Gold has been an absolute portfolio star this year. It’s ridden the markets rising fears on sovereign debt, inflation and political incompetency. What will drive it back down? It seems unlikely fears will lessen, especially if predictions of rising instability and stagflation prove founded.
Gold. The Yellow Metal. It’s been a rather good investment… up nearly 40% this year. But I am getting antsy. My largest PA position is Gold. It might not pay interest, but its “appreciation” has worked rather well as a hedge to the perceived risks of rising inflationary expectations, huge national debt loads, and the competency of governments to manage their solvency. Gold has made off like a bandit on the back of these mounting concerns, demonstrating its traditional role as the crisis-flight-event, safe-haven.
The Price of Gold is directly correlated to fear. The rally in Gold is a clear sign of something rotten in the global economy. And that something would appear to be debt. (Spoiler – Rule No 1 of a good mystery thriller: Make the audience think debt is the killer, to deflect and distract from the real murderer!)
The time to worry about the longevity of any long-term trade – like my gold position – is when everyone else starts commenting on it. The trick of successful trading is anticipating what the market is going to think, reading the markets fears and panic. Presently I’m highly confident in my Gold Position because the dominant fears driving markets is growing panic that global government debt is increasingly unstainable, interest rate payments are crowding out spending, and the fear policy mistakes will lead to an “inevitable” debt cataclysm. The market “commentariat” is running out of ink as it warns of multiple approaching debt crises along these themes.
But, the art of good investment is understanding the outlook.
I’ve spent a whole career in bonds. I will always consider myself to be in learner mode – but I’m pretty sure much of the current debt fears are overblown. I suspect much of it is being deliberately fanned for political reasons, attempts to paint political foes as incompetent is generating exactly the kind of fear and panic that does destabilise governments and trigger financial crises. You can read all about in in the wonderous tales of “The imminent collapse of Fiat Money”, “Buy Bitcoin as the better than Gold safe haven”, “Economy Drowning in Interest Rate Payments” articles that now fill Linked-In. Anything in the Torygraph on debt is now written to scare the horses. There was a time you had to read Zerohedge to find such sensationalist, incoherent financial mumbo-jumbo online.
The bottom line is much of the generated fear on the global bond markets is probably overplayed. But there is no point in trying to shout “Don’t Panic” to a terrified crowd already running for the lifeboats.
There may be some respite. Next week the Fed will cut interest rates, and we are likely to see a massive rally in the short-end of the US yield curve. The economic data increasingly suggests its “safe” for the Fed to ease. However, I suspect the yields on the long-end and the ‘belly of the curve” (5-15 years) will remain stubbornly high, reflecting lingering doubts on inflation and stagflation. That will have consequences in the White House.
There is a reason strong economies “own” their own currencies. It gives them financial sovereignty, and financially sovereign nations don’t go bust. They can always pay their debts. They can do so by printing more money. That has consequences – usually inflationary, and upon the value of its sovereign currency. A tumbling currency simply magnifies inflation, and too low interest rates will cause the currency to tumble. Its complex, but a broadly competent government (actually, the professionals in its treasury) will ensure its’ kept functional. (Crypto proponents will use exactly the same argument I’ve presented above to justify non-Fiat alternatives – arguing Governments exploit Fiat to control the economy.)
The countries that do go bust, go bust because they’ve made the mistake of borrowing in someone else’s currency. For instance, perennial defaulter Argentina historically borrowed dollars but then found their peso could not buy enough dollars to repay the dollar bond without printing more pesos, causing the peso to further collapse, triggering massive inflation. Borrow, Devalue the Currency, Crisis. Repeat.
Borrowing in someone else’s currency is a problem for France – especially after the loss of another prime minister last night. It does not control the printing press for the Euro. That’s a committee within the ECB that’s politically constrained from paying the French Republics’ welfare bills with taxes paid by other EU members. The risks of a damaging bust-up within the ECB will be politically managed, but everyone is aware the Euro is a politically constructed monetary union, unbacked by anything but notional fiscal union. The solution will be some kind of fudged concocted deal to ensure France stays solvent, doesn’t destabilise the union, doesn’t go bust, but makes all kinds of commitments to scale back spending within European rules. Its messy. (I predict it will get messy, but at some point, French bonds are going to get very cheap – and that’s the point to buy!)
