The Albert call

The view from a long-standing stockmarket bear

The risks of a hard landing in China remain, and the euro will break up

IN UNCERTAIN TIMES Albert Edwards is someone you can rely on. For more than two decades, latterly as global strategist at Société Générale, he has been a steadfast prophet of gloom. As he stood to address the 400 or so investors gathered at his annual conference (or “bear-fest”) in London this week, he made a typically confident forecast. “We work at a French bank,” he said. “So we’ll be sure to get you away by five o’clock.”

That was the only cheerful prediction of the day. His colleague Andrew Lapthorne and guest presenter Gerard Minack (formerly of Morgan Stanley and a kindred spirit) struck similar notes. The core message has not changed much, but neither has Mr Edwards’ popularity. With unfailing regularity he is ranked number one in his category in surveys of global investors. He admits to getting it wrong a lot. But his talent for imagining the worst is valuable. If you have a vague anxiety, Albert will give it form. “When I’m right, it’s very painful,” he says.

Like a lot of non-conformist preachers, Mr Edwards started out in the lower clergy, or the finance profession’s version of it—as a researcher at the Bank of England. He has scarcely had a good word since for the established church of central banking. In the early noughties, when a callow Buttonwood was a colleague, he charged Alan Greenspan, the Federal Reserve chairman, with near-criminal negligence for his easy-money policy. At a sales meeting, he likened Japan’s policy of quantitative easing (QE) to necrophilia: if the economy is twitching, it does not mean it has come back to life. At this week’s bear-fest he scoffed at the confidence central bankers have expressed in their ability to reverse QE.

When Mr Edwards first developed his “Ice Age” thesis in the 1990s, he stood out from the general cheerleading of stockbroker strategists. The template was Japan. Debt and disinflation would lead to rising bond prices (and falling yields). At the same time, there would be a “derating” of equities, so that prices would fall relative to earnings (and the earnings yield would rise). One part of this was right. The trend in bond yields has been down (see chart). But the derating of equities did not happen. This was because of “massive, massive QE”, he explains.

Now that QE is being withdrawn, it is no surprise that markets are jumpy. Recessions of recent vintage began when a fairly modest tightening in monetary policy led to a blow-up in finance, he argues. High levels of corporate debt in America mean the next one will be deep. Mr Edwards is no more sanguine about other economies. The risks of a hard landing in China have not abated. And the euro is doomed to break up. Mr Edwards cites a survey that shows how younger Italians are far more hostile to the European Union than older ones. Italy’s steep unit-wage costs militate against the jobs the young crave. Trapped in the euro, it cannot easily lower them.

When things get rough, what then? “Fat-cat QE” has led only to rising asset prices, reckons Mr Minack. Politicians will instead turn to “People’s QE”, a policy (favoured by Jeremy Corbyn, leader of the opposition Labour Party in Britain) of personal tax cuts paid for by printing money. Mr Edwards concurs—but of course he goes further. When recession bites, “Corbyn will be seen as a moderate!” The pressure on policymakers to do something will be hard to resist.

To protect themselves, investors should favour cash and gold. Mr Edwards thinks the yields on Treasuries will plummet to below zero in the next recession. So bonds will offer protection in the short term. But they will suffer a painful reckoning, if the authorities are eventually able to create inflation. Mr Lapthorne puts in a word for Japan as the best equity market to be in, comprising as it does cheapish, profitable firms that have run down their debts.

Mr Edwards is often dismissed as a perma-bear. It is true that he does not update his views very often. In this he resembles an old-school Marxist or a modern-day Eurosceptic. They all believe that in the end they will be proved right; the twists and turns in the meantime are of minor importance.

In at least one sense Mr Edwards is already vindicated. His pet themes of disinflation, the dangers of debt, the vices of central bankers and the perils of complacency are now also found in the PowerPoint packs of rival strategists. There were hints at the bear-fest of a post-Ice-Age era, in which bonds are to be avoided and inflation hedges are the thing to own. Until then, the message is the same as always. The world is ending. But at least you’ll be home in time for tea.

