Probably the most counter-intuitive trend we might see over the next few years, is a bull run in equities which is driven by fear.  This scenario defies logic from the perspective of an individual investor, as the typical retail investor views price movements as a function of upside potential (profitability.)

For any student of Game Theory, it should be quite obvious that there are two optimal states- the first is maximizing gains, the second is minimizing losses. The latter is known as a maximin solution.

game-theory-2011-3-728
A maximin strategy, exhibited above, is the outcome of two players facing a set of mutual payoffs whereby the incentives align to the strategy that minimizes loss for both players.

While Game Theoretic concepts might not be directly applicable, the concept of a maximin strategy should be- in times of extreme risk, risk mitigation and capital preservation becomes the key as a optimal payoff.

Why is this important?

There are multiple participants in financial markets- from behemoths like pension funds and sovereign wealth funds, to individual investors, to relatively nimble (and often well informed) hedge funds.  The majority of the capital, however, is tied up with institutional investors- logical, rational, “intelligent” investors. This isn’t the equities market of the 1950s, or the 1980s. The capital has accumulated in the hands of a few institutional participants.

Therefore, it stands to reason that these highly rational investors are now scrabbling around, looking for places where capital can be parked to assure preserving it:

The general  rumor (mirroring my conversations with a few guys I know in investment) is that Bitcoin is being scrutinized as an investment by some hedge funds.  Hedge funds, of course, being smaller and less clumsy than pension funds (and SWFs) could likely take moderate positions in Bitcoin without significantly shifting the market-this is due to Bitcoin’s market-cap, which as of writing this stands at approximately 6.74 Billion US.

Precious metals, namely gold is approximately 7.4 Trillion US Dollars in market cap. Silver is around the same order of magnitude.

When you consider that Norway’s Government Pension Fund Global (GPFG) Sovereign Wealth Fund is over 800 billion dollars in size alone (about one eleventh of the total gold market cap) you begin to see that these markets are tiny, even gold.  The size of various market caps can be viewed here.

A thought experiment..

Imagine you are in charge of Norway’s GPFG, (it could be any sovereign wealth fund, however) and you are aware that some markets are failing.  These are the biggest markets in terms of market cap. In addition your job is to maintain the value of the assets under your management?  What would you do?

Personally I would look for any asset market which was deep enough to absorb the cash under my management. I would need to shift my positions slowly over time (so as to not tank markets- selling 1 billion USD worth of Canadian property in a month, and so on would move the markets in a massive way.)

Thus..

It is common knowledge that the US Dollar is the global reserve, it is the deepest and most liquid currency market in the world. Furthermore, equities are the largest asset class behind fixed income, with the US equity markets being the the deepest equities market.  If the US Dollar and US equities happened to fail, it would basically signal a new dark age (in which case you’d be better off investing in military grade bunkers, tins of food and ammunition for your citizenry.)

Which might have something to do with why every single market which has been a historic safe haven (as well as some newer asset classes) seem to be on an endless drive higher in the face of a global sovereign debt crisis..

Bitcoin is rising..

BTC
Bitcoin 1 year chart in US Dollars, taken from Cryptrader.

As is gold and silver…

Gold
Gold 1 year chart in US Dollars, taken from Xe.
Silver
Silver 1 year chart in US Dollars, taken from Xe.

Which makes you wonder at what point US Equities will break through the sell momentum (as everyone thinks they will crash right now) and take off to the upside:

S&P500
The S&P 500 price chart over 5 years. Taken from Yahoo Finance.

And note: property markets appear to be languishing, as do most sovereign debt markets (with the exception of Argentina, which most recently defaulted in 2002.)

Conclusion: For large institutions, US Equities are (just about) the only game in town.  For smaller institutions and individuals Precious Metals, Cryptocurrency and so on remain an option.  Institutional investment can, and will drive these market trends forward, and retail investors may follow after.

 

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