Capital Group takes on the passive investors

Once secretive asset manager embarks on an uphill battle against index funds

by: Robin Wigglesworth and Stephen Foley


When Tim Armour graduated from Middlebury College, a liberal arts institution in Vermont, he faced a conundrum. He could either accept a graduate programme slot at a West Coast investment group, or go and run a windsurf shop in Florida.

Because he loved to windsurf but did not want to turn down a more sensible job, he asked the asset manager whether he could put off the traineeship for a year. He was grudgingly given nine months, so off he went to the beaches of Sanibel, an island off the south-west coast of Florida.

“It was one of the best experiences of my life because it taught me, in the first two weeks, that that’s not what I wanted to do and I was so thankful to have a job to come back to,” he says.

It worked out just fine for Mr Armour. Since 2015 he has been chairman and chief executive of the investment company he joined over three decades ago: Capital Group, one of the oldest and biggest in the world, with more than $1.5tn of assets under management. But he has taken the reins at a perilous time.




Traditional asset managers face an epochal battle against the rise of passive investing. Even Capital, one of the industry’s best-regarded players, has felt the ground shift beneath its feet, with outflows for much of the post-crisis era. In 2007 its Growth Fund of America was the biggest mutual fund. Today, it is dwarfed by Vanguard and State Street’s flagship passive funds.

That is why the company has ripped up a decades-old policy of operating in relative anonymity and is advancing new research that aims to destroy the “myth” that active management is doomed. “I feel we’re yelling from the top of a mountain, and no one is listening,” Mr Armour says. “Passive is here to stay, and it’s an important option. But we are better than passive.”

He has a reasonably strong argument to make. Although Capital’s funds did poorly in the financial crisis — tarnishing a reputation for dodging bubbles — it has regained its footing.

Thanks to improving performance and buoyant markets, its assets under management are now again close to the 2007 peak of $1.55tn. In 1993, Capital’s American Funds was the fourth-largest US mutual fund brand, behind Fidelity, Vanguard and Franklin Templeton; now it is second, behind Vanguard, the all-conquering passive specialist.

This year it launched one of its root-and-branch reviews of the entire business — a project codenamed “Delta” — to “step back, re-examine and innovate”. But the Los Angeles-based company is battling a fundamental change in investor preferences that will be hard to reverse, says Todd Rosenbluth, director of exchange traded funds and mutual fund research at CFRA.




“The shift to passive is not abating, it is accelerating, and unlike many other asset managers, Capital is entirely focused on active,” Mr Rosenbluth says. “It tends to offer lower fee products, so their returns are going to be competitive, but . . . as investors seek out passive products, Capital is going to get caught up in the trend regardless of their performance.”

For the investment industry, the post-crisis era has been marked by steady growth — but also disruption.

On the plus side, central banks have boosted markets to new highs, lifting the size of the US mutual fund industry to more than $16tn, up from $12tn on the eve of the crisis in 2007, according to the Investment Company Institute.

Yet mutual funds have proven progressively poorer at navigating markets. Over the past 10 years, 87.5 per cent of US equity funds underperformed their benchmarks, for example, and more than half of all international and emerging markets equities funds also lagged behind, according to an S&P study.



Current Capital Group CEO Tim Armour and former chief Jon B Lovelace, who helped build the company his father started into a mutual fund industry leader © FT montage


Meanwhile the likes of Vanguard, BlackRock and State Street have continued to slash the costs of their passive products, while smaller providers have unveiled a dizzying array of ETFs that allow investors to put money in any investment style or theme at a fraction of the cost of a traditional mutual fund.

But Capital’s analysis of historic fund performance — research that has been corroborated by Morningstar, an industry data provider — has shown that two factors are strong indicators of long-term, market-beating returns: fund managers having plenty of their own money in a fund; and low fees. Capital scores well on both measures.

Almost two-thirds of American Funds’ share classes have fees rated as “low” by Morningstar, while another fifth were below average. And 97 per cent of Capital’s assets are managed by a portfolio manager with at least $1m of their own money invested.“

I feel really good about the battle we’re waging,” says Steve Deschenes, director of client analytics at Capital, the architect behind much of its research on active management.


Passive rivals such as funds from State Street and Vanguard have outperformed Capital Group © FT montage / Bloomberg


Beating the drum loudly does not come naturally to Capital. Its profile was long so low that when Theresa May became British prime minister, a UK newspaper that wrote about her husband Philip’s role as a client relationship manager at Capital could still mistakenly describe it as “a little-known hedge fund”.

No longer. Capital’s ads have taken on a mad-as-hell-and-not-gonna-take-it-any-more feel. “American Funds has done what sceptics claim is impossible,” says one. “Don’t buy the myth. You can beat the index,” says another.

Mr Armour has even taken on Warren Buffett, whose latest annual letter to Berkshire Hathaway shareholders exhorted readers to put their money into cheap index funds. “We agree that the average investment manager does not outpace the market over meaningful time horizons [but] Mr Buffett and others acknowledge that there are exceptions,” Mr Armour said when the letter came out.

