After the initial shock in mid-March, when market participants seemed to finally realise that COVID-19 was going to spread well beyond China and severely impact all major developed economies, risk assets has been in for a ride.
Desperately trying to avoid a deflationary shock, as well as (in some cases) with a more or less stated purpose of propping up bloated financial markets, central banks have deployed a wide range of measures – slashing rates to almost zero and buying pretty much everything from government bonds to high yield credit.
Gold proved its resilience once more and stood up for its “safe heaven” status, claiming the strongest YTD performance at 13.8%.
The big question for investors now is, of course, how sustainable the rally is over the long run. Well, in my opinion, the answer is: rock solid.
The number one argument supporting the bullish case for gold has been covered extensively in financial press in recent weeks: inflation dynamics play strongly in favour of gold against all major currencies. There is perhaps no better source to reference than the recent “In Gold We Trust” report, covering a range of arguments for an inflation comeback. Some of them have, in recent weeks, became part of the mainstream consensus pushed by a lot of research desks and the like: excessive monetary and fiscal stimulus deployed in both DM & EM, shortage of supply and productivity amid the pandemic, return of protectionism and trade barriers, etc. There is no need to further develop these arguments here.
There are however, 2 driving forces that caught my attention that I’ve seen less frequently elsewhere, namely the growing focus on ESG issues & “academic mind games” like MMT and other fiscal bazookas.
ESG & Inflation
The fact that economic growth has been and continues to be fueled by environmentally damaging sources is not to be contested. Equally clear is the fact that this must change so that people like myself can have a future without boarding a SpaceX rocket. From a global macro investor’s perspective, however, the question of the cost of this transition arises.
Ronald-Peter Stöferle and the co-authors write:
The growing importance of ESG, which will make it increasingly difficult for commodity producers to access capital. There are many indications that alternative sources of energy, which are considered more environmentally friendly, will make the energy mix significantly more expensive.
While the costs of alternative energy sources have indeed been dropping significantly over the past 30+ years, oil&gas remain the cheapest available. With bonds issued by ExxonMobil being priced at a relatively low 2.61%, it is unclear just how “difficult” accessing capital is for such companies today. However, the trend may indeed materialize as more investors will start including ESG criteria in their portfolios.
In such case, the requirements for a green future may prove to decrease emissions while also strengthening the case for an inflation comeback as households will see their energy costs increasing. In turn, the case for gold being central in portfolio positioning is also strengthened.
Not-so-modern Monetary Theory & Gold
With the effectiveness of conventional monetary and fiscal stimulus tools under a big question mark in recent months (or years?) and given the “discussion about financing the gaping budget holes”, the authors dedicate a section to the possibility of MMT being implemented on both sides of the Atlantic.
Why this sub-heading? From the paper:
The following anecdote from 1930s Japan proves that MMT is by no means a “modern” theory. On February 26, 1936, Viscount Takahashi Korekiyo, former Prime Minister and multiple times Finance Minister of Japan, was assassinated. As Minister of Finance, he had attempted in the first half of the 1930s to alleviate the worst damage caused by the Great Depression, which had also hit Japan hard. Within a year, the yen depreciated by 60% against the US dollar. Initially, Korekiyo deliberately accepted the higher inflation rate. However, he was not murdered by a saver who was angry about the inflation-related reduction in his savings, but because he wanted to end the strongly expansive fiscal and monetary policy and land the “money helicopter”.
Closely linked to the first point as a financing tool for green infrastructure and the like, MMT (and other similar ideas on this matter) shift the responsibility for controlling inflation from monetary policy to fiscal policy. Excessive levels of debt are not hard to foresee (if one cares to look) as a result of such practices.
Alongside unlimited money printing and deficits, inflation is, in this dynamic, almost inevitable. Spending cuts and taxation as measures of containing inflation are, of course, more difficult and/or controversial than turning on the money printer at full throttle.
When the political, social and economic mess generated by such a difficult position for the government becomes clear, there is one asset which will most likely shine brighter than the others. You guessed it.