Easy money brews sudden swings The two-day drop of more than $200 in the price of gold can only further chill the way investors have been looking at risk-taking in recent months. The virtues of gold as an investment sharply divides opinion, but no investor can ignore its stunning fall from favour over the past week. In the current climate of easy money from central banks, investors are right to worry that the distortion of asset prices is no golden era. As risk managers examine the scale and speed of gold's sudden and unexpected descent, a logical reaction is to ask whether such an episode could erupt in other asset classes, such as equities and bonds whose prices are being buoyed on a tide of central bank liquidity. Since Monday, US equities and inflation bonds, for example, have not been spared from investors questioning their current prospects. Although Wall Street was firmer on Friday the S&P 500 suffered its worst week since its post-election swoon last November. Meanwhile, inflation bonds have suffered from volatile trading as investors have reacted to the big retreat in commodity prices and the benign nature of consumer prices. A hedge fund manager concedes that clients feel a little less sure about chasing an equity market, fresh from setting a nominal record high only last week. "The move in gold has taken the juice out of speculation, and clients that were pretty bullish on the S&P a week ago are now cautious," he says. Also weighing on investors" minds are the mixed signals they are seeing for the US and global economies. Investors, such as Lucas Turton at Windham Capital Management rotated their US equity exposure into larger companies that perform better in a higher volatility environment at the start of the week. Such circumspection could well linger as risk managers review their value-at-risk models and ask harder questions about the possibility of big swings suddenly erupting across asset prices. Peter Tchir of TF Market Advisors makes the observation that risk managers will probably create "fatter" tails in their models that reflect a higher chance of a severe shock hitting portfolios. "Some spike in volatility, previously unheard of, will be used in models," he says. He thinks a combination of tighter risk controls loom for portfolios, which in turn will prompt investors to take more of their "chips" off the table across asset classes that have prospered in recent months. The tension between investors and easy money policy is illustrated by the defensive stance being followed in equities. It is a stance that runs counter to the general view that in a world awash in money from central banks, investors should pile into real estate, equities, bonds and commodities, dubbed "risk on." The downside of this approach is that investors are participating in markets that are being distorted by central bank policies. A big case for owning US equities made by many on Wall Street is that they look appealing versus low yielding bonds. But ask any bond manager where the 10-year Treasury should really trade and you get a shaking of the head and hear 3 per cent or higher, not its current level of 1.70 per cent. It is a backdrop that is storing up plenty of fuel for big and unexpected moves in markets. The new era of constraints on bank capital also removes a key source of support from dealers that in the past were more willing to step in and help moderate volatile swings in prices. What we continue to see is a preference for quality stocks that pay high dividends and thus provide income, hardly the ingredients of a traditional bull run. When it comes to bonds, many portfolios are geared to perform better than the benchmarks they track, should interest rates rise. It is an insurance posture that has cost them some of the gains from the recent rally in Treasury prices, which move inversely to yields. It illustrates how for all the support from central banks, investors are very focused on not getting crushed like this week's gold bugs.