With ‘whatever it takes’ becoming the global central bank motto after Powell’s conciliatory December speech, most arguments against owning gold have evaporated. “It generates no cash flow” becomes significantly more appealing as real yields on large portions of the global bond market enter negative territory, with the US seemingly trending towards the zero lower bound.
I understand this is a relatively contrarian opinion on here, but the market is not yet pricing in enough cuts into 2021. While the short-end of the curve may whipsaw due to trade developments, it will end decidedly lower without moving higher again this cycle. Let me repeat that: the Federal Reserve will not raise rates or tighten again this cycle. December was both a policy error and proof that a.) rate increases are intolerable given the amount of outstanding debt ex households b.) the world is awash in dollar denominated debt and decreasing overseas liquidity will crush global economic activity.
Let me point out that the equity market seems to be the only thing anyone on this subreddit focuses on, however it’s also the least relevant capital market. The bond market is screaming that a policy error has occurred, and the bond market typically ends up being correct. Does that mean stocks have to come plummeting to earth? Hardly. In fact, given rhetoric around the globe it has obviously become a mandate of the global monetary authorities to continue the economic expansion at all costs. The why is more difficult, but my personal opinion is that another global economic recession has been deemed untenable given the worldwide rise of populism since 2008. People are angry about their circumstances, angry about inequality, and although paradoxically a recession tends to decrease inequality, it would also lead to a drastic rise in populism and discontent.
Conventional wisdom is that the central banks are out of ammunition; they aren’t. A few things have changed:
a.) Central banks are quite blatantly working in concert and coordinating policy responses.
b.) Globalization means that barring capital controls interest rates should trend together barring outliers (eg Venezuela). US govt credit is the last risk-free asset with a reasonable yield, and it appears to be the last domino to fall.
c.) QE was a paradigm shift. If an authority controls the money supply and is willing to perform OMOs on any asset class, they can without a doubt support prices within that asset class. Could equities be next? Japan has blazed the path in monetary policy and ETF purchases are where they are presently at.
So, do I believe central bankers can prevent a deflationary bust or global economic slowdown akin to 2008? If you had asked me ten years ago I would have referenced ‘this time is different’ in jest. Today, I’m not so sure. I’m confident that they could prevent a credit crunch and bust in asset prices a la 2008 if policy is coordinated on a global scale. The question now seems to be whether they should. Recessions often entail creative destruction and the loss of jobs whereas Japan has shown that perpetually depressed rates (eg no hurdle rate) can lead to zombie companies and potentially lower growth going forward. There’s obviously way more to it than that, but this post is getting long and I haven’t even talked about gold miners yet.
Now, why should one own some form of gold? When it’s clear that a slowdown is ahead, central banks around the globe are going to go further negative and ease like the status quo depends on it, because it does. Presently almost every leading indicator I follow is showing a slowdown in global economic activity, and while it may not presage a recession, the stark policy pivot we’ve seen from every major central bank across the globe is what people should be paying attention to.
You might ask, why not own bonds then? Why junior gold miners instead of the physical metal? I’ll start with the first. There’s a few reasons why bonds seem less appealing than gold on a forward looking basis. I’d argue that the biggest predictor of bond returns on a forward-looking basis is starting yield, but that’s largely irrelevant when most simply want a portfolio hedge. Well, I’ve got good news for you, why do bonds go up in a recession? Because yields go down. So if you presently own Treasuries as a hedge you’re essentially betting that yields will approach and potentially go below zero in the event of a slowdown. Well let me tell you, regardless of economic conditions the smart money will flock to gold when there’s no longer an opportunity cost to holding it over risk-free assets, and that happens when real interest rates approach zero. If you don’t see a use case for a metal that has historically acted as a store of value (over time), compared to a currency that’s been around for ~300 years, is engineered to be inflationary and is currently priced to lose money over time, then I’m not sure what to tell you. The only case in which treasuries or sovereigns will make money is a case in which junior gold miners will almost assuredly make more money.
And finally, why junior gold miners instead of gold? Well, it’s simple really: gold isn’t an asset that produces cash flows so I’m using it largely as a hedge. Instead of holding 40% bonds I’m sitting at around 10% GDXJ and 7.5% other miners that exhibit a sort of optionality in relation to gold price; the miners have low debt & expenses with a cost of production well above the current price of gold, so they act in a sense as an OTM call on gold, have a low cost of carry and lower bankruptcy risk than the index.
Alright, that’s the end of the line for me. I’ve spent too much time writing this and if I add much else it’ll become even more convoluted.
Edit: Wanted to add a few more things. Although I find it to be exceedingly unlikely, on the off chance of some inflationary shock gold would significantly outperform bonds, even in a rising rate environment. The big downside risk is that the economy is wonderful and Powell raises rates, in which case hopefully the extra equity exposure as opposed to owning bonds would make up for some of the difference. I also think gold miners are generally a terrible investment and that this is a special situation given the current macro & monetary environment. I do not plan to hold miners and rebalance for years, if my thesis plays out I’ll begin paring my position as rates (FFR) approach 0. Don’t be surprised to see a short-term reversal going into the July Fed meeting. IMO many headwinds for gold will abate as it becomes more obvious that this slowdown in global leading indicators likely isn’t transient or entirely related to the trade war.
Submitted July 05, 2019 at 09:16PM by Evebitda https://ift.tt/2S1bxQj
