What Should We Then Expect (From Investing)?

By John Mauldin

“Plans are worthless, but planning is everything.”

—US President Dwight D. Eisenhower

There are many versions of that Eisenhower quote he learned in the Army. Nixon, who probably heard it from Eisenhower directly, modified it to “… plans are useless, but planning is indispensable.” Both are variations on the theme, “No battle plan survives first contact with the enemy.”

Today we’ll look at what we should expect from our investing. In case you haven’t noticed, financial markets are really a giant expectations game. A company can report great quarterly results and still get crushed if earnings are less than analysts expected.

I have talked about this before: All economic, budget, and investment models are based on assumptions. Those assumptions generally use past experience to project the future. I actually heard a well-respected Federal Reserve economist admit that forecasts using the Phillips curve are fraught with problems. When asked, “Then why do you keep using it?” the (paraphrased) answer was, “We need something to base our projections on. We don’t have any other better model, so we use it.” Knowing their method will deliver faulty results, they still use it anyway.

During World War II, Nobel laureate Ken Arrow was assigned to a team of statisticians to produce long-range weather forecasts. After a time, Arrow and his team determined that their forecasts were not much better than pulling predictions out of a hat. They wrote their superiors, asking to be relieved of the duty. They received the following reply, and I quote: “The Commanding General is well aware that the forecasts are no good. However, he needs them for planning purposes.” 

With that acknowledgment, and since we are going to discuss potential future investment returns for your own planning purposes, it is important to recognize the choice of which data you use, which assumptions you make, and which models you select will have a big influence on your plans and thus your outcomes.

Let me make one obvious, at least to me, point. Many financial advisors, when developing retirement plans, use a simple long-term average of the stock market. They often assume a 7% or 8% growth in the equity portion of a portfolio both pre- and post-retirement.

I think the data shows that is an extremely unwise assumption. If your investment and retirement plans assume such results, I suggest you reconsider. Maybe find a financial planner or software program with a bit more sophistication.

All Models Are Wrong, but Some Are Useful

The above heading is often attributed to the statistician George Box. My goal today is not to help you create an accurate model, but a useful one. One-size-fits-all assumptions about future returns are worse than useless. They are misleading and potentially dangerous. I hope to help you avoid that result.

This process is really just a collision of hope and reality, and it’s inevitable because (sorry if this shocks you) none of us know the future. We can make reasonable forecasts, but they’re always uncertain.

But here’s the important point. We need context with which to greet the uncertain future. That’s why Eisenhower, Nixon, and so many others have said that planning is essential, even if we don’t know the future.

I had a real-world example last week when visiting with Andy Marshall. In the 1970s, he was one of a few to argue that Soviet GDP was likely a fraction of CIA and State Department estimates. Was he right in all its particulars? I think he would say no, but he had the direction right and following his guidelines in defense planning delivered a much better outcome for the US.

So I don’t want anyone to read this and think I’m against planning. It is critical to the process. We just need to be very careful about where we get our inputs. Our government’s official analysis of Soviet GDP was bad input. The data Andy relied on was much better and eventually proved more correct.

Last week in How Should We Then Invest?, I said the next decade will be profoundly and deeply different than the past, and we will get different results than most people expect. That raises the question, different in what ways? What are these expectations I think will prove wrong?

I want to dig into that question a little deeper, and maybe offer some ideas to raise your expectations. But as you’ll see, you may not want to raise them too much.
Starting Valuation Matters

As noted, our inability to foresee the future is both a problem and an opportunity. While I’m fairly confident in my 10-year forecast of increased volatility and eventual bear market, I can’t rule out a shorter-term market melt-up before the meltdown. Bull markets end when optimism peaks, because at that point everyone who is going to buy into the market has done so. Then prices have nowhere to go but down.

What could cause a market melt-up? What if the Trump administration announces a resolution with China and the May government in the UK announces a successful Brexit deal? Combine that with recent Federal Reserve dovishness, and a relief rally could quickly evolve into a melt-up. Of course, if all those circumstances turn negative, you could see the opposite.

As Benjamin Graham taught us, in the short run markets are a voting machine; in the long run they are a weighing machine. The short-run voting machine analogy is just another way to talk about optimism.