Europe is an alliance, not a union of values

Internal divisions are less powerful than the external pressures keeping members together

Gideon Rachman

Throughout the Brexit process, Britain has tried to split the other 27 EU member states. But it has failed. Much to the surprise of the authorities in London (and probably Brussels, too), the European Union has lived up to its name — and stayed united.

This display of unity over Brexit is not an accident or a one-off. On the contrary, it says something important about why the European project is much more resilient than its critics realised. The 27 small and medium-sized nations that make up the EU have a powerful shared interest in protecting the European single market.

That strategic imperative is only going to become more pronounced in a world shaped by two superpowers — the US and China. Both Washington and Beijing are increasingly using trade and investment as a political weapon. As individual nations, the EU27 know they can be picked off by the superpowers. But, as the world’s largest cross-border market, the EU knows that is has comparable weight to China and America and can push back.

If America decides to impose car tariffs on European producers in the coming months, the EU can respond with measures imposing comparable pain on the US. The EU is also taking unified action against China’s forced transfer of technology. And it has responded to Russia’s annexation of Crimea by imposing sanctions that cover the whole of the EU single market.

There is no doubt that there are deep divisions within the EU. Poland is being sued by the European Commission for straying from democratic principles. The Italians and the French are feuding over budgets and borders. The Hungarians and Germans are at loggerheads over refugees. Greece was almost thrown out of the euro.

But the internal divisions pulling the EU27 apart are less powerful than the external pressures pushing them together. This simple point is sometimes missed, even in Brussels, because the EU likes to call itself a union of “values”. However, the idea that EU leaders are united by shared values is increasingly hard to maintain. Viktor Orban, the prime minister of Hungary, and Matteo Salvini, the deputy prime minister of Italy, have a lot more in common with Donald Trump in the US (or even Vladimir Putin in Russia) than with Emmanuel Macron or Angela Merkel, the French and German leaders.

The Italian, Hungarian and Polish governments are also fond of the anti-Brussels rhetoric favoured by Britain’s Eurosceptics. But that does not mean they will diverge from the Brussels line in the Brexit negotiations. They understand that their economic and strategic interests are much better served by sticking with the EU27.

In that sense, the EU looks increasingly like an alliance built on shared interests than a union of values. Talk of alliances tends to cause shudders in Brussels because it is redolent of warfare in Europe. But in the 21st century, European countries have a clear interest in allying with each other, rather than against each other, as in the past.

Thinking of the EU as an alliance also clarifies another vexed question — the loose talk of a “ European army”. The formation of such an army is unlikely because the EU is not a unitary state. But a close military alliance, perhaps with a mutual defence clause, does look feasible.

Until the advent of the Trump administration, talk of an EU military alliance would have seemed either redundant or dangerous — since it might undercut Nato. But Mr Trump’s apparent questioning of US membership of Nato makes it only prudent for Europeans to think harder about making their own security arrangements.

The EU is still a long way from being a military superpower and may never get there. But it is already a global player in trade and business regulation. That is important because, in the nuclear age, superpowers are more likely to struggle with each other by economic rather than military means. The European Commission is already at the forefront of challenging the monopoly power of big Silicon Valley companies such as Apple, Amazon, Facebook and Google. And the commission is now also looking at new ways of policing Chinese corporate takeovers in Europe.

However, China, in particular, is expert at breaking the unity of an alliance by offering inducements to the weakest link. That strategy is on display in Beijing’s Belt and Road Initiative, which seems set to offer particularly juicy projects to smaller EU states in eastern Europe. They might then be persuaded to vote against EU policies getting tougher on China.

But the EU will survive the occasional division over policy towards China or the US. The fact is that the package of benefits that the EU provides can never be replicated by the US or China.

The European single market offers proximity, size, legal certainty, freedom of movement of people and a vote on new laws and regulations. That is why countries such as Poland and Hungary — which love to complain about Brussels — are highly unlikely to risk leaving the EU.

There are some in Warsaw who predict that Poland will, in fact, walk out of the EU the moment that generous EU payments to Poland cease. But the reality is that even net contributors to the EU budget lose a lot if they leave. Just ask Brexit Britain.

