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Gold Now?

Gold never changes; it’s the world around it that does. Why is it that we see a renewed interest in gold now? And more importantly, should investors buy this precious metal?

Key attributes in a ‘changing world’ that may be relevant to the price of gold are fear and interest rates. Let’s examine these:

Gold & Fear
When referencing ‘fear’ driving the markets, most think of a terrorist attack, political uncertainty or some other crisis that impacts investor sentiment, and sure enough, at times, the price of gold moves higher when this type of fear is observed. While that may be correct, I don’t like an investment case based on such flare-ups of fear, as I see such events as intrinsically temporary in nature. We tend to get used to crises, even a prolonged terror campaign or the Eurozone debt crisis; whateveras the ‘novelty’ of any shock recedes, markets tend to move on.

Having said that, I believe fear is under-appreciated – quite literally, although in a different sense. Fear is the plain English word for risk aversion. When fear is low, investors may embrace “risk assets,” including stocks and junk bonds. A lack of fear suggests volatility is low; as such, investors with a given level of risk tolerance may understandably re-allocate their portfolios so that the overall perceived riskiness of their portfolio stays the same. While retail investors might do this intuitively, professional investors may also do the same, but use fancy terminology, notably that they may target a specific “value at risk,” abbreviated as VaR. Conversely, our analysis shows that when fear comes back to the market – for whatever reason – ‘risk assets’ tend to under-perform as investors reduce their exposure.

Assuming you agree, this doesn’t explain yet why gold is often considered a ‘safe haven’ asset when the price of gold is clearly volatile. To understand how the price of gold is affected relative to risk assets, we foremost need to understand how risk assets move; after all, remember our premise that gold doesn’t change, the world around it does.

A traditional way to value a risky asset is with a discounted cash flow analysis. With equities, for example, one adds up expected future earnings, but discounting the future earnings stream. When future cash flows are uncertain, analysts apply a higher discount factor to future earnings, thereby deriving a lower value. When investors apply a high discount factor – be that because they are uncertain about the business (think of unproven biotech or young tech firms) or about the market as a whole (a broader sense of fear), we believe this theory dictates a greater focus on short-term cash flows (as future cash flows are more heavily ‘discounted’). As a result, we believe it’s reasonable for share prices to be lower and more volatile when fear is higher.

If you have followed me so far, you may be thinking: but gold doesn’t pay any dividends! Correct, and that’s why we reason that the price of gold is not as affected by changes in the ‘fear factor’ because, again, gold doesn’t change.

Note that it is not correct that gold always does well when ‘risk is off’ in the markets. There are periods when the price of gold moves in the same direction as equity indices; and there are times when it moves in the opposite direction. In fact, since former President Nixon severed the tie between the U.S. dollar and the price of gold in 1971, we have observed a zero correlation to equities. And that is how it should be given that the cash flows of gold (of which there aren’t any) are not correlated to the cash flows of corporations.

Ultimately, of course, prices are dictated by supply and demand. And even as gold may not have cash flows associated with it, the supply and demand of gold may be related to the health (expected cash flows) of users and producers. It’s in this context that I often mention that we believe gold is less volatile than other commodities because it has less industrial use. Taking copper, for example, it doesn’t change either (well, it oxidizes), but supply and demand dynamics are far more elastic (volatile).

And of course, just like any asset, prices can be distorted, even for a considerable period. For example, I allege that the price of gold moves more like a ‘risk asset’ when gold has been hijacked by momentum investors, thereby potentially turning it into a proverbial hot potato.

With this framework provided, let me get to a point I have been making about the markets for some time: in our analysis, the Federal Reserve, in conjunction with other central banks, worked hard to take fear out of the markets. That is, central banks “compressed risk premia,” i.e. making risk assets appear less risky. As a result, risk assets from stocks to junk bonds rose on the backdrop of low volatility (when junk bond prices rise, their yields fall). Conversely, as the Fed is trying to engineer an exit, we believe risk premia will rise again. All else equal, we believe this suggests more volatility (more fear) and lower equity prices.

If you agree with the logic outlined here, an environment in which the Fed is pursuing an exit may be favorable to the price of gold. And it’s not because investors are fearful of another terrorist attack, it’s because fear has been suppressed, yet the world is a risky place; and if market forces have it their way, fear as a healthy part of the markets will return. It also means that, all else equal, we believe the price of gold should be higher relative to equities.

