, whenever there was a major event that caused volatility in the markets, you would see flight into gold and into the Swiss franc. But the Swiss National Bank is successfully defending the floor that it put in place under the euro-Swiss exchange rate at SFr1.20, driving away a large volume of flight into the Swissie. Gold too has dropped over $200/oz in recent weeks, driven down by liquidations of gold positions to cover margin calls. Silver too recently broke below its 200-day moving average for the first time since July 2010.

But as well as investors running out of safe havens, there has been a tightening of correlations across asset classes, inhibiting choices for traders looking to hedge their positions. While you might usually see a strengthening in commodities despite an indiscriminate sell off in the equity markets, we have recently seen risk assets falling into line with each other. “There is no easy way to hedge, because when risk assets such as equities take a large hit like they have in recent days, other assets that may be considered a safe haven – gold for example – also get hit as investors unwind positions in areas such as commodities and metals to pay for losses elsewhere,” says Angus Campbell, head of sales for Capital Spreads.

“At times like this, there is no easy way to hedge, unless you are doing a pure one-on-one hedge by selling your long exposure to an underlying asset by using a derivative such as a CFD,” says Campbell. For example, if you held 10,000 HSBC shares, you could sell 10,000 CFDs as a perfect hedge.

But where do investors look when things really turn for the worse? Looking back to the 2008 crash, the dollar made substantial gains as Lehman Brothers and Bear Stearns caved in – and in the last week we have seen the dollar strengthening again. “The largest economy in the world will always be a safe haven,” says Jordan Lambert, a trader at Spreadex. Lambert points to US Treasuries to be the best option for capital gains as they benefit from an influx of dollar demand.