Posts tagged ‘gold’
Economically speaking there has been little drama or excitement in the UK over recent months. While markets agonized over Greece, and then China, and subsequently the Fed, the British economy quietly kept on going. There have been no growth surprises in either direction; no change to the Bank of England’s guidance or rhetoric on interest rates; no unexpected outcomes in the labour market, or price indices, or activity indicators. The PMI survey for September showed a bit of weakening in output. And Mark Carney did have some diverting things to say about topics other than monetary policy (climate change for instance). But all in all, it has been an uneventful time.
Nonetheless the UK markets are of key importance to British investors and do not always reflect goings on in the economy, to say the least. So while the economy might not invite too much scrutiny just at the moment, here is a summary of conditions across the major UK asset classes.
Starting with property, the residential market rally that took off in 2013-14 continued into this year but has abated somewhat. Government data showed a 5% increase in house prices in the twelve months to August, down from a 12% annual rate in the early autumn of last year. Valuations are mixed: the simple average earnings to average house price measure suggests the market is red hot but on this measure that has been true since 2004. Using a measure of mortgage affordability (which takes account of interest rates) the market is priced fairly: the ratio of average mortgage payments to average earnings is almost exactly in line with the average since 1976.
The commercial property market has been having a jollier time of things, with the Investment Property Databank All Property total return index up 15% over the twelve months to September. Again, the valuation picture is mixed. Rental yields have fallen sharply over the last couple of years and are about as low as they were at the peak of the late 1980s boom (though still a little way off the lows seen before the Great Recession). On the other hand, the rate of capital growth has not been as aggressive as in previous rallies and there is some distance before the market surpasses its 2007 peak.
Staying at the riskier end of the spectrum the equity market has been picking up nicely in recent days. The FTSE 100 has risen by 5% so far this month and is now 8% above the low it marked towards the end of August – though remains 10% below the record set back in April. There has been pressure on earnings from currency and commodity effects this year so the improvement in valuation since then has actually been rather muted: the forward p/e ratio has risen from 14x to 16x, which looks toppy against a ten year average of 12x. At the same time, however, the dividend yield has risen from 3.5% at the end of last year to 3.9% today (the ten year average is 3.6%).
Talking of yields, the gilt market has barely shifted from where it began the year. All the key maturities – two year, five year, ten year, thirty year – as well as the ultra longs are within 10bp of where they ended 2014. There is one exception: the ultra long end of the index-linked market has rallied, with the yield on the 0 3/8% 2068 linker down 16bp to an uncompelling -0.8% in real terms. The ten year conventional gilt yield stands at 1.8%.
Corporate bonds have similarly had a dull time of things, at least in the investment grade arena where widening spreads have seen total returns of about 0.5% according to the Bank of America Merrill Lynch family of indices. High yield has done better: spreads are about where they were at the start of 2015 so there has been relatively little capital impact on income return (the total return on the sterling high yield index stands at 4% for the year to date). In valuation terms credit spreads are much higher than they were in the years preceding the 2007 crunch but not very compelling against average levels given the scale of the collapse at that time. Using the Markit iTraxx Europe index as a benchmark the price of investment grade credit is just over 80bp today, up from a pre-crisis low of 20bp but somewhat below a ten year average of 90bp.
There is nothing much to say about cash with base rate stuck at 0.5% for the last six and a half years, though the worst performing assets of all are to be found in the commodity space. The near Brent crude oil future has rallied from the new bottom it reached in August (by some 14% in fact), but is still worth less than half what it was before the crash last year. The economic and market consensus is for very limited improvement over the coming months and with supply still materially stronger than demand there seems little reason to argue with this. There would also appear to be the will in some important quarters for oil to stay cheap: Saudi Arabia alone increased daily production by just over one million barrels during the first seven months of this year.
Precious metals have had a better time of things too lately and both gold and silver are trading very near the levels at which they began the year. Still, gold at $1183 an ounce remains expensive relative to inflation-adjusted 30 and 40 year averages of $793 and $825, even though that price is almost 40% below the $1900 reached at the peak of the bubble.