Capital’s fightback against passive is not just about marketing. In perhaps its boldest gambit, it is aiming to change the rules of engagement, by eliminating something it says tilts the battlefield in favour of ETFs: distribution fees.




These fees are passed on to distributors such as broker-dealers, and come on top of the fee that managers like Capital charge, potentially doubling the cost (or more). Mutual fund performance is calculated net of fees, which means active managers not only have to beat the index, they have to beat it by more than the fund’s fees to be deemed a success, and distribution fees make that hard. Capital won permission from regulators this year to start selling what it calls “clean shares”, which, unlike most mutual fund share classes, do not include a distribution fee baked in.

Clean shares will include only Capital’s own management fee. Investors may not necessarily see the benefit — brokers will add their fees by another means — but clean shares will automatically record better performance numbers than traditional mutual fund shares. If clean shares catch on, the statistics will start to show fewer active managers falling short of the index.

“When people are comparing passive returns to mutual fund returns, they’re often comparing apples and oranges,” says Mr Armour. “We want to simplify things.”

Capital is also trying to burnish its bond business. In 2015 it poached Michael Gitlin, head of fixed income at mutual fund rival T Rowe Price, to lead its bond team — an unusual move for a company that prides itself on promoting internal talent rather than hiring outside stars.




Mr Gitlin has even been promoted to its management committee.

Mr Gitlin has gone on a hiring spree, snapping up about a dozen people to boost the asset manager’s capabilities in junk bonds, emerging market debt and municipal finance among other areas.

The bond business is now growing at a healthy clip, from $225bn at the start of 2015 to $263bn by the end of last year. Mr Gitlin is targeting $500bn of assets in the next four to five years.

“The business has a substantial size already, without scratching the surface of what we can do,” he says.

Capital’s culture is different from many other investment groups, and was primarily shaped by its former head Jon Lovelace, whose daughter once labelled him a “Buddhist businessman” for his distaste of hierarchy.

The company was founded in 1931 by his father Jonathan Bell Lovelace, a former stockbroker who dodged the 1929 crash. But its egalitarian “multi-manager” system was fostered by the son, who wanted to ensure Capital would not suffer the “key person” risk that has bedevilled rivals, where the brand of one star money manager overshadows the fund.

Capital Group and the mutual funds industry



A Capital Group site in Indiana

$16tn Size at the end of 2016 of the US mutual fund industry, up from $12tn on the eve of the crisis in 2007

87.5% Percentage of US equity funds that underperformed their benchmarks over the past 10 years

$157bn Size on March 20 of Capital’s Growth Fund of America, a third smaller than State Street’s SPDR S&P 500 ETF, the biggest US equity ETF


Each of Capital’s funds is run by a team of sometimes more than a dozen portfolio managers and analysts, all of whom are responsible for investing independent slices of the fund, adding up to hundreds of individual stock picks. Critics argue that such a broad approach means its performance is likely to hew closely to the broader market index; active managers are increasingly electing to place fewer but bolder bets, making their funds look more like the concentrated portfolios of a hedge fund manager or a Mr Buffett.

That is the direction taken by Dale Harvey, who quit as a portfolio manager at Capital in 2007 to launch Poplar Forest. But he concedes his approach may not be right for the more conservative savers targeted by Capital’s American Funds, who want insulation from market rollercoasters.

The company’s bonus structure is also heavily tilted towards rewarding long-term performance. Almost half of compensation is tied to results over eight years — while most other asset managers rarely reward performance beyond five years. “Capital is a get-rich-slow kind of place,” Mr Harvey says.

Fund managers hope US president Donald Trump’s unorthodox policies might usher in a new market era that will be kinder to active asset managers, who struggle when assets rise and fall in unison, but thrive — at least in theory — when turbulence causes divergence.

“A more volatile world, I think, is good for us. It fits right into what we do well and so we’re pretty excited about what we see coming down the pike,” says Mr Armour.

Yet so far the evidence of a stockpicking renaissance remains elusive. And the central challenge confronting Capital is that the shift in investor preferences towards cheap passive investment vehicles seems so seismic that even strong performance can only ameliorate the trend.

The assets of Capital Group’s biggest fund — the Growth Fund of America — peaked at $193bn at the end of 2007, when it was almost twice the size of State Street’s SPDR S&P 500 ETF, the biggest US equity ETF. But at $155bn today it is now one-third smaller than its passive rival, despite returns in the top decile over the past five years.

“Over the last couple of years there’s just been this great sucking sound of money flowing out of active and into passive,” says Marc Pinto, the head of Moody’s asset management rating division. “You’ll always have the old masters — the Van Goghs that tend to over perform over time — but there just aren’t that many out there. Cheap is good, but even cheaper is better. That is the mantra of markets at the moment.”


Technology and risk: New hires aim to profit from disruption

The hottest hires in the asset management industry are no longer MBAs and CFAs, but data scientists and programmers. Jobs advertised for the latter outnumber those for fundamental analysts by a factor of eight, according to Bank of America. And Capital Group is also dipping its toe in the tech waters.

