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

    Email of the day on gold and negative yields

    Hope you are doing well. I just thought you may find interesting this Financial Times story on gold - 

    In particular, it has a chart showing that “the correlation between the growing volume of negative-yielding bonds and the rising value of gold is striking.” And, also, “Gold as a zero-yielding asset will look even more attractive versus an asset that is guaranteed to lose money,” said Paul Wong, a former senior portfolio manager at Sprott Asset Management.

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    Paradigm Shifts

    This article by Ray Dalio is one of the most eloquent arguments for gold I have read in a long time. Here is a section from the conclusion:

    That will happen at the same time that there will be greater internal conflicts (mostly between socialists and capitalists) about how to divide the pie and greater external conflicts (mostly between countries about how to divide both the global economic pie and global influence). In such a world, storing one’s money in cash and bonds will no longer be safe. Bonds are a claim on money and governments are likely to continue printing money to pay their debts with devalued money. That’s the easiest and least controversial way to reduce the debt burdens and without raising taxes. My guess is that bonds will provide bad real and nominal returns for those who hold them, but not lead to significant price declines and higher interest rates because I think that it is most likely that central banks will buy more of them to hold interest rates down and keep prices up. In other words, I suspect that the new paradigm will be characterized by large debt monetizations that will be most similar to those that occurred in the 1940s war years.

    So, the big question worth pondering at this time is which investments will perform well in a reflationary environment accompanied by large liabilities coming due and with significant internal conflict between capitalists and socialists, as well as external conflicts. It is also a good time to ask what will be the next-best currency or storehold of wealth to have when most reserve currency central bankers want to devalue their currencies in a fiat currency system. 

    Most people now believe the best “risky investments” will continue to be equity and equity-like investments, such as leveraged private equity, leveraged real estate, and venture capital, and this is especially true when central banks are reflating. As a result, the world is leveraged long, holding assets that have low real and nominal expected returns that are also providing historically low returns relative to cash returns (because of the enormous amount of money that has been pumped into the hands of investors by central banks and because of other economic forces that are making companies flush with cash). I think these are unlikely to be good real returning investments and that those that will most likely do best will be those that do well when the value of money is being depreciated and domestic and international conflicts are significant, such as gold. Additionally, for reasons I will explain in the near future, most investors are underweighted in such assets, meaning that if they just wanted to have a better balanced portfolio to reduce risk, they would have more of this sort of asset. For this reason, I believe that it would be both risk-reducing and return-enhancing to consider adding gold to one’s portfolio. I will soon send out an explanation of why I believe that gold is an effective portfolio diversifier.

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    Most of the World's Companies Are Duds

    This article by Vildana Hajric for Bloomberg may be of interest to subscribes. Here is a section:  

    Investors have heard this refrain before, that just a scant few pull the pack. And it’s easy to see their outsize influence: Microsoft, Apple, Amazon.com and Facebook Inc. account for more than 20% of the S&P 500’s returns this year. That number is even starker for the tech-heavy Nasdaq 100, for instance, where those four companies account for about 50% of gains.

    But Bessembinder and his team, including two co-authors from Hong Kong Polytechnic University and Goeun Choi of Arizona State, are among the first to look at the phenomenon long-term. The best-performing 306 firms accounted for about three-quarters of global net wealth creation during the 28-year period of the study, they found. Just 811 companies could be framed as accounting for all of it.

    Their findings echo Bessembinder’s previous work. In looking at nearly nine decades of U.S. stock and bond performance, he found that out of 26,000 stocks, about 58% underperform Treasury bills in their lifespan.

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    Powell Says Fed Has Room to Cut, May Have Kept Policy Too Tight

    This article by Craig Torres and Reade Pickert for Bloomberg may be of interest to subscribers. Here is a section:

    Powell told Senators that the so-called “neutral rate,” or policy rate that keeps the economy on an even keel, is lower than past estimates have put it -- meaning monetary policy has been too restrictive.

    “We’re learning that interest rates -- that the neutral interest rate -- is lower than we had thought and I think we’re learning that the natural rate of unemployment is lower than we thought,” he said. “So monetary policy hasn’t been as accommodative as we had thought.”

    Federal Reserve officials in fact marked down their estimate of the longer-run policy rate to 2.5% in June, from 2.8% in March.

    Investors fully expect a quarter-point cut at the Fed’s July 30-31 gathering, according to pricing in interest-rate futures, though odds were dialed back a bit after a stronger-than-expected U.S. inflation report earlier on Thursday.

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    Powell Signals Rate Cut as Trade War Outweighs Strong Job Market

    This article by Craig Torres and Katia Dmitrieva for Bloomberg may be of interest to subscribers. Here is a section:

    Powell carefully explained the reasons why the policy committee has shifted its views this year, and noted that “crosscurrents have reemerged, creating greater uncertainty.” Despite a current trade war truce with China, he continued to stress downside risks to the outlook.

