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ABC Bullion

Gold Rallies as Star Fund Manager Heads to Cash

19 June 2015

Gold posted strong gains overnight as the price of the yellow metal reclaimed the USD $1200oz mark. Currently sitting at USD $1202oz, the yellow metal was up close to $20oz for the day. The market clearly interpreted the latest Fed policy decision and accompanying statements as dovish, with some economists now stating that the expected September rate hike might be further delayed, whilst continued concerns over Greece are still providing support for bullion.

On that note, despite testing the patience of markets, investors, politicians and everyday citizens for about 5 years now, Greece was again headline news this week, with German newspaper BILD reporting that the Greeks were seeking to delay a scheduled payment (of circa 1.5bn EUR) to the IMF by 6 months, a suggestion that was quickly denied by Greek government officials.

The issue of this payment arose again overnight, with IMF chief Christine Lagarde stating that Greece won’t be given a grace period past the 30th June, and that the Hellenic state will be considered “in default” if it has not paid up by the end of the month.

The ongoing drama (we should say tragedy) in Greece will keep investors nervous for the next 10 days at least, though if recent history is any guide, there will likely be another delay, or temporary solution put in place, just in time for European bureaucrats and officials to go on their taxpayer funded summer vacations.

Back to the Federal Reserve, and their interest rate decision this week, it was always expected that they’d keep rates unchanged at 0-0.25 per cent. Market moves in the aftermath were always going to be driven by interpretations of their monetary policy statement, and the press conference they gave after announcing their decision.

And in their usual case of doublespeak, they stated that they believed the US economy was strong enough to handle a rate hike, but that one wouldn’t be forthcoming until further improvement in the labour market is seen, and when they are reasonably confident inflation will head back to its 2 per cent target.

In the press conference held after the interest rate decision was announced, Fed chairwoman Janet Yellen sounded decidedly dovish, at least in my opinion.

Yellen commented (courtesy of ForexLive) that;

• "My colleagues and I would like to see more decisive evidence that moderate economic growth will be sustained (before hiking)"

• “Clearly most [Fed] participants are anticipating that a rate increase this year will be appropriate. Now that assumes as you can see that they are expecting a pick up in growth in the second half of this year. And further improvement in the labor market conditions. And we will be making decisions that depend on the actual data that we see in the months ahead"

• "I want to emphasize and I think the IMF would agree with this that the importance of the timing of a first decision to raise rates is something that should not be overblown whether it is September or December or March, what matters is the entire path of rates and as I have said the committee anticipates economic conditions that would call for a gradual evolution of the Fed funds rate towards normalization"

It was interesting Yellen even mentioned the IMF, with the fund stating in early June that they though the Fed should delay any hikes until Q1 2016 at the earliest. Apparently Christine has the upper hand over Janet (and Angela for that matter).

The dovish undertones in the above statements are also evident. She talks of only moderate economic growth, that rate hikes will only come into effect if growth accelerates and labour markets improve (there is a big question mark over both of these). Finally, the fact she’s actually mentioned that a rate hike might not occur until March 2016 at the earliest is a clear sign there is no certainty of any uplift in the federal funds rate this year.

For Australian dollar investors, the outlook for precious metals of course also depends on what happens with the local currency. On that score, the AUD has climbed above USD $0.78, despite a fall in the Westpac Leading Index, which led to Westpac stating that the RBA could soon shift to an ‘explicit easing bias’, which portends further cuts in interest rates.

The stubborn refusal of the currency to fall toward the USD $0.70 level will be frustrating the RBA, as well as the government, and we have no doubt Westpac will end up being correct, with cash rates of close to 1.50% not to be ruled out before the end of this year.

Whilst none of this portends an imminent upside breakout in the precious metal complex, it does support the notion that physical gold and silver should form a core holding in your portfolio, and I for one topped up my holdings again earlier this week.

More Gold News

Gold was in the news this week for a number of other reasons unrelated to the Fed, Greece and the overnight rally.

First up was Russian central bank governor Elvira Nabiullina, who stated on CNBC that the Russian central bank has been buying and will continue to accumulate gold bullion based on the “principles of diversification.”

She was asked by CNBC; “Why would you be adding significant amounts of gold at this time when you could be taking euros or dollars or other foreign currencies to makeup reserves?”, to which Nabiullina replied that the Russian central believes in “the principles of diversification of our international reserves and we bought gold not only last year but during the previous years. Our gold mining industry is very well developed and it is ready to supply gold. That is why our attitude towards here is based upon diversification of our reserves.”