Gold & Interest Rates
But all else isn’t equal, as interest rates might be moving higher. At least that was the story we were told for years as the Fed was preparing the markets for an ‘exit’. Given that markets tend to be forward looking, investors seemed to be fleeing the precious metal. After all, the real competition to a shiny brick that doesn’t pay any interest may be cash that does pay interest. Cash, though, is an artificial construct, and investors have every right to be skeptical. Notably, investors may care more about the real interest they receive on cash, i.e. the interest after inflation is taken into account. While we are told what inflation rates are through official statistics, investors may choose their own perception of inflation in making investment decisions.

Instead of high rates, the world appears to be in a rush to go negative. Bloomberg in its Feb 22, 2016, Economics Brief wrote that one third of 47 countries in their global survey have negative 2-year government bond yields. Sure, in the U.S. rates are positive, but will the Fed be able to pursue its exit? Can we get real interest rates that are significantly positive? Or are we heading the other direction, i.e. is an economic slowdown coming that might take rates down further? In a recent editorial in the Washington Post, former U.S. Treasury Secretary Larry Summers “puts the odds of a recession at about 1/3 over the next year and at over 1/2 over the next 2 years.” He then suggests that a “400 basis point cut in Fed funds … is normally necessary to respond to an incipient recession.”

While I don’t encourage anyone to base their investment decisions on Larry Summers’ musings (at least not unless he takes Fed Chair Yellen’s job), I don’t see real interest rates moving higher anytime soon. Larry Summers’ scenario may be positive for gold, although – if we had rate cuts, it might, of course, compress risk premia once again, taking fear out of the markets…

The way we assess the Yellen Fed is a bit like an ocean tanker, i.e. it moves very slowly. The reasons for that we discussed in a recent Merk Insight, but have mainly to do with the fact that Yellen is a labor economist and, as such, typically looks at data that will lag developments in the real economy. To us, this suggests risk premia may continue to widen (causing risk assets to remain under pressure), and that any rally in the markets may be a bull trap, i.e. deceptive. In our assessment, investors are likely to use rallies to diversify their portfolios as they continue to be over-exposed to equities and other risk assets. The question is whether gold will be part of their diversification efforts. We think investors may want to consider adding a gold component to their portfolio.

For more information you can join Axel Merk’s ‘Gold to Beat Stocks?’ on Thursday, February 25.

Where are we in the Credit Cycle?

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Standard Life Investments warns investors should expect another year of volatile outcomes in global credit markets, with further dispersion in regional performance.

In February’s Global Outlook, Craig MacDonald, Head of Credit for Standard Life Investments, has used a number of indicators to assess where investors are in the credit cycle, including trends in bank lending standards, corporate leverage levels, and the flatness of government yield curves.

MacDonald said: “Although credit markets came under general pressure last year, there was still considerable dispersion in regional performance and investment grade debt which provided selective opportunities for savvy investors. European high yield outperformed US high yield; Sterling investment grade outperformed Euro investment grade, and Asian emerging market credit was actually a strong performer despite global concerns over China.”

“However, there has been a weak and much more correlated start to 2016. Bank lending standards have tightened in emerging markets, and there are nascent signs of tightening in the US, although European lending is still loosening. Corporate leverage is relatively high in the investment grade sector, but remains lower than during the 1990s once the energy and commodity sectors are stripped out. Finally, although yield curves have flattened, they are still steeper than has been associated with previous recessions. While defaults have risen, this is only from historically low levels and they are generally a lagging, not leading, indicator.”

US high yield was one of the worst performing credit markets in 2015 with a -5% return. Almost 50% of bonds produced negative returns and a number entered distressed levels. Just over 20% of US high yield names are in energy and commodities and therefore vulnerable to the fall in commodity prices. Distress has also been seen in retail and telecommunications, however, yields have widened out to 9%, leading to selective opportunities.

“In US investment grade, good-quality issuers now look cheap and while we are avoiding some of the smaller regional US banks with over-exposure to commodities, it is a different story for the large banks such as JP Morgan, which have strong balance sheets with low book exposure to commodities. Another source of market worry has been emerging markets (EM). However, Russian corporate credit had a very strong performance in 2015 despite Russia’s myriad of problems. And Chinese credit outperformed, particularly property bonds. The lesson is that there are opportunities as well as risks in EM credit. The upshot is that we expect another year of volatility in credit markets, and believe the risk of recession is lower than the market is pricing in. This is an environment of selective opportunities. In high yield during 2015, our funds benefited from a reduced exposure to the most risky CCC rated debt, but it is still too early to reverse this positon despite the wider yields on offer, says MacDonald.”

Candriam Adds New Head of UK Distribution, of UK Wholesale, and Global Head of Corporate Communications

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Candriam Investors Group recently announced two senior hires – Chris Davies as Head of UK Distribution, and Derek Brander as Head of UK Wholesale – as it seeks to bolster its presence in the UK. Both will be based in Candriam’s growing London City office.