At this point we have departed from strictly British assets of course but that, at least, is all the key bases covered!
It has not been the easiest of years for UK investors and readers will have noted that this blog sees continued volatility ahead. But there are always opportunities amid uncertainty. Time will tell if we are able to find them out.
We are now comfortably over half way through 2014. After a shaky start, and despite persistent jitters, much of the year was actually quite undramatic for financial markets. For a while it looked as though asset prices were struggling to establish any direction. In some areas this has remained the case. But since the spring there have been signs of movement, and these have been mostly supportive of the pricing of risk.
Starting with assets which have prolonged their mundanity: gold, at just under $1,300 an ounce, is priced almost exactly in line with its average for the year to date. Despite some volatility over May and June it shows no sign of directional movement whatsoever. The story is the same for oil, which spiked up as news broke of the crisis in Iraq but has since fallen back again to about its average level for the year so far.
Government bonds have not been terribly exciting either, at least in general. The ten year gilt yield, for instance, has moved within a range of 2.5%-2.8% since mid-February and currently stands at 2.6%. On the other hand the ten year German bund yield hit a record low of 1.15% only this week, having tumbled from 1.94% at the end of 2013. In recent years this might be seen as a reaction to crisis fears in Europe, but this time round it would appear to have more to do with declining inflation and anticipation of the ECB’s policy response: bond spreads in the peripheral eurozone countries have, without exception, tightened over the year to date.
In fact, credit markets generally have been giving the strongest risk-on signals. High yield spreads, as measured by the Markit iTraxx Crossover index, narrowed with conviction as the year wore on. Twelve months ago they were above 4%. Now they are under 2.5% and have closed below 2.2% in the last few weeks. At that level they were almost exactly in line with the average for 2006 when the Great Recession was a mere glint in the US mortgage market’s eye. Consider also that only this month we saw a default event materialise in the banking sector of a south European country. Just imagine the effect this would have had on markets in late 2011 / early 2012. In this case spreads came off their lows but by no stretch of the imagination has there been any sign of real panic. The transformation is astounding.
Equity has found some tentative direction too. As late as mid-April, year to date returns for both the MSCI World Index of developed-world markets and the MSCI Emerging Markets Index stood at an unbeatably dull zero. But since then they have now risen to 7.3% and 9.4% respectively.
Past performance, as they so rightly say, is no guarantee of future returns. There are several “known unknowns” to contend with as the year continues. Political risk in the Middle East and Ukraine shows no sign of subsiding. Earnings growth, especially in Europe, needs to come through to support equity markets at current valuations. And the ancient phenomena of price inflation and monetary tightening could provide unsettling surprises as the quarters grind on.
While there is nothing to stop them being unwound, however, these signs of a rediscovery of market direction are cautiously encouraging. Looking forward the safest observation we might make is that the behavioural inconsistency in some asset prices should not be expected to persist indefinitely. Bears, as well as bulls, now have a little more scope to position themselves accordingly.
Yesterday came the news that the US economy grew at a 3.2% annualised pace in the fourth quarter of last year. This encouraging sign came on top of Tuesday’s Q4 GDP data for the UK, which capped off the strongest year since before the Great Recession. Yet markets hardly noticed. Perhaps it’s the freak winter weather over the Atlantic, but January has got 2014 off to a bearish start.
At the time of writing the S&P 500, the FTSE 100 and the Euro Stoxx 50 are all down by 4-5% so far this year and the Nikkei has dropped by over 8%. Ten year yields in safe haven markets are about 0.3%-0.4% lower; Greek debt has sold off. Emerging market debt is weaker, and EM equity is also off, especially in Latin America. The trade weighted yen has strengthened for the first month since August, and the dollar has risen too. Highest profile currency losers have been Argentina and a few other EM nations. Gold is up; industrial metals, down. Credit spreads are wider.
Risk, in other words, is off again.
