On December 18th of 2019, our team at Global Gold shared their thoughts on the most probable outlook for the global economy and titled that post “STUCKFLATION – the New Normal”. The article was written with the mindset of warning our clients and readers of the pitfalls, as well as the opportunities, to expect in 2020. While we did not expect the economic speed at which the damage was done by the pandemic, there was enough reason to consider the potential of a very sluggish economy in the least, combined with the growing danger of inflation in the years ahead. At this point, that scenario appears almost certain!
Now, for the fact checkers: you will hardly find the term “stuckflation” in Wikipedia, and certainly you will not find it in your dusty econ 101 textbook. We came across the term in a comic (see below), which we found amusing and, unfortunately, also quite applicable to the period we expect to witness ahead.
The bad news: this time is not just different, it’s much worse!
The IMF just released its April 2020 World Economic Outlook and it’s not pretty. They describe this crisis as the worst since the Great Depression.
For the Advanced Economies, the IMF’s projections for economic growth in 2020 are –6.1%. According to the IMF, the economic contraction will be much worse than in 2008: “The COVID-19 pandemic is inflicting high and rising human costs worldwide, and the necessary protection measures are severely impacting economic activity. As a result of the pandemic, the global economy is projected to contract sharply by – 3.0% in 2020, much worse than during the 2008–09 financial crisis.”
On the brighter side, the IMF also expects a sharp rebound in 2021 – the much-discussed “V-shape" recovery. They project growth in Advanced Economies for 2021 at 4.5%. Globally, they project 5.8%. Now, anyone familiar with these projections knows that, so far, over the past 20 years or so, they’ve always proven to be too optimistic, often by a considerable margin. I expect this time to be no different. To be fair, however, they do discuss the “severe risks of a worse outcome” in their report.
Source: IMF, World Economic Outlook, April 2020
Here’s what we wrote back in December: “The New Normal: STUCKFLATION. No, this is not a spelling error and we’re not referring to “stagflation”. The new kid on the block, causing a stir among traders and economists, is “Stuckflation”. It describes the current monetary policy stalemate, where central bankers continue to flood the market with liquidity, STUCK in a mode of ultra-loose monetary policy, well aware of the ultimate risk of INFLATION, which itself also appears to be STUCK in its lows despite all the money printing and the lower-than-low interest rates.”
Monetary and Fiscal Stimulus, 2009 – 2010 vs. 2020
Source: Brookings, IMF and BCA Calculations
Inflate or Die! That has been the motto of central bankers for some time now. And, if our warning was true in December, you can be assured it is even more true today.
As of now, we are only halfway through the COVID-19 crisis and the (arguably) radical lockdown policies that came with it. Yet, the aggregate amount of fiscal and monetary stimulus (see chart above), and the accompanying debt, has already surpassed the aggregates pumped into the global economy during the last crisis of 2008 and 2010 in their entirety. It is equally noteworthy that running into this latest crisis, the levels of debt were already much higher than they had been prior to the 2008 crisis.
According to IMF statistics, the global debt to GDP ratio stood at precisely 200% at the end of 2007. At the end of 2019, the same ratio stood at 287%. Moreover, the global debt had more than doubled, from US$ 116 trillion in 2007 to US$ 244 trillion in 2019!!!
If you think this debt does not matter, you need to think again. We are reaching record highs in public and private debt levels at a moment when interest rates are at historic lows, suppressed to that level by increasingly drastic artificial measures. They will start to rise. That change of direction can be sudden and sharp. When that happens, we will have an insolvency and foreclosure horror show on our hands.
Meanwhile, the global GDP had only grown from US$ 58 trillion to US$ 85 trillion. The world, since 2007, has lived – and partied – on the basis of a rapidly growing mountain of debt. The world has lived beyond its means and has gotten hooked on the drug of “cheap money”. For the past 40 years, we have had increasingly lower interest rates (see the following chart, depicting the yield of 10-Year Treasuries from 1962).
A few things should become clear from looking at this chart: first, we are coming to the end of a secular trend. Secondly, we are looking at historic lows; never before have Treasuries yielded less. And remember, the yields of government bonds of most other large and noteworthy economies are in the negative zone. Finally, one question should be worth consideration: with all the debt, and with all that additional cheap money currently hitting the global economy in order to “beat the virus”, what do you think will happen when interest rates turn and/or inflation starts picking up?
It makes you wonder how central bankers really expect this global monetary experiment to end. They can hardly be very optimistic. Surely, they understand they must "inflate or die”, as the late Richard Russell put it.
US 10-Year Treasury Constant Maturity Rate (%)
Note: Shaded Areas indicate U.S. recessions
Source: Board of Governors of the Federal Reserve System, fred.stlouisfed.org
The good news: challenge is opportunity
So, what’s the good news in all this? Well, for starters, the good news is that while we sail through treacherous and uncertain waters, there is at least one thing that we can be VERY CERTAIN about: we know what the policies of central bankers and governments around the world will be. They have no other option at this point except to “try it once again”: pile more money and more debt on top of that mountain they’ve already created. And they will. QE4 is in full implementation mode, and it’s “a beauty”!
