So where will Saudi hot money go next: gold or cash deposits?

Market analysts had been warning Saudi Arabians that their stock market was seriously overvalued for some months now. And on Sunday February 26th the Tadawul All-Share Index crashed by 980.18 points or 4.75% to close at 19,654.68.

This was near to the maximum fall allowed by the Saudi Capital Market Authority which had reduced the band for maximum share price fluctuation from 10% to 5% only the previous Saturday. But the slump in share prices was not unexpected in a market up by 17.6% since the start of the year, and after a gain of 103% in 2005. What goes up must come down!

All 78 stocks listed on the market dropped on Sunday 26th, and the main Banking and Industrial indexes plunged more than 2,000 points each. Yet with the market trading on a price-to-earnings ratio of 40, compared with 20 in the neighboring UAE who can be surprised by a correction?

Investor shock

Probably rather a lot of people in fact, markets like this are driven by momentum and crowd behavior and there will be shock bordering on disbelief. For when stock prices head upwards vertically there will always be those who think they can not loose and that 'this time is different'.

This phenomenon has been witnessed since the birth of capital markets and is no reflection on Saudi Arabia. Indeed, we have only to look at the Nasdaq crash in the US in 2000 for a previous example of monster overvaluation levels driven by the supposedly sophisticated American investor.

Those who fare worst in a stock market crash are the over-borrowed. They need to sell shares into a falling market to meet their debts, which may not be covered by the proceeds. Then they will need to sell other assets and could face personal financial ruin.

But the big question for those investors not involved in the Saudi stock market, and few GCC investors have much exposure in this largely closed capital market, is what happens next to the flow of Saudi investment capital, which is by far the largest in the region?

Hot money options

Will the Saudi Arabians now return to US markets in force and send the Dow Jones up 1,500 points? Or will Saudi investors look to another asset class entirely? And perhaps drive up the value of precious metals as they did in 1980 when gold spiked to $850 an ounce, a level it has still not reached 25 years later.

Like everyone else those exiting the Saudi stock market will find that risk premiums have fallen very sharply in virtually all asset classes. Indeed, we have commentators like Dr. Marc Faber warning on AME Info that this could be a correction time for most asset classes.

In such an environment precious metals are the logical safe haven for investors worried about inflation and geopolitical risk; or perhaps accumulating large cash balances on deposit is the next best thing, given that the bond market looks vulnerable to rising inflation and offers very low real returns.