Fortunately, we have a way to measure optimism, beyond just a self-reported emotional state. Earnings multiples tell us what people are actually willing to pay for the expectation (but not the certainty) of future profits. High P/E ratios signal confidence. Very high P/E ratios signal overconfidence.

Occasionally, I feature the work of Ed Easterling of Crestmont Research. He has co-authored several letters and chapters in my books. I really pay attention to his important and useful research. Ed looks at market valuations of long periods and compares them to subsequent returns. Historically, the correlation is pretty tight. When you buy into the market at above-average P/E ratios, the next decade brings below-average returns, assuming you buy and hold the entire period.

Ed just updated his data for 2018, so here’s the latest.

If you buy when the orange valuation line is high, returns for the next 10 years (the green bar directly below) are generally less than impressive and sometimes dismal.

This shouldn’t be surprising. As Ed says, “Starting valuation matters.” If you overpay you will likely underperform. And if you bought into stocks prior to December, you probably overpaid. The time to buy is, like the saying goes, when blood is running in the streets. And that’s not now, last quarter’s volatility notwithstanding.

Empty Quarter

You can look at this in other ways, too. Rob Arnott’s team at Research Affiliates calculates 10-year expected returns for many asset classes based on expected cash flows and changes in asset prices, instead of extrapolating past returns.

Research Affiliates further calculates expected volatility, which lets them produce the classic risk-reward scatterplot below. The vertical axis is expected return, the horizontal axis is expected volatility. The ideal investment (high return, low volatility) would be in the upper left quadrant. Unfortunately, that area is blank.

Instead, we see a wide variety of asset classes clustered in the lower left, indicating low returns and low volatility. Rob’s forecast is pretty bleak if you want more than about 4% returns over the next decade. Some major pension plans (which assume 7% or more) will be in serious trouble if this is anywhere close to correct.

You can view more details and play with different scenarios using the interactive version on Rob’s website. I personally find the interactive version very instructive and, for this geek at least, entertaining and fun. Good luck finding better news, though.

Fun with Forecasting: Choosing Your Time Periods

Longtime readers will know that from time to time I post the seven-year asset class real return forecast from GMO. It was fairly accurate and useful from 2000–2007. Looking back from 2010, the GMO forecast was not as accurate or useful about future potential returns.

But this offers a teaching moment. It illustrates the George Box quote, “Essentially, all models are wrong, but some are useful.” The GMO model assumes some mean reversion. That is, valuations and thus returns will come back towards the long-term average. Let’s look at the actual forecast chart as of the end of 2018. Notice that some asset classes are projected to be negative.

Source: gmo.com

While the accuracy of this model seven years out is not entirely random, there is some dependence on future economic conditions, which are unknowable. For the seven years going forward from 2010, the markets faced the unknowable event of quantitative easing, which I think we would all admit changed valuations and stock market prices.

Even so, the useful part of the GMO forecast is not whether the projected returns are correct, but what they tell us about mean reversion. The market is a lean, mean reversion machine over long time periods. Short time frames (like seven years) can vary but we can have a great deal of mathematical confidence that the markets will eventually revert to the mean. Future returns may in fact change the “mean” to which markets will revert, but the fact that reversion will happen is fairly straightforward.

That means future returns will be lower than the long-term average. We are reaching a point of the cycle where mean reversion will become a bigger factor.

I had the pleasure today of listening to Howard Marks at the Tiger 21 conference in Boca Raton, where I will be speaking tomorrow. I should note that Howard will be speaking at my conference in the middle of May, which I will mention below.

Howard’s latest book, Mastering the Market Cycle, Getting the Odds on Your Side, is a must-read for investors. He talks about market cycles and getting them to work for you. While he thinks that we may be late in the cycle, we don’t really know the future or what “inning” it is. A direct quote: “We sometimes have a feeling for what is going to happen, but we never know when.” On stage this week, Howard kept emphasizing the concept of uncertainty.

Late in the Cycle

This next chart needs a little explaining. It comes from Ned Davis Research via my friend and business partner Steve Blumenthal. It turns out there is significant correlation between the unemployment rate and stock returns… but not the way you might expect.

