I Am A Director Of An Offshore Investment Brokerage In Tokyo. Believe Me, There Is No Better Job. This Blog Consists Of Investment Notes Sent To Clients And Random Thoughts On The Markets. Hope That You Enjoy It!!
There is a widespread fear that gold is in a bubble and that the price could crash at anytime. This could not be more wrong. Gold's rise in value has not been due to "irrational exuberance" but because the US government has chosen (rightly or wrongly) to print money to buy their way out of recession.
The Federal Reserve is printing paper backed by politician's promises. People have recognised this and in order to prepare for 'the great inflation' have bought gold in physical and paper form in order to protect their capital.
Gold is just a yellow metal. It has little industrial use. It's value is based upon it's comparative rarity and investor perception. However, to many, gold is currency. This is made evident by renewed purchasing from the the Chinese and Russian Reserve Banks. In fact more than 20% of the worlds 'above ground' gold is owned by governments.
These governments are worried. The United States is their biggest trading partner and the US government owes them trillions of dollars. Unfortunately, it is also bankrupt.
So whilst the US prints more money and coordinates its stimuli with its global governmental partners, they buy gold, as a hedge against their dollar holdings and a potential debt default.
The relative weakness of the dollar and demand from BRIC nations have kept commodity prices high. This is dangerous. When the recovery comes, there will be a global craving for oil, copper and coal etc.
So now we have a scenario where the US government is flooding the market with money in order to lubricate the cogs and gears of its economy but cheapens its currency internationally, with every note printed pushing up the dollar price of materials. Add to this an eventual commodity bull market which will have been force fed on the steroids of recovery and we have an inflationary nightmare.
This is why people buy gold.
Below is a great chart from Barry Ritholtz of 'The Big Picture' busting the myth that gold is at a high. As he correctly points out, the high is merely nominal and not inflation adjusted.
As the chart shows, the actual gold price high in real terms is over $2,300. However, that high whilst magnificent was brief. This time, I believe that gold is in a long term secular bull market that has only just begun.
Are we irrationally exuberant about the price of gold? I don't think so. A good example are Apple shares. They are up over 120% since the start of the year whereas the ETF GLD has barely made a return of 20% since January 1.
In fact since March 2008, gold can barely scratch a 2% gain!
Exuberant? No.
Confident? Yes.
Inflation will come and we'll be vested in order to benefit and profit from it.
It's been a miserable year if you are a logical thinking, market fundamentalist. This bear market rally, based not upon return or results but upon exceeding extremely low expectations has broken all records.
It's like rewarding a kid who got an 'E' rather than an 'F' in his economics exam.
My portfolios have stayed away. This rally was always like trying to ride a rattlesnake. Logic told us that it could have reared up and bitten us at any time and my job is to protect my clients assets.
You've heard this all before. No doubt, you are sick of hearing how this is not a real rally and that the sky will fall in.
It hasn't.
But it will.
Probably.
Marc Faber says that "the longer a trend has been in place, the more cautious an investor should become". He is right. If this market had been in the midst of a bull rally, people would be screaming for a correction. But it isn't. Instead we are in the middle of the worst financial crisis in 75 years and people are desperate for this rally to continue onward and upward in order to make back their losses from 2008.
I have a tip for them.
Get out.
Get out now.
Before it is too late and this market corrects radically.
To my clients I say, "good things come to those who wait".
It's a bit like the marshmallow test. A child is left alone in a room with a marshmallow and told that he can eat it. However, if he waits, he can have two. The smart kids wait. The dumb kids eat the marshmallow. The dull kids then have to watch the shiny ones eat two.
We are waiting.
We shall have two marshmallows and the stupid kids can watch us eat!
We bought a heavily discounted high yield euro denominated bond in July. We paid a premium on the price which was at approx. 45 per cent of the face value. The yield though was paid at face value and so garnered us a 17% return. The bond price is up 10% thus my clients now received a handsome 27% return. Not bad for an investment since July.
For those of you whom I have called already, my apologies for overdoing the lap of honour.
For those of you who declined...reconsider. There is tremendous value in the high yield bond market still.
I hear so many reports of unemployment being a lagging indicator. This historically is true. However those who were rendered unemployed in previous recessions tended to be unskilled or semi skilled workers. This recession is different. It has affected every strata of society. It does not discriminate.
This recession was built upon our collective avarice and debt. Sure, the banks are guilty of bundling up mortgages and slicing and dicing and reselling them over and over again. But blaming the banks is like blaming a drug pusher for our addiction.
