Art, Land, or Gold

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The chief executive of the world’s largest asset management corporation made comments this week that suggested gold was passé. He said gone are the days where gold acts as the de facto store of wealth. Instead, those with excess cash flow are looking to acquire condominiums in international cities or are making a bid for contemporary art; however, gold is being viewed as nothing more than a relic of the past.

Blackrock’s CEO, Larry Fink might be regarded as one of the most sought after minds in international finance. And for a man that preaches a long term view that suggests all investors remain fully invested in the stock market, as that is the asset class that boasts positive returns over the long run, he is taking a rather myopic view on gold.

The rationale for owning precious metals like gold is simple when looking to acquire and retain wealth. Governments can confiscate land. Art is subject to fashion trends or current fads. But the allure of gold is something that has been time tested throughout history. It may go in or out of favor in the near term, and of course caries the characterization and negative stigmatization for those over focused on the asset known as “gold bugs,” but its relationship holds as a long term store of value, and a natural hedge to the world’s reserve currency.

The uptrend in the US dollar is only something that looks set to continue. To close the week the Wall Street Journal published an article that examined a world burdened with oversupply. Whether its commodity markets, laborers, or capital, there is no natural shortage in any of the aforementioned markets acting as a driver of demand. An oversupply in commodity markets is prompting selling pressure for the globe’s energy and mineral rich export countries. Youth and millennials despite advanced education struggle to make gains in competitive labour markets. And savers are essentially punished for being adverse to risk and thus are forced to accept a rate of return less than inflation.

Naturally this would create an environment where gold as a store of wealth struggles. Obviously gold is no longer the front-page asset that is garnering the excitement of investors because we are not in an environment where a level of overall risk requires increased diversification for alternative asset classes. Alternatively, the malaise of other financial markets has prompted investors (since 2009) to look elsewhere for returns and hence fears arise of bubbles in real estate and there are questionable valuations for modern art.

To digress, the luxuries of private versus public ownership in investment decisions are not made dependent on results in the next fiscal year or quarter. They are decisions that are based on the long term with only a limited number of shareholders to answer to. The same can be said for gold. Larry Fink may be right that overall market demand may be waning for the yellow metal as prices sits rather dormant. The point he is missing, or failing to comprehend is that gold has been around longer than the skyscrapers of Manhattan or the most recent piece of modern art.

To repeat: land is subject to taxes and confiscation. Modern art goes out of style. Gold is time tested and has remained coveted throughout history.

Dead Cat Bounce

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The US dollar index has fallen around 3 per cent since its high the beginning of March. This past week saw the best weekly performance for the Canadian dollar in the last four years. Obviously the two events are related as one currency’s strength is another’s weakness; moreover, the question is whether the Canadian dollar is rising on its own merits, the US dollar rally is over or taking break, or perhaps, a combination of both.

The strong rally witnessed in the Canadian dollar this past week was reaffirmed by retail sales numbers for the Canadian economy in the month of February, and core inflation jumping to 2.4 per cent annually in March. Not only do retail sales numbers suggest that the blow from an “atrocious” energy sector in the first quarter might be subdued (to borrow an adjective from Bank of Canada Governor Stephen Poloz), but also core inflation registering at the upper end of the Bank’s target decreases the likelihood of a subsequent interest rate cut. And it is both these factors that are obviously supportive of an economy that has been a far cry from inspirational.

As much as the aforementioned fundamentals can tell a story about the direction of currency markets, it’s difficult to deviate from the single most important factor in pricing the Canadian dollar over the last year, and that has unequivocally been US dollar strength. This trend has been challenged on multiple occasions over the last month, particularly this past week, which saw oil prices peak to their highest level in 2015. It was largely based of a report that production levels in the state of North Dakota (second largest producer by state in the US) had slipped from their peak. Coincidently, global oil production has risen to its highest level on record, over 1 million barrels/day more than February, and Saudi output was at its highest level in 30 years. However it was US benchmark prices for crude that led the global markets in regaining their footing.

The global supply story for oil has not changed. Especially from the standpoint that US production is not being cut back so much as active wells withholding production from the market, potentially awaiting higher prices, which could prompt a second wave of oversupply. This global commodity picture is one factor that could see the US dollar regain a second stage of selling pressure. The second is Europe.

This market is failing to get a grasp on the distortion being created from negative interest rates and how such a deflationary scenario is being created in Europe. The idea of negative interest rates ranging from lines of credits to business to 90 per cent of the mortgages in Portugal being based on a variable rate will eventually translate to real assets and their goods’ sector deflating. The Eurozone is transforming into a something from nothing economy. How growth and stability can be projected over the long term is a conundrum with interest rates where they are. If Quantitative Easing was an experiment in the US, it has become 10 times the gamble in Europe. As this risk plays out, it seems undoubtedly the US dollar will find a renewed round of strength.

The markets are setting the stage for dollar dilemma round 2. We have seen justifiable reasons for uncorrelated and negatively correlated assets rallying against the dollar, but the rationale is not convincing enough to buck the trend. An overused expression seems extremely applicable; simply put, this is a dead cat bounce.

Stuck in Purgatory

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Financial markets have been going through another wave of directionless movements as they obsess over the “will they or wont they” question as to when the US Federal Reserve will begin to raise interest rates. This uncertainty has in many instances led to range- bound volatility in a number of asset classes where we are not short of large price gyrations; however, markets like gold are caught in a defined trading range. In the instance of gold, on more than a few occasions we have seen a floor around $1,140 US per ounce to a ceiling around $1,300. It seems the days are gone where the story of record low interest rates or increasing inflation expectations will fuel gold’s next rally. As well, the lack of uncertainty stemming from likely economic outcomes and no real surprises to financial markets has seen the gold market remaining at bay.

Exceptions to this are of course the recent actions taking by the Swiss National Bank to end their peg to the Euro, but that one off event has now arguably been overlooked by financial markets and one still might wonder how well it taught a lesson to investors of the potential for a violent rebalancing in asset prices. The story has reverted back to record low interest rates from policy makers and a global economy that continues to lethargically move forward as it’s pulled along by a recovering US consumer.

The question regarding interest rates though is one that has almost become meaningless for two particular reasons. The first is that American central bankers are moving away from their forward guidance approach to financial markets. No longer do markets require reassuring of record low rates for years into the future in order to keep credit markets at ease, and provide fuel for the equity markets. Investors are beginning to take comfort in what they believe to be a domestically strengthening US economy without the life support of a liquidity backstop by the Fed. Central bankers in the US are attempting to withdraw themselves from the picture.

The second reason the interest rate discussion is becoming less relevant in the US is because the pace at which they raise rates will be of little to no impact on markets. A rate move at this point in the cycle is more of significance to providing a signal to markets that we are lifting off emergency level lows. It’s not to say, curtail reckless borrowing habits of US homebuyers or over-levered corporations.

All else being equal, considering a US Fed that begins to move interest rates in accordance with a gradually improving economy will have limited impact on financial markets. Interest rate policy will not be a determining story for asset prices like precious metals as it has in years past because the story has already been anticipated. Whether it creates more volatility when we finally see liftoff is another question as thinner trading volumes have made the gold market more vulnerable to dramatic moves; however, this steadfast trading range seems more and more likely to be tested in a to be determined scenario.