Intuitively, you would think low unemployment means a strong economy and thus a strong stock market. The opposite is true, in fact. Going back to 1948, the US unemployment rate was below 4.3% for 20.5% of the time. In those years, the S&P 500 gained an annualized 1.7%.

Source: Ned Davis Research

Now, 1.7% is meager but still positive. It could be worse. But why is it not stronger? I think because unemployment is lowest when the economy is in a mature growth cycle, and stock returns are in the process of flattening and rolling over. Sadly, that is where we seem to be right now. Unemployment is presently in the “low” range which, in the past, often preceded recession.

It is certainly possible this time will be different in a good way. Maybe we can sustain low unemployment this late in a cycle and still see stocks deliver good returns. I wouldn’t rule it out. But I wouldn’t expect it, either.

Consistent with Ed Easterling’s chart, the time to buy is when fear—and the unemployment rate—is at its highest, not its lowest. That’s not the case now.

Removing Emotions

All the above examples are directed toward long-term portfolios. That’s not where most of us are. It’s true, at least historically, that “buy and hold” works well if you stick with it and if you allow sufficient time. But in my experience, very few investors can stick with it. They see their net worth shrinking, get scared and bail out, typically at just the wrong time. Then they re-enter at the wrong time and the cycle repeats.

There have been several historical periods where actual returns for 20 years were negative. Buy-and-hold starting in 1966 didn’t see a nominal positive return for 16 years, and it took 26 years to get an inflation-adjusted positive return. Most of us would think of 20 years as the “long term.” As the charts I’ve used above illustrate, your starting point really does make a difference in what your returns will be over the next 10–15–20 years.

So what do we do in the meantime? I have been arguing for some time that instead of the typical investment strategy of diversifying asset classes, we need to diversify trading strategies as our risk control. And as I’ve written and demonstrated numerous times, emotional decisions aren’t effective risk control. You need a quantifiable, non-emotional decision process.

If you are not using investment advisors that offer such an advantage, and you are running your own portfolio, the better approach, in my opinion, is to recognize this tendency and counteract it with a disciplined risk-management process. In most cases, that means removing emotions from the equation. But how?

There are all kinds of methods, but here’s one very simple one as an example. The 200-day moving average identifies an asset’s long-term price trend. You can use it to stay on the right side of the trend. Stay exposed when the current price is above the 200-day MA, get out when it drops below.

Is this perfect? No. It will make you miss opportunities and occasionally keep you in the market through a quick-developing plunge. But it doesn’t have to be perfect to improve your results. It just has to be better than what you would do on your own.

The lower part of this chart shows the Dow Jones Industrial Average total return (blue line) and the same Dow if you had entered and exited using a 200-day MA rule, going all the way back to 1900.

Source: Ned Davis Research

Note this is a log scale so the difference in dollars is even greater than it appears. Better yet, the difference in your mental state would have been incalculable as you missed the major bear markets and then got back in when the uptrend resumed.

Now, there are much more sophisticated versions of this strategy. Some are better than others. But again, I think even something this simplistic is much better than going it alone, particularly in the unprecedented, never-before-seen conditions I anticipate in the 2020s. The one thing we can be pretty sure about is the trends will change periodically, and every such change will be an opportunity for profit or loss.

This year in Dallas I will gather a number of close friends and some very famous and wise investors to talk about those very trends and opportunities.

Can It Get Any Better Than This?

Each year for the last 15 years at the close of the Strategic Investment Conference I have asked myself, “Can it get any better than this?” And each year it has. And this year will not be an exception.

Look at the lineup that will join me May 13–16 in Dallas: former president George W. Bush, Howard Marks of Oaktree Capital, Felix Zulauf, Carmen Reinhart, Jeffrey Sherman of DoubleLine, Louis Gave, Grant Williams, George Friedman, David Rosenberg, Lacy Hunt, and the inimitable Bill White. We just confirmed Liz Ann Sonders, the chief investment strategist for Schwab, along with data maven Peter Boockvar. Neil Howe and Pat Caddell will talk about demographics and politics in 2020. Plus more A-list speakers you can see on the website.