We live in a society which allows excess without taking responsibility. We can get fat on MacDonalds and sue them for our obesity. We can get drunk on cheap alcohol and take the brewer to court. If our lives are not happy, we blame our parents. We have become a society of grasping needy children wanting whatever shiny thing it is that takes our eye without considering the consequences.
We want fame without having talent, beauty without having the looks. We wanted homes without the wherewithal to buy them and the lifestyle without the hard work or means to finance it. Now that it has all gone wrong, we are looking to apportion blame. We take no responsibility. Yet "The truth", as the poet Browning said, "lies within us".
In Asia, people look askance at Europe and the US, wondering how these massive economies could have created such chaos. How entire nations could have allowed their economies to crash head first into the hardened concrete of financial reality. It almost became a right to own a million dollar home or to have a brand new car every year and take holidays in exotic climes. As aforementioned, we are grasping, needy children who have no regard for the consequences of our actions.
This recession is different. This one matters. This is not about overvalued stocks. It is about our financial values.
A good model of a sensible western economy is France. France was comparatively unaffected by the downturn and is now officially out of recession. In France, very few people own a credit card and proportionately less own their home. Lending criteria is much tighter than in the UK or US and therefore personal debt levels are markedly lower. Additionally, the state plays a massive role, in what is a Keynesian economy. This is not to say that France (or Germany) won't go back into recession, but it does highlight how a society more sensitive to personal debt can weather the credit crunch better.
From The Economist of May 7th 2009:
The French are great savers and most have not taken out unaffordable mortgages or spent heavily on credit. Household debt as a share of GDP is less than half that in Britain or America. The prospect of nationalising banks may give Americans nightmares about turning French. In fact the French government has not yet had to rescue any big French bank from collapse, let alone nationalise one. Though there is outrage at bonus payments in firms laying off workers, bosses’ pay in France is not that extravagant, and the income gap between the top 10% and the bottom 10% is far smaller than in Britain or America.
Please excuse the awful pun, but I think for the smirking Germans and French, schadenfreude has now become deriguer.
Surely the prerogative of government is to regulate. I cannot walk down the street shooting people because it is dangerous. We legislate and create severe penalties to stop me from doing that. I understand the letter of the law and the morality behind its spirit and so I choose not to kill. However, should a group of people decide to risk the financial security of others and enrich themselves doing it, then that is OK. Should they do so and bankrupt entire nations in the act, then they may do so with impunity. It seems that sheer greed has its own moral code.
So where are we now and where are going?
What worries many in the UK and US is the level of individual debt built up by people even on minimal wages. Many lower income workers have a large mortgage on their home and substantial debt via credit cards. It is the always the unskilled and semi skilled workers who are more likely to be laid off.
Once unemployed they are more likely to be unable to pay their mortgages thus could lose their homes increasing inventory reducing the value of all property. Even those that keep their houses and their jobs are likely to be underwater and so cannot move to an area with better employment prospects. Workforce mobility is key to long term economic growth.
Below is a graph highlighting state by state as to when US properties are likely to reach their previous highs. It is from an excellent article by Barry Ritholtz of The Big Picture (click provided links accordingly).
If you are wondering what CSI stands for; it is the Case-Shiller Index which calculates data based on repeat sales of single homes.
The findings are quite shocking with some states having to wait more than 14 years to regain peak value.
The devastating effects of this crisis are multifarious. For example, those who are younger may find themselves frozen out of jobs as senior staff are forced to take later retirement because of the decimation of their pensions. Employment is a trickle down system where older workers retire creating room upstairs for the next generation of senior staff. This continues down to the very lowest trainee levels.
Thus we have high unemployment with no relief from worker retirement and less worker mobility due to mortgage indebtedness. More dangerously, we may also have a generation of unemployed youngsters with nothing to do and no prospects.
On the matter of the unemployment figure; it did drop during the summer, but now we face the prospect of winter and an official figure somewhere north of 10%. Yet all we hear from the fund managers on CNBC is talk of green shoots and confidence. It is pure propaganda. They need you to spend your hard earned savings on equities. The fact that they know that the equity indices are overbought is irrelevant. So long as you believe that the recovery is here; all is right with the world.
However, where there is a lie, truth can also be found. To create this false environment of growth and stability, trillions of dollars, pounds sterling and euros have been spent by governments around the world in order to prop up their failing economies. This 'quantative easing' (QE) is where central banks inject into the banking system massive amounts of cash to lubricate the rusting teeth of the cogs of lending. Its immediate effect is beneficial. Used well and in overwhelming tranches, it will defeat deflation. But it comes at a price. When the printing of money is out of control, a time will come when it is supported by nothing other than a politicians promise.
