Gold: a hedge against future policy misfires

A new exchange traded commodity holds several advantages

David Stevenson

© Andrey Rudakov/Bloomberg

Gold has recovered some of its lustre as the go-to asset for turbulent times in the past few weeks. The immediate catalyst for rising prices is obvious to all but a cave dweller: the dreaded coronavirus.

There is a more interesting story lurking in the background, but one which, as something of a gold bear, I have struggled to accept. The first part of it is familiar to anyone who has ever stared at those amazing charts which show where global wealth is hoarded.

Property in all its shapes and guises towers over bonds and then equities. Gold at around $7tn is an afterthought in asset allocation terms.

This powers the narrative of gold bulls such as Incrementum, an asset manager which paints a picture of gold being an underowned asset at a time of unorthodox central bank intervention.

Gold bulls also point out that central banks, especially Russia’s, have been quietly hoovering up supplies even as traditional physical holders such as the Indian middle and lower classes liquidate their hoards.

So yes, gold is underowned but on its own that doesn’t mean very much. It could remain underowned for many more moons to come.

The next bit of the narrative is more technical. Look at any chart for the gold spot price and you’ll see that for much of the recent period — since 2013 at least — the precious metal has traded in a range between $1,150 to $1,350. Last summer it surpassed $1,400 and is now heading towards $1,700. Crucially, gold is now trading firmly above its 20- and 200-day moving average.

But this breakout has no parallel in terms of price volatility.

The main gold volatility index, ticker GVZ, has for long periods from 2017 through to the summer of 2019 traded in the 10 to 13 range but even with its latest breakout, price variability remains historically low. This is crucial.

A “safe haven” only feels safe if the price of said asset isn’t shooting around like crazy every few days or hours (unlike crypto and digital currencies).

The last leg of the story is that gold feels more and more like a hedge against that central bank unorthodoxy I mentioned earlier. Many years ago I wrote about one of the few gold-only funds managed by hedge fund manager Ben Davies who is still influential in those circles. He was also co-founder of gold app Glint.

He nicely summed up the case for gold last week, saying: “Asset classes, specifically US indices, are experiencing what the infamous Austrian economist, Ludwig von Mises termed the ‘crack-up boom’.

This is a manifestation of rising inflationary pressures as a function of excess periods of freely available cheap credit. Gold is underpinned by the same excess and rising negative real rates and at less than 2 per cent of global financial assets, holdings or the value of gold are set to rise significantly over the next few years.

”In layman’s terms, gold might be a great bet if you think that all that central bank loosening will at some point end in ignominy. That said, I’d be extraordinarily cautious about betting against further central banker ingenuity. Helicopter money, for instance, could make an appearance in the next recession.

It’s against this benign, arguably positive, backdrop for gold that we’ve seen a new product launch in the market here in the UK. The Royal Mint, in collaboration with specialist white label issuer HanETF, has launched a new exchange traded commodity (with the ticker RMAU).

Gold ETCs that own actual allocations of physical gold are not new and there is plenty of competition in this space. Some of the big ETF issuers boast either much bigger products in terms of assets under management — such as Wisdom Tree and its long established Gold Bullion Securities structure — or cheaper structures, especially Invesco and iShares with their 19 basis point charge.

This new product may be slightly more expensive, but it has a number of advantages. The first is the entity behind the product: the UK government, which has owned the Royal Mint for many hundreds of years.

Interestingly, this isn’t the first mint-backed gold product. In the US market the Perth Mint also sells a physical gold tracker product. For me that governmental backing is a killer advantage for ordinary private investors.

Another is the location in Wales, well away from big cities where most existing vaults are located. There’s one other plus: you can take physical delivery of bars and coins, with the latter being particularly unusual. This can be done in some circumstances with Gold Bullion Securities but not with the other peers in this competitive sector.