Underscoring the sense of the asset manager trying to shake things up a little, last year it lured over Heather Lord from Charles Schwab to be its head of “strategy and innovation”. She has been tasked with bringing some disruption to the investment group, examining what processes can be automated or augmented with technology. “What’s on my mind at night is, how do you balance the thoughtfulness that’s let this place exist for nine decades — and pivot as many times as it did over that period of time — with the need to move faster over the next three-five years,” Ms Lord says. “This period of disruption and instability creates threat and opportunity.”

Capital has also recently set up an innovation lab called the “Emerging Technology Group”, led by former Accenture partner Jeff Roedersheimer, who answers to the investment group’s chief information officer, Julie St John. It has quietly started to invest in tech companies with products that might be useful for Capital’s more digital future.

But it can be hard to modernise a company as old and big as Capital, something that Ms Lord admits. “How do we get comfortable in some areas, taking a little bit more risk and failing fast? We’re not a place that does that,” she says. “And I think to really take advantage of some of the emerging technologies coming available, we’ve got to be comfortable with that ambiguity [of not knowing what will work],” she says.


The Challenge at Mar-a-Lago: Wooing China to Drop Its Tariffs

Beijing joined the WTO in 2001 on terms that no longer make sense for an industrial powerhouse.

By Bill Lane

               Photo: Agence France-Presse/Getty Images


There’s a Civil War story about a farmer who wakes up one morning to find his house wedged between large Yankee and Rebel armies. In an effort to extricate himself from the predicament, he puts on blue pants and a gray coat before walking outside under the white flag of truce. But he doesn’t get far. The Confederates shoot him below the waist while the Union troops shoot him above it.

That’s the risk of trying to split the difference—a lesson worth keeping in mind this week as President Trump meets China’s President Xi Jinping. Some of Mr. Trump’s supporters want him to restrict imports from China sharply. Yet many Americans fear that doing so may spark a trade war. So how to avoid putting on the blue pants and the gray coat?

The answer is economic growth. Presidents Trump and Xi, as the leaders of the world’s two largest economies, must certainly realize that robust growth at home would be the best answer to their respective critics. Better to coordinate policies to stimulate prosperity than to cause a confrontation and risk an economic downturn.

A central issue during the meeting this week will be America’s bilateral trade deficit with China of about $350 billion—more than half of the overall U.S. trade deficit. Whether one is a free trader, a managed trader or a protectionist, there is no denying that trade between the U.S. and China is out of balance. The average American spends 17 times as much on Chinese products as the other way around.

Economists come up with all sorts of benign-sounding reasons for this imbalance: China saves too much; the U.S. doesn’t save enough; Americans simply like to buy inexpensive stuff. Others suggest more sinister causes: currency manipulation, trade barriers or cheating. But regardless of whether the U.S.-China trade imbalance is economically sustainable, the 2016 election demonstrated that it isn’t politically sustainable.

That’s where the opportunity comes. President Trump has a chance to recenter America’s economic relationship with China not by the saber but through flattery and mutual respect.

Beijing joined the World Trade Organization in 2001, nearly two decades ago, on terms that made sense then. Since that time, however, no country has more enthusiastically embraced economic change. Mr. Trump encourages America to do big things, yet China has been practicing what he preaches—from the Three Gorges Dam to its network of high-speed trains. America’s top universities are full of the best and brightest Chinese students. These massive investments in infrastructure and education have made China dramatically more competitive.

But global trade rules haven’t changed. As an industrial powerhouse, China no longer needs to hide behind double-digit tariffs. In the old days, these weren’t considered a big deal because new rounds of negotiation under the General Agreement on Tariffs and Trade were held every decade or so to revise the rules. The expectation was that greater trade liberalization would be coming.

Today revising WTO rules is perceived as too difficult, so the world is stuck with an outdated framework. This particularly affects trade with the countries that have changed the most—China in particular. What’s surprising is that Beijing knows it, but has generally taken the attitude of “why change unless you have to?”

President Trump should point out that China has options. It can further open its markets to the U.S. via bilateral, regional, multilateral or, best of all, unilateral action. But Beijing has to act with a sense of urgency, as the status quo is no longer politically acceptable.

President Xi made eloquent comments at January’s economic summit in Davos about the virtues of free trade. President Trump insists he is a free-trader, too, albeit with caveats. Maybe this is the right time for the two leaders to cut a deal to slash Chinese trade barriers. This would give Chinese consumers increased access to U.S. products, while Mr. Trump could claim a victory for American exporters and their workers. And the whole world would benefit as the U.S. and China—the twin engines of global economic growth—start pushing once again in the same direction.


Mr. Lane is a retired director of global government affairs at Caterpillar Inc.

jueves, abril 06, 2017

GOLD - THE WAIT IS ABOUT TO BE OVER / SEEKING ALPHA

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Gold - The Wait Is About To Be Over

by: Nikhil Gupta

 

- Gold is once again testing the 200-day SMA near $1260.