It used to be that money was supported by gold and that government could not spend money like a drunken sailor unless there was enough gold or taxes to support it. No longer. Federal deficits rose under Reagan, fell under Clinton and exploded under George W Bush. Unfortunately, the Republicans lacked the courage of their outspoken convictions by refusing to cut services whilst slashing taxes and fighting two major wars. Preferring to talk of freedom from big government whilst indebting themselves to China and Japan.
So here we are faced with the massive levels of personal debt that caused the credit crunch and enormous governmental debt designed to fight it. The outcome will be inflation. If a government prints more money than the value of the assets that back it, then inflation will ensue.
From the Independent 22nd July 2009:
In the UK, debt as a proportion of national income is expected to surge above the level it reached when Jim Callaghan was forced to go cap in hand to the International Monetary Fund in 1976. And as a proportion of GDP, it is shooting up to levels not seen since Britain was paying off the borrowing it incurred to fund the Second World War.
So as an investor how do you make money with a large lump sum of cash? How can your portfolio grow in 2009/10?
The interesting thing about a market like this is that your choices are so limited. Therefore you work on what you know and what is systemic. The time for imaginative portfolio management has gone for the time being. Now it is about discipline and patience.
We know that inflation is coming. We know that gold reacts well to an inflationary environment. We know that gold is up despite it presently being in a deflationary environment, an adverse condition. Therefore we can assume that if gold is up in a negative climate, that its rise will logically be greater when inflation arrives.
We also know that the Chinese government is selling the concept of buying gold to its people via TV and radio advertising. Therefore, we can ultimately expect a massive increase in the purchase of physical gold making it more scarce, thus pushing up the price. This is in conjunction with Hong Kong withdrawing its gold reserves from London to be deposited in its own vault near Chep Lap Kok airport. This weakens the London gold market and establishes Hong Kong as a regional gold hub. The Chinese government knows the value of having access to available gold reserves at a time of financial crisis.
Lets assume that the inflation comes. It will not only be gold that rises but other commodities too. These we will select according to their particular market environment at the time. However, we like CAD and AUD. These are two great commodity currencies that offer a fair amount of hedging against a falling USD.
Mining has been on a tear for the last 6 months. It (possibly more than any other sector) was traumatised by the collapse in equity prices in October/November 08. When the hedge funds began to receive record redemption requests from worried clients last year, they dissipated their positions in mining. The effect was catastrophic. Anybody who held mining stock then, experienced a massive loss.
This time may be different. Mining stock is comparatively cheap compared to a year ago. In fact year to date the gold ETF, GLD has outperformed the worlds two largest gold miners, Barrick and Freeport McMoran by 10%.
This is key because during a bull market in gold, the physical metal prices will go higher, but the gold mining shares are leveraged to the physical price. In other words, as the price of gold rises, profits from mining stocks rise more in percentage terms. Generally, over the longer term, the share prices of the major gold producers rise by a factor of two to three times more than the price of gold. Successful junior mining companies can rise by a factor of 5 to 10 times more than the price of gold. The reason for this leverage is that a rising gold price does not lead to a rising cost of production. Therefore, for companies that are already profitable, incremental revenues received from selling gold at a higher price flow straight to the bottom line. For mining companies that are not profitable, a rise in the gold price can suddenly lift them into profitability and a much higher share price.
Effectively, I am recommending a three tier approach. Tier 1 is cash and physical gold. Tier 2 is large miners and tier 3, junior miners. As aforementioned, we are also looking at other industrial metals but the worlds largest gold miners tend also to be amongst the worlds largest silver and copper miners too.
So whether by lump sum via a portfolio bond or as a fund in a savings plan the future looks very shiny for those who love gold..
The dollar looks oversold and the Yen seems to have hit a wall. We bought at ¥98.8 we'll sell now at the lower ¥91's.
It won't be too long before we are long JPY again.
Happy days.
Gold will naturally weaken as it looks for a reason to make a sustained bid to get back over $1000. That context may not be available just yet. But no mistake it shall come.
Why is it encouraging its citizens to buy gold and silver?
Why?
It is a specific investment.
The Chinese government is recommending a particular investment.
It is acting as if they were 'The Peoples Investment Broker'.
Could it be that they are confident that gold will go up, because they are about to dump the US dollar?
The effect on commodities will be cataclysmic.
A cheaper US dollar is inflationary. Oil, gas, corn (everything!) will rise in value at a rate of knots.
Whilst American manufacturing will benefit from being able to export their products at a cheaper price, the average American will find it harder to afford them because their dollar will be worth less.