She also went on to comment that Russian gold reserves, as they stand today, are not so large, especially compared with other nations who have a “bigger share of gold in their reserves”

You can read a transcript here

Next up was the news that the Bank of China is to participate in the LBMA Gold Pricing. The Bank of China will be the eight institution participating in the new electronic based LBMA Gold price, joining Barclays Bank, Goldman Sachs, HSBC, JP Morgan, Societe Generale, UBS and Scotia Mocatta.

Ruth Crowell, chief executive of the LBMA welcomed the news, stating that, in relation to the Bank of China; ““As one of the LBMA’s founding members, it is appropriate that they should be the first Chinese participant.” Yu Sun, general manager, Bank of China London Branch & CEO, Bank of China (UK) Limited, stated that; “Although being the world’s largest gold producer and consumer, China has never played a major role in the global gold fixing”.

This move confirms two things. First, that China’s role in the future of gold price fixing, and its influence over the gold market as a whole will continue to grow. But it also confirms just how important the LBMA and London itself remain to the global gold market, something Saxo Banks head of commodity strategy Ole Hansen attested too.

Finally, we’ve seen the news that Texas Governor Greg Abbott has signed legislation to establish a state bullion depository. Explaining the decision, Abbott stated that the he signed the house bill authorising the creation of the depository to “provide a secure facility for the State of Texas, state agencies and Texas citizens to store gold bullion and other precious metals. With the passage of this bill, the Texas Bullion Depository will become the first state-level facility of its kind in the nation, increasing the security and stability of our gold reserves and keeping taxpayer funds from leaving Texas to pay for fees to store gold in facilities outside our state."

You can read the bill here if you would like

This development is interesting for a number of reasons, not least because the University of Texas Investment Management Company (UTIMCO), itself holds about $1bn in physical gold, a roughly 5% allocation in their $19bn portfolio.

This gold is currently stored with HSBC in New York City. Whilst it’s too early to tell, it wouldn’t be a huge surprise to see this gold physically repatriated to Texas once their bullion depository is built.

Whilst not exactly the same situation, this is clearly a continuation of the trend we’ve seen develop in the past few years, where not only quantity, but security of gold ownership is growing in importance, with sovereign nations, including Germany, Austria and the Netherlands looking to repatriate physical bullion reserves held in both the United States and the United Kingdom.

Livewire Live – Star Fund Manager Sitting on over 40% Cash

Livewire

Before finishing this market update, I wanted to discuss equity markets in some detail, and why I think prudent investors might benefit from looking at gold as part of their cash holdings in their portfolios.

Earlier this week I was fortunate enough to be invited to attend a Livewire Live panel discussion, featuring three of Australia’s leading fund managers, Geoff Wilson, Anton Tagliaferro and Ben Griffiths.

For those of you aren’t aware of Livewire, it is a rapidly growing financial news sharing site, which brings insights from leading fund managers and investment professionals to their rapidly expanding reader base.

Livewire has been very well received both in the financial community itself and amongst self directed investors, and has been recognised by KPMG as one of the top 50 Fintech innovators in 2014, and also by Tank Stream Labs, who voted it start up of the year in 2014.

I’ve been fortunate enough to be invited to be a regular contributor (not just on gold but all things investing and economics) since Livewire started a couple of years ago, and I have no hesitation in stating that ABC Bullion clients interested in market updates should register with the site (it’s free) so that they can access the content , including the following video, which was taken at the event on Tuesday. Note that if you aren't already a Livewire subscribee that link will prompt you to become one!

The reason for me wanting to share this with ABC Bullion readers today is two-fold. Firstly, Tom Mckay, managing director of Livewire Markets mentioned Ray Dalio in his opening remarks. For those of you who aren’t aware, Dalio runs Bridgewater, the world’s largest hedge fund. He also happens to be decidedly pro gold (without being zealous about it), stating that ‘if you don’t own gold, you know neither history nor economics”.

The second reason is that i think ABC Bullion clients will find the video incredibly interesting because it will give you a chance to listen to Geoff Wilson discuss why his portfolios are now sitting on more than 40% cash, as well as insights from the other panelists. For those of you unfamiliar with who Geoff Wilson is, he is one of the most well respected Australian equity managers in the marketplace, and has grown his flagship listed invested company, WAM Capital Limited, from $22 million to $836 million in the past 16 years.

The views of people like Wilson, as well as the other guests on the panel are always worth paying attention too, just like those of well respected international equity managers like Jean Marie Eveillard and Matthew Mclennan of First Eagle Funds, who are based in the United States.

In the panel discussion, you’ll hear Wilson discuss why he’s sitting on such a large cash pile, a very interesting observation regarding what some senior players in the property market are looking to do, and some comments regarding QE that you might not typically expect from equity fund managers .

Regular readers of ABC Bullions market reports will know that I’m not anti-stocks, and I actually believe people should have exposure to them in a well rounded portfolio of assets, especially in a world of ZIRP and seemingly perpetual QE.

