Toxic financial waste is back, bigger and badder...
SO WHAT will the financial markets do next?
wonders BullionVault's Adrian Ash at the mid-point of 2020.
Same as ever, according to one long-time hedge fund trader I know.
"The market will do whatever it takes to mess up the most people the most," he forecasts yet again...
...using a far less polite word than 'mess'.
If so, the trick to staying solvent and sane would be the same as cutting your risk of second-wave corona.
Spot where the crowds are gathering, and go in the other direction.
First up, government bonds.
"The mainstream view is that central banks can rescue their economies now without destabilizing prices in the future,"
says Bloomberg, pointing to how the really big investment money keeps pouring into government bonds...
...driving up prices...
...and so driving down interest rates...
...because no one fears the return of inflation any time soon. Not enough to stop buying fixed-income assets.
Of course, those plunging interest rates have also pushed money into other, more risky assets than government bonds.
Take the pensions industry for instance. To pay you a monthly income out of your retirement savings, your pension provider needs to invest those savings in something that also pays out an income.
But with government bonds now paying so little...less than zero in fact on a huge chunk of Japanese and Eurozone debt, even before you account for today's sub-2% per year pace of inflation ...your pension fund manager has to go elsewhere to find an income-paying investment.
Hence the boom in corporate debt...driving up bond prices...driving down the interest rates those bonds offer...and so driving pension fund managers ever further into ever higher-risk bonds.
Note how,
on this chart, the left-hand axis is inverted, upside down. It rises as the rate of interest offered by Eurozone government bonds falls towards zero.
So too does the proportion of Dutch pension savings held in lower-rated, higher-risk corporate debt.
Okay, so the amount of corporate debt rated only as BBB...what used to be called "junk"...
has also grown over the last 10 years.
So maybe pension funds in the Netherlands simply reflect what is available for them to buy.
But the huge demand for higher-risk stuff...all in the name of trying to find a positive rate of interest...has spawned a huge new bubble all of its own.
"Unless you work in finance, you probably haven't heard of CLOs, but according to many estimates, the CLO market is bigger than the subprime-mortgage CDO market was in its heyday."
CDO stood for 'collateralized debt obligation'. Those weapons of mass destruction took sub-prime mortgages and hid them among better-rated debt. They played a huge role in inflating and then exploding the banking bubble during the 2000s. Paul Tustain here at BullionVault christened them
"investment landfill"...
...a way for finance professionals to dump their toxic waste onto savers like you and me by making it sound all too tasty to the people running your money.
CLO now stands for 'collaterised loan obligation'...the very same toxic brew of leverage and debt, piled on top of debt and leverage...
...and lacking the very same 'toxic hazard!' warning that CDOs should have carried.
The CLO market is now estimated to be 30% larger than the CDO market ever was. And "loan defaults are already happening," says Partnoy of the US corporate loan market underpinning this junk.
"There were more in April than ever before. It will only get worse from here."
Of course, the fact that you may not (yet) have heard of CLOs acting as landfill on your own bank's balancesheet...or even of BBB bonds leaching into your retirement savings...means that not everyone has rushed to join these crowds.
"Not every bank has loaded up on CLOs," says Partnoy. Wall Street heavyweights from Pimco to AllianceBernstein meantime say "inflation is a problem that's bound to return," reports Bloomberg.
But in the main, and scanning the beach, those two issues of massive debt and betting against inflation look like they're merging into a single cluster of trouble.
Tourists have also gathered in gold as well, of course, as
we explained last week to readers of
Investment International.
Despite record-heavy inflows however, the size of betting and leverage in other markets...not least the stock market...makes gold look like pretty tame by comparison.
Take last Thursday for instance.
Stocks were down 2 days running. The news only got worse.
"I've rarely seen so many negative news stories for the market in one day,"
said someone.
Yet in the last hour, stocks surged...
Or take Monday morning's horror at the Karachi Stock Exchange in Pakistan.
Armed lunatics...apparently claiming to want a new, independent country formed in the desert province of Balochistan...attacked the KSE with grenades, killing 2 guards and a policeman before being shot dead by security forces.
Next day Pakistan's prime minister Imran Khan blamed fellow nuclear-armed neighbor India, saying "There is no doubt that [New Delhi]
is behind the attack."
Yet the
KSE100 share index, target of the murderous attack? It rose 0.7% on Monday, rose again on Khan's claims on Tuesday, and has risen each day since as well.
So forget a global pandemic, economic shutdown, US-China trade war, even direct terrorist attacks. Just what might it take to push this bull market in equities over?
"Cash levels are really high,"
notes MarketWatch of US investors, pointing to a record $4.8 trillion in money-market funds, plus a record $15.4 trillion in bank deposits...up by $2 trillion from March anbd way above the levels of early 2009, when this bull run in US equities began.
"Those numbers suggest a lot of investors who sold the March sell-off never got back in. They are itching to do so, which means they will support the market in any significant decline."
Perhaps. Or maybe it just means we'll get one more blow-off top in the financial markets...
...with the fear of missing out and the terror of a guaranteed loss of value driving all that cash into tradable assets as the US and UK central banks flirt with the negative rates' madness
already at work in Japan and Europe.
One man's bubble is another's dead-cert safe haven of course. And falling interest rates have proved very good for gold demand and prices...because unlike cash in the bank, gold has never paid any interest. Indeed, you should expect to pay a small charge for secure storage and insurance. So lower rates paid to cash or bonds mean a smaller opportunity cost for holding physical bullion instead.
Negative rates go further, in that they give the rare, indestructible metal...as well as its cousins silver and platinum...a simple advantage over official currency. Unlike cash on deposit, central banks cannot shrink the quantity of gold you own as your physical property.
That's why bullion demand has leapt among Eurozone savers since the European Central Bank introduced its negative rate policy in 2014. I expect UK and US demand to repeat that, growing even further from 2020's surge, if the Bank of England or US Fed resort to sub-zero rates after throwing the kitchen sink at new QE, direct business loans, and yield curve control.
Over the 6 years since the ECB first cut its key deposit rate below zero, the proportion of first-time
BullionVault users living in the Eurozone has risen from 29.0% to 34.8% of all new clients. Within that, Germany's share of the Eurozone total has almost doubled from 17.2% to 32.8%.
That's telling, because Germany is famously a nation of risk-averse savers. Negative rates are forcing cautious households to seek shelter in bullion. (Household savings are among the strongest of any developed nation, running at 11% of total disposable income on OECD pre-Covid data, against less than 8% for the US and zero for the UK.)
Die-hard gold investors never trust the fiat money system, of course. But central bankers seem hell-bent on making gold bugs of us all as their 'unconventional' policies grow ever-more desperate.
