Posted on 03 March 2014 with 1 comment from readers
Geopolitical risk premium in global financial markets is definitely on the rise this morning as investors digest the likely impact of what amounts to an invasion of the Ukraine by Russian troops over the weekend with an estimated 6,000 of them now stationed in Crimea in response to the overthrow of the Russian-backed president by an angry mob in Kiev.
Russian Prime Minister Dmitriy Medvedev said: ‘Ukraine for us is not a group of people who, pouring blood on the Maidan (Kiev’s main square), seized power in violation of the constitution and other state laws. Russia needs a strong and stable Ukraine. A predictable and economically thriving partner. Not a poor relation that’s always standing with a hand held out.’
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The G8 meeting of heads of state in Sochi has been effectively cancelled and the Russian military action condemned by all of these countries. Russia is every bit as isolated as it was in late December 1979 when it invaded Afghanistan and the Moscow Olympics the next year were a disaster. The UK has just pulled out of the Sochi Paralympics.
It was also in 1980 that the great bull markets in gold and oil of the 1970s reached their peak. Ominously today Brent Crude is above $110-a-barrel and gold surged to $1,344 an ounce as its strong rebound from last year’s sell-off gathered pace. Asian stock markets were mainly lower.
However, analysts still reckon the fall-out from the Ukraine can be contained as it is largely a domestic issue. The international community does not have any defense treaties with the new government nor any will to take military action. It’s hot air is no response to heavy military equipment.
Nonetheless, major geopolitical upsets like this have a habit of having unseen contagion impacts, particularly on banking derivative products. These derivatives are usually created from economic models that do not allow for such extreme events, and they can suffer violent reactions when they do unexpectedly happen.
Pull this sort of trigger in global financial markets that are already very overstretched in valuation and you have a potential black swan event that could unleash a far wider systemic contagion.
The S&P 500 index only put in a new all-time high last week. Japan looks vulnerable to a flight to the safety of the yen. Chinese credit markets are showing signs of strain alarmingly reminiscent of US markets before the 2007-8 subprime crisis (click here). The eurozone crisis was never really settled and its banks remain vulnerable. Debt defaults could be widespread undermining the banking system (click here).
This is the sort of shaky global financial edifice that could be very easily kicked over by a major crisis in the Ukraine. Investors today will start to price in that possibility. There will be a flight to the safety of the US dollar, yen and gold and silver, and away from riskier assets like emerging market stocks and major stock markets too.
Paradoxically this might be the best moment to buy Russian stocks as a contrarian bargain hunter as we suggested in the ArabianMoney investment newsletter last month (subscribe here) albeit without prior knowledge of the invasion of the Ukraine.