But that also doesn’t mean I’m oblivious to the risks, especially with margin debt (in the US) at an all time high of $507bn as at the end of April 2015, up $25 billion fro March alone. Worryingly, that $507bn number is some 50% higher than where it was back in October 2007.

When we look at price earnings ratios (especially the Shiller CAPE), we are also cautious, with the current reading of 27 suggesting that the market is at least 40% more expensive than it’s historical average, and at a valuation point that it has only exceeded three times in history, all of which ended in major market crashes.

Domestically, the ASX faces a number of headwinds in the coming years, not least of which is the sector concentration in financials (big 4 banks) and materials (BHP and RIO), the performance of which will dominate overall market returns.

As such, I can certainly see why Wilson is sitting on such a large cash pile, hoping to protect his investors from an eventual ‘bloodbath’ in markets.

But what if instead of merely protecting client wealth from a huge sell off, prudent managers like Wilson could add to returns in these environments, using gold as a partial substitute for cash.

And whilst that might sound extreme, gold is clearly still a monetary asset today, something most central banks, including the ECB, explicitly acknowledge, when they refer to the fact that the precious metal will “remain an important element of global monetary reserves”.

Further investigation lends ever more merit to the suggestion that gold could help prudent equity managers.

After all, as per the below table, gold has tended to perform incredibly well in AUD terms in the years when the Australian sharemarket has suffered most, averaging a 38% gain in the worst 5 years on the local bourse since the 1970s

Annual

And whilst the table above shows the return of gold on an annual basis, the reality is that decisions to increase or decrease cash weightings may need to be made more frequently, especially in periods of higher volatility.

As such, after attending the Livewire event this week, I went and analysed just over 25 years of market data, looking at the monthly returns for the ASX, Gold (in AUD), and cash.

The table below highlights the average returns of these three asset classes in the worst 10, 25 and 50 monthly market sell offs we’ve seen since Australia’s last recession.

Assets

As you can see, the returns on gold in these periods of extreme volatility in the equity market substantially outperform those of cash. What is also interesting is that the worse the equity market falls, the better gold tends to do. As you can see from the above table, in the worst 50 months for the market, it’s fallen by on average 5.34%, whilst gold has risen by 2.8%.

Concentrate the losses to just the worst 10 monthly observations we’ve seen, and the equity market losses almost double, to over 9% on average. Gold returns are over 5% per month on average in these environments, with the precious metal falling less than 30% of the time the equity market does.

In other words, a prudent fund manager looking to protect client wealth is likely to get it right at least 7 times out of 10 if they use gold as a portion of their cash weighting within their portfolio.

Delving further into this, and using Wilsons current cash holding of 43% as a guide (I rounded down to 40%), I wondered what percentage of their cash weighting a prudent fund manager might benefit from holding in gold instead. Now obviously the higher the gold weighting the better the return will be on average, as gold has outperformed cash, but the following table highlights the returns of 4 theoretical portfolios, in the same environment where the equity market sells off.

Note that in the table below – the portfolio 60/30/10 (E/C/G) refers to a portfolio made up of 60% equities, 30% cash and 10% gold

Portfolios

As you can see, even holding 10% of the portfolio (or 25% of the cash weighting) in gold can help improve returns, adding over 45bps to returns. Dial the gold exposure up to 20% of the total portfolio (equally splitting your cash holding between the paper and the rock), and you’d save almost 90bps in the worst of market environments, a not unsubstantial improvement in a scenario where you’d otherwise be losing over 5% of your capital, despite barely being more than 50% invested in the market.

Of course there is no guarantee that these kind of returns will re-occur in the future, but we can be relatively certain that cash rates are going to stay lower for a lot longer, meaning money parked there by catious asset managers will at best tread water in market sell offs, and in fact slowly erode in terms of real purchasing power due to inflation.

If history is any guide, and I know of no better one, prudent fund managers who incorporate some bullion into their portfolios, even if just as a tactical asset as part of their overall cash weighting, are unlikely to regret their decision.

Until Next Week

Disclaimer

This publication is for education purposes only and should not be considered either general of personal advice. It does not consider any particular person’s investment objectives, financial situation or needs. Accordingly, no recommendation (expressed or implied) or other information contained in this report should be acted upon without the appropriateness of that information having regard to those factors. You should assess whether or not the information contained herein is appropriate to your individual financial circumstances and goals before making an investment decision, or seek the help the of a licensed financial adviser. Performance is historical, performance may vary, past performance is not necessarily indicative of future performance. Any prices, quotes or statistics included have been obtained from sources deemed to be reliable, but we do not guarantee their accuracy or completeness.

JE