March 26, 2012
[Editor’s note: Tim Price, a frequent Sovereign Man contributor and Director of Investment at PFP Wealth Management in London, is filling in for Simon today.]
Acclaimed screenwriter William Goldman (The Princess Bride, among many others) famously began his autobiography with three telling words: “Nobody Knows Anything.”
The same logic would seem to apply to much conventional reporting of the financial markets. Any investor looking for informed analysis of market developments can therefore save themselves a few minutes every day by choosing not to read any of the ‘Companies and Markets’ section of the FT, which typically constitutes a fantastic piece of fiction.
(If there is a more thankless task in finance than trying to explain why certain markets did what they did yesterday, we don’t know what it is… unless it’s working in the PR department at Goldman Sachs.)
But as Soc Gen’s Dylan Grice has frequently pointed out, human beings are suckers for stories. We seek meaning from just about everything, and financial markets are no exception. Why else would otherwise rational people shell out ¬£2.50 every weekday just to read a selection of vapid and contradictory speculations about recent market price action?
At the risk of going out on a limb, here is our own inherently subjective “take” on the current market environment: Investors seem to believe that the euro zone debt metastasis has gone into remission. There is an uneasy calm to both equity and bond markets– it feels like the calm before the storm.
Both Goldman and Barclays have issued research notes recommending equities over bonds. It is certainly difficult to get excited about G7 government bond markets except from the perspective of shorting them. As Stratton Street recently observed, there are over $10 trillion in marketable US government securities, yet their average yield amounts to less than 1%.
But it might yet be dangerous to adopt Goldman’s binary response which is to advocate blanket support for stocks. This is not a black vs. white issue; just because most government bond markets are uglier than sin does not automatically justify going ‘all in’ on the stock market, even as deposit rates remain painfully thin.
We nurse an ongoing fear that equity markets are being largely supported by the inflationist antics of central banks. This may have led to many investors becoming addicted to the effects of cheap credit, and they may not like it when cheap credit is ultimately withdrawn.
But whatever is driving equity sentiment, there are undoubtedly pockets of value for those with the stamina and patience to embrace them. In Don Coxe’s latest and typically excellent letter, “All Clear?”, he highlights the opportunity in precious metals mining companies:
“If there were one over-arching theme at the BMO Global Metals & Mining Conference, it was that the gold miners are upset and even embarrassed that their shares have so dramatically underperformed bullion…
“On the one hand, they were delighted in 2011 when it was reported that since Nixon closed the gold window, a bar of bullion had delivered higher investment returns than the S&P 500 for forty years– with dividends reinvested. But some gold mining CEOs find it an insult that what they mine is more respected than their companies’ shares…
“In our view, we have entered the most favourable era for gold prices in our lifetime, and the share prices of the great mining companies will eventually outperform bullion prices.”
Gold remains one of the most widely misunderstood assets in the investible world. Indeed, it may be better to refer to it as a means of saving that does not expose the saver to counterparty or credit risk or to the depredations of the monetary authorities.
As Don Coxe makes clear, governments are running deficits “beyond the forecasts of all but the hardiest gold bugs five years ago; central banks are printing money and creating liquidity beyond the forecasts of all but the most paranoid gold bugs a year ago.”
The choice for the saver is essentially binary: hold money in ever-depreciating paper, or in a tangible vehicle that has the potential to rise dramatically as expressed in paper money terms.
Gold prices have now softened, offering investors yet another chance to get back on board what is perhaps the most compelling form of money- and portfolio insurance available.
Why large cap gold miners are being so undervalued by equity investors relative to gold is an open question that takes us back to the realms of stories. That the discount exists is undeniable; all that is required to crystallise that value, we believe, is patience.