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David Fuller and Eoin Treacy's Comment of the Day
Category - Fixed Income

Gold Heads for Biggest Drop in Seven Years on Rising U.S. Yields

This article by Justina Vasquez for Bloomberg may be of interest to subscribers. Here is a section:

“Today real rates clearly moved higher and that’s clearly what moved gold lower,” Michael Widmer, head of metals research at Bank of America Merrill Lynch, said by phone from London.

“You had stronger PPI data out and I think when that data came out the market had another look at rates and expectations.” Exchange-traded fund investors also took a breather, seeing back-to-back outflows for the first time since June. On Friday, State Street Corp.’s SPDR Gold Shares, the largest gold-backed ETF, saw its biggest outflow since March. Meanwhile, a Bloomberg Intelligence gauge of senior gold miners dropped the most intraday since March, down as much as 5.7%.



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Time for Thinking

Thanks to a subscriber for this memo by Howard Marks which may be of interest. Here is a section:

The first is that many investors have underestimated the impact of low rates on valuations.  In short, what should the stock market yield?  Not its dividend yield, but its earnings yield: the ratio of earnings to price (that is, p/e inverted).  Simplistically, when Treasurys yield less than 1% and you add in the traditional equity premium, perhaps the earnings yield should be 4%.  That yield of 4/100 suggests a p/e ratio (the inverse) of 100/4, or 25.  Thus the S&P 500 shouldn’t trade at its traditional 16 times earnings, but roughly 50% higher.

Even that, it’s said, understates the case, because it ignores the fact that companies’ earnings grow, while bond interest doesn’t.  Thus the demanded return on stocks shouldn’t be (bond yield + equity premium) as suggested above, but rather (bond yield + equity premium - growth).  If the earnings on the S&P 500 will grow to eternity at 2% per year, for example, the right earnings yield isn’t 4%, but 2% (for a p/e ratio of 50).  And, mathematically, for a company whose growth rate exceeds the sum of the bond yield and the equity premium, the right p/e ratio is infinity.  On that basis, stocks may have a long way to go.



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Navy's solar power satellite hardware to be tested in orbit

This article by Sandra Erwin for Spacenews.com may be of interest to subscribers. Here is a section:

The 12-inch square tile module will test whether power can be harvested from its solar panel and transform the energy to a radio frequency microwave. The experiment has been in the works for more than a decade.

The module converts sunlight for microwave power transmission. Depuma said engineers decided to not use optical power transmission because a lot of energy would be lost through clouds and atmosphere.

The Naval Research Laboratory said the results of the experiment could drive the design of a dedicated spacecraft to test the transmission of energy back to Earth. The Pentagon is interested in this technology to provide energy to remote installations like forward operating bases and disaster response areas.

Researchers believe that a space solar system traveling above the atmosphere would catch far more energy than it would be possible on the ground due to the abundant and unimpeded sunlight in space.

One of the concerns is the thermal performance of the hardware. “It’s kind of a tricky problem to have something that’s in direct sunlight all the time and maintain the temperature of the electronics,” said Jaffe.

Solar power satellites could provide energy anywhere in the world, he said. “So a really important component of these kind of satellites would be a device that can convert the sunlight into microwaves or some other form of electromagnetic energy that’s suitable for sending to Earth. Now is the time to test it in space and see how it performs.”



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Hearts of Glass

This edition of Tim Price’s letter for Price Value Partners may of interest to subscribers. Here is a section:

God only knows what the historians of the future will make of 2020. A global flu panic that results in countries shutting down entire economies sounds like the pinnacle of craziness – until you discover that Europe between the 15th and 17th centuries was periodically prone to something called the ‘glass delusion’, in which sufferers believed that they were made of glass and at risk of shattering into pieces. The French King Charles VI was one of the higher profile victims of the illness, and he would reportedly wrap himself in blankets to prevent his buttocks from breaking. Because human nature never really changes, we choose to allocate to uncorrelated investment vehicles known as systematic trend-followers, which make no attempt to predict the future, or to avoid seeming overvaluation, but which are simply content to ride such price trends as appear from time to time, both up and down, courtesy of the interests and enthusiasms of the mob.

We also allocate, at present, to precious metals-related companies, provided we can secure robust cash flows in the process from businesses trading on comparatively modest earnings multiples, and with little or no debt. As George Bernard Shaw once remarked,

“You have to choose (as a voter) between trusting to the natural stability of gold and the natural stability of the honesty and intelligence of the members of the Government. And, with due respect for these gentlemen, I advise you, as long as the Capitalist system lasts, to vote for gold.”



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Gold ETFs Top German Holdings to Become World's No. 2 Stash

This article by Ranjeetha Pakiam for Bloomberg may be of interest to subscribers. Here is a section:

Investors are so concerned about the global outlook that worldwide holdings in gold-backed exchange-traded funds now stand behind only the official U.S. reserves of bullion after they surpassed Germany’s holdings.

Gold has rallied to a record this year as the coronavirus pandemic savaged growth, with gains supported by massive inflows into bullion-backed ETFs. Bulls are fearful that the waves of stimulus to fight the slowdown may debase paper currencies and ignite inflation. They also point to simmering geopolitical tensions, rising government debt burdens, and lofty equity valuations.

Worldwide holdings in gold-backed ETFs rose to 3,365.6 tons on Monday, up 30.5% this year, according to preliminary data compiled by Bloomberg. That’s a couple of tons ahead of Germany’s stash. U.S. reserves exceed 8,000 tons.