- The U.S. dollar index has gained a bit.

- Will gold extend its gains? I believe it will.
 
 
The precious metals are about to break out of their resistances, even with the U.S. dollar firming in the recent sessions. For gold, I expect the 200-day SMA of $1261.40 to be taken out quickly, which would also push the SPDR Gold Trust ETF (NYSEARCA: GLD) above $120.
 
http://ei.marketwatch.com/Multimedia/2016/09/26/Photos/ZH/MW-EW610_Gold_2_20160926094251_ZH.jpg?uuid=1e6501ac-83ef-11e6-97bf-00137241c023
Source: MarketWatch
 
 
I like what is happening in the gold market. The precious metal is doing well to stay near its higher range and is repeatedly testing the 200-day SMA. This indicates that the market is preparing for an upmove in the commodity and greatly reduces the downside risks. The following daily gold futures price chart clearly tells that Aurum is maintaining its higher lows and that declines are being quickly bought by the investors. I believe that the precious metal will deliver now. And when it does that, it will attempt to tackle the medium-term downward resistance (the red trendline) placed in the $1280-$1300 range.
 
 
Source: TradingView
 
 
At the time of writing this article, gold is once again striving to break above the strong resistance zone of $1250-$1260. The importance of crossing this bears’ mansion cannot be stressed enough; the last time it broke below this zone, it attracted significant selling pressure that pummeled it down to $1130 odd levels. Crossing this zone now will make the bulls even more confident and force the short-sellers to exit their positions.
 
Source: TradingView
 
 
With the bullish momentum in lead, I believe that the underlying gold ETF, GLD will also cross its 200-day SMA at $120.15. I had expected GLD to cross the $120 barrier last week, and although it did touch $120.08, the minor pullback in the precious metal brought down the ETF as well. As the underlying strength remains strong – the current 14-day RSI value is 61.23 – we can reasonably expect levels of $122 in the next couple of weeks.
 
 
Source: TradingView
 
 
All of this positive action in the gold markets is even more encouraging if we bring the action in the U.S. dollar into perspective. In a recent article on silver (NYSEARCA: SLV), I had mentioned a possibility of the U.S. dollar index rising up to 101 in the near term. At that time, the index was trading close to 99 while it has touched a high of 100.69 now. So, even though the dollar is strengthening a bit, gold bulls are also not backing down. This could easily be because of the underlying demand for the precious metal.
 
Although I will wait for some more data, but I am of the opinion that the rapid appreciation of the Indian Rupee against the U.S. dollar will compel the world’s second biggest consumer of gold to massively increase its purchases.
 
 


$20 Trillion In Debt - And Why We Need Even More Of It

by: Long/Short Investments

 
- The federal government is working on a measure to bypass the statutory debt ceiling to accommodate additional spending initiatives.

- US equity markets as a whole are reliant on corporate tax cuts and infrastructure spending to a smaller extent to justify their current valuations.

- If these expansionary fiscal moves don’t come to fruition or underwhelm the market’s expectations, stocks are likely to drop.

 
Argument: Markets naturally trade on future expectations. Currently, US stock valuations rely on a necessary degree of public debt expansion. On its own, the federal budget is currently infeasible to balance due to ongoing trends in federal expenditures. The debt expansion most relevant to the US stock market includes the Trump administration's initiatives to lower corporate tax rates and increase infrastructure spending.
 
These plans will be challenged by fiscal conservatives, those who object to decreased government revenues through tax cuts generally, and through statutorily imposed debt limitations by the federal government.
 
Nevertheless, despite the harmful long-term effects of credit expansion exceeding the rate of nominal growth expansion (i.e. lower future growth), US stock markets are banking on the idea of these fiscal initiatives being implemented, and are time sensitive due to the way in which businesses are valued.
 
Should ideological conflicts or legal snares (regarding further debt issuance) challenge the implementation or eventual structure of the administration's intended expansionary fiscal measures, stocks are likely to give back a portion of the gains attributable to these expectations.
 
Overview
 
US stocks are currently stuck in a holding pattern, which, as I articulated in a different article, is predominantly due to the influences of Federal Reserve tightening, lack of clarity on the timeline regarding fiscal reforms, and (to a lesser extent) overestimated inflation expectations.
 
Investors greeted the Trump administration's intended policy enactments warmly given the corporate tax reform and various deregulatory initiatives are designed to expand corporate earnings, which is the main cash flow source, of which businesses are valued. Nonetheless, to go along with increased defense and infrastructure spending, these policy initiatives are not cheap, could decrease federal revenue uptake (at least initially), and will require a further expansion of the national debt.

Infrastructure spending is a lower-priority initiative and will have push-back among fiscal conservatives wary over its effect on widening the federal deficit, which was already 3.2% of GDP in 2016. The reported cost of such a plan is generally taken to be around $1 trillion, or 5.3% of the US's $18.9 trillion GDP.
 
