Rosenberg: "I love gold but…"
In David Rosenberg’s latest daily market commentary, he showed some concern about the rally in gold and suggested near-tern caution. Rosenberg writes:
I LOVE GOLD, BUT….
….The recent surge is the same chart as in March 2008, November 2009 and May 2010 … followed by meaningful corrections … that were to be bought. This market is long overdue for a near-term pullback, in our view.
It would seem as though investors are putting down their money on a big inflation bet.
- Gold is up 20% this year alone.
- The gap between the long bond yield and the 10-year note yield has widened to an eight-year high of 129bps from 92bps just six-months ago. This is the third highest spread in the past three decades.
- Since the end of August, 10-year TIPS breakevens have risen from 1.5% to 1.8%.
There is no doubt that we have commodity prices firming, a weaker U.S. dollar and a monetary policy that seems aimed at reloading the gun. These are inflationary tailwinds. But we also have contracting bank credit, a 6% (and rising) personal savings rate, a 6.5% output gap and core inflation already south of 1%. These are warning signs, and the Treasury market refuses to sell off, which has thus failed, to ratify the great inflation trade.
It’s funny that Rosenberg makes these arguments because I have been arguing that the risk/reward for Treasury bonds has become considerably less favourable as they too have outperformed. Also, Rosenberg seems to imply that you want to go for the highest duration play with his comment about the 10-year and the 30-year. Just as he complains that gold seems like a one-way bet on inflation, I would argue long-dated treasuries are a one-way bet on deflation.
Moreover, I see gold as a hedge against currency debasement than anything else, not against inflation per se.
Admittedly, getting to a much higher price for gold is not quite the leap of imagination that it seems. After adjusting for inflation, today’s price is nowhere near the all-time high of January 1980. Back then gold hit $850, or well over $2,000 in today’s dollars. But January 1980 was arguably a "freak peak" during a period of heightened geopolitical instability. At $1,300, today’s price is probably more than double very long-term, inflation-adjusted, average gold prices. So what could justify another huge increase in gold prices from here?
One answer, of course, is a complete collapse of the US dollar. With soaring deficits and a rudderless fiscal policy, one does wonder whether a populist administration might recklessly turn to the printing press. And if you are really worried about that, gold might indeed be the most reliable hedge.
Sure, some might argue that inflation-indexed bonds offer a better and more direct inflation hedge than gold. But gold bugs are right to worry about whether the government will honor its commitments under more extreme circumstances. In fact, as Carmen Reinhart and I discuss in our recent book on the history of financial crises, This Time is Different, cash-strapped governments will often forcibly convert indexed debt to non-indexed debt, precisely so that its value might be inflated away. Even the United States abrogated indexation clauses in bond contracts during the Great Depression of the 1930s. So it can happen anywhere.
Kenneth Rogoff has suggested in the past that the Fed should credibly commit to much higher inflation targets if QE gets no traction. This is something that Fed President Evans has mentioned as a potential policy path. So, let’s be clear, the Federal reserve wants inflation. However, in my view the Fed is more geared toward asset price inflation and currency debasement. Money printing does not necessarily lead to embedded consumer price inflation. Why hasn’t consumer price inflation soared already as the Fed tripled the size of its balance sheet? Asset prices on the other hand have risen in most every market: commodities, bonds, oil, precious metals, equities, high yield bonds, US government bonds, Bunds, emerging market debt, etc., etc
This leaves investors in a troubling predicament. The US economy is slowing. This connotes poor earnings in the future. Yet, the Federal Reserve is now telegraphing there is a Bernanke put on asset prices, which has market participants taking on risk. If you believe the Fed, they will ride to the rescue before asset prices falter in the case of a drop in economic growth. Equities and long-dated treasuries would benefit if so, since the Fed would start buying long-term bonds. However, if growth continues to muddle through or better, equity prices could also benefit but bonds could stumble badly.
Will the Fed ride to the rescue before asset prices falter? The chart by Annaly Capital Management showing a positive correlation between declining yields and declining stock prices suggests maybe not. Where do you invest then?