Is This Really the ‘Trade of the Century’?

Can you hear it…

The US economy is slowing. Aussie bond yields are falling. Wall Street’s fear gauge is flashing.

Can you hear the warning bells ringing?

I hate to start on such a sour note, hopefully we can turn that around towards the end. But a coming crash, a coming calamity, these are the things on the minds of investors.

My colleague, Selva Freigedo, told readers that ‘this is — in my opinion — one of the biggest stories in economics today.

I’m talking about central banks around the world reversing policy, and, more recently, the US yield curve inverting.

And she may be bang on.

Maybe we are in for a decline. Asset prices are arguably too high. Income streams haven’t kept up. Maybe we do need something drastic to shake things up…

If that is our fate, I welcome it. From change comes opportunity. And one hedge fund says they’ve stumbled upon the ‘trade of the century’.

But I’m going to show you something even better…

Recession indicator flashing

Before we jump to ‘the trade’, it’s worth giving you some context.

After all, dear reader, you are a free-thinking individual. You don’t just believe what you’re told. If someone makes a claim, you want to see some evidence.

So, where’s the evidence for a potential decline on the horizon? Most pundits use a bunch of headline data to prove the point.

Slowing GDP growth…a stall in monetary policy…abnormally high asset prices…

For most, however, it boils down to the US yield curve, which is a collection of US bond yields at different maturity dates.

Usually the yield curve is upwards sloping. From one to two months and five to 10 years, US bond yields tend to increase as you put more time on the clock.


Source: Investing Answers

What these yields represent are expectations. Expectations of future interest rates and expectations of the economy and its overall health.

So, if bond investors believe the economy is going to grow, then they might also assume inflation will pick up. This mightencourage central bankers to lift interest rates to maintain inflation targets. Bond investors will also probably want a higher return (yield) for tying up their cash in bonds too.

So, the yield curve becomes positively sloped.

But this normal-looking yield curve is not what people are worried about. They’re worried about one that looks like this…

Source: Investing Answers

An inverted yield curve implies slower economic growth, lower inflation and lower interest rates in the future.

But do you see what this whole argument is based on…expectations and feelings. The so-called ‘smart money’ can get it wrong just like you or I. Many times, they get it wrong far more often.

With all their years of experience and education, they learn to develop conviction in their ideas. Yet even the smartest of the bunch maybe only get it right 60% of the time.

Any who…let’s get our noses out of the textbooks. Here’s what the US yield curve actually looks like right now…

Source: US Department of the Treasury

Not exactly your textbook inversion. But yields are lower at two, three, five and seven years compared to that of one to six months.

‘So, what,’ you say. ‘Who cares if the yield curve becomes more inverted.’

Don’t worry, I’m right there with you. While I hope stock prices will come down in the near future, they might well stay at these lofty levels.

Maybe I’m just too young to understand…because the old fearful bunch who’ve seen something like this happen before are now preparing for the worst. Slate explains:

The yield curve has inverted in the lead-up to all nine U.S. recessions since 1955. As the Federal Reserve Bank of San Francisco notes, there has only been one instance in the last six decades when an inversion wasn’t followed by an official recession within two years or less. That was back in the mid-1960s, when growth slowed, but the economy didn’t technically shrink. Since then, there hasn’t been a single false alarm.

But did all nine recessions play out exactly the same? Of course, they didn’t. And the next one, whenever that comes, will be different too.

I’d point that fearful bunch to something legendary investor Jeremy Grantham said recently.

I was really hoping there would be a magnificent bubble ending to this as there had been to three great recent experiences, which were the housing bust, 2000 tech bust and Japan,’ he told CNBC.

They were all classic. They all ended with euphoria and a rapidly accelerating stock market. They’re easy. You know they’ll be followed by an abject decline.

This one…I was hoping that would happen. It doesn’t look like it will. And therefore you’re going to have a decline of a different nature.

But let’s have it…what’s this ‘trade of the century’ the doomers are talking about?

Civilised people don’t buy gold…

Oh yes, dear reader, you can make money when the sky falls. Crescat Capital plans to do exactly that. Bloomberg writes:

One of last year’s best-performing hedge funds says the “trade of the century” is to buy gold and sell stocks as risk assets are due for another meltdown.

Really…that’s the trade of the century…

I’ll let Bloomberg continue:

The consensus is pointing to a recession in 2020 or 2021, Tavi Costa, a global macro analyst at Crescat, said by phone. “We think it’s a lot closer than that and we have a number of macro timing indicators that we look at.”

Going long gold in yuan terms and shorting global equities currently explains three-quarters of the hedge fund’s strategy. While the firm uses the MSCI World Index in models to visualize the trade, it goes a bit deeper with its short position, selecting individual stocks and exchange-traded funds to bet against.

So, this (below) is what the smart minds at Crescat came up with…

Source: Bloomberg

Buying gold in Chinese yuan is a new spin, but it’s hardly what I’d call the ‘trade of the century’. In fact, as soon as I found out ‘the trade’ included buying gold I was immediately unimpressed.

Sure, gold might likely rise if a recession hit the US. But this kind of strategy is like betting on bitcoin because you have a hunch the ‘big money’ is about to move in…

It’s a strategy based on coulds and maybes.

Again, maybe I’m just too young. I haven’t lived through multiple recessions before. Maybe betting and guessing on the future price on an object is the way to go. That’s how the rich made their money, right?

OK, enough sarcasm. How much could you make on this ‘trade of the century’ anyway?

Double? Maybe five times your money?

If we look at the end of 2007 to its peak in early 2009, the price of gold (in AUD) only rose about 58.4%. On an annual basis, that works out as 48% return.

If you want to look at it in Chinese yuan, then the price of gold rose around 97% from the end of 2007 to its high in 2011, which is a 20% return annually.

Some trade…

I tend to agree with a guy like Charlie Munger on matters like these. ‘I think gold is a great thing to sew into your garments if you’re a Jewish family in Vienna in 1939,’ Munger said in an interview. ‘But, civilised people don’t buy gold. They invest in productive businesses.

And that’s exactly the ‘something better’ I was talking about. I think you should forget about buying physical gold. Even if the market drops. Don’t play that guessing game.

Invest in productive businesses instead.

Your friend,

Harje Ronngard


Harje Ronngard is one of the editors at Money Morning New Zealand. With an academic background in finance and investments, Harje knows how difficult investing is. He has worked with a range of assets classes, from futures to equities. But he’s found his niche in equity valuation. There are two questions Harje likes to ask of any investment. What is it worth? And how much does it cost? These two questions alone open up a world of investment opportunities which Harje shares with Money Morning New Zealand readers.


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