Strange correlations reveal it isn’t asset prices that are on the move

Back when I still wanted to be an investment banker, conveniently during the greatest financial crisis since the Great Depression, I had to take the banks’ exams and personality tests before getting any job interviews.

I can only remember one question from the online tests. Well, I remember part of it. It was a more complicated version of this…It’s a trick question. Made tricker the more details you add.

The answer is of course that the boat floats with the tide, so the number of rungs under water won’t change.

The point here is that perspective is the key. And, to get perspective, you need to be aware of and understand the context.

If the question hadn’t mentioned that it was a boat which the ladder was on, or that the tide was causing the water to rise, the context would change completely.

If the rising water level really is moving up the side of a boat, that’s a problem. It’s likely sinking…

Or, if the water level really is rising at the pace of the tide, it may not be the side of a boat you’re looking at.

Or, if it isn’t the tide, then the water level could just keep rising past the point of high tide.

Sometimes it’s everything around you that’s changing which holds the real insight. It explains what’s going on for the matter you’re actually focusing on.

The best performing stockmarkets in the world are in hyperinflationary countries. Measured in terms of pounds, they don’t do so well… What’s changing isn’t stock prices. It’s the value of money.

Japan has had deflation for a long time, but its economy was actually doing just fine in terms of real GDP, not to mention other measures like unemployment.

Australia hasn’t had a recession since 1991. But only because of immigration, which gooses the figures. Measured per capita, there was a recession in the financial crisis of 2008.

Each time, it’s the thing we assume to be constant which is really causing the change in the measure. And only understanding the context allows you to see this.

So, if, say, hypothetically speaking… or not so hypothetically… the price of avocados, Beyond Meat’s share price and bitcoin suddenly became highly correlated, this would suggest that it’s not the price of avocados, Beyond Meat’s share price and bitcoin which are really moving. Something far more like the tide is what’s floating or sinking all those boats.

Sure enough, avocado prices were closely tied to bitcoin last year. The blog CCN had this punny headline: “Freaky Bitcoin/Avocado Price Correlation Will Guac Your World”.

Bitcoinist had this headline more recently: “Breaking Down Bitcoin’s Unusual Correlation with Beyond Meat”.

For a while the stockmarket and bitcoin traded together too.

My point here isn’t the relationship between avocados, Beyond Meat shares, the stockmarket and bitcoin. That’d be making the same mistake as in the test question above – you’d be missing what’s really going on.

But what is really going on?

I think the global financial system is breaking down in a particular way. And correlated prices of things that shouldn’t be correlated are a symptom.

To put it simply, it’s the value of money that’s fluctuating. Prices are a reflection of the value of money too, remember. So, if you get odd price correlations between assets, it may be money that’s changing in value.

Of course, there are plenty of other things happening in avocado markets, the Beyond Meat business world, other companies’ stocks and bitcoin. Which is why correlations don’t hold for long.

But the correlations are still suggesting breakdowns – periods where money is fluctuating in value against assets.

This is part of the reason I’m recommending my readers at The Fleet Street Letter Monthly Alert diversify some of their wealth into non-financial assets.

If the value of money is on the move and the financial system is wobbling, owning some non-financial assets is the safer thing to do. In this presentation I’ll show you which assets you can diversify into without necessarily sacrificing returns.

But when I mention the value of money fluctuating, am I talking about inflation?

Partially. The thing is, inflation expectations are crashing around the world. Because, as I mentioned, we’re talking about a financial crisis too. Those cause deflation.

The connection is that money won’t be safe in the coming deflationary shock either. You won’t want to hold too much of it. For a simple reason I explain here.

If you shouldn’t own cash, but there’s a crash coming, what are you left with?

Well, avocados, Beyond Meat, shares and bitcoin do have some things in common. They’re not cash in the bank, for example. They’re safe from bail-ins (apart from bank stocks).

People who aren’t optimistic about investment opportunities spend their money on things like avocados – luxury consumption goods – instead. Or they invest in stocks with real growth potential despite a wobbling financial system – Beyond Meat. Bitcoin is the ultimate opt-out of the traditional financial system in favour of an alternative.

Whatever the reason, money is leaving the banking system because it is at risk there. And correlated asset prices are the giveaway.

It’s time to diversify out of this correlation. Here’s how.

Nick Hubble
Editor, Southbank Investment Research

Category: Commodities

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