Explanations for this sorry start vary, as ever. There is a vague consensus that emerging markets are a problem, and talk of capital flight and current account deficits. Unfortunately this doesn’t quite add up though. Turkey saw its currency lose nearly 9% of its value against the dollar by the end of last week and yes, it runs a material current account deficit – 7.2% of GDP at the last count – but it hasn’t run a surplus since 2002, so it is not clear why this measure should suddenly assume overriding relevance. For that matter, the Russian rouble has fallen by over 7% against the dollar so far this year, and yet Russia has posted a current account surplus each quarter since the crisis of 1998 (amassing some of the most substantial reserve assets in the world as it did so). Then there is the other North American dollar. Yes, Canada also has a current account deficit – but nobody seems to be talking about that in relation to the 5.5% sell off worn by the poor old loonie. In fact, coupled with more moderate weakness in the Aussie dollar, the real currency story begins to look like US dollar strength with EM specifics a bit of a side-show. Though again, that might not square with higher gold.
The half-hearted media attention given to EM is understandable. There is no news like bad news: crises shift copy. Away from emerging-land, however, there are plenty of other discrepancies which have gone unnoticed. In the UK we have had real evidence of the extent to which stronger growth is good news for sovereign debt, and with recovery on the Continent picking up, Spanish and Portuguese bonds have outperformed German bunds in this month’s rally. Ten year Portuguese debt came within a hair’s breadth of knocking through 5% today and has made new post-bailout lows. And yet Greek debt, as we have seen, has sold off – while the Athens Stock Exchange has outperformed all major markets, currently standing a little higher on the year to date.
In the US, stock market weakness has been accompanied by earnings reports which have surprised to the upside 72% of the time. As of this afternoon 250 of the member companies of the S&P 500 index have reported EPS for Q4 and have managed a +10.5% share-weighted change on the year since Q4 2012. Both of these percentages compare favourably with the picture at the end of January 2013, a month which saw the S&P rise by more than 5%.
There is more that could be said along these lines but the picture is clear – which is to say, not very clear at all, and subjected to interpretations which barely convince even at a superficial level.
What can perhaps be observed is that 2013 saw some unequivocal behaviour from asset classes and that uncertainty has reasserted itself since. We should not expect markets to move in straight lines. Sometimes this sets them against the grain of the fundamentals – and that, of course, can present opportunities.
On Wednesday, Fed Chairman Bernanke held a press conference. Making it clear that (in his phrase) the Fed would be “letting up a bit on the gas pedal” rather than hitting the brake, he announced that asset purchases conducted under the quantitative easing programme would likely start tapering off this year if the US economic recovery continued to show strength.
So far, so reasonable. QE is an emergency monetary measure designed to stimulate growth in desperate times. If the times no longer look desperate emergency measures are no longer required. Mr Bernanke’s announcement was a signal that the Fed’s view on the recovery has grown more positive. Some might describe that as good news.
Markets, however, did not see things that way. For them the story was the oncoming shrinkage of central bank stimulus. Since QE involves bond buying, bond markets sold off with the 10 year US treasury yield up about 30bp since the end of last week. Since some participants in the rather confused rush into owning gold had bought the metal out of fear that the QE programme would usher in hyperinflation and dollar collapse, gold continued its fall, closing below $1,300 an ounce for the first time in almost three years. And equity spiked lower again: the S&P 500 dropped by 2.5%, its biggest one-day fall in percentage terms since November 2011 (when Italy was thought to be on the edge of default), and losses in Europe were even worse.
Much of this behaviour is defensible in logic. But the reaction is also interesting for what it tells us about sentiment.
Back in the panic of H2 2011 the Fed got a similar bashing from markets when it announced a change to its QE programme. It wouldn’t be buying a greater quantity of bonds outright; it would simply be lengthening the maturity of the programme to move longer as well as shorter term interest rates lower. Dubbed “Operation Twist”, readers may remember that the market lurched lower – not because it didn’t like the idea but because the economic view put forward by the Fed as justification for the move was surprisingly negative.
