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Markets in La La Land

19 June 2020

Precious Metals Commentary

Metals tracked sideways this week with not too much action. Gold remained at $1,725 and is in a consolidation pattern for now; silver continues to trade around $17.50.

We talked about the AUD/USD looking stretched at 70c and the 68.5c level held this week, leading to metals being very flat in AUD terms relative to this time last Friday.

Highlights from economic numbers this week included Japan’s imports and exports year-on-year for May crashing 26% and 28% respectively. Australian employment change was negative 227,000 versus 125,000 expected, pushing unemployment up to 7.1% and the labour force participation rate dropping to 62.9%.

The Euro global trade balance for April was negative $1.157 billion versus an expected positive $2.7 billion and US continuing jobless claims just ticked over 20 million. The theme of 2020 so far is a deteriorating macro picture being patched over by central bank balance sheet expansion and overly optimistic global stock markets.

The most interesting chart in financial markets right now is the complete dislocation of the US stock market to the broader economic macro environment. In possibly the biggest dislocation of all time, we see the US stock market, and particularly the tech focused Nasdaq, making a V shaped recovery on the back of blind optimism. “Irrational exuberance” is one way to put it but stupidity may be more accurate.

“La la land” is how the CIO of Crescat Capital Kevin Smith put it this week, stating the equity prices are “insanely disconnected from their underlying fundamentals. S&P 500 profit margin estimates are plunging! ‘Buy the dip’ investors are not paying attention and have simply been too eager to call the bottom”.

We would have to agree and the chart below highlights this with forward earnings estimate plunging across the board, whereas retail investors jump over each other to buy stocks on the hopes of monetary stimulus leading to higher asset prices.

S&P 500 profit versus profit margins

The problem with this trade is that money does not fix everything, and eventually valuations matter. Smith highlighted several negative macro indicators in the article, and it is well worth a read.

money printing vs economic activity

At the same time as markets are being levitated, the smart money is seeing the disconnect with a record 78% of fund managers in a Bank of America survey saying that the stock market was too expensive.

Bill Blain from Shard Capital in the UK says that the markets are beginning to depress him, saying that they “have become so distorted they are evolving into something parasitical – feasting on central bank and government largesse” leading him to ask if there is any point in trying to understand the markets and instead just follow what the central banks are buying – “don’t think.. Just buy”.

Albert Edwards thought the picture below of the Wall Street Bull (which has its own website) covered in a blue tarp (or is that TARP?) being protected by police from the have-nots is the perfect representation of how the US Fed has been protecting the equity bull market of the haves.

wall street bull covered in tarp
 

Stocks a ‘Real McCoy’ bubble

Fund manager Jeremy Grantham agrees with Crescat, saying that he is increasingly confident that stocks are “the fourth ‘Real McCoy’ bubble of my investment career” and that the recent price action is “crazy stuff”.

The other real McCoy bubbles were Japan in 1987, the Tech bubble in the late 90s and the 2007 housing bust/GFC.

His measure of the disconnect between stock markets and economic reality is that the price earnings ratio for the S&P stock index is in the top 10% of historical observations when we are in the worst 10% of economic situations. He noted that before the virus the US and other global economies were facing many problems, so a correction was due anyway.

However, as one ABC Bullion’s distributors we met with this week said, in some respects COVID has provided an excuse for those wanting to promote a “unicorns and rainbows” view of the world to keep everyone borrowing and spending. It enables them to explain away the economic difficulties we are facing as purely virus related, which works against solving the underlying issues as the truth that the financial system was not fixed after the GFC is hidden.

Someone who is also trying to avoid reality is RBA economist Nick Garvin, which ABC News reported wrote to his colleagues saying that “it's dangerous for regulators to be reporting on housing prices as though the market is currently functioning” as well as saying that “it could indeed be wise to recommend that the [Government] temporarily halt all sales of established dwellings”.

The documents obtained via a Freedom of Information request show that internally the RBA was much more concerned than it presented in public, saying house prices could slump up to 15%.

Federal Liberal MP John Alexander said that housing could “face the worst price crash in 130 years without radical interventions” and his solution is to allow people to buy their homes within their SMSF and use retirement funds to offset mortgage repayments.

ABC Bullion has many SMSF clients who have bought gold and silver to provide some “reality” assets to their portfolio mix. Housing is another real asset and is currently allowed in super – the only rule change required for Alexander’s proposal is that the SMSF beneficiary can live in the house (as “personal use” of SMSF assets is not allowed).

Of course, it is not surprising that measures to allow access to super or relax the rules as met resistance from the financial services industry. Every new SMSF is one less client of a fund manager, especially for those who look to invest in assets outside of the financial system.

Ultra-wealthy Go for Gold

The ultra-wealthy get the message, with Reuters reporting that nine private banks overseeing $6 trillion in assets for the world’s ultra-rich are advising their clients to increase their allocation to gold.

Of the nine, four have gold rising by the end of the year. UBS said gold could hit $1,800 by year-end and possibly touch $2,000 if there was a second coronavirus wave.

This week Deutsche Bank raised is end of 2021 gold forecast to $2,000 given the longer-term monetary policy backdrop.

Those $2,000 calls might sound like a lot, but when compared to the behaviour of usual bubbles, a return of 2 times on the December 2015 bottom low of $1,050 is just the start.
decades are dominated by one key investment theme

Until next time,
 
John Feeney and 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 John Feeney (@JohnFeeney10) and 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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