There are moments in history that are tipping points. These events, whilst initially appearing inconsequential can act as the catalyst for major change.
Below is an article posted on Thursday 3rd September on www.mineweb.com. The report says that the Chinese government is advertising on TV in order to encourage its people to buy gold.
This is potentially huge. The Chinese are presently not avid buyers of gold, but could you imagine the effect on the gold price if they were?
China pushes silver and gold investment to the masses
A report suggests that the Chinese government is pushing the general public into buying gold and silver bullion, which could have a dramatic effect on the markets.
Author: Lawrence Williams Posted: Thursday , 03 Sep 2009
LONDON -
We are indebted again to Paul Mylchreest's Thunder Road Report for news that will bring big smiles to gold and silver investors everywhere. Apparently China is pushing the idea of buying gold and silver for investment purposes to the general population in the way that Western television sells soap powder. If 1.3 billion Chinese citizens start buying gold and silver, even in tiny quantities, imagine what that will do to the market!
The report notes that China's Central Television, the main state-owned television company, has run a news programme letting the public know how easy it is to buy precious metals as an investment. On silver investment the announcer is quoted as saying " China has introduced its first ever investment opportunity for silver bullion. The bars are available in 500g, 1kg, 2kg and 5kg with a purity of 99.9%. Figures show that gold was fifty times more expensive than silver in 2007, but now that figure has reached over seventy times. Analysts say that silver has been undervalued in recent years. They add that the metal is the right investment for individual investors and could be a good way to cash in."
What appears to have happened in China is a total relaxation of strictures on holding precious metals by the individual with the government pushing gold and silver as an investment option, seemingly at every opportunity. This is a far cry from the situation only a few years ago where the distribution of gold and silver was strictly controlled. Now, the Thunder Road Report notes that every bank will sell gold and silver bullion bars in four different sizes to individuals and gold related investments are said to be soaring in popularity.
Around a year ago, Leyshon Resources managing director, Paul Atherley, in an investor presentation in London - and no doubt delivered elsewhere in the world too - commented that some employees at the company's gold mining project in northern China would, on pay day, go to the local bank and buy a small gold bar as an investment and wealth protector. To an extent we put this down at the time to mining company hype - but this seems to be exactly the same phenomenon noted by Thunder Road. The Chinese are being converted from being the lowest per capita gold consumers in the world to a nation of small precious metals investors. Now, by next year, Chinese consumption of gold is likely to exceed that of India, which has been for years the world's biggest gold market. And one suspects that the potential for gold purchasing by individuals is only in its earliest stages. As more and more Chinese move into the cities and individual wealth grows, this trend is only likely to accelerate.
Paul ends the piece on Chinese gold and silver potential with the following comment: "Simply put, the Chinese government is trying to trigger a national gold craze...and it's working. The Chinese public now has gold trading platforms on steroids.... ...Also, for the first time in history, Chinese investors can even trade gold abroad (in London) with the swipe of a ‘Lucky Gold' card. I can't even get Bank of America to open a foreign currency account."
This may be an overstatement of the case from a precious metals bull - or it may not! Certainly if China is indeed pushing the public to buy gold then there may well be a hidden agenda here. It's unlikely they are doing it and will suddenly pull the rug out from under millions of investors. A cynic (or a raging gold bull) would suggest that this will precede a move to switch a good proportion of the country's reserves into gold which would have a huge effect on the global gold price and could prove disastrous for the dollar. Maybe it's not in China's interests to drive the dollar down too much until it has managed to divest itself of the huge dollar overhang (see the article on Chinese Sovereign Wealth Funds we published yesterday - Chinese sovereign wealth fund dumping dollars for strategic investments like gold ). The country may well already be, of course, surreptitiously building its gold reserves without reporting the build-up.
If the Chinese are indeed beginning to buy gold and silver as the quoted report suggests then this has to be a strong signal that prices are going to rise, and perhaps rise dramatically, in the relatively near future. We await comment from other China watchers for confirmation of the gold and silver buying spree, but with global gold production at best flat and probably in decline, even a small increase in Chinese buying could have a substantial impact on gold and silver prices.
Arguably, the worlds most powerful fund manager, when Bill Gross of PIMCO (click to link to their site) talks people listen. This month he looks at future market growth using golf as an allegory.