Conferences are my personal artform. I literally handpick and then craft an agenda that builds on itself. You’ll leave with specific investment ideas and an understanding of the world that you can’t get anywhere else. We cover geopolitical events, financial markets, housing, energy, market cycles, China, Europe, global and corporate debt, and more. This year there will be more interaction on the stage than ever between the speakers.

The biggest compliment I get? Not just the people telling me that it was the best conference they have ever attended, but over two-thirds of attendees have been to more than one conference. Many have been to more than five. There is a contingent of Aussies that comes from down under and has been doing so for many years. They tell me every year it’s the best ever. Each year the conference grows because attendees come back again and again.

We make sure that you get time to meet with the speakers, ask questions, and most importantly meet your fellow attendees and make lifelong friends. If you can, be there Monday evening to experience one of the exclusive “dine-around” dinners with speakers.

Right now, you can register at the early-bird discount. That price will go up soon, so don’t procrastinate. No other conference anywhere delivers as much information and economic thought power, tailored specifically for you. Join me as we think about the rest of this year and the 2020s beyond.

By the way, when you click on that link, scroll down a bit and watch the short video where I try to describe what a Strategic Investment Conference experience really is.

Puerto Rico, Dallas, Cleveland, Cleveland, Cleveland, and ???

I’m finishing this letter in Boca Raton, where I am speaking for the Tiger 21 conference. It has been an enjoyable time with many friends. Shane and I fly home to Puerto Rico tomorrow (it still seems odd to say that), and then back to Dallas later in February.

In March I will get my fair share of visiting the city of Cleveland. I have to go back-to-back weeks for eye surgery/cataract lens replacement, since the doctor doesn’t want to do both eyes on the same day, then again for a checkup. I may work in some media and small investor group meetings, if they’re just one flight away from Cleveland.

It’s time for the next conference session, so I will hit the send button. You have a great week!

Your trying to understand the cycles analyst,

John Mauldin
Chairman, Mauldin Economics

Palladium’s price strength risks becoming exhausted

The metal is more expensive than gold but technological change could tarnish its lustre

John Gapper

The other night at a dinner party in London, talk turned to how one of the couples had just been robbed of a precious metal. The target was not jewellery but the palladium in the catalytic converter of their hybrid car — the vehicle had been jacked and the device sawn off.

Criminals respond to markets as surely as everyone else and the theft of converters to strip for palladium, platinum and rhodium has become commonplace. As palladium has overtaken gold to become the most valuable precious metal, 5g of the silver-white element in some converters is worth £170. Who knew that a car exhaust could be so desirable?

When the metal you drive is worth more than the metal you wear, something odd is going on.

The rise in the price of palladium and fall in the price of platinum has nothing to do with vanity. Sales of diesel cars, which use platinum in catalytic converters, sagged following the Volkswagen emissions scandal; drivers have turned to petrol vehicles, which use palladium.

The volatility of “technology metals” in devices from catalytic converters to phones and batteries is exacerbated by scarcity: every shift in technology leads to big price swings. Gold can also be volatile but there is more of it, thanks to the breadth of demand from central banks, investors and married couples. Palladium and rhodium producers ought to sell more jewellery.

The rarity of elements such as palladium is not immutable — it is possible to uncover more. Aluminium was once so scarce that it was an act of symbolic extravagance to put a pyramid of it at the top of the Washington Monument in 1886 as a lightning conductor. As with nickel, which was scarce before the invention of stainless steel, demand can bring forth supply.

The plentiful supply of gold from many mines and an excess of speculative investment may be easing. Pained investors want gold companies to amalgamate and slim production: Newmont’s $10bn deal to acquire Goldcorp last week was accompanied by promises of greater discipline. Demand has revived and gold prices have risen after a period in the doldrums.

Buyers of platinum group metals, including palladium and rhodium, should be so lucky. It is hard to obtain palladium and Norilsk Nickel, the Russian metals group led by Vladimir Potanin, has not made it easier. Nornickel produces about 40 per cent of the world’s palladium (the metal is mined as a byproduct of nickel and platinum) and keeps supplies tight.