The UK is in a wholly different proposition. The Labour government is desperately trying to demonstrate its credentials to the bond market as a disciplined borrower by sticking rigidly to its rules about balanced budgets and the holy writ of the Office for Budget Responsibility. It resorted to the rhetoric of traditional conservative “austerity” to stem spending, but misjudged its own members. Now we have a political party in crisis as backbenchers refuse to support cuts, and the front bench are left like rabbits caught in the headlights, trapped in their own promises.
The alternative would have been much better. Before the last election Rachel Reeves was urged to engage with markets. Has she done so successfully she could have laid out plans to re-jig the UK economy with costed spending plans on infrastructure, increased defence spending, and a promise of a Royal Commission to completely overhaul and manage the costs of the NHS (before it consumes the whole economy.) A well-presented, considered plan could have met with Gilt Investors approval – allowing the Chancellor to slow tax-rises and create multiplier effects from spending in the economy. Didn’t happen, and now the UK finds itself under attack for the perceived weakness of higher 30-year rates.
But it’s the US where I am getting most concerned. Reading some of the ramblings emanating from out of the White House, like Scott Bessent’s recent rant in the WSJ – The Fed’s “Gain of Function” Monetary Policy, fill me with dread.
Bessent wants to fund US Government Spending though StableCoin funding. Oh, to own a stablecoin – that’s the way to get rich, as someone explained to Donald Trump. Tether is making enormous profits by holding US Treasuries to back its stable coin. It sells them for a dollar to folk who want to transact anonymously and keeps the 4.5% interest rate the bonds generate. And what possible risks are there to Tether? None at all – all these rumours about them not being worth a dollar in a liquidity crash, or that they are being levered – tush and nonsense… dear boy.. nothing to worry about. A dollar is a dollar – what is a tether? (What happens when the Stablecon market funds the whole US Treasury market, and the President sets the coupon on bonds at 0%?)
The reality facing the US debt market is potentially highly disruptive. At present the US government is funded by the strength of the Treasury Market. That’s based on the idea T-Bonds are as safe as gold. The strength of the US economy and its role as Global Hegemon ensured it.
That is no longer as true. Perceptions of the Treasury market are vulnerable to sentiment and facts. Sentiment towards the US is changing – and changing fast. The factual reality is also under threat – for decades every single commodity transaction was done in dollars. Profits went into banks who invested these dollars into US bonds. Now global trade is increasingly multi-lateral and denominated in other funds. That’s cutting the demand for Treasuries.
And then we have a President who demands interest rates are lower. We know how that is likely to happen – the Fed will cut rates next week. But Long-End US treasuries, even the benchmark 10-year, will stay high. The Trump-run Fed will then be told to exercise yield-curve-control, buying long bonds to pull down yields – effectively printing money to do so. The result will a repeat of the QE years – which generated the massive inflation in financial assets that Bessent referenced in his WSJ article – but also further weakness in the US dollar unless every other central bank is making similar coordinated attempts to remount QE.
Bearing in mind my key market mantra No 2: “Things are never as bad as we fear, but seldom as good as we hope”, I do think weakness in bond markets is being overplayed – but it cannot be ignored. When that pressure eases, gold will likely come off a little. The real killer probably lurks in the corporate space. (I’ve sold all my Tech positions (except my Tesla shorts) some time ago. I’m now pretty much flat US equity, with just a few specialist investments, European defence stocks, and some China positions on the book.)
For the time being I remain in Gold – and I’m going to keep it running for now.
Out of time and back to the day job… which involves catching a train to London with my Brompton Folding Bike under my arm….
By Bill Blain
Source: The Morning Porridge