Investment Outlook
Bill Gross | September 2009
On the “Course” to a New Normal
Analyzing why people play golf is like exploring the intricacies of string theory – there are so many permutations lacking scientific observation that physicists or golfers can pretty darn well say anything they like and the explanation might stick. When it comes to whacking that little white ball, the possibilities are nearly endless: People play to relax, to be with friends, to get close to Mother Nature, to enhance business connections, to compete and excel. Gosh, I don’t know, the Zen explanation for why we play golf could even resemble the old saw about climbing a mountain: People golf because it’s there. Whatever the reason, it is the most frustrating, damnable game ever conceived – alternately elevating and depressing you within the span of mere minutes. I love golf. No, I hate it.
Personally, the reason that golf draws me to its intricate web of psychological entrapment is epitomized by a simple six-inch trophy: a chartreuse ball resting on top of its ebony base, preening on a bookshelf in the family room at our desert home. Its inscription reads, “Hole in one, March 15th, 1990, 14th hole Desert Course, 155 yards.” Well and good, I suppose – the ace of my life – except it wasn’t. It was the ace of my wife. Above the inscription rests the name Sue – not Bill – Gross. It was a great shot but it wasn’t my shot, and I guess therein lies the explanation for why I continue to tee it up.
Actually, two years ago I did tee it up in the sweltering 105° June heat of the Palm Springs desert. No one, of course, was crazy enough to be with me including my “ace” role model wife who was sipping a cool lemonade in the comfort of our air-conditioned home. Now, there is an “unwritten” rule in golf that in order to be official, a hole-in-one has to be witnessed, and that you have to play a full 18 holes. Otherwise, I suppose, you could stand on the tee with a bucket of balls and hit hundreds or thousands until one of the little guys went in – whatever. The fact is, on this particular day, I was playing only one ball, but I was alone, and – good God! – it went in! The trophy with ebony base and spanking white Titleist ball would read: “Hole in one, June 7th, 2007, 17th hole, Mountain Course, 139 yards.” Or was it? Does a falling tree make a sound in the middle of a forest if no one’s there? Is a hole-in-one a hole-in-one if no one else saw it? I say emphatically – yes! That damn ball went in and later that day Sue agreed with me (although she had a funny look in her eye – especially since she didn’t know a thing about the rules of golf). No one else though. No one else agrees with me. Not a soul. I suspect they’re jealous and, in fact, I’ve seen a few of them hitting buckets of balls at dusk from that very same tee when they think nobody’s looking. I’m watching, though, which brings up a funny question. If they sunk one, would theirs be a hole-in-one because I was a witness? Like I said – a damnable game.
“Is a hole-in-one a hole-in-one” may not strike you as the most critical question of the hour, and I would readily agree. “Will we have a New Normal global economy (and investment market)?” would probably usurp it on even Tiger Woods’s top ten list. This “new” vs. “old” normal dichotomy was perhaps best contrasted by Barton Biggs, as I heard him on Bloomberg Radio in early 2009, when he said he was a “child of the bull market.” I thought that was a brilliant phrase, and Barton is a brilliant phrase-maker. He went on to say though, that his point was that for as long as he’s been in the business – and that’s a long time – it has paid to buy the dips, because markets, economies, profits, and assets always rebounded and went to higher levels. That is not only the way that he learned it, but that is the way, basically, that capitalism is supposed to work. Economies grow, profits grow, just like children do. I think that’s why he said he was a child of the bull market, not just because he had experienced it for so long, but also because economic growth and higher asset prices are almost invariably a natural evolution, much like the maturation of a person. That’s how people grow, and so I think Barton was saying that capitalism just grows that way too.
Well, the surprise is that there’s been a significant break in that growth pattern, because of delevering, deglobalization, and reregulation. All of those three in combination, to us at PIMCO, means that if you are a child of the bull market, it’s time to grow up and become a chastened adult; it’s time to recognize that things have changed and that they will continue to change for the next – yes, the next 10 years and maybe even the next 20 years. We are heading into what we call the New Normal, which is a period of time in which economies grow very slowly as opposed to growing like weeds, the way children do; in which profits are relatively static; in which the government plays a significant role in terms of deficits and reregulation and control of the economy; in which the consumer stops shopping until he drops and begins, as they do in Japan (to be a little ghoulish), starts saving to the grave.
This focus on the DDRs – delevering, deglobalization, and reregulation – may be conceptually understandable, but nevertheless still a little hard to get one’s arms around. Why would they necessarily lead to a new, slower growth normal? A little easier to grasp might be the following approach, which feeds off the same concept, but which extends it a little further by suggesting that DD and R lead to a number of broken business or economic models that may forever change the world we once knew and make even Barton Biggs a chastened adult. They are as follows:
American-style capitalism and the making of paper instead of things. Inherent in the “great moderation” of the past 25 years was the acceptance of a sort of reverse mercantilism. America would consume, then print paper assets and debt in order to pay for it. Developing (and many developed) countries would make things, and accept America’s securities in return. This game is over, and unless developing countries (China, Brazil) step up and generate a consumer ethic of their own, the world will grow at a slower pace.