For the national debt to rise, Congress will need to support a lifting of the national debt ceiling. The figure is currently at $20.1 trillion, or just a hair above the $19.85 trillion figure as of March 16, 2017. By around the third week in April, the debt should hit the $20 trillion mark. By mid-May, it's projected to hit the $20.1 trillion ceiling in place.
 
Raising the ceiling will be mandatory for the Trump administration to push through its objectives regarding corporate tax reform. Nominal corporate rates are expected to be dropped down to around 20% from 35%, which would put US rates more in line with those of other developed economies.
 
Effective US corporate tax rates approximate 21-22% and corporate profits are 8.4% of GDP at close to $1.6 trillion when including inventory valuation adjustment and capital consumption adjustment.
 
(Source: US Bureau of Economic Analysis; modeled by St. Louis Federal Reserve)
 
 
The drop from 35% to 20% would project to raise the fiscal deficit by $150-250 billion, or 0.8-1.3% of GDP. The expectation is that lowering the cost of doing business in the US will result in much of, all, or more than this amount eventually being recouped through higher growth. It would also depend on whether a workable proposal is formed in conjunction such that offshore cash can be repatriated with a portion flowing in as federal revenues.
 
While much of corporate tax overhaul is already priced into stocks, implementing this in time for the 2018 fiscal year would likely push the S&P 500 (NYSEARCA:SPY) over 2,400. A failure to raise the US debt ceiling - or a continued delay in this plan even with a ceiling increase - would lead to some dip in equities attributable to this expectation.

I projected that reducing the corporate tax rate from 35% to 20% - while keeping the tax deductibility of interest in effect - would increase US stock valuations by about 11%.
 
(Source: Author)
 
 
Naturally only some percentage of this projected 11% is priced in, given the probability of policy delays or no material changes to the tax code altogether. What amount is priced in is difficult to ascertain, though a sizable chunk of it (~70% or more) likely is.
 
The S&P 500 is up 11.6% from its 2,132 close on election day. Additional factors behind the market's rise come in the form of increased odds of deregulatory initiatives and infrastructure spending, higher inflation expectations, and general corporate earnings growth.
 
As for the timing, the statutory deadline to raise the debt ceiling was March 16. That's already passed. However, it's not a hard deadline. The Treasury Department has tools it can use in the interim to circumvent the debt ceiling's legal grounding.
 
The easiest method is to declare a debt issuance suspension period, in which it can meet federal obligations without default or a partial government shutdown. Current Treasury Secretary Steve Mnuchin put this into effect on the day of the deadline. This in effect halts investments into government employee pension plans. This will stay in effect until July 28 and gives Congress several more months to raise the limit statutorily. This measure was previously used by then-Treasury secretary Timothy Geithner back in April 2011.
 
However, an extension does not mean that free spending will be in order and that the market will get the additional fiscal-related jolt that it's currently pricing in. It's possible that Congress will tie upcoming increases in the debt ceiling to a piece of legislation. Over the past 10 years, debt has expanded at an annualized rate of 8.7%. Over the past 20 years, it's risen 6.8% year over year.
(Source: US Department of the Treasury; modeled by St. Louis Federal Reserve)
 
 
This compares with annualized nominal GDP growth of 3.0% over the past 10 years and 4.2% over the past 20 years.
 
If we look at the ratio of debt at the federal, corporate (excluding financial), and household level to that of nominal GDP, levels rose from 1983 to 1995, before plateauing between 1995 and 2008, and increased dramatically during the financial crisis. Credit expansion is still rising, though at a less rapid pace.
 
(Source: Bureau of Economic Analysis; modeled by St. Louis Federal Reserve)
 
 
Every recession is fundamentally caused by credit expanding at a faster pace than nominal economic growth.
 
Placing restraints on public debt expansion becomes increasingly necessary as the Fed looks genuine in its intentions to tightening monetary policy after 8-9 years of ultra-low rates (Rates still remain negative at -1.6% to -1.8% in real terms). At $20 trillion, each 100-basis point linear shift of the yield curve would tack another $200 billion onto the federal deficit, equal to 1.06% of GDP.
 
Net interest on the debt is already about $260 billion. An extra $200 billion would raise debt interest as a percentage of total government expenditures from 6.6% of GDP to 11.1%.
 
The worse the situation gets, the less the government has to spend to support the economy in other respects. This will eventually lead to measures such as cuts in government spending and/or an increase in tax rates, both of which are contractionary fiscal measures.

Or alternatively, there must be an alteration in pre-existing spending programs. Medicare/Medicaid and Social Security alone account for 53% of total federal expenditures and 11% of GDP. With the aging of the US population (average age is expected to hit 44 by mid-century, up from 38 currently), these programs are expected to account for an even greater proportion of the budget, as entitlement spending goes up while the proportion of working-age citizens decreases in conjunction. Taking in skilled foreign labor is one option to mitigate these demographic headwinds. But the US economy must first be capable of sufficiently employing its own labor base while being able to incentivize business investment to facilitate the creation of these Jobs.
 
