Investment choices in a world dominated by central bankers’ actions

Almost 90% of GDP growth can be explained by employment growth and productivity (labor productivity plus capital productivity, or net investments) growth. In the long run, employment will follow population growth. It is therefore not surprising to see slowing growth in developed markets.

Labor productivity can be increased by outsourcing to cheaper countries and/or replacement by robots, none of which helps aggregate domestic consumption. The cat bites its own tail.

Capital productivity is suffering, too, as cash flow is used for share buybacks instead of replacing and expanding productive assets.

Slowing growth in developed markets is aggravated by an ever-increasing debt burden. Most commentators focus on debt at the government level. However, unfunded future government liabilities, household and corporate debt often exceed those levels.

Total credit market debt outstanding (TCMDO) in the US has reached $58 trillion, or more than 300% of GDP.

Another sleeping giant is the amount of derivatives outstanding. According to the Bank for International Settlements (BIS), the gross notional value of global derivatives (Q4 2014) exceeds $600 trillion, $500 trillion of which concerning interest rate derivatives.

Deutsche Bank alone, for example, has (end 2014) EUR 52 trillion of derivatives outstanding; this amounts to more than 18 times German GDP, and 760 times Deutsche Bank’s shareholder equity. The failure of a prominent counterparty could easily bring down systemically important banks. It is questionable if governments will be able to save banking colossus of such size without being drawn into bankruptcy themselves.

The vast majority of monetary creation happens within the private banking sector. Every debt has a corresponding asset. If you agree our world has too much debt you also must agree the notion that the amount of assets is too high. A reduction in debt must and will happen via a corresponding reduction in assets. This can happen either via elevated inflation, or defaults. The Euro-zone is trying to save governments by digging a moat around banks via bail-in (depositors will suffer haircuts if other risk-bearing capital is not sufficient). This method has already been practiced in the test-case of Cyprus.

It is therefore advisable to keep (at least some) assets separate from the banking system in order to avoid haircuts and ensure access at any time.


1. Stocks: Measures by Central Banks have led to artificially low interest rates and artificially high stock prices. “TINA” or “There is no alternative” always turns out to be the worst investment advice. Corporate profits (in absolute terms and in relation to GDP) are at record levels. This seems unsustainable, as those profits have been achieved to the detriment of income from labor. A mere normalization of corporate profits would already lead to a drop in profits of 50%. Given high valuations it is hard to see much real return from stocks over the next decade. On the contrary; investors with certain risk appetite might want to play stocks (or indices) on the short side.

2. Bonds: Politicians usually lack any interest in reducing deficits, as it would cost votes. Most of the developed world is moving towards unsustainable debt levels. However, an economic slow-down, a crisis or additional quantitative easing might temporarily be positive for bonds.

3. Real estate: Partial inflation-hedge (but not desirable in our opinion as the bubble has only partially deflated and low-quality job creation does not allow for household formation). The absorption of excess inventory in the US might take 10 or even 20 years.

4. Currencies: In the long run, all fiat currencies approach their intrinsic value (which is the cost of putting ink on a mix of cotton and pulp). In a financial crisis however, money flows back into the US dollar. Most other currencies lose value towards the dollar. Hardest hit will be currencies from commodity-dependent countries (Australia, Canada), emerging markets, Latin America, and, due to a debt crisis, the Euro.

5. Precious metals: How do you value something that doesn’t pay interest or a dividend and has no earnings? Our model suggests a strong inverse correlation with real interest rates. Gold has several advantages, such as chemical inertia, divisibility, density of value and transportability.

While global gold prices are still dominated by “paper” gold (futures trading in Chicago), physical gold is being shipped to Greater China and India on a large scale. It is only a question of time when Western gold vaults will be empty.

We would stay away from “paper gold” products such as ETF’s, or gold held within the banking sector. Gold and silver mining stocks offer a (leveraged) play on precious metals without having to deal with the worries of insurance against fire, loss or theft (when storing physical gold at home).