The 2018 Year in Gold Recap, and What It Might Forecast for 2019

Jeff Clark, Senior Precious Metals Analyst, GoldSilver

While a myriad of forces pushed the gold price around in 2018, it basically ended the year flat.

This report recaps the year in gold, shows how it compared to other asset classes in both short and long timeframes, and explores the factors to watch in 2019.

2018: A Tie Between the Bulls and Bears

The gold price traded in a fairly tight range in the first quarter of 2018, mostly between $1,300 and $1,350. Then it began to decline sharply in the second quarter, largely due to higher equity prices and strong GDP figures. It fell particularly hard from April through August (a seasonally weak period for the yellow metal), declining 15% from $1,365 to an 18-month low of $1,160.

Once volatility returned to equity markets and global growth worries emerged, gold gained 10% from August to year end. December saw a 5% rise, gold’s strongest month since January 2017. It ended the year down 1.1%, its first annual decline since 2015.

As can be seen, the only asset class that rose last year was the US Dollar (and inflation). Gold was not the only investment that ended the year in negative territory, actually holding up better than most.

A strong US dollar, typically a headwind for gold, gained 4.7% in 2018. The US/China trade conflict pushed the US currency higher, along with the steady rise in interest rates.

Despite the tug of war in the gold market, volatility measures of the metal were near 10-year lows in 2018, only slightly higher than in 2017.

Meanwhile, gold remained one of the most liquid asset classes in 2018.

This high liquidity continues to provide a high degree of functionality to investors.

With 2018 in the record books, let’s widen the picture to examine gold’s long-term performance.

Gold in Context: The Long-Term Picture

Over the past two decades, gold has experienced both bull and bear markets. Here’s how its performance compares to stocks and bonds since the champagne was popped back on New Year’s Eve 1997.

This has practical considerations. A simple $10,000 buy-and-hold investment in gold in 1998 has yielded a greater return than stock and bond investments.

Of course, gold’s greatest strength as an investment is most prominent when it is combined with these assets, since it tends to be inversely correlated, especially with the equity markets.

Given that context, what could be ahead for gold this year?

What to Watch for in 2019

There are a number of factors and events that could potentially influence the gold market in 2019. Here are some of the most likely.

US Dollar: Depreciation Ahead?

A number of analysts have called for the US dollar to depreciate in 2018.

• Morgan Stanley reports that “large economies such as Europe, Japan and China are now investing less in global financial markets, so demand for the US dollar will likely reduce. That's significant because the US is running both fiscal and current account deficits, so the country needs buyers for the bonds that it sells.”

• Goldman Sachs’ foreign-exchange strategy team believes the greenback is approaching a peak.

• Credit Agricole sees a weaker dollar after Democrats took control of the House of Representatives.

• Citi writes that the greenback “may more than reverse 2018’s rally over the medium term.” The bank predicts 12% downside versus other major currencies, citing the flattening yield curve as a signal of weaker economic growth.

• Mike McGlone, commodity strategist at Bloomberg Intelligence, says mean reversion in the dollar will be the theme in 2019, which would favor gold. “It’s unlikely for 2019 that the dollar will remain atop the list of best-performing assets… the markets appear in the transition phase of passing the bull market baton from U.S. stocks to commodities.”

A weaker US dollar is a favorable condition for gold. When you add the possibilities of a slowing economy, falling oil prices, a stabilizing yuan, and tighter liquidity in U.S. markets, a weaker US dollar seems more likely than a stronger one in 2019.

Interest Rates: Will Hikes Slow or Even Stop?

Long-term bonds appear to be signaling that the Fed is likely done raising short-term rates. As further evidence, CME Group’s FedWatch Tool showed the first week of January that there was an 87% probability the rate would either stay at the current level or be lower by the end of 2019. Bets the rate would rise over the next 12 months have dropped to just 12%.

If US rate raises stop or reverse, gold would be more attractive, especially if real rates remain flat or negative. Globally, the amount of negative-yielding debt climbed over 46% in Q4 2018.

The flattening of the yield curve is also something to watch, particularly if it inverts, since this is frequently viewed as a sign of impending recession. Gold is typically sought as a safe haven during periods of negative economic growth.