In other words, just the opposite happened in 2011 as happened this week. Then, the market ignored the Fed’s intention to increase monetary stimulus and focused on its gloomy assessment of the economy. Now, the market is ignoring the more constructive economic view and focusing on the intention to reduce monetary stimulus.
This week’s stock market reaction has been bearish. Not as bearish as it was in September 2011: then, the fall after the Operation Twist announcement was 6%, not 2.5%. But it is bearish nonetheless. An American stock market which rallied on the back of the most consistently positive economic data period for some years has now fallen as the chairman of the central bank expressed a cautious view that this period would continue.
It is foolish to be dismissive of sentiment. Operation Twist succeeded in driving US mortgage rates to new lows, and housing market activity has picked up ever since. If bond market fears deepen and long term rates continue to go higher, some of that shine could be taken off over the next few months. But it is undeniable that fear is more rational at some times than at others.
During 2011 the US labour market was stalling, the Greek crisis brought fears of catastrophe in Europe and China was tightening monetary policy to contain an inflation problem. Today the US economic picture is so much more obviously confident as to be almost unrecognisable, the “European crisis” has not been remotely as bad as feared and the Chinese are keener to promote growth than stifle it.
Markets are equally in a much happier condition than they were two years ago. As a result, the opportunities are not quite so obvious as they were back then. But episodes like the current period of bearishness can still create them – with or without the help of press conferences from central banks.
The gold market has been interesting again recently. Following a few months’ stately decline it suddenly collapsed over the weekend, losing more than $200 per ounce in the course of two days’ trading (prices here). It has bounced a little since but remains 20% down over the past six months. Now the gradual decline could be explained by reference to dollar weakness, but the spike down suggests something else.
Reuters has some interesting comments from Singapore overnight. Asian investors are at least as hooked on gold as are some of us in the west, and generally assumed to be keener buyers at a retail level. Here’s what a gold trader had to say:
Prices have suddenly jumped but I guess it’s because gold
has broken the $1,400-level again. Technically, people are just
buying up again …
This is from the global head of commodity strategy at ANZ:
A key factor to watch will be gold (exchange-traded fund)
ETF holdings, with a stabilisation in ETF holdings and then
fresh ETF buying to restore some of the lost confidence for
longer term gold investors.
The rest of the article waxes on about declining inflationary risks in the US and putative bullion sales by European central banks. As regular readers will know, the economic arguments used to explain the price behaviour of gold have always been utterly specious. The rally has been driven by sentiment – a heady mix of panic over the world at large and greed at the prospects for the supposed opportunity presented by gold ownership in particular.
So what is interesting about the discussion and coverage now is that the focus has shifted to this way of thinking. Note that the professionals comment on technically-driven trading and investor interest. This is what is getting the attention. Wise-sounding opinions on “fiat currency”, quantitative easing and so on are being displaced by the rather less elevated analysis of the commodity market’s real drivers: supply and demand.
Gold has always been a safe haven – in a sense. (It is, after all, a costly and highly volatile one.) Should funk set in again it might well reach the $2,000 or even $10,000-an-ounce levels being predicted for it with some confidence only 18 months ago.
Meanwhile, however, it would be consistent with growing confidence for investors to lose their appetite for gold as a haven asset. Perhaps what we are seeing is a buying opportunity, as is being advocated by some. Alternatively, this could be the early popping sound of a major bubble.
As Greece flirts with economic suicide and JP Morgan loses $2bn under the carpet, it is worth revisiting the subject of safe havens – those assets that receive attention from time to time as possible ports in a storm. We last looked at this back in July 2011, covering various government bonds, currencies, commodities – and cash. Events since the summer give us the opportunity to see how safe these havens really proved.
Starting with government bonds: lots of these went up. 10 year US Treasuries yielded 2.74% at the end of July; they now yield 1.86%. The equivalent German yield has fallen from 2.45% to 1.51% and ten year gilt yields from 2.80% to 1.95%. As well as coupon income over the period, therefore, investors in these kinds of bonds would have seen capital appreciation of the order of 7-8%.
