After a long hiatus from the blog, I’m back! I never really went anywhere. Things were so hectic in March and April that I was focusing all of my time on staying on top of everything. After that, I was using direct communication to keep my clients updated and since then I just haven’t had as much to say since so much of the path moving forward is being driven by:
- how things play out with COVID
- what the governments policy response will continue to be
- Who wins the election in November
All of these are still very big unknowns so it’s hard to have any clarity out beyond the very short-term. The only thing that is clear at this point is that the Fed has had their “whatever it takes” moment and has openly admitted that they cannot and will not stop buying assets.
Here’s what I’m seeing right now:
From a big picture, macro point of view, bonds and commodities are both saying that we’re in a “hopeful” bounce and not yet the start of a new up cycle just yet. This makes sense since down cycles tend to take a good 12 to 18 months to play out.
Treasury yields are still hanging around the lows, with real yields (inflation adjusted) recently making new lows last week. This suggests we still have a lot of deflationary impulses and tough economic sledding ahead. The start of a new expansionary cycle typically sees a rapidly steeping yield curve and we haven’t seen anything close to that yet.
The copper-to-gold ratio is suggesting a similar picture.
As is the stocks-to-gold ratio. This is probably the most important chart to keep an eye on (chart below). The ratio peaked in the second half of 2018 and continues to make lower lows and lower highs. I like to follow the KISS principle and the message is crystal clear: gold should continue to outperform stocks. Obviously COVID has created a large dichotomy between winners and losers in the stock market, but the overarching message is that the reason economic-sensitive asset prices like copper and stocks as whole have been bouncing this summer is from monetary debasement. If we were in an environment of strong economic growth and recovery, they would be up more than gold, but they’re not.
So if the government wants to continue printing money by the trillions, then yes, stocks can remain elevated. But in this environment things like precious metals will definitely continue to outperform. If the government stops, the economic risk is real and stocks and corporate credit could fall quite a bit again. It makes for a tricky situation with a wide distribution of outcomes.
Theres no way to know how things will play out, although our policy makers have made it clear which way they’re leaning, so I’m making sure we’re covered for both scenarios (the money printing inflation scenario and the stop printing/stocks fall scenario). We have some reserves not in stocks that you can use to buy more if stocks do fall. And current exposure to stocks is hedged with a relatively large allocation to precious metals and other hard assets. Gold is in the process of replacing treasury bonds as the flight to safety asset and people are starting to notice. I would encourage you to read my post on why this was inevitable from last spring and watch this recent short clip of Mohamed El-Erian.
Finding Big Gains in a Low Return World
All investors face a predicament over the next decade. Most investment assets, especially your traditional stock, bond, real estate variety, are currently priced for very low returns over the next decade. This is where assets that do provide big upside potential come in. I believe we are still in the early innings of the bull market in precious metals so this will remain a key component of my client’s portfolios. In addition, I also recently started adding exposure to Bitcoin via the Grayscale Bitcoin Trust (GBTC).
I like Bitcoin right now for all of the same reasons that I like gold. It’s a hard asset of limited supply and it’s become “harder” roughly every 4 years as new supply paid out to miners is halved. But I believe it provides substantially more upside potential than gold. So while I view gold as a key hedge against traditional dollar based assets like stocks, bonds, etc., I view Bitcoin as the hedge against gold given it is the new digital version of gold, made for an increasingly digital world.
The asymmetric part is that no other asset class has the same return potential relative to risk. Even if the risk is that Bitcoin is worthless and goes to 0, I believe the potential upside is anywhere from 10x to 25x over the next few years. The key is to size the position based on how much you’re willing to risk assuming that it does go to 0. It then becomes a call option with no expiration and meaningful upside potential.
The convexity aspect comes from the fact that the world is slowly starting the recognize the importance of decentralized networks and assets like Bitcoin. If Bitcoin does continue to rise in value, it will almost force the big institutional players to add exposure to it, creating a reflexive loop where big gains drive continued gains.
In an increasingly digital world where governments cannot stop printing money by the trillions and traditional assets are priced for very low returns over the next decade, I definitely want to own an asset of fixed supply and huge upside potential like this in my portfolio. These little extra kickers can go a long way to buoying total returns.
I’ve been thinking about this all summer given the policy response we’ve seen following COVID. And just last week, Teddy Vallee wrote a great post summarizing all of this. Rather than repeat a lot of the numbers and conclusions, I highly recommend you read his post. You can find it here.
The Graysacle Bitcoin Trust has been around since 2015 but they just became an SEC registered reporting company earlier this year, so it’s about as legit as you can be now. The bigger issue I’ve always had with it was that it traded a huge premium to the trust’s NAV. I’ve always said that I would rather just teach a client how to go buy Bitcoin directly at cost rather than pay a big premium. The premium has come down somewhat over the years as the trust has grown though (now over $4 billion in AUM). Additionally, you cannot buy Bitcoins in a tax-deferred retirement account yet so this trust is basically the only way to gain exposure to Bitcoin in a retirement account. Given my view on the upside potential, I think the premium is relatively small and a cost worth paying to potentially make some outsized gains tax-free in a Roth IRA (if a client has a Roth IRA, that’s where I’m buying it).
So why now? 1) I don’t think governments can stop printing stupid amounts of money, and 2) I think this breakout on the chart is for real:
Only time will tell but large, asymmetric payoff [option-like] profiles have always been valuable to portfolios and this is probably more true today than ever before given the low expected returns of major asset classes.
Thanks for following!
-Nick