I’d also note that this product features gold that is only sourced responsibly based on new rules set out by the industry in 2012. Plus, pricing is based on a much smaller equivalent amount of gold. Each share entitles the holder to 1/100th of a fine troy ounce.

So, though you’re paying marginally more than the competitors for holding the shiny stuff, my hunch is that these more intangible benefits are quite literally worth their weight in gold — and even more if central bankers really do face a policy crisis in the coming years.

David Stevenson is an active private investor. He has interests in securities where mentioned.


The politics of pandemics

All governments will struggle. Some will struggle more than others

TO SEE WHAT is to come look to Lombardy, the affluent Italian region at the heart of the covid-19 outbreak in Europe. Its hospitals provide world-class health care. Until last week they thought they would cope with the disease—then waves of people began turning up with pneumonia.

Having run out of ventilators and oxygen, exhausted staff at some hospitals are being forced to leave untreated patients to die.

The pandemic, as the World Health Organisation (WHO) officially declared it this week, is spreading fast, with almost 45,000 cases and nearly 1,500 deaths in 112 countries outside China.

Epidemiologists reckon Italy is one or two weeks ahead of places like Spain, France, America and Britain. Less-connected countries, such as Egypt and India, are further behind, but not much.

Few of today’s political leaders have ever faced anything like a pandemic and its economic fallout—though some are evoking the financial crisis of 2007-09 (see article). As they belatedly realise that health systems will buckle and deaths mount, leaders are at last coming to terms with the fact that they will have to weather the storm.

Three factors will determine how they cope: their attitude to uncertainty; the structure and competence of their health systems; and, above all, whether they are trusted.

The uncertainty has many sources. One is that SARS-CoV-2 and the disease it causes, covid-19, are not fully understood. Another is over the status of the pandemic. In each region or country it tends to proliferate rapidly undetected.

By the time testing detects cases in one place it will be spreading in many others, as it was in Italy, Iran and South Korea. By the time governments shut schools and ban crowds they may be too late.

China’s solution, endorsed by the WHO, was to impose a brutal quarantine, bolstered by mass-testing and contact tracing. That came at a high human and economic cost, but new infections have dwindled. This week, in a victory lap, President Xi Jinping visited Wuhan, where the pandemic first emerged (see article). Yet uncertainty persists even in China, because nobody knows if a second wave of infections will rise up as the quarantine eases.

In democracies leaders have to judge if people will tolerate China’s harsh regime of isolation and surveillance. Italy’s lockdown is largely self-policed and does not heavily infringe people’s rights. But if it proves leakier than China’s, it may be almost as expensive and a lot less effective.

Efficacy also depends on the structure and competence of health-care systems. There is immense scope for mixed messages and inconsistent instructions about testing and when to stay isolated at home. Every health system will be overwhelmed. Places where people receive very little health care, including refugee camps and slums, will be the most vulnerable. But even the best-resourced hospitals in rich countries will struggle.

Universal systems like Britain’s National Health Service should find it easier to mobilise resources and adapt rules and practices than fragmented, private ones that have to worry about who pays whom and who is liable for what.

The United States, despite its wealth and the excellence of its medical science, faces hurdles. Its private system is optimised for fee-paying treatments. America’s 28m uninsured people, 11m illegal immigrants and an unknown number without sick pay all have reasons to avoid testing or isolation. Red tape and cuts have fatally delayed adequate testing (see article).

Uncertainty will be a drag on the third factor—trust. Trust gives leaders licence to take difficult decisions about quarantines and social-distancing, including school closures. In Iran the government, which has long been unpopular, is widely suspected of covering up deaths and cases. That is one reason rebellious clerics could refuse to shut shrines, even though they spread infection.

Nothing stokes rumour and fear more than the suspicion that politicians are hiding the truth. When they downplay the threat in a misguided attempt to avoid panic, they end up sowing confusion and costing lives. Yet leaders have struggled to come to terms with the pandemic and how to talk about it. President Donald Trump, in particular, has veered from unfounded optimism to attacking his foes.