Conclusion
 
It seems unlikely that the debt situation in the US will ever be resolved and we are still a decent ways from obtaining a balanced budget. With a US taxpayer base of around 120 million, debt per taxpayer comes to nearly $170,000. It's unnecessary to whittle the debt back to $0. But it does need to remain on pace with or lower than nominal GDP growth to avoid the future economic ramifications of even lower growth as debt payments take up a greater proportion of public expenditures.
 
For now, however, the US equities markets are reliant on a degree of debt expansion in the form of corporate tax rollbacks, and, to a lesser extent, infrastructure spending.
 
Credit expansion beyond income growth has a deleterious long-term impact but is necessary to meet the market's demands in the short term. A failure to achieve some or all of these policy objectives in timely fashion will likely be met with a drop in stock prices.


The Dancing Bears

by Jeff Thomas




In the early 2000s, I recommended to associates that we were in for a major gold boom. Most thought that this was a ridiculous suggestion and didn’t buy a single ounce. I continued to recommend the purchase of gold regularly over the ensuing years, and the price continued to rise. Only in 2011 did they start to buy, at a time when gold was peaking. We were due for a correction and in late 2011, it arrived.

For several years, the price has remained in the neighbourhood of $1,200—roughly the price it needs to be to bother removing it from the ground.

During that time, gold has periodically risen a bit, then gotten knocked down again. It’s understandable that this should happen. Central banks have a stake in holding down the gold price, since a rising gold price makes it appear more attractive than storing cash in banks.

We’ve reached the point that the central banks have run out of tricks to float the economy and we’re already past due for a crash.

But crashes don’t always occur as soon as they become logical. As long as the public can be fooled into remaining confident in the system, a doomed economy can limp along for a bit before toppling.

Statistics on unemployment and inflation can be fudged (and they have been). The stock market can be falsely pumped up (and it has been) in order to create the illusion that all is well.

These factors, taken together with knocking down the price of gold periodically, helps to convince people that they should keep their money in cash and their cash in the bank, not in gold.

Just as in 2000, the number of people who understand that gold is not the equivalent of a stock but a store of wealth during dramatically changing times is quite small—certainly less than 1% and more likely less than 1/10th of 1%. Those that possess this understanding tend to hold gold long-term and are relatively unconcerned about fluctuations—even if they’re over $100 in a given month. They’re in it for the long haul and believe that, eventually, gold will rise dramatically and may well be the only safe haven after a crash.

But let’s go back to those speculators that waited until gold had risen dramatically before jumping on board the gold train. During the last four-year period, whenever gold rose as a result of economic and political developments, many of them would buy in once more, after it had risen significantly. Then, when it had been knocked down again, they tended to sell—often at the new bottom.

Of course, this behaviour is not limited just to the purchase of gold. In fact, a very high percentage of investors “play” the stock market in this way. They wait until everyone and his dog is buying in and the price is peaking, often buying on margin in order to maximize their positions. Then, when the bubble pops, they tend to ride the market down, hoping in vain that the price will return at least to what it was when they bought in. In essence, they tend to buy high and sell low almost every time.

The gold bears—those investors who don’t truly understand that gold is a very different animal from stocks—typically dislike gold but buy high when it becomes trendy to do so and sell low after it’s been knocked down. This dance is guaranteed to cause the gold bears to lose money time after time.

The dance is sometimes described as “chasing the market,” or “following the trends.” Brokers keep the dance going by advising their clients of established trends, telling them that they’re “missing out if they don’t get in now.” They serve as the market’s equivalent of a caller in a square dance: “Swing your client to and fro—watch his investment dollars go.”

Just as few investors understand the economic nature of gold, they also tend to overlook the fact that the broker doesn’t benefit from the success of the client—he makes his money when the client buys and sells frequently. So, of course his advice is going to be for the client to keep dancing.

So, will this dance go on as it is, ad infinitum? Well, no. There will be a dramatic change following a crash in the markets. Following any major crash, a panic occurs and whatever money is left on the table scrambles to find a new (hopefully safe) home. Following the coming crash, a portion of that money will head into gold. The price will rise dramatically, very possibly to such a degree that it can no longer be easily knocked down by the central banks.

At first the gold bears will assume that it’s an anomaly. Then, as gold passes $1,500, some will dip their toes in. As it passes $1,800, some will wade in. Beyond $2,000, this trend will strengthen quite a bit. As the crash deepens, stocks will tumble further. The bond bubble may also pop, increasing gold’s shine.

At some point, bankers may begin to freeze accounts, create bank holidays, and/or confiscate deposits. At that point, gold will head into its long-predicted mania phase and the bears will be falling over each other, chasing the buying trend.

Gold will rise to a logical price in keeping with its value as a hedge against a collapsing economy. At that point, it would make sense for it to stop, but that’s not what will happen.

Those who understand gold will cease their purchases and sit on what they have. But then a new dance will begin. The bears will become decidedly bullish. It’s important to note that, at this point, they will not fully understand why gold is rising so dramatically; they’ll just know that it is. They’ll want to get in on the gold rush and will do whatever they have to in order to keep buying.

