WHAT OTHERS ARE THINKING
FT Alphaville recently blogged on Deutsche Bank’s latest long term asset return study, subtitled A Journey into the Unknown.
The subtitle comes from the authors’ observation that “many economic or financial variables” are “now outside of any previous historical observations” reducing “confidence levels in predicting the future to fairly low levels.”
In their review of a number of assets (including gold), over different time periods, in various countries, over the last hundred years they note the unusual performance of gold since the US left the gold standard in August 1971. By way of example, consider this one comparison drawn from the table “Real Returns for US Assets over Different Time Horizons” (page 57):
10 Year Treasury
Since 1900 on an after inflation basis, equities outperformed gold by 5.24% but since 1971, gold is only down 0.54% compared to equities.
The authors note that gold’s equity-like after inflation performance post-August 1971 is “impressive considering that Gold over the very long-run and certainly up to 1971 was largely considered a store of value only and one that couldn't compete with riskier assets over the long-run, especially given its lack of income generation.”
This leads them to ask whether Global Financial Crisis (GFC) started on August 15th 1971, as the ending of dollar convertibility into gold meant that:
“…the shackles were off and countries no longer had to adhere to strict policies in order to defend their peg to Gold or to the Dollar. The era of global fiat currencies had begun and we moved into a new world order almost totally different to any that had preceded it. With nothing backing paper money, the path to almost unlimited credit creation had begun. … A combination of fiat currencies and ever weakening financial market regulation basically ensured almost unlimited credit and debt creation. It was surely inevitable that this money would end up somewhere and we therefore started a period of higher inflation than seen through history, and one where we saw frequent asset price bubbles all around the world.”
They note that in theory “the real price [of gold] shouldn’t have changed if published official inflation had responded to the post-1971 exponential credit, debt and money creation binge”, which leads them to suggest that possibly “Gold reflects the inflation in the monetary economy since 1971” whereas “CPI measures more reflect the prices of goods and services” (supressed downwards by China and cheap labour).
Gold’s 41 year “out-performance against inflation may as a minimum cast doubt on the quality of the inflation numbers” and leads them to ask whether gold is “the real inflation measure that we should benchmark all other assets” against or whether it has “been pushed towards bubble territory because of the system we have created.”
This indecisiveness continues in their analysis of potential future asset returns, assuming prices revert to their long-term mean. Their mean reversion calculations conclude that gold will have a negative return over the next decade of -7.8% (nominal) and -10.0% (real) and is thus “not a great real adjusted long-term investment from this starting point. We are basically close to 600 year highs!”
However, they have “been long-term bulls of Gold given the money printing that we’ve felt will be necessary for many years to come and also the fragility of the financial system” and “given the work we’ve done in this study it’s fair to say that the world changed dramatically post 1971 and we wonder whether a long-term mean reversion for an asset like Gold now actually works.”
Nevertheless, they come out in favour of accumulating “core, higher quality, real assets on dips. An income stream is also desirable. So higher dividend, quality equities remains the favoured traditional asset class of choice for us. Credit spreads hedged for an eventual rise in yields are also a decent safe haven investment.”
I consider it a bit odd that they did not see a stronger role for gold in an investor’s portfolio, given their judgement that:
• money printing is here to stay across the globe until it eventually works and restores stability or it creates its own problems further down the line
• inflation will win out as we haven’t seen a year of global deflation (using our median YoY measure compiled from 24 countries) since 1933 and
• defaults, deflation and hyperinflation are still all possible in many parts of the world
Probably the strongest case for gold is their statement that “we are more reliant on our politicians and central bankers to manipulate and shape markets and returns than perhaps ever before. These are not free markets.” As George Bernard Shaw was quoted as saying, "You have to choose between trusting to the natural stability of gold and the natural stability and intelligence of the members of the government. And with due respect to these gentlemen, I advise you, as long as the capitalist system lasts, to vote for gold."