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World in a Silent Depression

21 February 2020

Precious Metals Commentary

This week, gold broke above $1,586, which ABC Bullion’s Nick Frappell says was a significant level - being 61.8% Fibonacci retracement of the huge down-move between the 2011 high and the 2015 low. A close above this level going into March would add to the bullish picture.

Gold Spot US Dollar Chart

Nick says gold is benefitting in the short term from safe-haven flows and in the longer term from the expectation of easier monetary behaviour in response to the coronavirus. Read Nick’s monthly technical analysis with support and resistance levels here.

Citigroup said that it expects gold to hit $1,700 in the next six to 12 months and $2,000 in the next 12 to 24 months as “market jitters will prompt investors to pile into the so-called safe haven asset” to hedge against the stock market falling.

FX broker Pepperstone says that market chatter is that one of the reasons gold has been so strong is that investors who wish to maintain exposure to stocks but worried about the risk of a fall have been investing in gold and US Treasuries to hedge that risk. However, they say that there is also a solid speculative case for gold, especially if economic data “starts to deteriorate and central banks don’t follow the markets leads with a dovish tilt”.

Silver has also benefitted, with a strong move above $18, placing it in a resistance zone between $18.40 and $18.50 – according to James Turk, this has silver at a critical moment, but “when silver eventually breaks through, then +$20 is likely quickly. Silver is the most undervalued asset on the planet”.

MA Chart

As the precious metals burst up, the Australian dollar busted down past 0.66. This perfect storm put a rocket booster under the metals’ Aussie prices, with gold adding $100 to $2,460 as we write, and silver $1.60 to $28.05.

60/40 Lost Decades

When it comes to deciding what investments to allocate your hard-earned money to, the traditional 60/40 portfolio – 60% stocks, 40% bonds – has long been considered the benchmark for conservative investors looking for safety.

Fund manager GMO, however, says that 60/40 is not necessarily the best shelter for those looking for an all-weather portfolio.

Their chart below looks at what happened to the 60/40 portfolio for the US when either stocks or bonds were expensive (as measured by the cyclically adjusted price-to-earnings ratio or real yield, respectively).

As you can see, over the past 120 years, that portfolio has had many “lost decades” where the return after inflation has been flat or negative.

60/40: Lost Decades Chart

More concerning is that today both stocks and bonds are expensive. The last time this happened was in the early 1900s, resulting in the 60/40 portfolio going nowhere for nearly 20 years. For those approaching retirement, and even those in their 50s, 20 years of zero returns would result in their golden years being more like brass.

GMO note that the US stock market’s impressive run-up has not been based on fundamentals but more upon price/earnings multiple expansion in the face of declining profit margins.

Another example of the markets’ lack of focus on fundamentals comes from JP Morgan, who note that “the ratio of the S&P 500 technology to energy sector is now the same as during the tech bubble”.

Ratio of Tech to Energy, and single stock call options volumes chart
This is Tech Bubble 2.0 and hard to see a continuation of it in 2021 but if it does, it will be spectacular. JP Morgan said that this time is not different and cautioned that this bubble will likely collapse.

Backing up GMO’s analysis, fund manager Hussman Funds estimate the likely 12-year total return on a “conventional passive investment portfolio (60% S&P 500, 30% Treasury bonds, 10% Treasury bills)” at “just 0.04% annually, below even the previous record of 0.34% set in August 1929”.

Standards & Poors Chart
For Australia, the chart below from Wheaton Precious Metals shows that we are in what they call a “silent depression”, with after inflation growth in GDP per capita (which backs out the effect of Australia’s historically high rates of immigration) following the anaemic path of previous depressions.

Australia: Comparing the three global, economic depressions of the past 150 years chart
We recommend listening to the podcast Wheaton’s Emil Kalinowski recorded with MacroVoices, covering this chart and their case for the world being in a silent depression. That podcast also has an interview with Chris Cole of Artemis Capital Management, whose Dragon Portfolio we cover below.

The Dragon Portfolio

So how do you protect your portfolio from the risk of markets returning to an appreciation of fundamentals? Of course, you won’t be surprised we suggest considering gold.

The World Gold Council (WGC) recommends an allocation of between 2% and 10%, and while that is for a US investor, these four ways gold enhances a portfolio are applicable to Australia as well:
  • acts as a diversifier and mitigates losses in times of market stress
  • provides liquidity with no credit risk
  • improves a well-diversified portfolio’s overall performance
  • generates long-term positive returns in both good times and bad
Further to the last point about long-term returns, the table below shows that Australian gold and silver have performed well relative to shares, property and bonds, ending 31 December 2019.

Australian Gold and Silver Performance chart
Recent years’ returns have also been good. You can find year-by-year historical returns for gold, silver and platinum in Australian dollars on our Key Market Statistics page.

Australian advisory firm Crestone Wealth Management comes in a bit more conservative than the WGC, suggesting a strategic weight of between 0% to 3% to gold is appropriate for investors with either a balanced or growth risk profile.

They say that “a 3% allocation (at the expense of equities) would have improved portfolio risk across a wide range of time periods, with the added benefit of boosting return across longer periods” as it provides portfolios with a hedge against rising inflation and a falling US dollar or when major shocks impact riskier assets.

For a real long-term view, Artemis Capital Management looked at over 90 years of financial market returns to answer the question of what assets should you invest in if you were looking to build a portfolio that could last 100 years to pass on to your children’s children.

The result is their “Dragon Portfolio”, which you can see below is radically different to the typical US exposures of US pension funds and has a 19% allocation to gold.

Dragon Portfolio Chart
The thinking behind this five-way split is that the “key to superior portfolio returns is to make surprisingly large allocations to alternative assets that perform when stocks and bonds do not”.

Artemis argue that assets which are negatively correlated to stocks and bonds - going up when others are down and vice versa - are worth more to a portfolio than assets which have better returns. Indeed, they say that even defensive assets which consistently fail to make money can be more valuable to a portfolio than assets which provide positive returns.

This certainly seems counter-intuitive but Artemis demonstrate their point with the theoretical example below.

Artemis Chart
Most people, if asked to choose two out of the three assets in the left chart, would choose assets A and B and shun asset C as it has a zero return over time. However, in the middle chart, Artemis show that the combination of A and C ultimately provides the same return as A+B but with much less volatility.

More surprisingly, the third chart shows that if you borrow money and apply leverage to the A+C portfolio, it massively outperforms the A+B portfolio with the same amount of leverage.

The reason we have highlighted this theoretical example is that one of the most common arguments against gold is that it is a sterile asset that doesn’t generate income, and that it has periods of poor performance. Everyone thinks that gold is like Asset C with occasional speculative bubbles.

Such arguments miss the point of including gold in a portfolio, as Artemis demonstrate. If you are still sceptical and think we are talking our book, we can only suggest reading Artemis’ 40 solid pages of analysis in The Allegory of the Hawk and Serpent.

We close with an important point that Artemis make on the difference between Physical Gold and Fiat Gold. They say that it is not a conspiracy theory to “conclude that during a period of fiat debasement, the price of Gold-Backed fund and Derivatives may deviate from the price of Physical Gold” due to taxation, capital controls and liquidity problems.

Their advice: “it makes sense to own real, physical, Gold”.

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, or call us during trading hours on 1300 361 261.

This publication is for educational purposes only and should not be considered either general or 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, and 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.