Markets can be as volatile as a volcano, and two early warning signs indicate an eruption is imminent. But are investors paying attention? The financial landscape is heating up, and the signs are there for those who know where to look.
Nature's Subtle Warnings, Market's Imminent Eruption
Just as a volcano rumbles before it blows, markets often provide subtle cues that something is about to erupt. These signals don't necessarily mean a permanent shift, but they're crucial indicators of underlying pressures. True structural changes take time, much like the buildup of pressure beneath a volcano. However, when the tension is released, the consequences can be explosive, and the damage severe.
The Gold Rush and Bond Yield Surge: Early Steam Clouds
In today's financial climate, gold and sovereign bond markets are like the early steam clouds signaling a volcanic eruption. Gold prices have skyrocketed, surging nearly 70% in the last year. Simultaneously, long-dated bond yields, particularly in historically low-rate countries like Japan, have climbed to new heights. This is a significant development, as Japan, once trapped in deflation and burdened by an aging population, now sees its 10-year yields briefly surpassing 4%.
The Post-2008 Legacy: QE's Double-Edged Sword
The roots of this financial tension can be traced back to the post-2008 era and the introduction of Quantitative Easing (QE). While QE undoubtedly saved the global financial system, the issue lies in its continued use even after the crisis. Central banks repeatedly intervened whenever markets wobbled, creating a cycle of dependency. This strategy only 'worked' as long as bond markets cooperated, keeping yields low.
COVID's Fiscal Legacy: Deficits and Debasement
Then came COVID, and governments embraced unlimited fiscal spending. Similar to QE, this spending didn't stop when the emergency ended. Wartime-like deficits persisted, including in the U.S., where last year's deficit reached 6% of GDP. Now, central banks are poised for another round of QE, not to stabilize markets but to absorb massive government debt issuance. This is where the real danger lies: currency debasement. When central banks print money to finance deficits, the currency's purchasing power rapidly diminishes. Consequently, a dollar today buys significantly less than it did in 2019.
Asset Owners vs. Cash Holders: A Tale of Two Fortunes
Those who owned assets like housing and equities were able to offset this erosion through inflation, but those holding cash have been hit hard by the affordability crisis. Demographics further complicate matters. Many aging baby boomers, who hold a large portion of these assets, may soon need to sell. However, the next generations are either unwilling or unable to take on heavy leverage at today's higher rates. If the bond market continues to push back, we could witness a devastating combination: falling home and stock prices amidst ongoing currency debasement.
Global Trends: A Shift Towards Gold
The situation could worsen if global governments continue reducing their U.S. Treasury holdings and reallocating reserves into gold. This trend is already evident, as central banks now own more gold than Treasuries for the first time in three decades.
Investor's Dilemma: Act Now or Face the Consequences
For investors, inaction is not an option. It's time to scrutinize your portfolio, especially government bond exposure in places like Canada, where the federal government holds no gold reserves, and 10-year yields near 3% offer minimal risk compensation. Commodity-based economies typically offer some protection against debasement, but Canada remains an exception due to excessive regulation and policy uncertainty.
Portfolio Strategies: Navigating the Storm
At TriVest Wealth Counsel, we've increased our exposure to physical gold ETFs and gold producers, as well as selective positions in other metal producers like copper, which provide additional protection against currency depreciation. We've also avoided sovereign bonds, opting for structured notes with substantial downside barriers and attractive yields. Additionally, we've boosted our investment in high-dividend companies in sectors with strong competitive advantages, such as utilities, infrastructure, and select telecommunications companies.
The Ultimate Hazard: Inaction
When it comes to protecting your wealth, doing nothing is the greatest risk. Whether it's delaying necessary portfolio changes or staying in cash while inflation erodes its value, inaction can be costly. As with a restless volcano, the signs are there for those who look. Ignoring them could mean finding yourself in the path of a financial eruption.