Private vs. public-driven growth. The invisible hand of free enterprise is being replaced by the visible fist of government, a temporarily necessary, but (if permanent) damnable condition itself in terms of future growth and profits. The once successful “shadow banking system” is being regulated and delevered. Perhaps a fabled “110-pound weakling” may be an exaggeration of where our financial system is headed, but rest assured it will not be looking like Charles Atlas anytime soon. Prepare to have sand kicked in your face, if you believe you are a “child of the bull market!”
Global economic leadership. It’s premature to award the 21st century to the Chinese as opposed to the United States, but if the last six months have been any example, China is sort of lookin’ like Muhammad Ali standing over Sonny Liston in 1964 yelling, “Get up, you big ugly bear!” Not only has China spent three times the amount of money (relative to GDP) to revive its economy, but it has managed to grow at a “near normal” 8% pace vs. our “big R” recessionary numbers. Its equity market, while volatile and lightly regulated, has almost doubled in twelve months, making ours look like that ugly bear instead of a raging bull.
United States housing and employment. Old normal housing models in the U.S. encouraged home ownership, eventually peaking at 69% of households as shown in Chart 1. Subsidized and tax-deductible mortgage interest rates as well as a “see no evil – speak no evil” regulatory response to government Agencies FNMA and FHLMC promoted a long-term housing boom and now a significant housing bust. Housing cannot lead us out of this big R recession no matter what the recent Case-Shiller home price numbers may suggest. The model has been broken if only because homeownership is declining, not rising, sinking to perhaps a New Normal level of 65% as opposed to 69% of American households.
Similarly, the financialization of assets via the shadow banking system led to an American era of consumerism because debt was available, interest rates were low, and the livin’ became easy. Savings rates plunged from 10% to -1%, as many (if not most) assumed there was no reason to save – the second mortgage would pay for everything. Now things have perhaps irreversibly changed. Savings rates are headed up, consumer spending growth rates moving down. Get ready for the New Normal.
I could go on, reintroducing the negatives of an aging boomer society not just in the U.S., but worldwide. Increased health care may be GDP positive, but it’s only a plus from a “broken window” point of view. Far better to have a younger, healthier society than to spend trillions fixing up an aging, increasingly overweight and diabetic one. Same thing goes for energy. Far easier and more profitable to pump oil out of the Yates Field in Texas or even Prudhoe Bay than to spend trillions on a new “green” society. Our world, and the world’s world, is changing significantly, leading to slower growth accompanied by a redefined public/private partnership.
The investment implications of this New Normal evolution cannot easily be modeled econometrically, quantitatively, or statistically. The applicable word in New Normal is, of course, “new.” The successful investor during this transition will be one with common sense and importantly the powers of intuition, observation, and the willingness to accept uncertain outcomes. As of now, PIMCO observes that the highest probabilities favor the following strategic conclusions:
Global policy rates will remain low for extended periods of time.
The extent and duration of quantitative easing, term financing and fiscal stimulation efforts are keys to future investment returns across a multitude of asset categories, both domestically and globally.
Investors should continue to anticipate and, if necessary, shake hands with government policies, utilizing leverage and/or guarantees to their benefit.
Asia and Asian-connected economies (Australia, Brazil) will dominate future global growth.
The dollar is vulnerable on a long-term basis.
Like playing in an Open Championship, future golfers/investors need to play conservatively and avoid critical mistakes. An “even par” scorecard (plus some hard earned alpha) may be enough to hoist the trophy in a New Normal world. Holes-in-one? Maybe if you’re lucky. But make sure someone’s watching, and that their eyes are focused on the New Normal. As for golf, even Sue, my only supporter, has asked me to move my ball, on its own ebony base, away from her more authentic and perhaps the still solitary ace made by Gross family golfers. What a damnable condition.
It is the question that I get asked the most: “What is the better investment, the ETF or the mutual fund?” There is no easy answer, so lets look at the differences.
Mutual funds begin with buckets of cash and a (hopefully) top-notch investment team. The fund is then marketed by salesmen to the public. The fund manager is more often than not, a stock picker with a particular brief. The quality of the fund manager determines the success or otherwise of the mutual fund.
ETFs work almost in reverse. They begin with an idea -- tracking an index -- and are born of stocks instead of money.
