December Market Commentary

Update on Gold

It’s been a volatile few months – especially the last number of weeks where we’ve seen a handful of days where the price has moved up or down more than $20 in a single day. However, the volatility is the only thing that is changing… rest assured, the underlying reasons why we own gold are not changing and, in fact, the case to hold the metals is only getting stronger. We’ve heard the naysayers issue their anti-gold rhetoric consistently for the past decade… as the following chart shows, they’ve been wrong and will likely continue to be wrong.

Market Commentary

Executive Summary: The fiscal cliff is looming and markets don’t seem too concerned. The markets have been significantly impacted by QE (quantitative easing) and remain generally overvalued and dangerous – we believe it is prudent to continue to underweight our stock market exposure. Gold and precious metals miners have been volatile lately but they remain the best asset for future growth and we continue to own gold bullion and precious metals mining companies – in fact, we’re buying on the dips.

The Details:  The fiscal cliff is all the news right now, and rightly so, but it’s certainly nothing new. We, and a growing group of investment managers, have been repeating the simple truth of the matter: we are spending more than we are taking in and this can’t last. Well, that’s precisely what the cliff is… the point at which we try to increase revenue (taxes) or decrease spending (entitlements, benefits, government spending, etc.) in order to lessen this gap between income and expenses. Well, the resulting slowdown in the economy when this happens (picture you deciding to pay down your line of credit or mortgage rather than taking a trip or buying a new car) is catastrophic to a system that is built upon ever increasing growth. Bottom line, we believe the cliff is required medicine. The politicians will try to ‘fix’ the cliff by preventing us from going off of it, but at the end of the day, we are simply postponing the inevitable and “kicking the can down the road” as we think you’ll recall hearing numerous times now.

The markets however, seem to be pricing in a resolution on the part of politicians and while they have had moments of sheer panic over the last few weeks, they are generally remaining a lot stronger than we anticipated. We are pleased with this on some levels but it makes us leery of how long this can persist and our belief is still that markets, on average, remain clearly overvalued and ripe for a significant correction.

Bond yields remain at 150+ year lows leaving little room for further price appreciation. Further, the Bank of Canada is hinting at raising rates (although we believe this to be more likely moral suasion than an imminent reality), which would also be very negative for bond prices. We remain positioned in Short Duration (less than 2-3 year, high quality) bonds and Real Return (inflation protected) bonds. This allocation has delivered excellent returns over the last few years but we are mindful that we can’t stay here forever. In the near-term we will likely make a trade to include some floating rate bonds to protect again rising rates – more details on that to come at a later date.

Now, the 10-year (US) government bond yield remains at 1.6% making it very difficult to deliver a safe income to our clients. The result is we are forced to take more risk to deliver a suitable return or income stream than we ever thought we’d have to. To do so, we have allocated a portion of the portfolio to undervalued sectors such as the gold miners, the energy companies (oil and gas), the agriculture sector and the emerging markets (BRIC nations). This overall allocation remains well below our long-term targets in view of the generally over-valued market conditions we see. If there is a correction in the next few months, you’ll see us move capital into these positions to take advantage of better pricing… but until then, we remain patient and disciplined. This discipline is seen in our maintaining high cash and liquid bond positions (> 50% in most cases) and we will be able to use this capital very quickly when needed.

The fiscal cliff is going to return, along with all the drama it brings. Europe hasn’t be solved and expect more excitement from them as well in the coming months. Another actor soon to make an appearance again on the global stage will likely be Japan whose debt to GDP has soared over 200% and is continuing huge QE programs (to the tune of 21 trillion yen in Sept and Oct alone) to battle the deflationary trends there (20+ years now!) and a steadily decreasing domestic savings rate that has kept their fiscal cliff at bay for all these years. Add on their demographic problems (much like ours) and we believe a crisis is imminent there as well that could lead to a much weaker Yen that could be the catalyst to a global currency crisis.

All of these factors further reinforce our current portfolio positioning. We are very confident we are on the right track and these positions, combined with our disciplined portfolio management approach (downside protection limits and upside profit taking and defined markers), will deliver positive out-sized returns to you during these difficult times.