With Great Reward Comes Great Risk
Friday, 23 April 2021
Gold continued to trend higher this week on the back of weaker 10Y yields and news of the green light given by Beijing for some 150 tonnes of gold imports to China by domestic and international banks. With gold finding its feet, silver too marched higher to over $34 AUD with the AUD/USD drifting slightly lower to 77.0 US cents. Both the crypto market and the US stock market seem to be at a critical point in time, after having such an excessive charge higher in recent months it may be time to think about reallocating or adjusting portfolio weightings.
A nice trend is starting to develop for AUD gold now. After the brutal correction from all-time highs, we are looking like we have found our feet and marked a bottom to form a base for the next move higher. Nothing has charged in the past few months when it comes to the gold narrative, Central Banks continue to expand their balance sheets and many analysts are starting to get concerned over the possibility of inflation coming back from the dead. Bond yields moving lower and Chinese demand for gold at current levels is no doubt helping to support prices, with the PBOC stepping up quotas for gold imports. The local premium above spot still remains at around $7 to $9 an ounce, which could be impacting local availability of gold in Australia, as much of what is produced today may well be heading into that market. Since February 2020 the country has averaged around $600 million a month worth of imports, or circa 10 tonnes, so the new 150 tonne green light is a significant volume of gold to hit the hungry Chinese market in the months to come.
India’s gold demand also remains very strong at the current price with record-breaking imports in March of 160 tonnes.
The crypto space is again in focus this week as prices retreat. The Bitcoin chart was giving off major warning signs as buyers looked to be hitting a point of exhaustion. This week the crypto market took a hit with bitcoin dropping more than $10k from the recent highs, back to $49,500 at time of writing. If we look at the price action of late, you can’t say you weren’t warned. Every single new all-time-high in recent months was met with weaker follow through each time, indicating that the momentum was waning and the price was at risk of a major correction.
The size of the rallies getting smaller and smaller after each new all time high is not something you want to see from an asset class that depends entirely on momentum trading. Now that a lot of crypto currencies have seen large pullbacks, the mentality can easily change from greed to panic, and the race to cash out for fiat looks like it is starting yet again. The trouble with holding any asset that has an exponential rise in a short space of time, is that there is significant risk of profit taking after such an event. It may be too soon to call, but I would comfortably say that this latest bubble in crypto is no smarter than the last, and from this point to the end of 2021 you are more likely to lose money than make it in the crypto space.
If you were trading crypto and caught a large portion of the move until this point, then congratulations, but the price action is giving major warning signs of a significant top being put in place. At the recent peak the total crypto market was valued at over $2 Trillion dollars. So, think about it. Is the global population moving towards using cryptocurrencies over traditional central bank issued currency, putting central banks out of business? Or does everyone participating simply want to get rich in fiat from doing nothing?
Last week we mentioned the Ripple chart as example of the crypto market losing their minds once again and we can see below the eventual outcome as predicted:
Ripple Last Week
Ripple This Week
The level of risk taking in financial markets that we are seeing currently will not end well. It is not just the crypto space, where arguably some worthless digital currencies are valued at billions, but the US stock market is another example. The Nasdaq is so far extended at this point that future expected returns from the index should be negative for the next 5 years. Everywhere you look there is excessive amount of risk, and when it comes to equities, valuations are extremely disconnected from the underlying fundamentals. This spectacular past performance only means that future returns in these asset classes will be incredibly hard to come by from this point onwards. The great reward that has been achieved up until this point, only means that the risks are far greater moving forward.
A recent report that looked at the US equity market tells us that due to current valuations, the US stock market’s return between now and 2030 is forecast to be negative 0.7% annualized over 10 years (on both an inflation and dividend adjusted basis). So even with dividends considered the market is expected to return a negative result after inflation from now until 2030.
This can only make sense when one looks at historical valuations. Price discovery has died and investors have clearly lost their minds completely when it comes to calculating fair value. When things are going well, all you hear about is how much money your neighbour is making trading crypto currencies or stocks. But the fact that the performance of these asset classes up until today has been so phenomenal, should not give you confidence to buy them. Quite the opposite. You should seriously consider rotating out of any asset class that has dramatically outperformed their underlying fundamentals when the going is good. Don’t wait to finally throw the towel in when you’re at break even.
This inflation adjusted negative return expected from the US stock market ties in with our theory of what is to come over the next few years. That is an inflationary environment as a result of the unprecedented expansion in global money supplies in 2020. Stocks could easily deliver inflation adjusted negative returns if inflation starts running out of control to the point at which central banks are forced to tighten. We are starting to see inflation creep up in various commodity prices and it should only be a matter of time before we see global CPI’s doing the same.
Until next week,
Guardian Gold Sydney
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