From Peter Reagan at Birch Gold Group
This week, Your News to Know rounds up the latest top stories involving gold and the overall economy. Stories include: The parallel collapse of stock and bond markets reminds us of real safe havens, Jeremy Grantham and Ray Dalio dive deep into economic woes, and gold remains the primary inflation-resistant asset for an interesting reason.
Bond investors might be surprised that their safe-haven is failing, but our readers are not
The editor-in-chief of MoneyWeek, Merryn Somerset Webb, recently wrote a Financial Times editorial to gently break some news to newer (or forgetful) investors:
If you have only been knocking around in markets for, say, 15 years, you are seeing the collapse of everything that you have been told is true and have also observed to be true about markets.
The timespan she provides is an interesting one. 15 years in the investment sphere might be a cycle for someone like Ray Dalio, but for many, it might very well be the entirety of their exposure to the markets. The truth is that one doesn’t need Dalio’s tenure in the markets to, in so many words, know better. Our readers don’t need five years: just one is plenty enough to alert those who are paying attention to market reality.
She continues, outlining some of the false narratives that fueled the “Everything Bubble” for so long:
It turns out that quality growth stocks do not always outperform; that the Federal Reserve will not always step in to protect your wealth… and that the prices of the growth stocks in your portfolio have long been more a function of loose monetary policy than the priceless nature of innovative thinking.
In other words, prices matter – overpaying for overvalued assets doesn’t make them worth more, it just makes them cost more. Especially when the so-called “Fed put” is dead, with our nation’s central bankers demonstrating their willingness to stand back and watch while stocks and bonds tank together in response to their too-little-too-late attempts to deal with inflation.
Speaking of stocks and bonds:
Finally, it turns out that the idea of sticking with a long-term portfolio consisting of 60 per cent equities and 40 per cent bonds does not mean everything will always be fine.
In 2019, we placed special emphasis on bonds going into negative territory when many ignored the issue. The bond market was already in a historic crisis. The Treasury was being squeezed as the only sovereign bond offering a yield, and a historically low one, too. The Deutsche Bundesbank offered bonds at a negative interest rate (even before inflation). That means owners of German bonds were literally paying the government for the privilege of loaning the government money!
In subsequent years, we reported the growing movement away from the 60/40 portfolio model, toward one that treats gold as a necessary diversification. Large-cap money managers were coming around to this perspective – possibly, too late. So far this year, the S&P 500 is down about 17%. Shockingly, the “40” of the traditional 60/40 portfolio is down sharply as well. If we consider the iShares 10-20 Year Treasury Bond ETF (TLH) as a proxy for the bond component, 60/40 investors lost 16% so far this year on the “safe” part of their savings.
Many Americans are surprised. I’m confident regular readers of my columns are a lot less surprised.
The point of bonds in a 60/40 portfolio is to diversify away from risky equities. Unfortunately, in this case, diversifying away from equity risk has brought with it a slew of totally different risks, including:
- Interest rate risk
- Duration risk
- Default risk
- Inflation risk
How can a safe-haven perform its role when its market is in a historic crisis? We discussed this last week here, in the segment “Bonds fail to protect.” We also discussed Verdad’s research on gold’s performance in such an environment.
Our readers will also know that the consensus is that the stock market’s losses so far are not the end of the bear cycle that we’d expect to come after the longest bull market in history. That cycle, we expect, will make 18% losses look minor…
Like Verdad’s analysts last week, Webb also turns to history to discover what works during such market crises:
The only good news is that while all this feels new (and is new to most market participants) it is not actually new. Much of it mirrors the conditions of the 1970s — another time in which everything seemed to change at once. Everything is not completely the same — but there is enough that is, to be worth checking on the few things that then made people richer not poorer.
So, what are those “things that then made people richer not poorer”? Webb’s answer:
If you agree that history provides examples of similar episodes, and what worked then should work again today, this is very likely sound advice.
Bridgewater’s Dalio and GMO’s Grantham on the end of the Everything Bubble
When it comes to long-term money management experience, what more can we ask for than Bridgewater’s Ray Dalio and GMO’s Jeremy Grantham? Their in-depth conversation covered virtually all topics relevant to the economic situation and the financial implications.
The theme of an “everything bubble” is once again overarching, and it’s being mixed with several other anchors to drag individual wealth down. These include factors like Russia and China’s”soft exit” from the global commodity market, and its effects of worsening inflation and straining supplies of goods the world has become dependent on. But it also covers some not exactly new, albeit intensifying issues where ideology is clashing with growth.
Grantham highlighted how the world has grown extremely vulnerable to supply disruptions, not just of goods but of labor as well:
And that is the world we’d better get used to living in. We’re going to have a world of increasing number of bottlenecks and shortages. And the same applies to food. The UN Food Index is higher today than any time in its history over the last 50 years since it started. So, you have price pressure on raw materials, metals, food; you have price pressure long-term on labor. This surely feels like a new era in which inflation will be part of the background music just like it was in the 20th century and perhaps more so.
In other words, Grantham sees this not as a typical market cycle, but as a totally new paradigm. A “new normal,” to use the oft-abused phrase. A world in which food and raw materials permanently cost more – and inflationary pressures don’t go away regardless of the Fed’s interest rate decisions.