The firm also announced the appointment of Marion Leblanc-Wohrer as Global Head of Corporate Communications. She will report to Candriam CEO, Naïm Abou- Jaoudé.

With 30+ years of experience at his helm, Chris Davies joins after 11 years at Fidelity. He will be responsible for driving distribution across institutional, wholesale and retail investor segments. Chris began his career at Lloyds Banking Group, where he was for seven years before moving to Prudential, and later to Fidelity.

Derek Brander brings 25 years of experience within asset management, most recently spending five years at Natixis Asset Management. Prior to his work at Natixis, Derek held senior roles at Societe Generale Asset Management, GLG Partners and AEGON.

Marion Leblanc-Wohrer’s career started in 1993, when she joined KPMG in Washington DC., shortly before moving to the World Bank in 1994. She next moved to London to Thomson Reuters and later worked as editor-in-chief of several magazines in Paris.

Cash and Europe, Investor’s Picks

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According to the latest BofA Merrill Lynch Fund Manager Survey, 42% of global investors are overweight on cash, taking their balances to 5.6%, their highest levels since 2001. The FMS also shows that investors have “reset” expectations for macro & markets lower and see default/recession as risk rather than reality. Actually, for the first time since July 2012, both growth and profit expectations are negative.

More than a slowdown in China, the biggest tail risk for global investors surveyed is a recession in the US, where ninety percent of fund managers expect no more than two Fed hikes in the next 12 months, up from 40 percent in December 2015.

Other key takeaways include the fact that positions in equities have fallen sharply to a net 5% from January’s 21%, while bullishness is growing on bonds. In regards to trades, the most crowded continues to be long US dollar, followed by shorting oil and shorting Emerging Markets. The most preferred region globally is Europe with 36% of managers overweight in it.

“Investors have ‘reset’ expectations for macro and markets lower and see default/recession as a risk rather than a reality,” said Michael Hartnett, chief investment strategist.

You can download the full research report in the following link.

The EU Needs Regulatory Stability for the Period to Come

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The European Fund and Asset Management Association (EFAMA) has responded to the European Commission’s Call for Evidence on the EU regulatory framework for financial services. EFAMA welcomes the far-reaching debate launched by the European Commission with its Call For Evidence and wholly acknowledges its challenging nature. They believe “it will provide an excellent opportunity to address and resolve remaining regulatory inconsistencies and unintended consequences.”

With over 40 examples, the European asset management industry argues why existing barriers, inconsistencies and duplications that still exist in the current EU regulatory and policy framework need to be addressed. The examples are wide-ranging and include the regulatory framework built by the European institutions (European Commission, European Parliament and Council), but also regulatory and policy trends stemming from the European Supervisory Authorities.

In its response, EFAMA expresses a desire to ensure a certain degree of regulatory stability for the period to come. Much has been done in recent years in the regulatory field, setting a state-of-the art benchmark for global regulators, many of whom look at EU legislation for inspiration. However, some work remains to be done in terms of implementing and applying these new regulations.

In this regard, EFAMA calls for a realistic implementation timeframe. Too short or unrealistic implementation deadlines lead to legal uncertainty and cause serious challenges for European asset managers in the implementing phase of EU financial legislation.

Alexander Schindler, President of EFAMA, commented: “There are currently many examples of fundamental directives affecting our industry (MiFID II, UCITS V, PRIIPs) where it is extremely difficult to be prepared within the prescribed timetables”.

EFAMA equally supports the so-called “ better regulation” approach to European legislation.

Peter de Proft, Director General of EFAMA, commented: “Better regulation relies on constructive and efficient dialogue with all stakeholders, to obtain the necessary industry and technical expertise of those impacted by regulation. It also relieson the European co-legislators and the Commission to properly assess the potential consequences of a given piece of legislation”.

EFAMA also encourages further consistency and coordination within the European Commission services, between the European Commission and the European Supervisory Authorities (ESAs), but also among the latter (ESMA, EBA and EIOPA) as well as the European Systemic Risk Board (ESRB).

ESMA Resumes US CCP Recognition Process Following EU-US Agreement

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The European Securities and Markets Authority (ESMA) welcomes the common approach announced on February 10^th by the European Commission and the US Commodity Futures Trading Commission (CFTC) on the equivalence of CCP regimes. This is an important step towards market participants being able to use clearing infrastructures in both the US and Europe, and for the proper functioning of the global derivatives markets.