Stock Market: Risk Is Greater to the Downside

After a 9-year non-stop run, it wouldn’t be surprising for stocks to take a breather, if not tip into a full-blown bear market. As former Fed chairman Alan Greenspan said recently, “It would be very surprising to see the stock market stabilize here and then take off.” Markets could still rise, he said, but the ensuing correction would be painful: “At the end of that run, run for cover.”

Strong words, but if his diagnosis turns out to be correct, the Fibonacci retracements based on the recent high in the S&P suggest lower stock prices are ahead.

Has a bear market already started? According to Hedge Fund Research, hedge funds collectively lost over 7% in 2018, the industry’s worst year since 2011.

At a minimum, volatility in the financial markets seems likely to continue. Falling stock prices and market turbulence have historically pushed increasing numbers of investors into the safe haven asset of gold.

To be continued, tomorrow…

Oops! An Awkward Jobs Report for the Fed

The Federal Reserve said the case for raising rates had weakened. Then came the jobs report.

By Justin Lahart

A key manufacturing index bounced back in January.
A key manufacturing index bounced back in January. Photo: eric johnson/Reuters 

The Federal Reserve just told us it isn’t planning any more rate increases. The job market may have something to say about that.

The Labor Department on Friday said that the economy added 304,000 jobs in January — far more than the 170,000 than economists expected. Even with the caveat that employment growth over the previous two months was lowered by a net 70,000 jobs, that counts as a big surprise.

The government shutdown was on, after all, and it is likely that government contractors’ temporary layoffs depressed the payroll count. It did help lift the unemployment rate to 4% from 3.9%, the Labor Department said — a move that seems likely to reverse itself now that the shutdown is over.

The strength in the job market stands in contrast to survey-based reports that have been flashing warning signs on the economy. It is beginning to look as if those measures were sending a false signal: On Friday, the Institute for Supply Management reported that its manufacturing index, which had registered an unexpectedly large drop in December, rebounded last month.

This suggests that recent signs the economy is weakening have been driven more by a temporary decline in confidence than anything concrete. Of course there could still be trouble lurking — employment is a lagging economic indicator so it may not reflect the reality of what is happening on the ground. Another couple more months of jobs strength would extinguish any doubt, though.

The way Fed Chairman Jerome Powellframed it on Wednesday, the data will have to give the central bank a reason to raise rates — an economy that is doing fine and a notion that the appropriate level of rates is higher isn’t enough. As long as inflation stays contained and asset markets don’t start getting bubbly, that gives the Fed some latitude to stay on hold.

But if the recent pace of job growth continues, the unemployment rate will start pushing lower again, while wage growth will keep drifting higher. So long as the economy is able to get past some of its near-term challenges, such as the possibility of another government shutdown later this month, it could get much harder for the Fed to stand pat.

Mr. Powell may find that the unexpectedly dovish message on rates he delivered this week was a mistake that could prove difficult to get out of.

The Saga of the Kuril Islands

Russia and Japan are talking about a peace treaty once again.

By GPF Staff

It’s been more than 70 years, but Russia and Japan still haven’t worked out a peace treaty over World War II, thanks to the Kuril Islands. The Russian and Japanese foreign ministers met in Moscow on Jan. 14 to discuss concluding a treaty on the disputed islands that’s been in the works since 1956. Japanese Prime Minister Shinzo Abe and Russian President Vladimir Putin agreed last fall to tackle the issue, but with no guarantees. Negotiations have yet to produce any changes, and Tokyo and Moscow still have significant differences over the treaty.

According to the Soviet-Japanese Joint Declaration of 1956, Moscow would discuss transferring the islands of Shikotan and Habomai to Japan, contingent on the signing of a peace treaty over World War II. Japan, however, will consider signing such a treaty with Russia only once territorial issues are resolved. Today, Tokyo insists on the return of Iturup, Kunashir and Shikotan islands, along with the Habomai archipelago, to Japanese control. These islands’ position enables Russia to claim the Sea of Okhotsk as internal waters, and Moscow continues to demand that Tokyo recognize its claim to them. Russia refuses to discuss the sovereignty of the Kuril Islands, since transferring the contested islands – Iturup and Kunashir, in particular – would undermine its position in the Far East.