Both money managers are very much concerned with the debt bubble breaking and the stock market collapsing, with Dalio pointing out that stocks are now running on a 14-year long bull market. Until recently, this was propped up by historically loose monetary policies of an almost unimaginable magnitude. (This is old ground, and not an idea we’ll explore further today.)
Grantham, on the other hand, believes the coming market meltdown will fall into line historically:
We have a market today which feels superficially like 2000, and I think it’s going to play out initially like 2000. Then the deflationary effects on the economy and the stock market will result in a world rather like the 1970s, where all assets are simply much lower priced than they are today.
Dalio thinks that wealth itself may need to be redefined. That may sound radical, but in Dalio’s defense all of the world’s major sovereign nations are suffering from the same systemic problems.
Specifically, “systemic problems” are the easy-money policies that fueled the everything bubble:
…that happens by creating money and credit, which creates debt. And that dynamic means that you must have a decline in real wealth measured by that, because the financial wealth has become enormous relative to the real wealth. Everybody who’s holding bonds or assets, and particularly the debt assets, believes — or financial assets in general, which are just journal entries; they’re claims — but they believe that they can take that buying power and sell it and buy goods and services.
One extremely important point here: “Financial assets in general” are just “journal entries” or “claims” – in other words, an IOU from someone. These, in Dalio’s view, are completely different from “real wealth” which is not a claim or an IOU. Gold is pretty much the only investment that meets Dalio’s “real wealth” criteria. Dalio calls gold both an asset and a currency, and believes allocating 15% of your savings to gold has a negligible impact on returns while serving as a massive insurance policy.
Why gold? Dalio says:
Gold is the third-largest reserve currency held by central banks. And in periods of time of war or such periods of time of credibility, it is the medium — like they say, it’s the only asset that you could have that’s not somebody else’s liability. That means you have to be dependent on them giving you money or giving you something. And it is international, it can be moved, and it’s tried and true.
This is probably the best description of gold’s safe haven status I’ve ever seen.
Gold’s price doesn’t really change
In Forbes contributor John Tamny recently made a bold assertion: gold’s price doesn’t move.
What we see as fluctuations in gold’s price, well, those are simply tracking the value of the dollar. It’s not a matter of supply or demand, but rather how the currency itself is faring.
He says a major contribution to this misunderstanding of moves in gold price comes down to a fundamental misapprehension of what inflation is:
To begin, it’s useful to stress up front what’s not stressed in just about every media discussion of inflation: It’s not rising prices. There’s a major, major difference between rising prices and inflation… Inflation is a decline in the value of a currency, period. Rising prices are a consequence of inflation, or better yet, can be a consequence. But they’re not inflation itself. To presume that rising prices cause inflation is the equivalent of asserting that wet sidewalks cause rain. Causation is reversed. Stop and think about this…
Tamny’s perspective stems from bitcoin’s inability to outperform gold during the latest bout of rising inflation, despite having a more limited supply. Indeed, the two assets have been compared often over the last year or two, with bitcoin taking some heat from a lot of analysts and called “digital gold” by others.
We’d like to offer a more tempered view that falls somewhere in the middle. I think of bitcoin as both a hedge and an anti-inflation tool. The main consideration here is that it is “a” hedge and “an” anti-inflation tool. Gold, on the other hand, is both the hedge and the anti-inflation tool.
In Tamny’s words:
To be clear, gold doesn’t rise as a result of inflation; rather gold’s rise is the signal of inflation. When the dollar weakens, gold reflects this weakness. Gold’s rise IS the inflation. To understand why, it’s crucial to understand that the price of gold itself doesn’t move. Repeat the previous truth over and over again. Gold is the constant. And it’s the constant due to highly unique stock/flow characteristics such that increases in supply or demand for the yellow metal don’t move its price.
Whether one invests in bitcoin for speculative, returns-oriented reasons or even inflation-protective reasons, they are making a bet. It’ a bet similar to the ones made on stocks, and for that matter, bonds – but it’s also fundamentally different. Stocks and bonds have a track record well over a century old. As we discussed above, how stocks and bonds behave in economic situations like these are a matter of historical record. We can look it up. Bitcoin’s historical track record is much shorter, and no one knows with certainty how such a novel asset will react when economic situations change.
Take one example: 30-day volatility figures for bitcoin (65) and gold (8.45). This tells us that, over the last 30 days, bitcoin’s price has moved about 8x more than gold’s price. What does it tell us about tomorrow? Next month? Nothing. Now, if we were to take a much longer-term view, comparing rolling volatility periods over years, over different economic environments, we might begin to unearth useful information. Alas, in this particular case, we can’t.
Regardless of the amount of history an asset has, we can’t know how any asset will perform as circumstances change. We can merely guess. For assets with a long history, our guesses are more likely to be correct (or at least closer to reality).
On the other hand, those who own gold can have confidence their investment will pay off, so long as they invested for the right reasons: savings protection and risk management.
Gold’s returns can disappoint growth-minded investors. However, it’s important to keep gold’s primary purpose in mind. If you buy gold as an inflation-resistant safe haven, a reliable long-term store of wealth, you’re unlikely to be disappointed.
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