Saturday 21 April 2018

Paul Sommerville: Forget Brexit, or the French elections, US bond yields are key to 2017

The rise of Trump could mean big jumps in gold prices, as people seek safe investments
The rise of Trump could mean big jumps in gold prices, as people seek safe investments

Paul Sommerville

The dichotomy of reaction to the Trump election victory from the mainstream media versus financial markets is truly extraordinary.

While the world looks on bemused and confused by Donald Trump, the financial markets have taken his election with enormous celebration. The Dow Jones is up some 15pc since election-night lows, the S&P 500 some 11pc.

The dollar has reached a 14-year high and conversely gold has plummeted 15pc. Most importantly for investors, USA bond yields have shot higher, the USA 10-year yield reaching 2.6pc. Bank shares have soared - Goldman Sachs leading the way with a 36pc increase.

In simple terms, the market has made the most seismic shift in many years on its thought process of what the future is likely to look like. The market is clear and unequivocal that the financial landscape has dramatically changed and Trump is the catalyst.

Before the result, traders and investors had priced in the prospect of slow-to-no growth - not just in near future but in the medium to long term, with low inflation probable and deflation possible. Now the consensus view is USA GDP growth will accelerate, Inflation is on the way and, most importantly, higher interest rates are on the horizon.

For investors this is a tricky prospect. Higher yields and interest rates (and less regulation) may be good for certain sectors such as banks but it is clear that if bond yields continue to increase, other sectors may come under pressure. Especially high-dividend, highly valued but low-growth stocks which are the backbone of the majority of stock investors' portfolios at present.

Trump has certainly helped the fears of deflation dissipate and the rising global bond yields must be seen as a major positive for the global economy. But it is possible that Trump may only succeed in pushing up inflation without the corresponding acceleration in growth leading to what is described as "stagflation" .

For investors, the key to 2017 will not be Brexit, nor the French elections but rather USA bond yields. If the 10-year yield breaches 3pc we would expect major dislocations in many markets and a huge repricing of assets across the globe.

This latest stock market surge has all the hallmarks of the last hurrah of an ageing bull run rather than the start of something new. Bull markets do not die of old age they die when everybody agrees the only way is up, we are certainly nearing that point.

Should I buy gold?

Throughout the financial crisis many commentators advocated purchasing gold as a hedge against uncertainty (not us). It has turned out to be a poor choice, thus far at least.

Gold has fallen 40pc from its highs in 2011 from more than US$1900 towards US$1100 pre-Christmas.

The gold bugs suggest gold to be a hedge against everything from inflation to deflation, and several other things, but performance has been poor.

In fairness to them it is very clear the price has been manipulated lower as central banks, while pursuing quantitative easing, could not allow gold to rally as it would have acted as the proverbial canary in coal mine that their monetary experiments were not working as intended.

But with Trump entering the White House and promising a weaker dollar, gold having fallen out of favour with the investment community and inflation potentially on the way, now may be a time for investors to take a fresh look.

There are many ways to trade gold and it can be confusing. For short-term traders it is easy.

They can trade futures contracts or, if your broker provides a rolling contract, then that is best. Both methods are cheap, liquid and very importantly offer a tight/bid offer spread that saves hugely on costs.

But these are only for experienced traders who know what they are doing.

For longer-term "buy and hold" investors it becomes trickier as there are multiple options.

Firstly, we hear the adverts on radio for all types of ways to buy physical gold but in my view this is certainly not the way to go.

The costs are high, the bid/offer spread is simply enormous and you have the added risk that these companies are holding the gold on your behalf.

A key problem is that, if you need to sell your holding, it is cumbersome, takes time and they see you coming a mile away and offer you a lower price. Simply put, the costs totally outweigh the possible rewards.

The best method is to buy an Exchange-Traded Fund (ETF). Again, the problem here is there are so many associated with gold and it very important that you avoid the leveraged products in this area.

It is also better to avoid the "gold mining" ETFs which hold the shares of gold mining companies.

This is because if gold goes up there is no guarantee the gold mining shares will go up. For example due to cost overruns, debt levels, labour issues, management missteps.

If you are interested in the reasons to buy gold for the long term, a new book has just been published by Jim Rickards The New Case for Gold. I certainly would not agree with all he has to say but it is a good read for those interested in the subject .The gold bugs have been wrong thus far but that does not mean they ultimately may not be proven correct. With a new regime in the White House, their arguments look more compelling. It has already bounced 8pc from Christmas.

Paul Sommerville is CEO and head of advisory at SAM

Sunday Indo Business

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