Mr Potanin has relaxed his grip slightly — Nornickel is now investing $12bn to increase its output of commercial metals 25 per cent by 2025. He also plans to create the world’s largest platinum group cluster in Siberia but is not in any hurry — the project is planned for the late 2020s.

One can see his point. The nickel price is far below its peak before the 2008 crisis and platinum has fallen since 2011. Nornickel and South African miners that supply palladium could gear up to meet today’s demand for catalytic converters, only to be caught out again.

The biggest risk is the transition to electric vehicles, which do not produce emissions or need converters. A gradual shift towards electric cars over decades, accompanied by tighter emissions standards in China, might sustain demand for palladium and platinum. A rapid change in consumer behaviour, encouraged by governments and carmakers such as Tesla, is perilous.

Warren Buffett, who specialises in investing for the long term, is placing a bet on electric. His company Berkshire Hathaway is discussing an agreement to extract $1.5bn of lithium each year from geothermal wells in California for use in vehicle batteries. Lithium is less scarce than palladium but the US still listed it last year as one of 35 minerals “vital to the nation’s security”.

This puts precious metals with narrow technological applications in a bind. Morgan Stanley estimates that catalytic converters accounted for 79 per cent of demand for palladium in 2016, making the metal vulnerable. Unlike gold, which is also bought by consumers (jewellery contributed 56 per cent of demand in the third quarter of 2018), it has nowhere else to turn.

Palladium producers can learn from the diamond industry, which has for decades cultivated a market that spans jewellery and industry. The jewel was helped by the power of De Beers, which came up with the advertising slogan “A Diamond is Forever” in 1948. About 30 per cent of platinum is also turned into jewellery but palladium and rhodium are relatively neglected.

As De Beers broadens its reach further by producing synthetic diamonds, the palladium price keeps rising amid a supply shortage. In the short term, that is nicely profitable for Nornickel and others; in the long term it risks volatility, and ultimately obsolescence. In such a tight market, parts suppliers will invest to substitute cheaper metals for palladium in converters.

Geology matters, but platinum group producers have a choice of how rare they wish their metals to be. One day, my friends could drive to a dinner party in an electric vehicle, wearing palladium jewellery.

A Smart Bank Strategy That May Have Peaked

UBS and rivals like Morgan Stanley have become asset gatherers, which was great while markets rose and rose  

By Paul J. Davies

One of the better bank strategies of recent years has been to focus less on deals and more on fees. That approach now faces a severe test.

UBS ’s fourth-quarter results, published Tuesday, were generally disappointing, but of particular concern for investors should be the trends seen in asset and wealth management, visible also in results from Morgan Stanley and BlackRock.
All three have endured some combination of asset outflows, lower financial-market valuations and a drop-off in trading by institutions and wealthy individuals. These problems have been driven by widespread worries about the economic cycle and more combative politics within and between countries, none of which are disappearing in the near term.

UBS’s group profits and revenue were worse than expected in the final quarter of 2018. Even in a tough quarter generally for investment banking, the Swiss bank’s equities trading, advisory work and underwriting looked poor compared with U.S. peers. The loss in September of its chief investment banker, Andrea Orcel, may have had an influence, though it is too soon to be sure.

But more disappointing for UBS investors will be the $8 billion in net outflows from wealth management in the final quarter, of which $4.7 billion was from the global superrich, who are banks’ most profitable customers.

Not only is money leaving the business, but investors did less with what remains: UBS’s transaction-based revenue in the business fell to its lowest quarterly level in a decade. Sergio Ermotti, UBS chief executive, said U.S. investors have almost a quarter of their assets in cash, a record high. In Asia, UBS avoided outflows, but clients cut their borrowing and slashed transactions too.
UBS has been focusing on growing repeat revenue from management fees or interest income in wealth management.

 UBS has been focusing on growing repeat revenue from management fees or interest income in wealth management.
UBS has been focusing on growing repeat revenue from management fees or interest income in wealth management. Photo: arnd wiegmann/Reuters

Overall, global wealth management revenue was down 2% in the final quarter versus the same period last year, a slightly better outcome than Morgan Stanley’s 6% year-over-year decline.