Of the major currencies, the strongest was the dollar, which has risen 6.5% since last July as measured by the Bank of England’s trade weighted index. Sterling almost managed to keep pace, rising 5.9% on the same basis, and the yen drifted a bit higher too. The Scandinavian currencies softened slightly (-0.4% to -1.8%), dollar zone rates fell by a bit more (-3.6% to -5.4%), the euro lost 5.7% and the biggest faller was the Swiss franc (-7.9%).
The major commodities for which haven status is claimed are of course precious metals. Gold shot up during the stock market crash in August, reaching a peak of over $1,900 before falling back again to $1,580 today – about 2.4% lower over the period as a whole. Silver has performed dismally, losing over a quarter of its value at the same time.
Cash of course would not have lost its value. Banks have continued to fail since July (e.g. Dexia), but there have been no losses to retail deposit holders.
It would be unwise to draw anything axiomatic from this information, but tentative lessons might include the following:
- If the banking system does not implode and one’s appetite for volatility is low, then cash is an obvious choice in a crisis. (Nonetheless, the UK Retail Price Index was 2.6% higher in March than it was eight months previously. This annualised inflation rate of 3.9% would have been impossible to match with a cash deposit rate.)
- Currency views are genuinely speculative and exchange rate movements over a length of time such as 8-9 months are completely unpredictable.
- The claims made for precious metals are exaggerated.
- The most effective hedge against panic is government bonds (though only those seen as safe).
Of course every situation is different and the next crisis is unlikely to look much like the last. Perhaps the most robust conclusion remains the one we reached in July: that caution needs to be exercised. What looks like a hedge at first can sometimes be the edge of a cliff.
To be fair, equity markets had been creeping higher all week and were already up on the day. Bonds had nudged lower. Colour was beginning to return to the markets’ cheeks. But the announcement yesterday that the ECB and the Fed (and the Bank of England, Bank of Japan and Swiss National Bank) were joining forces to prevent a squeeze on dollar funding to eurozone banks turned cautious hope into outright relief. On top of the Franco-German statement of continued support for Greece on Wednesday, it looked as though the cavalry were riding to the rescue at last.
As it happens, of course, the cavalry joined the fray a while ago. Europe’s problems – and fears for the global economy at large – have dominated the political and financial agenda for some considerable time. If the world’s traders, journalists, economists etc. can see something, so can its leaders. The banking crisis, and other major crises before it, occurred because too many people had taken their eye off the ball and believed all was well. In fact, most participants in and observers of the doomed subprime and structured credit markets thought that they and their products were the cat’s whiskers and that anyone who disagreed was an idiot.
Such is the way of booms and bubbles; such has hardly been the way with Greece and its attendant concerns.
And yet there is one corner of the financial world where unbridled optimism remains the order of the day.
According to a report out yesterday from a firm of metals analysts, gold is going to hit $2,000 an ounce this year on the back of record investor demand. “Where else do you park your money?”, asked one of its authors.
Nonsense, says a strategist at SocGen. A miserly two thousand bucks an ounce? The fair value of gold is actually over ten. (This insight was based on dividing the size of US gold reserves into a monetary aggregate. As well as the concept one could also criticise the particular aggregate used as it happens, but life is short.)
This blog has long been sceptical of gold. A hedge against a falling dollar that also went up as the greenback rose; a hedge against inflation that continued to rally as annual CPI turned negative – heads you won, tails you couldn’t lose. Even the language – “park your money” – reveals a psychology insouciant in the face of the exceptionally high volatility associated with investment in commodities. (Rather than leaving your car in a nice car park, trading metals is more like strapping it to a giant rollercoaster.)
And of course, this blog has been wrong: gold has continued to rise – and rise, nearing the $2,000-per-ounce territory it last (briefly) held in early 1980 (in today’s dollars). “Just look at the money I’ve made,” a critic of the bear view might reasonably reply. “You’re an idiot.”
Such is the way of things. But should demand wane, where will support come from? The world needs a financial system. We still need banks, and credit. That’s why the cavalry have appeared: there are some battles that have to be won.
Who needs gold?