They’ll find that physical gold is in short supply, as traditional holders are unwilling to sell, seemingly at any price. Potential buyers will offer $50 above spot, then $100 above spot, then more. They’ll additionally buy on margin in order to increase their position.

It will be at this point that the mania will take hold. Irrationally high prices will become the new norm. How high will it go? $10,000? $20,000? Impossible to say. It will rise as high as desperation makes it rise, and we cannot now determine what that level of desperation will be.

A new bubble will be created, but this time, it won’t be in stocks or bonds. It’ll be in gold and, like all bubbles, it will eventually pop. This will occur when those who understand the nature of gold recognize that the price has far exceeded what’s logical and, as much as they value gold, they’ll sell a portion of their holdings and use the proceeds to invest in whatever assets have already bottomed and have nowhere to go but up.

They’re likely to retain a portion of their gold holdings for the same reason they always have, but will be happy to release a portion when it becomes significantly overvalued.

This will cause the gold bubble to pop and the gold bears, who have recently become bulls, will wonder where it all went wrong. At this point, they still won’t understand gold; they’ll simply have chased yet another trend and lost.

So, is there a moral here? Well, if so, it’s simply that an investor should not become involved in a market that he doesn’t understand. Nor should he trust his broker to understand it for him.

Ironically, as long as there have been markets, there have been those who go out on the dance floor without first learning the dance. A great deal of profit will be made by some gold investors, but the majority are likely to leave the floor with empty dance cards.


NYSE Arca Suffers Glitch During Closing Auction

At least $150 billion of exchange-traded funds said to be affected, including world’s largest gold ETF

By Asjylyn Loder



A glitch snarled closing trading in dozens of exchange-traded funds late Monday at the New York Stock Exchange’s Arca platform, in one of the largest trading snafus of 2017.

ETFs with market values exceeding $150 billion were affected, including SPDR Gold Trust, the largest gold ETF, according to a person familiar with the trading.

NYSE Arca, the largest listing exchange for ETFs, suffered a trading problem in the final minutes of trading Monday. The NYSE offered few specifics on the nature of the problems.

While securities can trade on any exchange throughout the trading day, trading typically reverts to the listing exchange in the last minutes of the day, in a process known as the closing auction, which determines the settlement price.

A failure to determine a settlement price could affect investors and traders across Wall Street, traders said. ETFs have been one of the fastest-growing products in the securities industry, and the trading difficulties could hit Arca’s reputation.

“A lot of people rely on that closing price, especially with ETFs,” said Joe Saluzzi, a partner at Themis Trading LLC in Chatham, N.J.

Canceled orders could leave market makers and other traders without proper hedges, Mr. Saluzzi said.

Other affected funds include SPDR Dow Jones Industrial Average ETF Trust, SPDR S&P Midcap 400 ETF, Energy Select Sector SPDR Fund, Financial Select Sector SPDR and iShares Russell 2000 ETF, according to the person familiar with the matter.

NYSE Arca sent a series of alerts starting at 4:07 p.m., seven minutes after the stock market closed. The exchange said “all live orders will be canceled” and that a backup method would be used to determine settlement prices.


The exchange didn’t say how many ETFs were affected, or how many orders were canceled.

Kristen Kaus, a spokeswoman for NYSE, declined to comment beyond the exchange’s published notices.

Arca is the listing venue for 1,511 ETFs that were valued at about $2.5 trillion at the end of February, out of about 2,000 U.S. listed ETFs.

The exchange issued its first alert saying a technical issue was under investigation. Four minutes later, an alert said trading was unavailable in many tickers. At 4:37 p.m., the exchange announced that any symbols that didn’t get a proper closing price would be settled using the volume-weighted average price in the last five minutes of regular trading hours, including closing auction prints of all markets.

There is no way to determine whether the alternative pricing mechanism resulted in a better or worse price for the fund, Mr. Saluzzi said.

“It definitely does cause a lot of issues for many people,” said Mohit Bajaj, director of ETF trading solutions at WallachBeth Capital. He said the lack of settlement pricing could hamper traders’ efforts to fulfill end-of-day orders or close out their books at the end of the trading day.

NYSE Arca said at 8:59 p.m. that a subset of securities listed on Arca failed to conduct a closing auction or transition from the regular trading session to the late trading session at 4 p.m. on Monday afternoon. NYSE Arca suspended trading at 4:13 p.m. and canceled all open orders.

“The underlying cause of the disruption has been identified and remediated,” the exchange said in the Monday night alert, without specifying what the problem had been.

Any exchange-traded fund investors who wish to file a claim for compensation must do so by 9:30 a.m. Tuesday morning, the exchange said.


—Gunjan Banerji contributed to this article.


Das Knowhow Kapital

Ricardo Hausmann
. Zuma



JOHANNESBURG – It has been a quarter-century since apartheid ended, and 23 since the African National Congress took power in South Africa. But, as President Jacob Zuma reported in his recent State of the Nation Address, the country’s whites remain in control.
 