Both these banks and Credit Suissehave been reorienting their businesses away from volatile transaction-based revenue in both investment banking and wealth management and focusing instead on growing repeat revenue from management fees or interest income in wealth management.

This has been a great strategy while markets kept rising. But if they continue to stutter over coming quarters, then a shrinking asset base will hurt recurring revenues and earnings prospects for these banks as well as for managers like BlackRock. Asset gathering hasn’t had its day, but it may have had its best years for some time.

The Right Investments to Address the Human Capital Crisis

The world faces a growing human capital crisis that demands urgent attention. By making the right investments in people, especially the poorest and most vulnerable, we can help to give them the health, knowledge, and skills they need to realize their full potential.

Kristalina Georgieva  

kenya flooding school

WASHINGTON, DC – For 75 years, the World Bank has been at the forefront of development, helping countries make smart investments to prepare their citizens for the future. It has been particularly focused on the poorest and most vulnerable – their access to infrastructure, health, education, assets, jobs, and markets. In recent years, it has embraced policies and investment in areas critical for the world’s future, such as combating climate change and making technology work for the por.

Everywhere I travel – from Rwanda to Zambia, or from Indonesia to my home country, Bulgaria – I see the difference that technology can make in people’s lives. The impact is apparent in a multitude of ways, such as digital payment systems or the emerging gig economy, leading to remarkable success stories.

But just as technology is improving the lives of millions around the world, it is also changing the nature of work. Our 2019 World Development Report focused on how innovation is changing or doing away with existing jobs and launching entirely new fields of employment that didn’t exist a few years ago.

This raises some difficult questions: What jobs are people going to do? How will they support their families? How will they fulfill their potential in an increasingly complex world?

We have powerful new tools to help developing countries answer those questions. At the World Bank Group-IMF Annual Meetings in Bali in October, we launched the Human Capital Index. Initially covering 157 countries, the Index is a summary measure of the human capital that a child born today can expect to attain by age 18, given the risks of poor health and education where he or she lives.

The Index focuses on outcomes in three key areas. First, survival: What is the probability that a child born today will survive to age five? Second, health: Will children be stunted before age five? Will they be healthy into adulthood, ready for work, with a foundation for lifelong learning? And third, education: How much schooling will children complete, and more importantly, how much will they learn?

The Human Capital Index is unique because it focuses on productivity-linked indicators such as child survival, stunting, learning-adjusted years of school, and adult survival, and it draws a direct line between future economic growth and better health and education outcomes. Above all, it paints a clear picture for leaders of how much more productive their workers could be when they are healthy, educated, and equipped with the skills needed for a rapidly changing labor market.

A country can score between 0 and 1 on the index, with 1 representing the best possible frontier of complete education and full health. In our first index, the average value for the world was just 0.56. This means that, across the 157 countries covered, children born today will grow up to be roughly half as productive as they could be.

The implications for growth – and therefore poverty reduction – are enormous. If a country has a score of 0.50, its future GDP per worker could be twice as high if that country reached the frontier. Over a half-century, this works out to 1.4 percentage points of GDP growth every year.

Investing in people is even more urgent because of two challenging global trends. First, global growth is slowing. Our Global Economic Prospects report, released earlier this month, is appropriately titled Darkening Skies. Global growth has moderated – in 2019, it is expected to slow to 2.9%, from 3% in 2018. And growth in emerging markets and developing economies is expected to stall at 4.2%, the same pace as in 2018.

Second, the pace of poverty reduction is slowing. Our Poverty and Shared Prosperity report found that in 2015, the most recent year with robust data, extreme poverty reached 10%, the lowest level in recorded history. But the 736 million people still living in extreme poverty will be harder to reach. The poverty rate in areas suffering from fragility, conflict, and violence climbed to 36% in 2015, up from a low of 34.4% in 2011, and that share will likely increase.

Investment in human capital can help drive inclusive, sustainable economic growth. But this is not just the domain of health and education ministers. Heads of state, finance ministers, CEOs, and investors need to make these investments an urgent priority.

