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60-40 Portfolio a Wealth Hazard

02 October 2020

Precious Metals Commentary

After zigging last week the metals zagged this week. Gold dropped 4.6% last week but is up 2.4% as we write. While it hasn’t made up all the ground lost, it has poked its head a few times above the psychological $1,900 level.
gold price chart
ABC Bullion’s Nick Frappell says that gold was mostly likely rising in part on the prospect of no agreement on US stimulus measures. While the Democrats have just passed a US$2.20 trillion stimulus bill without bi-partisan support it will be swiftly rejected in the Republican controlled Congress.

The US Dollar has recently been a significant (inverse) factor affecting gold and with US personal income falling as jobless benefits expire, the resulting reduction in consumer imports is slightly Dollar positive.

Nick sees gold supported at $1,884 with resistance levels at $1,921, $1,928 and $1,944.

Silver also staged a recovery this week, up 4.2%, following a dramatic 14.5% fall last week. Silver remains short-term bearish and as a result the gold:silver ratio has moved from 72 back up to 80.
gold silver ratio chart
Nick has downside (as in silver outperforming) targets for the gold:silver ratio of 76, 75 and 71 with some possibility of it moving to 83. Resistance for silver will come in at $24.40 and then $25.77.

US bank Wells Fargo said they were buyers of gold on its correction, which they said was partly due to froth and partly due to the US Dollar, and are still forecasting $2,200 to $2,300 by the end of next year.

Three more came out this week in support of gold. First was Frank Giustra who said that the gold price is headed much higher than its record of $2,075 an ounce as when the trillions of dollars sitting in bonds panic, it will go into gold and other hard assets.

Thomas Kaplan, chairman of NovaGold, said that "gold will be the greatest generational trade" with its next leg up bring the price between $3,000 to $5,000 an ounce as it “remains on Wall Street and in the west probably the most under-owned, least crowded trade in the global financial markets”.

As those two billionaires (or should that be bullionaire) have mining backgrounds one may dismiss them as talking their book but investor Leon Cooperman said in a recent interview that he bought gold for the first time in his life a week ago as he thinks “we’re on the way to some banana republic situation. Nobody’s worrying about the debt that’s being created”.

60-40 Portfolio a Wealth Hazard

The classic, and simple, portfolio strategy of 60% equity and 40% fixed income was built on the idea that those two assets counterbalance each other, providing stability across different economic environments.

However Chad Padowitz, from Melbourne based Talaria Asset Management, argues that investors following this strategy will face a reckoning as it “is now not up to the job” for three main reasons:
  1. Low interest rates mean income from the bonds component is under pressure
  2. Bond prices cannot be relied upon to rise during economic distress as there is little room for interest rates to fall further (falling rates increase bond prices)
  3. The threat of inflation means bonds could lose value in real terms
As a result, Chad says that for the first time in many decades “bonds and equities could fall together with both sides of the 60/40 portfolio losing money”.

Nicolas Rabener from UK research firm FactorResearch, agrees, saying that “bonds have become much less useful in asset allocation”.

His outlook for stocks isn’t good either. Replicating the work done by the Federal Reserve Bank of San Francisco on how the retirement of Baby Boomers will provide a headwind for US equities, Nicolas notes that the “valuation of US stocks between 1950 and 2020 was largely driven by population changes”.

The chart below demonstrates this by comparing the price-to-earnings ratio to the ratio of 40 to 49 year olds (who would be buying stocks) to those aged 60 to 69 years (who would be selling stocks).
price to earning ratio versus middle to old age ratio chart
Currently the price-to-earnings ratio is out of alignment with the middle-to-old age ratio, implying that it will fall (lowering stock returns) and then stay low for many decades in the future.

Nicolas’ analysis is not just bad news for stocks. He says that an aging population means a more stagnant economy so says that investors should be selling any asset that relies on economic growth, such as bonds, real estate, and private equity.

He suggests that investors should seek out assets that are “truly uncorrelated to traditional asset classes or, even better, benefit from increased economic and financial volatility”.

UK portfolio manager Nutmeg has also noted that bonds are at extreme levels historically and have recently added gold to a number of their portfolios, replacing some of their treasury inflation protected bonds.

They see gold as a treasury inflation protected bond on steroids as it has bond-like characteristics, is a hedge against inflation and “can play its role as systemic hedge if there are structural interruption to markets via geopolitical crisis”.
 
Until next time,

Bron Suchecki
ABC Bullion
 
If you have any questions or feedback about this week’s report, we would love to hear from you. You can contact Bron Suchecki (@bronsuchecki) directly on Twitter, otherwise please feel free to send us an email at comms@abcbullion.com.au, or call us during trading hours on 1300 361 261.

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