This week he announced a 30-day ban on most travel from Europe that will do little to slow a disease which is already circulating in America. As people witness the death of friends and relatives, he will find that the pandemic cannot be palmed off as a conspiracy by foreigners, Democrats and CNN.

What should politicians do? Each country must strike its own balance between the benefits of tracking the disease and the invasion of privacy, but South Korea and China show the power of big data and mass-testing as a way of identifying cases and limiting their spread. Governments also need to anticipate the pandemic, because actions to slow its spread, such as banning crowds, are more effective if they are early.

The best example of how to respond is Singapore, which has had many fewer cases than expected. Thanks to an efficient bureaucracy in a single small territory, world-class universal health care and the well-learned lesson of SARS, an epidemic of a related virus in 2003, Singapore acted early. It has been able to make difficult trade-offs with public consent because its message has been consistent, science-based and trusted.

In the West covid-19 is a challenge to the generation of politicians who have taken power since the financial crisis. Many of them decry globalisation and experts. They thrive on division and conflict. In some ways the pandemic will play to their agenda. Countries may follow America and turn inward and close their borders. In so far as shortages crimp the world economy, industries may pull back from globalisation—though they would gain more protection by diversifying their supply chains.

Yet the pandemic also puts doctors, scientists and policy experts once again at the heart of government. Pandemics are quintessentially global affairs. Countries need to work together on treatment protocols, therapeutics and, it is hoped, a vaccine. Worried voters may well have less of an appetite for the theatrical wrestling match of partisan politics. They need their governments to deal with the real problems they are facing—which is what politics should have been about all along.

What The Hell Is Going On?

by: The Heisenberg
- The Dow fell into a bear market (at least intraday) on Wednesday, another session that found the benchmark down more than a 1,000 points.

- This "yo-yo" price action is not as inexplicable as it seems, and regular readers are acutely aware of the dynamics that are exacerbating things.

- And yet, considering the circumstances (which are, in a word, extraordinary), I wanted to pen another "guide for the perplexed."

