Taal selectie

Pension funds

Central Bank

Pascal Blackburne, CIO 2020-05-01

“Extraordinary” monetary policies enacted during the 2007-2008 Great Financial Crisis (GFC) never actually came to be reversed – save for a brief attempt in the US, thwarted by President Trump. And this Covid-19 crisis is taking central banks a step further into uncharted territory, at the risk of becoming but the financing arm of (increasingly authoritarian) governments.

The European Central Bank is ruled by a set of treaties, specifically designed to protect the financial system. Right now, however, it is operating much as it likes. Sovereign debt purchases, for instance, are no longer being made according to a capital key that reflects each country’s weight in the EU economy. Rather, they are being targeted where necessary (read: Italy) so as to keep sovereign credit spreads under control. While not of the same media headline stuff as – say – the emission of “Coronabonds”, such underground action probably has a greater impact.

Across the Atlantic, the Federal Reserve is also engaged in a form of spread control. By extending the list of securities eligible for its – henceforth unlimited – asset purchase program to non-investment grade corporate bonds, it is effectively becoming the market maker in the high yield space too.

One can argue whether such unlimited buying of just about everything (which, incidentally, has been going on for many years in Japan) can be considered as “helicopter money”, “debt monetisation” or the roll-out of “modern monetary theory”. Strictly speaking, to the extent that the money created is backed by bonds that are held on central banks’ balance sheets, it is none of the above. Still, for all practical purposes, monetary authorities are now focused on a single goal: doing whatever it takes to keep interest rates near zero such that politicians can spend however much they want/is needed to avoid a depression.

This poses risks to the financial system, indeed even threatens to undermine some basic principles of democracy. For when a government has unbridled access to money, it can control who gets financing and at what cost, and it can make sure to work towards its own re-election. Importantly, the cost of financing encompasses not only the interest rate, but also the strings that will likely be attached to corporate loans/grants: requirements to make reserves, limitation of dividend payments, bans on employee layoffs, restrictions on executive compensation, etc. To date, such measures have been taken on a piecemeal basis but, just like after the GFC, they will no doubt become more systematic over time. The Western world system of free competition on an equal basis risks to be broken and, the longer it takes for a Covid-19 treatment to be found, the greater the damage to the system might be.

As such, we must admit that we struggle to understand the strength of the recent equity market rebound. Uncertainties remain high and picking the “right” stocks stands to become increasingly difficult over time. Many companies are struggling to survive and if consumption does not get back to normal soon a lot of them risk insolvency if they cannot get access to government aid. That said, with interest rates durably near zero, where else but equities can investors look to? Some carry opportunity on high yield bonds perhaps, now that central banks are effectively underpinning spreads. Alongside exposure to risky assets, we would be careful, however, to hold protections in portfolios.

The appeal of (Physical) Gold

Were the monetary system to really become endangered, physical assets would be the better place in which to “hide”. Real estate obviously springs to mind, but has the disadvantages of being illiquid, impossible to move and an easy prey to greater taxation. Which leaves gold as an interesting alternative.

Indeed, the first three months of 2020 saw gold-backed ETFs post record quarterly net asset growth in dollar terms (USD 23 billion) and their largest quarterly tonnage gain since 2016 (298 tonnes). Just during March, gold ETFs added 151 tonnes, closing the month at a new all-time high of 3,185 tonnes. Demand for physical gold, meanwhile, has been held back by a frozen jewellery market, owing to the global economic situation.

Furthermore, and contrary to what occurred late April in the oil space, delivery issues in the futures market could actually work in favour of investors holding physical gold or gold backed ETF’s. With the functioning of gold mines impeded by the public health crisis (vs. a massive oil oversupply) and an increasing number of gold futures buyers wanting actual delivery (vs. no one wanting to take delivery of oil, due to lack of storage space), the gold price could quite possibly experience upward spikes (vs. a plunge into negative territory in the case of oil) ahead of contract expiration dates.

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