The baseline assumption of corporate finance that US Treasury debt is ‘risk-free’ has been questioned by S&P. ‘As safe as houses’ is about to be shattered in the UK. Artificial stock market levels could be massively corrected by rising bond yields. In this context, it is hardly surprising that gold has pierced the $1500 ceiling.
People have been asking me from time to time this year whether I regret not taking advantage of the Stock Market’s ‘return to growth’. I tell them no, for three reasons. First, having bought a fair amount of gold, we’ve now doubled our money. I don’t know of any stock market that’s done that. Second, the stock market remains a huge gamble, and winning or losing that bet is now entirely about choosing the right time to get out. There will come a point later this year or perhaps early next when investors will have to sell shares that nobody wants to buy. With gold, you can be certain that – for eighteen months at least – people will be clamouring to buy it. (Real live bullion is selling at a 15-20% premium over the ‘advertised’ tracker price).
It’s the third reason that most people can’t get their heads round. I tell them that the rise in the ‘value’ of their stocks is illusory, because the spending power of their currency has been eroded. This is a national as well as a personal problem for the Brits, in that the driving force behind such inflation as we have at the moment is largely to do with the expense of importing raw materials and energy. But a pretty large proportion of holidaymakers these days go to Europe – or on long-haul to Australia, South Africa, Canada and so forth. Looking at the £ against the euro since 2006, the exchange rate has slumped from 1.50 to 1.13 – a drop of around 35% in the value of Sterling. Over that time, the £ has halved against the Aussie dollar.
Not only is our spending power being reduced, our capital wealth is about to be hammered as never before. The housing market lost all its value gains of 2010 in the first quarter of 2011. And Jeremy Warner’s comprehensive piece in the Telegraph earlier this week admirably described the real world outside the London Bubble – one in which some northern areas of the country have seen prices drop 60%.
Put those two things together and the picture is far from pretty: for a lot of our citizens, their cash is worth 35% less, and the house 40-50% less. Their private pensions have woefully underperformed, and this – coupled with the Government’s idiot new scheme to reduce the amount we can withdraw from them each year – means that available pension spending power has halved. Housing has, in my view, a good 30% further to fall in the Midlands and South, given the lack of mortgage availability and falling real wages.
But people say to me, “Yes – but you’ll have to convert the gold one day too”. I answer that the same rule of desirability applies: property is an asset with falling value, and even that won’t be realised during 2012 without a long wait and a big price cut. Gold, on the other hand, has much further to climb yet….and is the ultimate collateral for borrowing. A world in which one’s investments and properties are plunging in value is something few people have experienced: in that context, the price of gold could go berserk. Then it too would be a bubble: but if by then you’ve already used it as an asset against which to borrow, that needn’t matter….especially as the value of what one has borrowed will fall in the medium term.
Why borrow, then? Well at my age, I won’t – probably: nothing is definite any more. But were I 43 not 63, I’d buy ‘brown infill’ land – lots of it. This I would see as the ultimate hedge. If the all-out banks going bust and Treasuries unable to bail them out domesday happens, land with water underneath it and good soil on it ensures survival and retained value. And if everyone in the G20 simply winds the inflation/deflationometer and currency variation back to nought (a far more likely scenario in my view) then it is suddenly viable and valuable building land again.
All the assumptions about falling British individual wealth assume, of course, that the FTSE will keep steady at or above the 5800 mark. Goldman Sachs in particular thinks it will rise another 15% before ‘topping out’ as they put it. ‘Choking’ is another word one could use. Whether it maintains growth or not (and personally I doubt it) gold’s growth will easily outstrip it – on the basis of two big and inevitable future events: the collapse of a 16-nation euro, and the continuing slide in the dollar.
Are there other reasons I think the stock markets will plunge? Yes, lots….in a rational world. This year so far and last, the Dow has been pumped up by QE2. But with their currency on the slide bigtime, the Americans too will soon realise they need something offering more than stocks as an investment to maintain purchasing power. Some will turn to gold, some to oil. However, since S&P’s downgrade of the US outlook last Monday, the writing really is on the wall for Wall Street.
US big business is turning in some stunning results and paying good dividends. But these again are based on cheap money being hoarded and invested – not just on sales and margins. As the wealth spouts upwards and the jobless accept lower wages, mass purchasing power must fall off….as will the tax take for Washington. So the outlook for the economy and the debt will worsen, not improve. S&P got multiply shot up as the messenger, but its view of American debt and economic potential is spot on: stocks are as much about future potential as past performance.
So you’re a US investor, and you have a choice: to stay with a high stock market offering a lousy outlook – or to invest in an American debt where you can earn more from a desperately strapped Government. The long-predicted exit from the stock market and into Fed bonds then looks like a certainty to me.
Earlier this year, I wrote about the magic 5% figure on 30-year Treasuries. The current yield has fallen back slightly to 4.46% – and the renowned Texas-based independent modelling outfit FFC has this falling back to 4.18 during the year. I distrust models, and always will. I also think this forecast owes more to past data and wish-fulfilment than what is really likely to happen. It is based on a ‘normalisation’ of the American economy over time: not factored in are the S&P downgrade, the bunfight between Congress and Obama, and what Ben Bernanke has to say on the 22nd June. New economic experiences always destroy the validity of models.
I haven’t changed my outlook at all. If anything, recent events have firmed it up. Rising Asian and European interest rates have pinned Ben into a corner, and this plus downgrades will force the US to pay more to borrow. Long Treasury rates will inevitably rise beyond the psychological 5%, and the rush to get out of stocks will become a stampede.
The UK will be different, I suspect – but no better. Our cost of borrowing will also rise, but so too will concern about the parlous state of our finances. At some point, the bond market trade-off between risk and yield becomes critical: investors will back off completely one day. While the EU can still talk a good game about guaranteeing investor funds centrally (although there is more talk of haircuts) a guarantee from the UK Treasury is no longer much of a guarantee.
S&P only downgraded the US outlook. It remains to be seen what they’ll say, in due course, about us. Although everyone seems to have forgotten this, our own outlook was downgraded nearly two years ago. But then Dave and his white knights charged to the rescue, achieving….nothing. One of the biggest reasons the Osborne programme of ‘cuts’ has proved to be blunt is the spiralling cost of being in the EU – with whom Britain’s trade gap widened yet again last month. All this makes one wonder how long the credit-rating agencies will give Blighty the benefit of the doubt.
When I first raised the question of Britain’s debt credibility in 2006, I got a shoal of emails (nby didn’t have a comment thread) wittering on about the long-term nature of gilt debt, and how my scenario of banking collapse was a fantasy. Things have moved on a tad since then: no matter how long term debts are, they have to be serviced. In this sense, the difference between us and Greece is merely one of degree. We have a poor economic output, an unbalanced economy, falling tax incomes and banks only partially repaired…with a Treasury not capable of doing Bailout II. I will leave the final word to the yesterday’s FT:
‘At some point, bond markets will turn. When markets turn they can do so quickly. Sadly, the chances of S&P nudging the politicians into action before the markets torpedo them do not look good.’
The Slog 