Kurtosis: the risk of extreme events

It is too simplistic for investors to think about the new Cold War as simply about defence spending.

War also has more profound economic consequences and wider investment implications, leading to more risk of extreme events. Statisticians call this “excess kurtosis” or “fat tails” relative to a normalised bellcurve distribution.

In the unipolar post- Cold War world, investors’ prime concern was the economic cycle, which could be managed by central banks.

But central banks can’t prevent de-globalisation, or fight geopolitical conflicts. So investors must think about extreme, “unpredictable” outcomes, higher inflation, and higher volatility. We are already witnessing a reshaping of the global economy. The low inflation of the post-Cold War era, which has allowed for historically low interest rates. This is now changing.

The American and Chinese economies continue to “decouple.”

Chinese exports to the US are now down 25pc from peak. Western corporations are looking to “friend-shore” manufacturing to Malaysia, India, Vietnam, or Mexico instead of China.

The US government has provided $280bn in subsidies to “re-shore” semiconductor manufacturing from Asia, while also seeking to prevent the export of high-performance semiconductors and manufacturing equipment to China. What is politically logical comes with economic cost.

The projection of geopolitical power is also changing the unipolar global financial system based around the hegemony of the US dollar. There is $300bn of Russian financial assets frozen (mostly in Belgium’s Euroclear), which the US wants to give to Ukraine, but Europe, fearing retaliation, is resisting, instead considering using the accumulating interest as war reparations.

Russia has responded by freezing the assets of investors from “nonfriendly” countries. This should be a shot across the bows for any UK investors in the Chinese stock market.

Equally, the “anti- hegemonic” alliance is highly incentivised to diversify their assets “outside” the Western banking system to avoid political default risk.

Chinese holdings of US Treasuries are now down to just $800bn ( from $ 1.2 trillion at the peak in 2016). Gold – with a market value of $15 trillion – is the most liquid alternative as a store of value. The People’s Bank of China has emerged as its current biggest buyer.

The “Axis” powers must also “de- dollarise” their financial systems since transacting in the greenback results in the risk of accumulating assets which could be confiscated. It also incurs the risk of being frozen out of international trade by sanctions via the dollar-based Swift system.

The new Cold War increases the attractiveness of “outside” money in all its forms: cash, gold, crypto and, for the Axis, their own currencies.

Russia, Iran and Venezuela have already adopted China’s CIPS payment system to evade sanctions.

America has enjoyed the “exorbitant privilege” of the greenback being the world’s reserve currency. But as the British experience of the early 20th century demonstrated, this privilege can be forfeit.

War increases demand for commodities, which is inflationary, particularly when their supply is not indigenous. The inflationary nature of war means that gold – and its more volatile peer silver – should replace government bonds as a portfolio risk diversifier. Blue- chip gold miners such as Barrick and Newmont are now looking cheap perhaps for the first time in my investment career.

To all investors in the new Cold War era: welcome to the jungle and think about both guns ’n’ kurtosis.

Barry Norris is founder of Argonaut Capital and manager of the Argonaut Absolute Return fund