Gold goes for it

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Gold keeps going up, dammit

I’m a cash flow guy so I don’t like gold. This turns out to be an expensive preference:

Stocks are having a great year. Gold, which recently broke an all-time high of $2,500 an ounce, is having an excellent one historically. Not only did gold beat the S&P 500 by a few percentage points. It is that gold investors earned these profits by owning an asset whose main advantage is that it is not correlated with stocks. It is a hedge for God’s sake! Bonds, the other classic (and more rational) hedge, are miles behind.

What, a humbled gold skeptic must ask, is going on here?

Part of the rally is easy to understand. The dollar weakens in anticipation of a cut in US interest rates, and gold is priced in dollars. Real rates have fallen since May, so the opportunity cost of holding gold has fallen. Add to that the usual (vague) points about geopolitical, economic and/or fiscal uncertainty, and the basic ingredients for a strong gold price are in place. The fact that global central banks have begun to increase reserve allocations for gold adds a significant tailwind.

Another possible support: China’s poor economy. Chinese retail investors don’t like local stocks and have been burned in real estate. But they need a place to park the wealth. As my colleague Robin Harding recently wrote, “with the outlook so bleak, it seems perfectly rational for Chinese investors to pile into bonds and gold.”

David Rosenberg of Rosenberg Research is confident that gold will hit $3,000 soon. Not only are there all the usual rally staples, but the gold is under held. American households have the largest allocations ever to stocks and need a hedge. They don’t trust bonds – perhaps rightly so, given the fiscal outlook. It’s “an under-owned asset,” he says. Bob Elliott of Unlimited Funds agrees. He points out that because there is a relatively small and slow-growing amount of gold available, a minor change in the investor could move the price a lot.

However, James Steel, chief precious metals analyst at HSBC, is more nervous. He notes that:

• Across all trading venues, volumes have been thin this summer

• Silver and platinum do not follow gold as they usually do

• The high price has “taken a sledgehammer” to physical demand in China, India and the US coin and bullion market

• Recent price movements appear to have been driven instead by financial buyers in the West looking for cover; when the US election is settled and the future feels more certain, what happens to these buyers?

• Everyone is already pricing in a lot of rate cuts from the Federal Reserve

• Central bank purchases have been strong in recent years but eased between the first and second quarters; central banks, like Asian retail buyers, are price sensitive

All music to the ears of a grumpy golden bear. Readers lucky enough to own the stuff probably feel differently.

Origin of 25 basis point cuts

Why does the Fed always move its policy rate in quarter percent increments? Why not tenths, thirds or halves?

Because it worked, and now we’re used to it. From Gary Richardson of the University of California, Irvine:

In the 1990s (the Fed) moved to effective targeting of the federal funds rate. . . Alan Greenspan (gave) directives to the trading desk to target a certain federal funds rate, but they realized you can’t be incredibly precise. So they settled on a smaller increase (by difference) to the target and then communicated that to the market. They set 25 basis points as the minimum steps to take, and that worked, and the (open market) committee decided to keep using it.

The federal funds rate is as much — or more — about communicating with the market than reaching a certain level of the rate that will influence the economy by a certain amount. Increases of 25 can be considered Fed language. A 25bp reduction or increase says, “The economy is changing at a normal pace, everyone can relax.” A change of 50 or 75 basis points says, “This is a serious situation and we are taking strong action.” Sending a clear message in a market lingua franca, is more important than the rate itself.

(Reiter)

X’s debt

The seven banks that financed Elon Musk’s (uh, sorry, X) purchase of Twitter suffered big losses on $13 billion in debt, The Wall Street Journal reports. Banks have already taken write-downs, but with X at war with its own advertisers and the economy tanking, the value of the loans could drop further. Even if Musk turns things around and lending returns to normal in a few years, the business will remain a return-on-capital nightmare. Why don’t banks sell and move on? Post-Dodd-Frank banking is all about capital efficiency, and there are plenty of distressed asset funds that would be a natural home for those things.

Three theories:

• Banks have always known that loans are loss leaders. They were a way to go into business with the richest man in the world. Musk runs a lot of companies. Better deals in the future as an advisor or lender are the real prize. Selling debt and angering Musk puts that in jeopardy.

• Debt losses don’t count in cash. Hung debt is about bank accounting. Musk has not gone into default and they are still receiving large interest payments. Why give up a steady stream of payments?

• The grades the banks took on the loans are very soft, and the sale would reveal how bad things really are. Better to hold off and pray.

Another question: Why isn’t Musk, with an estimated net worth of more than $200 billion, buying discounted debt? If he thinks he can fix X, he can buy back dollars for (say) 70 cents and save on future interest payments. Two theories about this:

• There is not enough liquid. Musk financed the initial deal with margin loans for his Tesla holdings, but the value of Tesla shares has nearly halved since then. Musk recently received about $56 billion in Tesla stock as incentive payments, but there are still some legal questions, so the money isn’t in the wallet yet. And selling his newly acquired shares could send Tesla shares lower, upsetting the shareholders who gave him the payout in the first place.

• He thinks his money is better than buying debt X at a deep discount, possibly because he knows debt X deserves a big discount.

Are we missing an opportunity?

(Reiter and Armstrong)

A good read

Plant the messiah.

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