Sovereign Wealth Funds
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Many have heard the term, “Sovereign Wealth Fund,” but its meaning is elusive. Sovereign wealth funds are funds of capital used by nations for investing. Roughly 70% of them are created by oil producing nations, which normally enjoy excess cash due to their oil revenues. This cash is put to work in markets all over the world, but most notably, the US exchanges and debt markets.

The liquidity generated by these funds is of no small concern, hundreds of billions per year flow into markets from these funds, which means they can make or break markets. Even more importantly, the funds are not usually “hot money,” in that once deployed, they often remain invested for long periods. This provides stability and liquidity to markets.

The recent oil bust is usually discussed in terms of its affect on energy companies, energy investment, consumer spending, and jobs, but with a resource such as oil, there are near limitless secondary effects to consider. One of them is the effect on Sovereign wealth funds.

Oil producing nations now find themselves not only unable to accumulate extra cash for these funds, but also unable to even cover their national budgets. So, these nations go from being net contributors to market liquidity to net consumers of liquidity, due to requiring loans themselves. In an environment like the one we have today, with the world economy already fragile and depending entirely on central bank monetary policies for growth and liquidity, this is akin to removing the third leg from a four leg table, leaving only one leg, central banks.

The effects are not immediate, especially with the FED having just concluded printing trillions of dollars, as well as the ECB and BOC. The world is awash in money, but money is not capital. What we really need is money resulting from actual growth and production, not money printed out of nothing from printing presses.

If oil stays lower for longer, these nations may also decide to begin to sell assets, such as stocks, bonds, and stakes in companies. Indeed, just today we saw Saudi Arabia sell its stake in News Corp. after decades of being a large shareholder. That’s a very serious move for the Saudis, not only as an income generating asset, but as political capital within the US. As these nations make decisions like this one, more and more capital is pulled from the system in order to service financial obligations, rather than finance growth.

Markets will soon see lower levels of liquidity, and the past week or so has proven this true. On the eve of the last FOMC meeting, late January 2015, liquidity was at a multi-year low. Very odd for the day before an FOMC meeting, when typically the FED statement is designed to lift markets, at least temporarily. This trend will continue, and grow in intensity, until dips in the market won’t be bought because there just isn’t enough liquidity.

This is how a bull market turns into a bear market, one day at a time. Then, one day many programs will give a sell signal to their investors, for one reason or another. Sophisticated investors will be alerted first, due to their software which sees liquidity levels dropping, or early signs of trouble which mere humans won’t notice for weeks later. This market is very different than any other before it, for just these reasons. Never before have we had so much information available so quickly, and with the ability through HFT to sell so many shares within milliseconds. This crash will occur at light speed, markets will shut down, and average investors will never have a chance to get out in time.

HFT can literally sell or buy millions of shares within fractions of a second, as compared to software employed by most investors which takes at least 2 seconds to place a trade. Knowing this, it’s easy to predict who will be the first out of the market when it turns around. And ironically, if you ask investors what their exit strategy is, you’ll find most believe they’ll be among the first ones out. Truth is, most will be at work or asleep when it happens and won’t even know until hours later.

Sovereign wealth funds and their effect on markets isn’t a topic most financial media outlets discuss much, because it’s a topic which gives the professionals an edge. Being able to monitor fund flows enables professional traders to anticipate market moves well in advance. This is why some investors turn to newsletter writers or blogs for info. In my city, Vancouver blogs prefer to discuss lifestyle issues, so finding a Vancouver blog about sovereign wealth funds is all but impossible. That’s why I started mine.


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