Monday, July 20, 2015

Descending the Great Wall of Worry

This is an update to the first chart in my post last week ("A dozen interesting charts") with prices as of noon California time:

Gold is now breaking down to multi-year lows, as the prices of 5-yr TIPS trend lower as well (the chart uses the inverse of their real yield as a proxy for their price).

One of the other charts in last week's post was "Stocks climb walls of worry." I think the chart above represents one big wall of worry that the world is now descending. Global worries peaked with the PIIGS debt crisis in late 2011. Other contributing factors were concern about the weak dollar, Quantitative Easing, oil prices, and geopolitical concerns, to name a few. All those worries pushed up the prices of gold and TIPS because the world was desperate for safety. Now those worries are dialing down a bit, and investors are unwinding the "safety hedges" they put in place some years ago. It's not that confidence is surging, it's that pessimism and fear are declining.

Gold is still about twice it's long-term average price in inflation-adjusted terms. Real yields on 5-yr TIPS are still 125 bps below their long-term average yield of 1.4%, and almost 400 bps below their all-time high (which occurred in early 2000 when stocks were booming and the world thought the U.S. economy would grow 4-5% per year for as far as the eye could see). Gold and TIPS are still quite expensive from a long-term historical perspective. People are still willing to pay a premium for their safety, but that premium is declining.


Joseph Constable said...

That's funny, 'Descending the Great Wall of Worry'.

I call the stock market the great rotation. Rotating out of companies smaller than the top 100 and into the top 100. I have seen it before and it didn't end well. More than once. But this time we do have the FRB to help support the market, or at least the belief they can and will.

Using compare equal weighted $SPXEW and $SPX putting one behind rather than over or under. Compare $NDXE to $NDX. Do a ratio of $OEX:$NYA. You will see what I mean.

I am looking for commodity prices to hold up and save the stock market. Inflation at 2% previous post is encouraging for commodity prices.

steve said...

I'm not a warren buffet fan but I do agree with him that gold is a dumb investment if it can be called that. over the long run, gold has SUCKED at even keeping pace with inflation. And if you think about it, it makes perfect sense. why would a single arbitrary commodity do well as a measure of value?

Joseph Constable said...

Regarding the previous post, I think those that think inflation in the Reagan years, really since 1982, was cause for prosperity are really thinking of asset prices. Middle class people prospered because they took out increasing amounts of debt against their stocks and real estate. We grew up in magical times.

Benjamin Cole said...

What would be the connection between quantitative easing and gold prices?

In fact, gold prices cracked at about the time the US Federal Reserve introduced QE.

The Federal Reserve is no longer conducting QE, but the ECB, the People's Bank of China and the Bank of Japan are all presently conducting QE. Those banks serve combined economies larger than the U.S.

If anything, it appears central bank QE cracks gold prices.

It may be that QE enhances investor confidence in equities and property, and ergo people move funds out of gold and into real investment.

Scott Grannis said...

Benjamin: QE 1 started in early 2009, and gold didn't "crack" until QE 2 was finished.

randy said...

Gold is a fascinating topic. Oil is more interesting to me. At what point does IXC etc seem like a reasonably safe place to park some cash and pickup the yield? The long term trend is all wrong.. alternatives will continue to get better, supply can ramp up faster than demand (for now). Still, unlike gold, oil will have value and probably relative scarcity at some point in the future.

Andrew Ross said...

Struggling to find a theoretical connection between the price of Gold and 5yr TIP yields.

Notice that Gold prices spiked in 2011, which was not matched by 5yr TIP yields.
Also, 5-yr TIPS spiked in 2013, which was not matched by Gold prices.
Finally, Gold prices are not being adjusted for inflation. So, over the long term, this relationship will breakdown.

Short term TIPS yields seem to be about as good as any proxy for risk free returns.
In a well-managed monetary system would think they would tend towards zero.
So, absent a real crisis or poor management, would expect to eventually find a divergence on this graph.

Very appreciative of Scott’s expertise on these matters, but also know that it’s important to maintain a questioning attitude.

Scott Grannis said...

Andrew: thanks for your thoughts. I agree that this relationship between TIPS and gold is unlikely to last forever. However, I think that real yields on 5-yr TIPS should track, more or less, with the market's expected real growth rate—with TIPS real yields being somewhat less than real growth, given that they are government guaranteed. In a strongly growing economy, TIPS yields should definitely be much higher than they would be in a very slow-growth economy. Risk-free returns can only be found in very short-term TIPS and T-bills. The fact that gold peaked sooner than TIPS prices should not be significant. After all, these are completely different markets and it's not surprising that one could react sooner than the other to changing economic circumstances.

Benjamin Cole said...


But you avoided the other half of my comment---three of the world's major central banks have gone to QE recently (People's Bank of China, the ECB and the Bank of Japan) and gold is still falling.

Moreover, as you point out, gold cracked after the Fed went to QE. Introducing QE made gold prices crack? So what is the connection then between QE and gold?

If QE promotes gold prices, why are we not seeing in record gold prices now?

Gold is a global market, of course.

Here is a story from Bloomberg, about the (weirdo) China government buying tons of gold in the last six years.

Maybe the Chinese are secret Austrians! But despite their buying, gold has been falling anyway.

And, of course, the biggest markets of all for gold are the private-sectpr Indian and Chinese jewelry markets.

Maybe there is some connection between Fed QE and gold prices. Or major central bank QE and gold prices. But a case can be made it is a negative connection. QE coincides with falling gold prices. So far, anyway.

But, really, gold strikes me as the rare market where EMT does not work. Gold is worth what people say it is worth, and that putative worth is not related to yield.

Gold is one of the rare markets, like perhaps Andy Warhol art, or maybe Manhattan condo towers, that can be in a "bubble."

William McKibbin said...

My concern with precious metals has always been the lack of earnings. Better to invest in equities that pay regular dividends and rents, or skills that earn premium wages. But, that's just my view.

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