If we act now, we can create a world where all children arrive at school well-nourished and ready to learn; where they can grow up to be healthy, skilled, productive adults; and where they have a chance to fulfil their potential.

The children of today deserve this future. The employers of tomorrow will demand it. The leaders of the world owe it to them to act now.

Kristalina Georgieva is Chief Executive Officer of the World Bank.

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

Jeff Clark, Senior Precious Metals Analyst, GoldSilver

Debt: Not Slowing Down

While debt is always with us, the concern at this juncture is that debt creation is no longer fostering a significant amount of economic growth. Virtually every category of society is weighted down with unsustainable debt loads:

US Federal debt: In just 10 years, it has grown from about 60% of GDP to 104%.

Consumer debt: Credit cards, auto loans and student loans (excluding mortgages) just hit $4 trillion. This is an all-time high, and was $3 trillion just five years ago.

Student loans: Total student loan debt is now $1.6 trillion, an all-time high. Of particular concern is that this amount is now larger than the amount of junk mortgages in late 2007 (about $1 trillion). Further, default rates on student loans are already higher than mortgage default rates were in 2007.

Corporate bonds: Over the last decade, the amount of corporate bonds outstanding has almost doubled, hitting $9 trillion. And nearly $2.5 trillion of that figure is rated BBB, nearly triple the amount of 2008. This includes stalwarts such as G.E., AT&T, Campbell Soup, Bayer, CVS Health, Sherwin-Williams, IBM, and Keurig Dr. Pepper. The particular concern here is that it can be more difficult to manage or bail out corporate debt than sovereign debt.

Leveraged loan market: Collateralized debt obligations, or CDOs, were valued at $61 trillion globally in 2007, according to the Bank for International Settlements. Despite attempts to regulate this sector and avoid or limit the damage caused by these instruments in the financial crisis of 2008, the total leveraged loan market has since doubled, based on the S&P/LSTA Leveraged Loan Index. S&P Global stated that "risks attributable from this debt binge are significant.”

China: China had about $2 trillion total debt in 2000. Today, it’s about $40 trillion, an increase of 2,000% in less than 20 years.

The levels of debt reached in many areas of society are not realistically repayable, except in radically inflated currencies. Either way, any fallout from a debt event or crisis, or a return to QE efforts, would draw investors to gold.

There are also factors within the gold market itself that bear watching.

New Gold Supply: Decline Locked In

Mine depletion, geopolitical risks, start-up delays, and a lack of industry investment over the past several years all point to lower gold production levels going forward.

Pinched supplies of new gold stocks could impact the price.

There’s a related concern for the mining industry: due to falling ore grades, production costs will likely never return to where they were a decade ago. Production costs ultimately serve as a floor for gold prices. 
Central Bank Buying: Trend to Remain Up?

Despite some gold sales from Venezuela and Turkey in 2018 to offset currency declines (one reason why gold is so valuable), central banks have been net buyers since 2008.

While central banks in North America and Western Europe are not adding to their gold reserves, strong demand continues to be seen from Asia, Russia, Eastern Europe, the Middle East, South America, and Africa.

Investment Demand: The Ultimate Indicator

While retail demand for bullion hit an 11-year low in 2018, global fund holdings (including e-funds and depositories) remained buoyant.

Investment is the biggest variable among all demand sources. According to a Legg Mason survey of over 16,000 investors globally, a growing percentage cited gold as the best investment opportunity over the next 12 months. Roughly a quarter of those polled in Germany, Italy, Switzerland and the UK identified gold as the best investment opportunity. In the UK gold was seen as better than equities, bonds, cash, and alternatives.

As investment goes, so does the price.

The Hard Asset Hedge

Gold holds a distinct advantage over most paper assets. Gold…

• Is the best-performing asset over the last 20 years

• Can hedge against systemic risk, stock market pullbacks, and inflation

• Is a store of wealth

• Improves the risk-adjusted returns of portfolios, while reducing losses

• Can provide liquidity to meet liabilities in times of market stress

An appropriate balance of gold in a portfolio can serve as a useful hedge, particularly as we face ongoing risks in geopolitics, markets, currencies, debt, and interest rates.