Once the equivalence decision by the European Commission on the US regime for CFTC- supervised CCPs is adopted, ESMA will rapidly resume the recognition process of specific CFTC-supervised US CCPs that had applied to ESMA to be recognised in the EU.

While the European Market Infrastructure Regulation (EMIR) gives ESMA up to 180 working days to conclude that recognition, ESMA intends to do everything within its powers to shorten that period to the maximum extent and proceed with recognition as soon as the US applicant CCPs meet the conditions contained in those equivalence decisions.

Given the 21 June 2016 deadline for the start of the clearing obligation in the EU, ESMA understands that US CCPs will have a strong interest in becoming fully compliant with the EU equivalence conditions in order to be eligible to fulfill the EU clearing obligation requirement, which should help in shortening that period. ESMA cannot commit to any specific dates for the recognition decisions, given that such decisions mainly depend on the compliance by CCP applicants.

ESMA will also consider as a matter of priority the next steps on its consultation on the amendment to its Regulatory Technical Standard (RTS) regarding the minimum period of risk for different types of clearing accounts in EU CCPs.

After The FATCA Exchange, Investment Returns Will not Be The Same!

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From this moment forward, a U.S. taxpayer ought to recognize that IRS will have knowledge of a taxpayer’s financial assets outside of the U.S. that it did not previously have. Before passage of Internal Revenue Code Chapter 4 (FATCA), a U.S. taxpayer faced little risk of discovery, income tax liabilities and sanctions, or a penalty from I.R.S. for not reporting his foreign financial assets or income. So, a U.S. taxpayer making a 10% return on an investment was actually keeping the 10% return.

The United States has always taxed its U.S. taxpayers’ taxable income on a worldwide basis. Thus, absent a treaty or Internal Revenue Code benefit, there is no tax advantage for compliant U.S. taxpayers to investing offshore if the same pretax internal rates of return are obtainable in an onshore U.S. investment. Now that FATCA reporting by Foreign Financial Institutions is occurring, the previously untaxed internal rate of return from an unreported passive investment in an offshore structure will no longer be the actual rate of return. U.S. tax and reporting requirements applied to foreign financial assets and offshore passive investment will reduce an offshore structure’s return on investment. To explain further, given that the current highest effective U.S. tax rate on ordinary income is 39.6%, the long term capital gains or qualified dividend income rate is 20%, and the estate & gift tax rate is 40%, when they are factored into an investment decision, it can dramatically change the tax landscape for a U.S. taxpayer.

Part of the rationale behind the activity of investing overseas has been asset protection; and in some cases – U.S. income tax non-compliance to maximize investment returns. Certain offshore jurisdictional confidentiality laws and rules have historically helped protect assets and increase effective rates of return in those jurisdictions.

FATCA significantly increases the risk of IRS becoming cognizant of assets and reportable income amounts that have not been compliantly reported. Furthermore, U.S. taxpayers should be aware of some of the potentially punitive nightmare scenarios involving offshore investments including but not limited to:

Passive Foreign Investment Companies (PFIC),
Unreported Foreign Financial Accounts,
Unreported Foreign Trusts, and
Non-US Businesses.

It is a reality that tax transparency will have a negative impact on actual returns from offshore investments. A U.S. taxpayer with offshore investments ought to consider whether asset protection structures with the potential for causing punitive taxpayer treatment in the absence of compliance merits increased costs associated with compliance, as well as the latent penalties associated with non-compliance. Finally, FATCA is here to stay, and the era of secrecy has ended.

Neuberger Berman Appoints David Rowe as Head of Marketing, EMEA

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Neuberger Berman, one of the world’s leading employee-owned investment managers, announces the appointment of David Rowe to the role of Head of Marketing – EMEA, effective immediately.

David is responsible for developing and implementing marketing strategy to support Neuberger Berman’s growing EMEA business across all client channels, based in London.

Dik van Lomwel, Head of EMEA and Latin America, commented: “We are excited about David’s addition to the firm at a time when communication with our clients is more important than ever. His deep understanding and experience of marketing across EMEA will play a key role in tailoring our capabilities to each diverse market and supporting our dedicated client teams.”

David has over 17 years’ experience in the asset management industry. He joins from PIMCO where he was Head of MarComms EMEA since 2012 and additionally responsible for APAC since 2014. Previously, he held several senior marketing roles at Threadneedle (now Columbia Threadneedle) including Head of Wholesale & Institutional Marketing and latterly Head of Marketing. Prior to this he was Marketing Director – Funds at GAM.

David commented, “I am delighted to be joining one of the few privately owned investment firms of true scale. With the breadth of product range across asset classes the firm is well positioned to partner with clients in the short and long-term.”