The following chart portrays the past three U.S. quantitative easing exercises, plus the current fourth version underway. Since March 12th, the US Federal Reserve has bought up more than US$ 1 billion worth of Treasuries. Already now, merely a month later, these QE4 measures make the 2008 QE look like child’s play. The measures are getting more and more gigantic. And, they are looking more and more desperate, and destructive.
QE4 Treasury purchase in perspective (US$ billions)
Source: BofA Global Research
So, what does this mean for gold? And what about bonds?
Well, it should really be quite obvious in the case of gold, given all the newly created paper money. Gold is on the rise. Its volatility is certainly frightening some investors. But, overall, the performance of gold as an investment and, more importantly as a safe haven, has been simply outstanding. In fact, in most currencies other than US$, the gold price has now reached historic highs! See the chart in Euro below. I am certainly enjoying my gold, stored safely in the high-security vaults of Loomis in Zurich. I pay my bills in Swiss francs, and, in my home currency too, the price of gold is getting closer to its record highs.
Gold Price in USD/oz, from 1973 to 2020
Gold Price in EUR/oz, from 1973 to 2020
Most people will be surprised to hear that over the past 10 years, gold has been the best performing asset class, followed closely by US Treasuries. In the last financial crisis, stock markets reached their low on March 9th, 2009. Since that date, the price advance in gold amounts to about 82%. If you invested in US Treasuries, and assuming you reinvested the coupons, the total gains came to roughly the same level. Of course, gold was much more volatile than Treasuries, with a severe bear market in between, which shook off many investors.
Returns on gold and US treasuries have been similar to date
Source: FUW Chart of the day; Gavekal Data / Macrobond
Historically, these two investments have certainly done their job as safe havens in difficult times. Both gold and US Treasuries are currently testing their highs in US dollars, while gold has surpassed its highs in most other currencies.
Looking forward, the following points speak for gold more so than for Treasuries:
The physical demand for gold is much higher than the price would imply. The lockdown in India and Switzerland has meant that roughly 80% of gold refining has been closed down. That has led to, and will continue to lead to, scarcity for the coming months.
Investors, both private and institutional, are hoarding gold bars, mainly 1 kg and standard bars. Demand is high.
The growing public and private debt levels, combined with QE4 the world over, will lead to higher inflation and higher interest rates in the next 12 to 24 months. Gold will benefit from that; treasuries will not.
What are the opportunities in stock markets?
My quick response to that might be “Huuuge”. But most people seem to dislike that expression these days. Nevertheless, there are substantial opportunities. This conviction is based on the basic fact that risk equals profit potential, and there was plenty of that during the most recent correction… and the second leg down that, at BFI, we expect shortly. If you go by the simple rule of buying low and selling high, we are looking at considerable buying opportunities in the coming weeks and months.
However, things are not going to be that simple. I expect the “stuckflation” roller coaster ride that I mentioned earlier to be a challenging environment for investors. It will certainly not be an environment for the faint of heart, and it will not be a market for amateurs. That said, I expect smart and professional investors to be able to do quite well in the next 12 to 24 months, particularly in certain sectors like health and technology. I also see an opportunity in commodities. They have been beaten down badly over the past 10 years, which is easily seen in the Bloomberg Commodity index depicted below. However, investing in commodities successfully, as in the stock market more generally, will require a lot of experience and skill. The tide might not lift all boats. But picking the right investments looks to become very attractive in the coming years.
Credit Suisse (LUX) Commodity index (USD)
Source: Credit Suisse, www.finanzen.net
In conclusion, the big picture continues to be one of increasing risk and uncertainty, but also one with a considerable level of buying and profit opportunity.
Central bankers will continue doing all they can to keep the gravy train on track. In this environment, unfortunately, I don’t expect the passive, buy-and-hold type of investing to be successful. You might consider doing that in gold. Beyond gold, particularly if you want to take advantage of the opportunities in stock markets, commodities and possibly other alternative asset classes, you will need to be NIMBLE and ACTIVE. And, you need to have a strict and disciplined investment process, combined with the necessary technology and market tools in place.
As a general rule, after this COVID-19 lockdown comes to an end and the people around the world get back to work, reviving their projects and companies, the element of resilience at a personal and business level will be key. As an investor, you need to prioritize the aspect of a HEALTHY BALANCE SHEET. Don’t buy companies that only look good in terms of profits, growth and P/E. The ability to absorb this shock and then get back in the game better than the competition will be critical for survival and long-term prosperity, and it will be very dependent on fundamental and financial health.
For most individual investors, even if they were able to do well in the past decade, investing on their own, the future should be considered a new era. Inflation-adjusted real returns from bonds will disappear. In fact, bonds will at some point no longer be the “safe” investment they have been. Merely investing in broad stock market ETFs and the respective indices will not lead to the positive results of the past 10 years.
Therefore, unless you love taking on big odds, you should seriously consider working with a qualified professional team. The time for Beta (i.e. buying and floating upwards with the general market) is OVER.