Dodd-Frank, and more specifically the Volcker Rule within that reform bill, has re-vamped the way Wall Street dealers operate. Since the rule has been implemented, the bond markets and other OTC markets have experienced significantly less liquidity.
The Volcker Rule’s intent was to eliminate the ability of market makers to lever up their portfolio hence reducing the systematic risk we experienced in 2008. The fallout of this endeavor has brought another systematic risk to the markets. Since dealers are discouraged from holding inventory, market trading can be very thin in volatile times.
Another goal is for OTC products to go on exchanges to reduce this risk, however, we are years perhaps decades away from exchange type of liquidity. So today the big risk is if investors head for the exits because of a rise in interest rates, the market makers will not make orderly markets because they feel that it’s not their job anymore.
As bonds and stocks selloff, investors will have to rely on other capital sources to buy their assets. Those capital sources are hedge funds and other private capital that have been raising cash for such an event. This capital will be looking to profit wildly from retail investors. So if this scenario plays out and stocks and bonds get killed, gold will perhaps be a true safe haven again.
This article was written by Dennis Rhee, Managing Partner of Treesdale Partners and Portfolio Manager of the AdvisorShares Gartman Gold/Euro ETF (NYSE Arca: GEUR) and AdvisorShares Gartman Gold/Yen ETF (NYSE Arca: GYEN).