    “Uncertainties about the outlook have increased in recent months,” Powell said in the text of his remarks. “Economic momentum appears to have slowed in some major foreign economies, and that weakness could affect the U.S. economy. Moreover, a number of government policy issues have yet to be resolved, including trade developments, the federal debt ceiling, and Brexit.”

    He noted that policy makers are carefully monitoring developments including the risk that weak readings on inflation could be “even more persistent than we currently anticipate.”

    In addition, Powell pointed to a slowdown in business investment, decelerating global growth, and declines in housing investment and manufacturing output.

    “It strongly suggests they’re going to be inclined to ease at the meeting later this month,” Michael Feroli, chief U.S. economist at JPMorgan Chase & Co., said in a Bloomberg Television interview. “He continued to highlight the uncertainties that are weighing on the outlook rather than highlighting the better jobs report.”

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    The Future of Housing Rises in Phoenix

    This article by Ryan Dezember and Peter Rudegeair for the Wall Street Journal may be of interest to subscribers. Here is a section:

    The house in Tolleson is one of several thousand around the city that Opendoor and two competitors—listings giant Zillow Group Inc. and Offerpad Inc.—have bought since 2014 in an attempt to perfect programmatic house flipping. Last year, they bought nearly 5,000 houses in the metro area, roughly one in every 20 existing homes sold. They’re after real-estate transaction fees and anything they can make on reselling the property. Margins are low, so volumes must be high.

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    Sub-Zero Yields Start Taking Hold in Europe's Junk-Bond Market

    This article by Laura Benitez and Tasos Vossos for Bloomberg may be of interest to subscribers. Here is a section:

    The number of euro-denominated junk bonds trading with a negative yield -- a status until recently associated with ultra-safe sovereign borrowers -- now stands at 14, according to data compiled by Bloomberg. At the start of the year there were none. Cheap money policies since the financial crisis have kept interest rates at, or near, all-time lows for the last decade.

    That’s prompted many investors to buy riskier assets that yield enough for them to meet their liabilities, driving bond markets higher and yields lower. The European Central Bank said on Monday it’s ready to add more stimulus to the euro zone, indicating that an end to the age of ultra-low borrowing costs is far from over.

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    Betting Against The Gods Is Now Impossible

    Thanks to a subscriber for this report from GaveKal which may be of interest. Here is a section:

    Swiss Standoff With EU Belies Country's Deep Economic Dependence

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

    An EU attempt to compel Switzerland to agree to the treaty by denying the country’s bourse recognition under EU equivalence rules seems to have had little or no impact, with the benchmark SMI Index closing at a record high on Tuesday. There may be more salvos to come.

    The EU could up the ante by refusing to revise an agreement on technical barriers to trade, which would hit several companies, notably in the medical-technology sector. There’s also Switzerland’s participation in EU research programs like Horizon 2020, which would thwart universities and research and development activity.

    “They’re in a position where they’re highly dependent on the EU - just look at the map,” said Nicholas Veron a senior fellow at the consultancy Bruegel in Brussels.

    Like Brexit
    Switzerland’s issues with the EU are not that different from those of Brexit backers in the U.K. Many in Switzerland are upset about high levels of immigration and regard the 28-member bloc as a dysfunctional bureaucracy. Unlike the U.K., however, Switzerland was never part of the bloc, and instead has a special relationship based on 120 agreements, which the EU now wants to consolidate and streamline into one new treaty.

    That’s proved to be a contentious undertaking. The EU made concessions on a dispute arbitration panel, but with labor unions up in arms about wages -- fearing they would face downward pressure in high-income Switzerland -- Bern wouldn’t sign on to the so-called framework deal. Certainly not ahead of a general election in October.

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    High Profits at Low Rates - The Benefits of Bond Convexity -

    This article from portfoliocharts.com contains a number of highly informative graphics and may be of interest to subscribers. Here is a section:

    This chart is one of my favorites that I’ve made in a while, as not only does it contain a lot of interesting information but I also learned a lot by making it. Here are a few of the most important takeaways:

    1. At high interest rates the coupon is most important, and at low rates capital appreciation is king

    2. Short and intermediate term bonds (typically capped at about 10 years) are much less sensitive to interest rates at all levels than long term bonds

    3. Low-interest 30-year bonds are very volatile! In fact, the range of returns is similar to what you might expect from the stock market.

    4. Note that the spread of total returns for long term bonds is not symmetrical. Because they are increasingly more sensitive with every drop in rates, for the same +/-1% change they actually have more upside than downside.

    5. One thing that’s not obvious from the chart is that interest rate sensitivity declines as bonds age. A new 30-year bond will start on the red line. When it only has 15 years left, it has the volatility of the green line. And when it only has 5 years left it has the predictable tight range of the purple line. Just like people, bonds get less active as they mature.

    But if you take only one point away from this post let it be this:

    Because of convexity, bonds have way more income potential at very low or even negative rates than most people realize.

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