"What the hell is goin' on?," my accountant half-shrieked, when I called him on Wednesday morning to make sure he'd filed my corporate return.
Norbert (not his real name, but close) is a lot like the rest of you: Flabbergasted by the sheer scope of the daily gyrations in US equities.
But, as regular readers are acutely aware, these "yo-yo" swings (as it were) are not wholly inexplicable.
Obviously, the coronavirus scare is the proximate cause of the market's consternation, but the stage was set for this kind of wild price action once we lost the vaunted "gamma pin" after options expiry last month.
It was at that point that stocks were "unshackled."
On February 24, I penned the following headline: "Gamma Collapse Opens Door For COVID-19 To ‘Shock-Down’ Stocks."
Time-stamp that, folks. Time-stamp it and put it on a chart. Or, actually, don't bother.
Because I did it for you:
To hijack and adapt one of the many memorable quotes from the Coen brothers' immortal classic The Big Lebowski: "Do you see what happens, Larry? Do you see what happens when dealers' gamma profile flips negative?"
On the morning of February 24, I wrote that the virus outbreak and still elevated equity valuations "need to be considered against a post-Op-Ex reality that finds the 'gamma pin' (colloquially: the force that’s kept spot 'sticky' and acted to damp volatility) losing a good bit of its influence."
That's a point I reiterated in multiple posts for this platform, including one that day (i.e., on February 24) and another one less than 48 hours later.
There was still some skepticism among readers about the extent to which this quant-ish (if you will) arcana "matters," but I imagine some of that skepticism has evaporated over the past week. As I wrote on March 8 in these pages, "any explanation you read purporting to explain [recent volatility] that doesn't reference gamma squeezes, systematic flows, a lack of liquidity provision and/or a dearth of market depth, can be dismissed out of hand."
Against that backdrop, things really didn't need to get any more precarious for markets, but they did anyway over the weekend, when the Saudis slashed OSPs across-the-board, sparking a price war with Putin in retaliation for Moscow's recalcitrance in Vienna last week. That facilitated the largest single-day collapse in crude since 1991.
The phrase "insult to injury" doesn't even begin to capture it.
Coming off the weekend, we were still miles away from levels that would flip dealers' gamma profile back positive and otherwise create a situation where systematic flows would again be supportive of markets. We had already thrown gas on the proverbial fire. The oil collapse was like tossing a grenade into a raging inferno.
"Imagine being a market maker who sold puts to major E&Ps and was already staring into the abyss after the last two weeks’ -25% move [and] now having to sell futures deep in-the-hole off the reopen gap lower last night/today," Nomura's Charlie McElligott wrote, on Monday morning, following a truly chaotic session in Asia.
Over the weekend, in the second linked post above, I mentioned that credit was starting to crack late last week. Just about the last thing a nervous credit market needed was a 30% collapse in crude prices.
I'll make two quick points in that regard.
First, CDX IG spreads (think of CDX.IG as the investment grade "fear gauge") jumped the most since Lehman on Monday. But that's not even the most astonishing part. Rather, the really shocking statistic is that the move wider was anomalous compared to the move lower in equities which was itself the largest move since the crisis.
Have a look at this scatterplot:
(Bloomberg, h/t Luke Kawa)
Second, high yield energy spreads ballooned 342bps wider on Monday.
That is the largest percentage move in history.
High yield CDX had a six standard deviation move that morning.
What does that mean? Well, it means that the market believes some folks are likely to run into operational difficulties going forward. And that's me being very euphemistic.
Again, that was insult to injury or, as SocGen put it in a Wednesday note which brings it all together, "the final blow." Consider this passage from the bank's latest volatility update:
The sharp drop in equity prices on 24 February sent the dealer positions deep into negative gamma territory, leading to daily amplitudes not seen since 2011. After that, all the other drivers went into play and enhanced the vol pick-up: deleveraging from passive funds (risk parity and vol.- target), short covering in the VIX market and forced selling in various assets to meet mark-to-market constraints among others. The plunge in the oil price came as the final blow.
That captures everything noted above - the negative gamma dynamic, the subsequent deleveraging from vol.-targeters, the forced selling and the "death blow" on Monday with oil's historic collapse.
The following visual from SocGen shows you the large absolute moves (i.e., higher and lower) in stocks since February 24 in the context of the gamma discussion. Note from the caption below the chart that the "Speed Index" is the spot move needed for aggregated gamma to flip from positive to negative when the Speed Index is negative (and vice versa).
Of course, once the benign dynamic wherein dealer hedging flows tamp down the selling in stocks "flips" (i.e., once dealer hedging begins to exacerbate directional moves instead of dampening them), it sets the stage for the kind of wild price action that drives up volatility, which in turn depletes market depth, in a pernicious feedback loop.
The "gamma trap" and the inverse relationship between market depth and volatility are two of the main reasons why you've seen such a dramatic escalation during this COVID-19/OPEC+ panic.
As alluded to in the excerpted passage from SocGen (and as I've detailed on countless occasions), it doesn't stop there.
Once spot careens through key levels for CTA trend and momentum strats, they deleverage into a falling market. That "abrupt unwind propagates their own negative momentum," to quote JPMorgan's Nikolaos Panigirtzoglou.
Once trailing realized starts to move higher, the vol.-targeting universe deleverages "passively" (if you will), and that selling continues to execute in the market until volatility resets sustainably lower or they run out of exposure to trim. Consider, for instance, the following updated visual:
In the space of roughly a month, the target-vol. universe has pared its exposure to equities to the tune of some $130 billion. Looking back three months, it's almost $200 billion.
Now then, if you're wondering what's going on during sessions like, for example, Tuesday, when stocks explode higher, you'll note that once some catalyst (in Tuesday's case, it was Trump promising to deliver an economic stimulus package to offset the hit to the economy from the virus containment measures) gets things moving, the same underlying market setup/dynamics work to accelerate the upside.
Consider, for example, this excerpt from the above-mentioned McElligott (from a Tuesday morning note):
Today has the feel of a standard “bear-market rally,” where selling is increasingly exhausted, monetization of dynamic hedging in futures shorts turns into a rather violent “squeeze”; as stated repeatedly, the enormous “Short Delta” via SPX / SPY options (-$560B, 0.6 %ile since ’13) will continue to act as a “core” catalyst for these raging UP trades (despite still-horrible sentiment and outlook from clients) as these options “have to” be monetized when they’re this in-the-money, especially as they’re expensive to roll.
All of the above has created a perfect storm for volatility and generally manic market action, the likes of which many current market participants have simply never witnessed before. After all, Lehman was nearly a dozen years ago, which means someone who's, say, 25 now, was just 13 years old when I was dumping the "gin-soaked ice cubes" in Mikey and Becca's sink.
Importantly, it's not just young folks who are shell-shocked. There is still a generalized unwillingness among many market participants to come to terms with what the evolution of modern market structure entails during periods of panic.
And just as I wrote that last sentence, the following headline crossed on the terminal:
I'll just leave it there for now.