“White households earn at least five times more than black households,” said Zuma, and “only 10% of the top 100 companies on the Johannesburg Stock Exchange are owned by black South Africans.” Whites still represent 72% of top management. The Gini coefficient, a widely-used measure of inequality, shows no sign of falling and remains one of the highest in the world.
 
These outcomes come after 14 years of a strong affirmative action program known as Black Economic Empowerment (BEE), which created all sorts of incentives and constraints to foster black participation in ownership, management, control, skills development, procurement and entrepreneurship. White equity owners were required to sell shares to blacks in equity deals that were often highly leveraged and publicly financed.
 
But, Zuma argues, the outcomes fall short of the goal set in 1981 by the ANC’s then-president, Oliver Tambo, who sought to achieve economic emancipation, through “a return [sic] of the wealth of the country to the people as a whole.” This goal should be achieved by “radical economic transformation,” which means, according to Zuma, “fundamental change in the structure, systems, institutions, and patterns of ownership, management, and control of the economy in favor of all South Africans, especially the poor, the majority of whom are African and female.” The country needs to confront what he and others have called “white monopoly capital.”
 
What Zuma seems to seek is radical asset redistribution in the direction suggested by Julius Malema, leader of the Economic Freedom Fighters and an admirer of Venezuela’s chavista approach. There, Hugo Chávez and his successor, Nicolás Maduro, nationalized oil, steel, cement, telecoms, banks, agricultural land, dairy companies, and supermarket chains, and invested in state-led joint ventures to produce cars, electronics, white goods, and myriad other products. Output in each industry collapsed, and the consequences for Venezuela have become catastrophic.
 
In a world where inequality is a major concern and appetite for radical change is high, what should the world make of these experiences? Why have both Venezuela and South Africa failed to achieve what their leaders sought?
 
Much of the thinking that inspired Zuma, Tambo, Chávez, and Maduro goes back to Marx. For them, and for current thinkers like the French economist Thomas Piketty, the economic world consists of two fundamental substances: capital and labor. Owners of capital control the means of production, which bestows on them power over labor. Emancipation, as Tambo called it, implies the “return of the wealth of the country” – ownership of capital – to its rightful owners, either directly, or through a state that represents them.
 
But capital, like the future, is no longer what it used to be. It has now become a cheap and abundant commodity. If you don’t own it, you can rent it.
 
The 40 largest firms listed in the Johannesburg Stock Exchange are predominantly “owned” by foreign institutional investors. Another 12.5% of the market is “owned” by the Public Investment Corporation of South Africa, which manages the Government Employees Pension Fund. From this perspective, the fact that individual black investors, according to Zuma, already own 10% of the stock market is impressive, given the predominance of institutional, not individual, investors. But the obsession with “black” equity ownership, besides making a few plutocrats super-rich, does not seem to be delivering “emancipation.”
 
The problem is that production requires not just capital and labor, but also knowhowa factor of production ignored by Marx and his acolytes. Knowhow is the capacity to perform tasks. It exists only in brains. It comes in incredible diversity, including cooks, auditors, plumbers, chiropractors, and web designers.
 
Knowhow is transmitted and accumulated slowly, mostly on the job, through a protracted process of imitation and repetition: learning by doing. A positive aspect of South Africa’s BEE policy is that it requires companies to recruit a racially more diverse team of managers and workers, so as to allow once excluded groups into the knowhow accumulation process.
 
But a manager with 20 years of experience cannot be created overnight. However radical a transformation you want to achieve, knowhow cannot be expropriated or nationalized. It cannot be extracted, like teeth, from the brains that possess it now.
 
Knowhow can, however, be fired, the way Chávez fired 300,000 years of experience from the oil industry in 2003. It can be scared away, too, as has happened with over 500,000 whites in South Africa. And it can be impeded from moving in, through, for example, South Africa’s tight immigration and labor policies.
 
When knowhow is shunned, production collapses, as it did in Venezuela and Zimbabwe. The problem, however, is not only the firms that exist; equally important are those that do not, because they were never founded or did not expand (if they had, South Africa would not be lacking the nine million jobs its people are seeking).
 
South Africa risks following in the steps of Zimbabwe, Venezuela, and Algeria, where post-independence or revolutionary governments inherited a stock of knowhow located in the brains of people the new leaders may not have liked. Use it or lose it, and the attempt at “radical transformation” implied losing it, through emigration and exclusion. In the process, the leaders made knowhow scarcer, causing its price to rise and society to become both poorer and more unequal. The attempt to “return the wealth to the people” ended up immiserating them.
 
The alternative is to overcome past divisions by forging a new, more inclusive definition of “us,” one that acknowledges the potential contribution of the knowhow that exists, in the heads where it exists, and ensures that it can flow to a broader segment of society over time.
 
Ultimately, the question is whether South Africa, like Zimbabwe, sees itself as a black African nation with a few unfortunate impurities, or as the “rainbow nation” promoted by Nelson Mandela, a country that is stronger because it builds on its knowhow and celebrates its diversity.