What does that mean? Major investing institutions like Barclays or the Deutsche Bank control billions of shares. To create an ETF, they simply transfer a few million of them, putting together a basket of stocks to represent the appropriate index, say, the Nasdaq composite or the Shanghai Stock Exchange.
They deposit the shares with a holder and receive a number of creation units in return. Creation units are the building blocks of an ETF. One creative share represents each individual stock within that ETF. Dependent upon the ETF and the weighting of the index, there could be 50,000 shares within a creative unit. The creation units are then split into individual shares for public consumption.
So, then what are the differences?
There are many, but rather than being fundamental, they tend to be nuanced.
For example, a mutual fund often has a minimum subscription of $50,000 or more. This is not the case with ETF’s, which have no minimum whatsoever.
As a mutual fund becomes more successful, more shares are purchased. In an open-ended mutual fund, additional shares do not dilute the net asset value (NAV) nor should they radically affect the value of the underlying assets.
A disadvantage of an ETF in an illiquid index (such as some soft commodity markets) is that the ETF can fundamentally change the price of the asset rather than reflect it. This has led to price fluctuations in markets such as corn and even oil. Many hedge fund managers favour the ETF because of its inherent flexibility.
But no investment is perfectly structured. Imagine, that you own a lump sum portfolio and it’s 10am in New York and the markets are tanking. The S&P 500 is 3% down and looking as if it has further to fall. You call me and ask me to sell immediately. I then immediately fax a sell instruction to the portfolio bond provider and the ETF is sold within the next few minutes. I can also take advantage of the declining market by buying short ETF’s.
Another client with another Tokyo brokerage owns mutual funds. He too, is spooked by a market down 3% and calls his broker who accordingly, faxes the provider who places the sell order. If the client is lucky (very lucky), the mutual fund will be sold at the end of the working day. Far more likely, it’ll be the end of the week or month or quarter with potentially horrendous damage to repair.
The ETF has also been bought and sold at a very low cost (less than 0.15%) whereas some mutual funds from boutique managers (usually fund of funds) can have redemption penalties of 5% or even more.
However, the story is not completely one sided. Whilst there are benefits to ETF’s with lump sums, there are also benefits to mutual funds with savings plans, particularly with regard to dollar cost averaging.
Dollar cost averaging demands that comparatively small amounts of money are invested on a regular basis into an investment. Here the mutual fund has an advantage. Because we are averaging, we are not going to sell should the NAV of the fund drop. In fact we initially encourage losses in order to build up additional units bought at discount. Additionally, because the mutual fund also holds cash, its position is slightly more defensive.
The ETF however, has a zero cash position and much higher expenses (brokerage fees etc) particularly if you buy very small amounts on a regular basis. Conversely, the costs of investing in a managed mutual fund based within a monthly contribution offshore savings plan with a major institution are comparatively low. Offshore mutual funds within a formal savings plan often have no bid/offer spread and they have unlimited switching.
So the answer to the question of “what is the better investment, ETF’s or managed funds?” is not simple. I generally prefer ETF’s for lump sum portfolios unless I come across something very special from a fund manager. However, within a monthly savings plan the managed mutual fund concept works very well indeed.
In my opinion, both of these popular investment vehicles have a viable future. The ETF industry will continue to grow at leaps and bounds, but there will always be a place for investments managed by people.
The chart above which takes into account inflation in order to plot 'real' returns is quite shocking. It seems that this financial crisis has been retracing the 1929-1949 bear market very closely indeed.
The run up from March 9th until now is almost unprecedented & the gains have been astronomic. Unfortunately, the rally has been built upon low expectations and cheap prices. But those expectations are now higher and the stocks are no longer cheap. These markets now have to justify their values and thats proving harder to do.
The rally is becoming unsustainable and is fast running out of breath. Volumes have been dropping gradually since March and rallies need to be fed.
The correction is coming and for my portfolio clients it will be an opportunity. They are cash rich and equity poor.
We expect all bond prices and commodity ETF's to drop in lockstep with equities and these will be our focus.
All savings plans less than a year old will dollar cost average, those with a considerable capital sum attached will be moved to a dominant cash position with possibly a small percentage switched to the CAAM Volatility World Equity Fund .
The question is this:
For those of you who are not my clients, I ask what are you doing to protect yourself from the gathering storm? More importantly, what is your financial adviser doing to preserve your wealth?
The next few weeks could be key. For many advisers who missed last years crash to your cost, it is a second chance. Should they miss the opportunity again, then you must surely reconsider your options.