Even after futures topped $2,000 an ounce, there are plenty of forecasts for further, substantial gains. Among them, Goldman Sachs Group Inc. says gold may climb to $2,300 as investors are “in search of a new reserve currency,” while RBC Capital Markets puts the odds of a rally to $3,000 at 40%.



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John Authers' Points of No return

This edition of the former Lex Column’s editor contains some interesting charts on the correlation between Fed intervention and stock market recoveries. Here is a section:

There is a negative correlation between what the S&P did a month ago and moves in the Fed’s balance sheet. In other words, if the S&P falls, we should expect the balance sheet to be increased about a month later. Once the Fed has made its change, we should expect the two to move in the same direction for the next month — a rising balance sheet raises the S&P, a shrinking balance sheet brings it down. The lag is clear; it takes about a month for a weak stock market to prod the Fed into a response, and once that response has been made the effect is felt in full a month later. 

So, the two are indeed related but with a lag. How strong is the link? The top chart shows us what we should expect the Fed to do in response to a 10% correction, while the lower chart shows the S&P 500’s response to a 10% shift in the balance sheet:

There was also — and this should surprise nobody — a marked asymmetry to the Fed’s actions. It responds to falls in the market with alacrity. It doesn’t seem to feel any great macro-prudential need to prick bubbles by comparison, and so the tendency to respond to a rise in stocks with a shrinking of the balance sheet, as seen at the end of Janet Yellen’s tenure and the beginning of Jerome Powell’s, was much weaker. In late 1996, less than two years before the “Put” era began with LTCM, Alan Greenspan was plainly worried about the possibility of asset bubbles, and uttered his famous warning of “irrational exuberance” (following through with a rise in rates that induced a minor stock market correction). Now, the idea of raising rates to curb share prices appears so outlandish to Powell that he said in June “we would never do this.”



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Email of the day on a double dip

Read a very interesting piece in Saturday's Telegraph by financial journalist, Ambrose Evans Pritchard. In a nutshell he suggests that western governments risk making the most catastrophic error of economic policy since the thirties by pulling away the stimulus rug too soon. The pandemic is still causing havoc and stimulus is running out before the rebound can reach self-sustaining escape velocity. He suggests the crunch will come in September/October.



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The Baupost Group Letter

Thanks to a subscriber for this letter by Seth Klarman and team. Here is a section focusing on appetite for risk:

Fed policy has been magnificently successful in achieving its objectives not only of lifting securities prices but also of altering investor behavior. The Fed wanted to influence buyers of securities to be bolder in their pursuit of return. The head of a major pension fund recently authored a piece describing how the fund had responded to lofty markets and low yields on safe debt instruments. Their reaction was not to lower the fund’s currently aggressive 7% risk-adjusted return objective to a more realistic threshold, but instead to direct more assets into “lower volatility” private investments while leveraging the portfolio. Private investments, of course, have the same underlying risk and inherent volatility as public investments – though because they are not publicly traded, their intermittent and privately determined appraisals may make them appear to be less volatile. And as for the choice to leverage up, we can only note that leverage is a double-edged sword that enhances returns in good times while sinking them in down markets. If markets falter, this fund will have not solved its problems but rather have multiplied them.  



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'An absolute necessity' Why this expert says China desperately needs a digital currency

This article by Veta Chan for Fortune.com may be of interest to subscribers. Here is a section:

How will data be used by central banks and how will the central bank reassure people about the privacy of their data?

The data you are going to collect, there are two sides to it. On one side, the data that they're going to collect, given they are going to be able to engage the complete economic activity of a country in realtime, that data will be recorded on a blockchain-type network, distributed ledger, we don't know exactly. So the government will have access to all of that. On the [other] hand, it will enable the central bank to do their job more effectively. Because rather than having a lag in economic data, they're monitoring all the spending, the transactions, money supply, inflation implications, all in realtime... Tracking where people go in the world, because CBDC will be available to Chinese as they do business in other countries. It's almost a sort of a way to track an individual. So there are big alarming questions that need to be properly considered when it comes to privacy and anonymity.

The technology is there to enforce anonymity, but it's a question of are they going to implement it? Is that something that they're going to build into their currency? Time will only tell if different central banks come up with their versions of digital currency, as they say there is no one-size-fits-all, they're all going to be different and likely to reflect the values and culture of their citizens. Are we just going to accept that all governments get to have this data like we've kind of accepted with tech giants like Facebook? No one has really done anything about it.



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Big Numbers Along Make No Proper Monetary Policy

This report from DWS may be of interest to subscribers. Here is a section:

In some ways, however, that was the easy bit. The U.S. economy now enters a phase that cautiously could be described as the beginning of a recovery. However, remember that the virus is still out there. This leads to the question of how QE can continue to provide support in the months ahead? In terms of mechanics, the Fed describes the main purpose of LSAP as putting "[…] downward pressure on longer-term interest rates […]" in order to stimulate economic activity by generating attractive financial conditions.5 The key word behind those mechanics would be financial conditions. Such metrics generally try to describe the "[…] financial conditions in money markets, debt and equity markets […]" as the Federal Reserve of Chicago puts it.6 In other words, measures of financial conditions gauge the effectiveness of monetary policy.

Deriving a metric that summarizes the stance of monetary policy once the policy rate hits the Zero Lower Bound (ZLB) is not a trivial task, however. The monetary stimulus, as a combination of rates at the ZLB and asset purchases, is not directly observable. Our preferred methodology to overcome this problem would be the so called shadow short rate (SSR) as provided through the Reserve Bank of New Zealand.7 This concept mathematically derives a theoretical policy rate which is based on the evolution of the whole yield curve, therefore accounting for the impact of QE once the true policy rate is at the ZLB (see Chart 2).



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