Another Historical Bush Family Tidbit

I have been watching Gold lately as an asset class – Gold has always been a curiosity of mine as to why people would invest in gold.  Over the last few years as I have been watching how momentum impacts markets, I feel I understand a little better about the hows and whys of how gold prices move.

As of this writing gold is up 26% YTD, and the gold miners index is up 136%:

So you might think you are an idiot for not investing in gold this year – except if you thought that 5 years ago, people would call you an idiot because gold had been steadily declining for the last 5 years:

Obviously Gold is a tricky investment, and lots of people stay are recommended to stay away from it.  However, it seems that as interest rates approach zero – people are wondering the downside of holding gold?  I think there is an increase in people’s nervousness that with all this sovereign debt floating about the world, some event will explode on the scene and inflation will kick in.  If that happens, bonds yielding 1% is not the place to be.

The argument against gold would be a deflationary scenario – in which prices fall – gold will follow.  Apparently markets don’t see that as a significant risk.

Jim Grant, who has consistently been a gold bull, and points to worldwide monetary shenanigans as the reason for golds new found popularity.

In a recent radio interview, former Fed chief Alan Greenspan suggested if we returned to the Gold Standard, ‘we’d be fine’.  Returning to the gold standard has long been talked about as a kooky idea by economists, and it may well be an antiquated idea.

However, something is driving the new found interest in gold, and I think the worldwide decoupling of printed money from government assets is leading the world to wonder about the value of currency.  So whether or not a formal move to the gold standard ever gets momentum, it appears investors are wanting their assets backed by tangible goods.

Anybody who has invested in emerging markets over the last few years will tell you they have been killed.    Investing in emerging markets has been a small part of my diversification strategy, so while it has not been a winner I see it as a cost of diversification.

So I was interested to see this article discuss the BRICs (acryonym for Brazil, Russia, India, China) – and how they have been turning around – and this chart tells an interesting story:

Nomura Research

While the point of this article is that India is the winner so far in emerging markets investments, the recent uptick in the other BRICs was what interested me.  Yes I think India is an interesting investment opportunity – but so does everybody else and thus its pretty high priced compared to other companies.

One of the other sites I check in periodically is this Star Capital page showing worldwide market valuations.

Note Russia, China and Brazil are the 3 cheapest equity markets in the world using this sites scoring system (which seems fair).  India is not shown – as it appear at #32 right ahead of the US at #33.

Yes Russia, China, and Brazil all have their warts and reasons not to invest in those markets – but the valuations when compared to India are intriguing.   For contrarians who believe the uptick of emerging markets is not just a blip but a trend, one would have to think there is an opportunity here.

This interview with Mohamed El-Erien has a great quote in it which got me to realize why I find economics so interesting:

In the mid-’80s the IMF made an attempt to understand financial markets. And I was sent to talk to asset managers in New York. The question was asked to them: “What was the first thing you did when you heard Mexico wouldn’t be able to meet its debt repayments?” — which happened in 1982. And the asset manager said, “I sold Chile.” To an economist, this made no sense. Chile was a very well-managed economy; it never had to restructure. So the economist in me thought, “Wow, this is a difficult, irrational market participant.” But he explained, “Look, I manage Latin American funds, I believed, and it turned out to be the case, that some of my investors, when they read about Mexico, would take their money out of the fund. I didn’t want to be left with an over-concentrated position so I got ahead of that trend by selling Chile and some other winners.” And I remember being amazed that there was this whole other dimension out there that goes beyond economics and policy, and it goes back to the idea that how you think about things is very important.

Like the game of chess – economists have to think a few moves ahead to visualize the future.  Predicting the future is fraught with error, which is why so many smart economists see a wide variety of futures.

So when I hear about how the world is overleveraged in a declining growth environment, and this portends bad news for the future,  I have been trying to make sense of who the world winners and losers will be.  One of my favorite sites for this is tradingeconomics.com where you can easily see world economics to try to understand bond valuations.

Lets first look at how world interest rates appear to be determined.  By looking at this chart below, it appears to be highly correlated to the countries inflation rate:

Source: tradingeconomics.com

But if you want to look at the potential for government debt default, wouldn’t you think that countries with high debt to GDP would have higher interest rates as a reflection of the debt default?  Not so:

Source: tradingeconomics.com

Japan, with the highest debt to GDP, and lowest GDP Growth, has the lowest interest rate.  Looking at this chart, why would anybody own Japanese debt instruments?  While its sad to see the US in the top 10 of this list, arguably it is the safest bet – highest GDP growth, highest interest rate, and (relatively) high inflation rate – which is important for highly leveraged companies to inflate their way out of debt.

I think current world bond pricing is ignoring soverign debt default risk, and I can’t explain it.  If fact, when the Brexit results came in, Japanese Yields went down as investors switch to Japan in a flight to safety.   So I don’t get it, but I do think markets will correct and debt quality will become a factor in bond pricing.  And when this happens, world markets will be in turmoil.

Its been awhile since I have brought up the economy (OK.. a month or two..) but with all my prognosticating about the economic future I think I finally got one right that was worth mentioning.

A couple days ago I was looking to adjust my asset allocation to match my targets I have set. I noticed I was overweight on Bonds and REITs, and was going to re-balance.  Coincidentally, word on the street is the Fed was going to raise rates in June and bonds are dangerous at this level as increasing rates will lower their value.   However, I made a conscious decision to wait until after today’s job report to re-balance and re-evaluate, as my thesis is that the Fed won’t raise rates because of worldwide economic weakness, even in the face of zero or below interest rates.

In comes today’s jobs report – and  I got this one right.  It came in way weaker than expected, and now everybody is saying the June rate hike is off the table.  Bond prices are going up as market rates are falling.

What was my reasoning for my conviction?  Recent retail sales numbers.  If you have been following Macy’s or Nordstrom’s, you have seen sales fall off a cliff.  I think the economy has something to do with this, but I think this is just a harbinger of the acceleration of online retail sales.  Clothing is the biggest online sales category, and you are now seeing its impact on malls and stores.

In the first quarter of 2016, online retail sales percentage is just under 8% of total retail sales.  As baby boomers age, and millennials take over the shopping demographics, this has to accelerate.  Not to mention demographically millennials seem to buy less ‘stuff’ in this technology age.

So to make a long story short – I think we are at the point where online retailing is making an impact on the economy.   Not necessarily in a bad way – the efficiency of shopping online is reducing the cost of getting goods and services to the consumer – but at a cost of jobs.  Jobs of retail salespeople, cashiers, and soon to be bank tellers and office workers.  If online sales doubles to 20% of total retail in the next 5 years – how will it impact the malls and shopping centers?  I am guessing they will be a lot quieter.

So short to medium term, I think the story of the day is deflation caused by increasing sales efficiency.  Thus, 30 year T-bill rates will creep to under 1% (and be more in line with other developed countries).  So I am OK with being overweight in Bonds.  Interestingly I am not sure what to think about Real Estate (REITS).  My current thinking is that people will drop money in income producing properties as rates drop – however – as storefronts go dark -some REITS are going to have a lot of empty properties with no rent.  So for now I am overweight in REITS, but have a nervous trigger finger.

Medium to long term I do agree bonds are a dangerous place to be.   Governments are fighting an uphill battle to try to inflate their way out of debt, and some corporations are trying to grow their way out of debt.  So on Bonds I also have a nervous trigger finger – but more concerned about credit quality than inflation.  I also agree with many of the economic bears that we may see a recession later this year – and if that’s the case, being in the wrong credit markets could be a disaster.