Oil Markets: Brent Crude Oil will Average USD 40/bbl in Six Months’ Time

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At the time of writing, crude oil is trading at USD 32.51/bbl and USD 29.04/bbl on the Brent and WTI spot markets respectively. Both oil benchmarks have lost around 14% and 22% respectively year to date and have dropped to their 2004 levels.

Towards the end of January and in early February, oil markets registered a brief rally. It has now expired despite the encouraging news that US unconventional oil production is falling and discussions between OPEC and Russia to reduce oil supply, with the publication of new OECD data showing higher oil & distillates inventories and rising risks of global recession. This sent spot oil markets plummeting 8% in London and 12% in New York in the first two weeks of February.

The oil market imbalance is set to persist throughout the year, though easing gradually in the second half of 2016.

The latest news of the talks between Saudi Arabia and Russia is that they have agreed to freeze their oil production if they are joined by other major producers. Subject to a broader and more definite agreement, we forecast that Brent crude oil will average USD 40/bbl in six months’ time.

In terms of demand, despite mounting concerns surrounding Europe and emerging markets, the three forecasters (EIA, AIE, OPEC) that the market follows stand by their expectations for 2016. Global demand should increase by 1.2 MMbbl/d to 95.6 MMbbl/d following stellar growth of 1.9 MMbbl/d in 2015.

Emerging countries represent more than 52% of global demand. They have been the drivers of global demand for the last ten years, and should remain so despite the weakness of China’s demand. The IEA expects oil demand to increase in 2016 by 1.1 MMbbl/d (2.3%) to 49.4 MMbbl/d for non-OECD countries and by 3.1% (vs. 5.6% in 2015) to 11.6 MMbbl/d only for China.

The IEA expects OECD demand to remain flatwhile the EIA and OPEC are forecasting a rise of just 0.2% y/y. In the US, total liquid fuel consumption is forecast by the EIA to increase by 0.8%, compared to 2015.

As for the supply, after expanding by 2.6 MMbbl/d in 2015, global oil supply should increase only slightly, by 0.5 MMbbl/d to 96.8 MMbbl/d, in 2016.

In 2016, non-OPEC supply should decline by around 0.7 MMbbl/d to 57 MMbbl/d. The global downside will be driven by lower US unconventional supply and complemented by decreasing production in China, Norway and the North Sea area. Crude oil production by the seven major US shale players is expected to fall in February by 116,000 bbl/d to 4.83 MMbbl/d, according to the EIA.

Lastly, OPEC production in 2016 should increase by 0.9 MMbbl/d to 32.9 MMbbl/d, up from 30.9 MMbbl/d in 2015. Iran might also increase its supply by 0.5 MMbbl/d following the lifting of the sanctions.

Opinion column by Erasmo Rodriguez, Equities Analyst at Union Bancaire Privée (UBP), specialiced in Energy and Utilities sectors.

Choppy Markets Spur Interest in Multi-Factor Smart Beta Strategies

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Pixabay CC0 Public DomainFoto: Andrew. Sube la marea, llegan nuevas noticias, ¿debería cambiar mi visión de mercado?

While market volatility will continue to fuel the growing popularity of multi-factor smart beta strategies in 2016, there will be greater focus on diversification than trying to predict which factor will dominate, according to the latest issue of The Cerulli Edge – Europe Edition.

“For delivering alpha, multi-factor strategies that tip-toe the line of active investing will gain favor,” says Barbara Wall, Europe managing director at Cerulli Associates, a global analytics firm.

In a Cerulli survey conducted in mid-2015, when asset managers were asked which smart beta products would see the strongest institutional sales over the next 12-24 months, 50% of UK managers said multi-factor, with 30% of Nordic managers answering the same.

“Over the past year as market uncertainty has reigned, multi-factor smart beta strategies have garnered greater interest. We expect total assets under management (AUM) to continue to increase not only in Europe but in the US and Asia as well,” says Justina Deveikyte, a senior analyst at Cerulli.

Big data platforms and improved off-the-shelf analytics that better understand how different factors work is also growing the market by broadening the investor base beyond sophisticated institutional clients, says Cerulli.

It estimates that total AUM for smart beta portfolios in Europe has grown from EUR 9.5 billion (US$ 10.6 billion) in 2011 to EUR 32 billion by the close of 2015. Return-oriented AUM increased from EUR 5.7 billion to EUR 23.5 billion over the same period.

“Investors sitting in more cap-weighted passive implementations or classic active management strategies will be looking at the multi-factor smart beta strategies as suitable alternatives because they are cost effective, transparent, and are more likely to live up to potential,” says Deveikyte.