The Flight to Safety Intensifies!

I noticed copper and the Australian dollar were both getting crushed on Monday. And gold — while not tumbling as fast as, say copper — is also seeing its fair share of selling this week.

But these aren’t the only signs that investors are running scared …

A couple weeks ago I sent a chart of the Brazilian real to my World Currency Trader subscribers. I suggested it may be an indicator of a major flight to quality or liquidity based on how it reacted back in 2008.

Here it is compared to the S&P 500:

The recent price action in the pair above is looking awfully similar to that of 2008, where the S&P topped first, the Brazilian currency caught up, and then they both plummeted together. Might we be looking at the same flight-to-liquidity set-up we saw then?

Then there was a story in Bloomberg this week comparing the last five months with the five months that followed the Lehman Brothers collapse. Back then investors withdrew $72.8 billion out of equity funds; since April 2011 investors have withdrawn $75 billion.

The article goes on to point out,

“Now, investors are withdrawing funds after companies beat profit estimates for 10 straight quarters. The world’s largest economy posted two years of growth and economists are calling for GDP to expand 1.6 percent in 2011 and 2.2 percent in 2012, according to the median estimates compiled by Bloomberg.”

Still, bulls say this is the time to buy. To paraphrase:

When the phone is ringing off the hook and investors are asking to sell everything it tends to signal a market bottom. The bottom is less about solid fundamentals but more about getting anxious investors out.

And thus, the way is cleared for all of this money on the sidelines to come rushing in, right?

I’m afraid it’s not that easy. Even if you clear the risk hurdle — which is no guarantee at this point — there’s another potential obstacle …

The Fed

The outflow of capital from equity funds is only half of the story. As noted, this could simply be risk aversion; but it could also be a major change in appetite.

Clearly the Federal Reserve has been integral in driving investors’ appetite for risk. They’ve provided the monetary ease that’s made financial markets the logical destination for investors’ capital.

But after Bernanke announced plans this week to alter the term of the securities in the Fed’s portfolio, to ultimately lower long-term interest rates and make it cheaper to borrow, the market tanked! Apparently it was not the “stimulus” the market wanted … if it wants any at all.

Personal savings shot up when deleveraging began in earnest after the 2008 financial crisis. It fell back as investors started to think the U.S. economy might improve in 2009 and 2010.

Now it is rising again, creating a pool of available funds from which to borrow. This is just another sign that capital is available to invest if there becomes any incentive to do so. Unfortunately, artificially low interest rates are not the incentive, as we’re beginning to realize.

Where does this leave investors?

A few weeks ago I said I was watching for a dollar breakout to confirm what may be the beginning of a major trend change. Well … we are getting that breakout from a 19-week range. Interestingly we saw a 20-week U.S. dollar index range before it broke out sharply higher thanks to the credit crunch back in 2008.

This indicates a real and sustainable move into the dollar. It might be a flight to safety and/or liquidity … take your pick. And it could eventually turn into something much more this time around.

Stay tuned!

Best wishes,

Jack