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Why Gold Is A Monetary Asset, and Not A Commodity – Mike Coleman, Director, RCMA Group

Transcript from Opalesque Singapore November Roundtable 2016

Mike’s biography could be found at: http://www.rcma.com/leadership-mike
5 Jan 2017

Mike Coleman: Precious metals are very different. I deliberately don’t talk about gold because we don’t trade precious metals. My personal view is that gold is a monetary asset, it’s not a commodity, and so gold is telling you more about real interest rates and, if you like, the integrity of the global financial system. We tend to emphasize fundamentals over macro and while yes, an inflation environment might be good for commodities, but demand trumps that. So yes, you might have stagflation developing but the stag part of stagflation will make it very difficult for commodity prices in real terms to do very much. Therefore we think that the utility of most commodities as an inflation hedge is quite questionable. Commodities are a good hedge for commodity-induced inflation such as the oil shocks of the 1970s.

Historically, commodities have actually not been a particularly good hedge for other types of inflation, but gold probably is. In the stagflation environment, maybe gold is quite all right. From a more macro level, you had the massive deflation and China’s growth scare at the beginning of this year. Since then you’ve had a big rally in emerging market equities, emerging market currencies, commodities, emerging market debt – in essence, it’s all in the same trade. Some people are saying, “Okay, this is the end of the 30-year dollar bond bull market. We’re moving into inflation or maybe stagflation and therefore let’s load up on gold and buy real assets.” I’d caveat that when it comes to commodities because in stagnation, the demand is not going to be there. But maybe just as people have piled into UK and Singapore property as a quasi-currency and store of value, maybe yes, maybe people will be willing to invest and store inventories of copper and rubber, and crude oil as an inflation hedge.

When we talk about asset classes, we are not sure that commodities are an asset class. They are a trading opportunity, and they are negative income producers. A commodity costs money to store therefore there is no expectations of a positive return on a buy and hold strategy.

At a broader level it seems to me we are moving to a world where everybody has to become a trader. That’s great for us, because we are traders and have always been. As commodity traders, we have grown up in a world where you’re trading a thing which has, as I mentioned, no expectation of real returns. If you look at the last 200 years of real commodity prices, there’s actually a declining trend in real prices. As economies become more sophisticated, the intensity of commodity use per unit of GDP tends to fall, and over time, producers tend to get more efficient in producing. Therefore, the long-term trend is downward for real commodity prices. If commodities were an asset class, it’s an asset class that tends to fall in real value.

Often, the better returns are to be made by being short in the commodity because there is a much symmetrical outcome of falling to rising prices than you would expect from bonds or equities. So generally, with bonds and equities, over time you expect the price to rise and you are receiving an income in the form of coupons and dividends. And therefore, being an investor, this means that buy-and-hold works.

For commodities, buy-and-hold absolutely does not work because of the negative cost of carry and even in a bullish environment, if the time structure of the market stays in carry, you can still lose money.

A classic example this year is WTI front month futures which have risen from US$ 37/bbl at the beginning of the year to around US$ 45.00/bbl today. This apparent gain of $8.00/bbl has actually been entirely consumed and more by the cost of storage reflected in the negative roll cost. The USO ETF that reflects a constant investment in front month futures has fallen 10%. So, for commodities, you can’t be buy-and hold.

Our proposition would be that the best thing to do is to give it to a good manager. The second best thing is to engage with a robo-advisor and maybe an optimized index solution provider. But again, my broader observation is that because of zero interest rate policy, everything in the investment world as a whole is being turned into a trading paradigm. The only way that you generate a return now is by trading, and that can be by selling volatility or going long or short commodities or buying negative yield bonds for capital appreciation. But, this is also a very scary world, because by definition it’s a zero-sum game. For every winner there’s a loser on the trade, and empirically most people are not good at it.

Well, again, in a way you would like to think, yes interest rates have reached their lows. I remember reading an article several years ago saying, “For 20 years, we in the West have criticized the Japanese for doing a terrible job. In fact, we should be congratulating them for the fantastic job they’ve done and that nominal GDP has been positive every year.” In the face of massively negative demographics, the Japanese have really done a good job in a massive deflationary environment. We will be lucky if we do half as good the job, and at the moment it looks like we’re not.

Of course, there are also lots of reasons why we are not Japan, but if you look at this belief in the optimism of infrastructure that suddenly if we build loads of bridges in America or in Europe, well, Japan has been doing that, the country is concreted over.

Back to my earlier comment, I think it’s a very scary world, and in a way I am happy that we are traders and don’t make our money by making investment decisions. We are focused on the next three or six months, but occasionally in my reflective moments, I ponder over the big picture stuff that’s going on, for example in demographics and the aging of the developed world population. Clearly, that is a major secular theme that’s playing out. What is the real normalized interest rate?

In many ways, it’s quite scary how we are replaying the 1930s. So, for the first time this year, global trade will fall in nominal value, so the actual numbers of containers shipped and ton-mile shipped possibly since the Great Depression.

You’re also seeing this in politics. I actually think “populism” is too polite a word. There are “strong” men promising the return to some mythical past, blood and soil nationalism, denigrating the institutions of democracy, targeting minorities. I mean, anybody with any historic appreciation of what happened in Europe from the end of the First World War to the beginning of the Second World War can see the parallels. Yes there aren’t armed militias battling on the streets yet, but maybe in the modern world, you don’t need that.

From a market’s point of view, I think we have reached the high point of globalization and open markets. I believe this is a huge challenge for all of us in our business. The pendulum swing from let’s say the mid ’70s until the global financial crisis, which was all about freeing capital and free movement, reducing, if you like, the value and power of labor. That swing seems to have reached its political limits and is beginning to reverse.

Singapore is a canary in the coal-mine, and you saw it in the 2011 general election in Singapore when the government were forced to focus on the concerns about the negative costs of, in Singapore’s case, too rapid growth in terms of higher immigration levels and strain on public services and questions of equity and growing inequality. But the broader theme is really how the wealth is being shared. And so that theme is out and running around the world, and therefore, I would say that the expectation is that we will see more trade barriers. Maybe you will start to see exchange controls coming back and more control on the flow of people. England voted for Brexit, in my opinion, largely on the immigration issue. So while intellectually it’s a very interesting time to be engaged in markets, it’s also really very worrying.

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