Buffett and Occidental: We’ve Seen This Movie Before

Occidental boss Vicki Hollub’s hubris delivered a rich payday to Warren Buffet’s Berkshire Hathaway

By Spencer Jakab

Occidental Petroleum Chief Executive Vicki Hollub overextended herself when she got into a bidding war for Anadarko Petroleum last year. / Photo: alessandro della valle/Shutterstock .

Warren Buffett once quipped that it isn’t until the tide goes out that you see who has been swimming naked.

U.S. energy-industry executives are surely praying that the ebb tide is nearly over, and few as fervently as Vicki Hollub, who runs Occidental Petroleum. OXY -17.71%▲

Ms. Hollub doubled down last year on the U.S. shale patch with extraordinarily poor timing by outbidding much larger Chevron for Anadarko Petroleum for $37 billion.

Chevron got lucky by losing out, proving once again that it is better to be lucky than smart:

Who could have predicted a coronavirus pandemic and a Saudi-Russian price war?

But Ms. Hollub was decidedly not smart. She was so desperate to win that she boosted the cash portion of her offer to avoid a shareholder vote and left her company exposed, forcing it to cut its dividend for the first time in three decades after she said it wouldn’t.

Mr. Buffett isn’t only a sage voice in this story—he played an instrumental role by giving Ms. Hollub nearly enough rope to hang herself. His $10 billion in preferred stock used to finance the deal, worth almost as much as the entire company, pays him $800 million annually.

Ms. Hollub’s predicament is reminiscent of another executive who did a deal with Mr. Buffett after recklessly endangering a storied company: Andrew Liveris of Dow Chemical. In the summer of 2008, he got into a bidding war for specialty-chemical firm Rohm and Haas and financed it in part by agreeing to the sale of part of Dow to a Kuwaiti state firm.

Once markets collapsed, it pulled out. and Mr. Buffett’s Berkshire Hathawayput up $3 billion in convertible preferred stock that later gave him 6% of the company. Dow cut its dividend on its common stock for the first time in nearly a century to squeeze by.

Ms. Hollub may not be as fortunate as Mr. Liveris, who retired recently as the company’s longest-serving CEO. Financier Carl Icahn, who blames Ms. Hollub for the debacle, revealed to The Wall Street Journal on Wednesday that he has raised his stake in the company to 10%. Occidental OXY -17.71%▲ should survive at least, though possibly at the cost of seeing Mr. Buffett convert some of his preferred stock cheaply to common equity. He always seems to appear when corporate America gets caught with its pants down.