The excessive surge in implied volatilities in currency markets ahead of the U.K. referendum is in our opinion not only an indication of increased systemic risk, but also symptomatic for structural changes among liquidity providers. Banks as primary market makers have been constrained by regulation in their ability to warehouse risk, and are therefore less capable of absorbing market turbulence during events like the U.K. referendum. In the coming months and even years, investors might see increased pressure to deleverage and hedge, while experiencing higher cost of doing so through increased risk premia and slippage.
As a result, aside from overall heightened volatility, we believe there is increased chance of market turbulence that can be triggered by a number of global catalysts, including central bank intervention, economic fears in China, slowing earnings momentum and uncertainty about the Fed rate path. Our risk management and portfolio management approach has proven itself to be prepared for this market environment, and we have positioned ourselves to potentially profit from the outlined market risks and provide investors with diversification to their other investments.
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Axel Merk is president and chief investment officer of Merk Investments.