This time is different, and traditional investment principles — including even the hallowed precept of diversification — can no longer be relied upon in a “house of cards” financial structure that may soon “come down on the heads of investors.”
So says currency portfolio manager Axel Merk of Merk Investments in his latest investment analysis.
Merk argues that “instead of a rebirth following the global financial crisis,” we got a broad decline in economic and political stability across the globe. In the U.S. that is indicated by fiscal and monetary policies that kick the can down the road together with a rise in populist movements on the left and right, Occupy Wall Street and the Tea Party; Merk cites populist Abenomics in Japan and the revolts of the Arab Spring in the Middle East.
In this kind of “house of cards” economy, investors must recognize that their interests are not aligned with those of policymakers.
“A government in debt has an incentive to debase the value of its debt, whereas investors have an interest in earning a positive real return on their savings,” Merk writes.
Indeed, citing Stanford University economist Martin Schneider, Merk points out that both government and citizens would benefit from inflation today. That is because inflation would debase both government and consumer debt.
“If you are a consumer with savings, sorry, you are in the minority and your interests will have to take a back seat,” he writes, adding that the same subordination will apply to foreigners who own U.S. Treasuries.
Merk foresees continued political decline and a continued blowing up of bubbles, making bonds and the U.S. dollar particularly vulnerable.
Moreover, in today’s environment, “traditional diversification can’t be relied upon as asset prices reflect the next perceived move of policymakers rather than fundamentals.”
For all these reasons, investors need their own toolbox consisting of gold and currencies to counter the toolbox policymakers use to debase the currency and spur inflation.
Gold’s value lies in its tendency to hedge against inflation and low correlation to other assets; currencies also have a low correlation to other asset classes and are less volatile than gold, Merk says.
Late last month, Merk launched just such a tool for investors who share his persuasion — a novel gold ETF that lets shareholders trade shares for physical possession of bullion. In a discussion of the new Merk Gold Trust (OUNZ) posted to the Merk Funds site earlier this week, Merk says that other ETFs allowing for physical delivery may be more restrictive than shareholders suspect — allowing only “authorized participants” to take possession.
Another unique feature of the fund, Merk says, is that “taking delivery is not a taxable event as investors merely take delivery of the gold they already own. With other gold ETFs, investors need to sell their shares, a taxable event, before they can deploy the proceeds to buy coins.”
The gold and currencies manager also notes that their belief in gold is so strong that they get paid in gold rather than cash (through shares of OUNZ that shareholders pay as their management fee, which is equivalent to a 0.4% expense ratio).
Ultimately, Merk’s case for gold rests on the strength of the trend he sees toward negative real interest rates among the world’s monetary policymakers. While gold pays no interest, zero is preferable to the negative real rate he sees in the world’s money centers.
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The U.S., he says is biased toward inflation, and even if policymakers were not of this view, Merk argues the U.S. simply can’t afford positive real rates:
“Looking at the projections of the Congressional Budget Office (CBO), a decade from now we may be paying over $900 billion a year in interest on government debt (marketable Treasury securities), up from about $200 billion currently. And the CBO does not think the average interest rate we will be paying on our debt will go back up to what has been the historic average; if it were, we would pay $1.2 trillion a year in interest expense alone. Fear not, I don't think this is going to happen; the price for this, however, may well be negative real interest rates, providing a potential catalyst for inflation and a weaker dollar.”
Merk similarly sees Japan as structurally incapable of positive real rates and the eurozone as fully committed to negative real rates.
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