The more things change, the more they stay the same. Below is a daily summary of the Wall Street Journal from 1930. They talk of a bull market and a summer rally as well as credit expansion by the Fed. It is shocking to read in light of what is happening now. The past truly is prologue.
Bulls encouraged by resistance to repeated bear efforts Saturday and Monday following explosive rise Friday; buying movement spread broadly across the market early. Major industrials strong including US Steel, GE, Westinghouse, as were major utilities and rails (Consol. Gas, New York Central). Steel news caused some irregularity, but good buying appeared on setbacks. Bond market firm; corp. and preferreds up; govts. steady; Dow 40 bond average at new yearly high of 96.61.
E. Johnson, former Pres. Victor Co. (merged with RCA), returns from trip to survey conditions in Europe; feels general US business recovery under way, will be comparatively rapid up to a certain point; thinks stock prices somewhere near bottom.
Conservative observers even more cautious than usual; believe recent rally due to oversold condition, and decline will resume when short-covering ends.
Some market students encouraged by repeated support above June lows, advise buying leading stocks if they again approach these levels.
J.H. Oliphant & Co. finds Dow action this summer technically interesting; 6 times since June, market has found strong support after declining to 215-218 level.
Bears reportedly less confident after last week's action, though short interest remains large. Public participation still seen small.
Increase in credit outstanding in first half was interpreted bullishly, but has stopped since mid-June. “This may mean that stimulus to business in the form of credit expansion induced by Federal Reserve policy has reached its effective limits ... ”
Economic news and individual company reports:
US rail freight loadings for week ended Aug. 9 were 904,157 cars, down 14,178 from previous week and 187,966 from 1929; worst decline yet vs. 1929.
Steel production industry-wide was at 54.5% last week vs. 56% previous week and 58% two weeks ago; US Steel at 62% vs. about 62.75% previous week and 64% two weeks ago. Decline was unexpected; some improvement had been rumored.
Oil curtailment still working: Gasoline in storage at refineries Aug. 16 was 41.252M barrels, down 1.477M in past week; refineries operated at 72.6%, up from 69.1%; crude oil production was 2.464M barrels/day, down 16,800 from previous week and 478,000 from 1929.
Public utility earnings generally higher year over year in each month, though declining month by month this year. June net earnings of 95 utilities were $83M vs. $79M in 1929, but lowest of year so far and down from high of $92M in Jan.
NY City budget for 1931 expected over $600M vs. $569.8M this year.
The stock and equity fund investor is always going to be vulnerable to losses during recessions. There are so many factors that can make a single stock or an entire market fall; whether it be disappointing earnings, declining profits, increasing losses or more general financial unhealthiness such as a fall in national GDP or even a perception of weakness.
Investing into a single stock or equity fund is a declaration of faith. It is an affirmation of a belief that the share or unit will be worth more when sold than when bought. To achieve that aim, all the positive financial ducks need to be in a row. Perception has to be ready to strengthen and that sentiment has to be translated into the physical purchase of goods and services. Moreover, those goods and services need to be sold at a healthy margin.
Only then can our equity funds show profit.
Unfortunately we are having to constantly battle a 7 year cycle of boom bust. For example:
2008: Global Financial Crisis
2001: Global Recession
1994: Mexican Peso Crisis
1987: Black Monday
1980: Global Recession
1973: Oil Crisis
1966: Global Recession
Investment can be hazardous (to say the least) for the average punter. However, those of you who invested with me were out of the equity markets in August 2008. We preserved capital and kept our powder dry.
The issue that we face now, is what to do with that saved money? We have bought some high yield bonds and will look (when appropriate) to buy more (probably tier 2+) in the future. We will buy these assets because they offer real value at discounted prices.
Last week I met with two senior executives of Friends Provident International. They told me of a new fund that they are launching with Credit Agricole which invests in the volatility created within the S&P 500, DJ Eurostoxx 50 and the Nikkei. Weightings are 50%, 30% and 20% respectively.
The basic principle is simple:
When volatility is high, they are short and when volatility is low, they go long. The results have been stunning. In 2008, the CAAM Volatility World Equities fund returned 26.84%. 2009 has also been positive YTD.
It is daily traded and marked to market with daily pricing and redemption and has an institutional class. It is available via the Reserve portfolio bond and as a mirror fund in Premier and Premier Ultra.
This fund is not designed to be a core profit driver but as a satellite holding with a 10% position.
Below is its chart since actual inception (please click to enlarge to full size):
I think that we can all agree that the recovery will be volatile. Happy days are not quite here again and it will be a bumpy road until we get there. This fund is designed to smooth those bumps and ensure that you get there wealthier and in comfort.
