Going back to basics


Going back to basics

A cryptocurrency (e.g. Bitcoin) is proving to be the best asset class for the Covid-19 infected FY21. Most cryptocurrencies have yielded astronomical returns in a year that suffered the worst synchronized global recession since the great depression of the 1930s. Against this, the traditional safe-haven Gold, Swiss Franc (CHF), USD, and US Treasuries have yielded an insignificant return. USD Index (DXY) in fact has declined over 10% YTD FY21. Silver is the only traditional asset, besides equities, that has yielded a strong return in the past 11 months.

Regardless, the overwhelming consensus amongst global strategists appears to be favoring gold and silver as overweight in the asset allocation of non-institutional investors. Most wealth managers and investment strategists are suggesting up to 15% allocation to gold. Many globally popular and prominent traders, chartists, and strategists have suggested a massive bull market in Silver in the next couple of years

Meeting with a senior asset allocator last week was quite revealing in this context. The gentleman advocated 10% allocation to gold, besides 10% allocation to global equities (mostly US equities). He strongly advised avoiding cryptocurrencies; though he expects a rather lucrative trading opportunity in silver. On a little deeper probing, he offered the following rationale for his asset allocation strategy:

(a)   Given the status of quantitative easing (money printing) by major central banks, global hyperinflation is inevitable. It is only a matter of time when the prices of all real assets and commodities explode. In these circumstances, gold will provide a safety cushion to the portfolio.

(b)   Stagflationary situation in the US could lead to a sharp depreciation in USD value and chances of a return to a gold standard could enhance.

(c)    Gold-Silver ratio is breaking out on technical charts. From a 10yr high of 120, the ratio has already corrected to 60. Technically it is expected to test the 10yr low level of 30 in short term. This implies a sharp rise in silver prices.

(d)   Unwinding of monetary stimulus would also lead to the unwinding of carrying trade in USD and EUR. This may lead to a reversal of flows away from emerging markets to developed markets. Therefore buying some developed market equity is desirable. It is also desirable from (i) diversification viewpoint and (ii) strategic viewpoint, i.e., to take a stake in global businesses doing very well.

His arguments were quite convincing on the first hearing. But on second thought these left me more confused than ever. What I could not understand from his detailed presentation was:

(a)   If a hyperinflationary situation does materialize as popularly believed, won’t I have many serious problems to deal with. How 10% gold will solve these problems?

(b)   If USD and EUR get debased due to excessive money printing, INR will naturally appreciate against USD. Since gold is mostly priced in USD terms, won’t no appreciation in gold in USD terms will get neutralized by appreciation in INR vs USD.

(c)    What is the guarantee that gold does not suffer from the same malaise as USD? Is it totally improbable that the physical stock of gold has been leveraged many folds to issue paper gold?

(d)   Why can’t the targeted Gold-Silver ratio be achieved through a fall in gold prices rather than a rise in silver prices?

(e)    If USD and EUR do get debased, why would an alternative currency not emerge to maintain stability in global trade?

(f)    Since anticipated hyperinflation is mostly expected to be the outcome of a supply shock rather than a demand surge, a further dose of quantitative easing might be in order to encourage the building of new capacities. If that is the case, then the whole premise of higher yields and hyperinflation might fail.

(g)    If USD and EUR debasement is a serious concern, then how does investing in global equities make sense?

(h)   A hyperinflationary condition may lead to material monetary tightening in India. Higher rates shall then warrant serious de-rating of equity valuations which are assuming a prolonged period of lower rates and lower inflation. Even real estate may also suffer from poor demand due to higher rates in that case. We may need to worry more about INR debasement in that case rather than USD or EUR!

Many more such questions bothered me for a couple of days before I reminded me of the following basic learnings from the first chapter of my investment strategy book:

1.    India has 1.38bn people who need to eat & wear clothes, want decent healthcare, and aspire to have a decent shelter of their own. These needs and aspirations will continue to create many decent investment opportunities for me in India for the next few decades at least.

2.    A tiny investor like me should never bother about diversifying the investment portfolio too much. A totally unproductive commodity like gold and mostly unknown animals like foreign equities are for large investors and traders with a much stronger risk appetite. I should be happy with ordinary assets like high-quality domestic equity (businesses which I can see and feel every day); debt to my government and some large corporates; a house for myself; a share portfolio of good rental properties, and some liquid money in the bank. Chasing a few extra bps of returns is meaningless and fraught with risk which I can hardly afford. I cannot afford to risk even a single penny for earning few bragging rights.

3.    An information that has traveled seven seas to reach a commoner like I has no-arbitrage value. If I know that USD hegemony is under threat; hyperinflation is on the anvil; silver is going to rise astronomically, then I must strongly believe that these happening will NOT shock the markets in any manner whatsoever.

 Chart for the day

Author: Midas Finserve

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