Illiquid Repo-Market Reigns chaos for precious metal investors! Understanding the crisis of 08 to learn where to park your money during this current recession! (market forecast)
Asset management advises with an economic forecast:
OPENER:
Introduce the economy, and how it is going to be assessed and what we will be looking at in this report, and how the references system will be used. (include context)
The economy as put by Ray Dalio (in the economic machine) is like a large machine with loads of small working parts, so when assessing the health of this machine it can be very hard and often not worth looking through it at it through the micro-lenses but to see it from the macro perspective. The markets are all intertwined, by that I mean they usually can and are stimulated and inhibited by the same things, currently, with the coronavirus, we have seen a huge drop right across the large majority of markets. Naturally, panic has then taken over as volatility had reached new highs as mass selling was occurring causing markets like the NSE to shut down temporarily to calm the markets due to frantic selling. Normally markets have an abundance of credit, there is generally a good level of productivity and government projects like infrastructure are used to ensure that people can spend less time on the roads to work and actually at work for boosting that productivity. With this being guaranteed we can then look at credit, as this can be created by any two parties, with one person taking on the debt and another person who is deemed credit worth can be able to take out credit with the promise to pay out the principle with the interest on a later date. This allows for more money to be in the economy, as the economy is made up of many transactions occurring over and over again. When productivity, however, begins to waver, we will find that the people who currently have debt outstanding will struggle to pay as they had the assurance that they will pay off everything in the future, the lack of ability to pay can set off a chain reaction causing multiple people to struggle to pay their debts off as the large majority of people in the economy have access and use credit in just about their daily lives. The lack of spending in an economy is deflationary and can cause recessions, depressions, and overall economic hold-ups. A stimulus will then be required to get the economy moving again usually in the form of the central bank injecting freshly printed currency into the system.
In this economic standstill, we are witnessing we can see how dire the situation is with a large majority of the world unable to work due to the coronavirus. Usually, when there is a healthy amount of productivity, debit and credit are used to propel the economy forward as we are borrowing future prosperity to be able to fund ourselves today with a promise to live under our means tomorrow. This, however, is a short term fix, but when the productivity drops so low as it has done of recent we can expect to see the economy to face collapse as many will not be able to live within their means and retain their current lifestyle which usually means defaulting on your debts. This because a systemic issue when hundreds of thousands and potentially more take this route as now debt that cannot be repaid is useless.
Federal reserve:
During QE3 the FED was printing $85billion/month but in this session of QE4, we are now printing $125bilion/day. One issue that we have seen in the Repo (Repurchase agreement) market is that there is not enough collateral, hence why there have been all these massive cash injections and interest rate spikes, like in Q4 2019. If we look to what has been said by the federal reserve have been open in stating that they would be buying $500billion worth of treasuries and $200billion in mortgage-backed securities. This new move and I quote, Represents an open-ended commitment to the QE program. What does this mean? To put this, simplify, when an individual takes some drugs, they get a high off it, but they eventually have to return to their base levels, but if they want to keep themselves propped up then there will be a need to continuously consume the drug in question. That is exactly what the fed has admitted here by saying open-ended QE. The economy as we know it has been propped up on cheap money and the only way, they can keep the mirage together is by pumping more and more money into the system that at this point has become dependent on that cheap money until it eventually gives out.
Now I’m sure you are asking what could possibly happen as a result of this, well if we do experience an economic collapse there is still a good chance of revival using this tactic the FED so loves to employ, giving another example of a patient whose heart has given out during an operation, what can happen is that if you inject enough adrenaline into the patient's system, along with the ECG you will again revive them though how long they can be able to thrive from this form of recovery is unknown as it is not a sustainable method; this seems to be the approach the fed are taking, we are yet to see the ramifications but for the time being let’s take a look at the actions they have been taking.
Liquidity and margin calls:
Now when a bank or hedge fund is trading, they usually leverage their trades and will buy stocks on margin. What this means is they will only put a fraction of the amount due down which can amplify your wins significantly but when the market regresses, you are required to put 25% of the stock value down to keep your order active. This means when markets begin to falter the banks that have taken out all these trades on margin are required to now raise capital quickly, one main way they can raise the funds is by going into the repo market. Using treasuries they will be able to maintain their positions but when there are massive repo fails (like the chart shows above during the period of 07–09) this shows that leading up to a crash we can expect the repo market to continuously show more and more failures, but this is just a symptom of an economic crash, so when you cure the symptoms hoping the disease will go away, usually the illness can and normally will manifest itself in a different area and way as it has not been dealt with by its roots.
Now how will the banks prevent themselves from losing too much in a position they are heavily invested in when the repo markets lack liquidity? They will very likely sell Gold. Gold being a stable asset shown to rise during the time of economic uncertainty with high levels of liquidity is a gold mine, so two options are usually available for the banks.
1. Short sell the precious metals, as they own the asset they can also buy back more as they increase the pressure on the selling side.
2. They can sell of the asset physically, however, when mass amounts are sold, to retain their buying power, they would also have to participate in the shorting of the very asset they are selling. Potentially naked sell as well however, the legality of this is questionable.
Describing what is going on in the chart above:
(04/07/2007–19/12/2007) As the chart begins, we see the green line (price of gold with its price along the right Y axis) steadily increase, as we know investors always flock to precious metals in times of uncertainty to hedge against inflation.
(12/03/2008) Now as the prices peaked, we saw bear sterns collapse, this now caused a massive issue in the repo market, as we see the blue charts across the bottom begging to pick up. This can be attributed to the hedge funds and other banks now having to sell and short the precious metal to gain liquidity.
We then see the price of gold ricochet up as the regulations on what can be allowed to be used as collateral in the repo market was lowered. We see something called asset-backed securities, this can be mortgage back securities for example that can be used as collateral, which are actually not good for storing value but because of the liquidity issues in the repo market pose a great risk to the financial system. This gives the investors of all kinds more options, in particular, the banks to receive money through the repo market which now alleviates the massive selling pressure that was previously posted on gold hence we see a retracement up!
They then ban short selling on the GSE’s (government-sponsored enterprises) this actually marks a panic if the government has to manually intervene in such scenarios, so when this ban was enforced, we then began to see the price of gold falling again!
We see price tank again around august 2008 as Lehman brothers shut down, and we see two tangible factors that stabilize the repo markets (collateral and fear) lose their grip on stabilizing the markets, as fear now takes the lead and we see a new high on the repo market failings, now close to $6trillion. This then causes the price of gold to plummet once again until the FED begins its QE which alleviates the pressure from gold, but we see now the normalization of gold.
Now from using the historical data from 2008 and using the repo markets as a basic guide, we should be able to see what the institutional investors are doing. Now let’s take a look at the current repo fails.
This goes back to March 4th but we need to check more data points to see If there is an increasing rate, and from the news, we know the markets are crashing and there have been huge injections into the repo market. When the repo rates spike and crash down we will know at that point that the institutional investors have sold all their gold or a large portion, or the FED has solved the collateral issue, Temporality.
Global monetary reset: Fiat currencies
With the mass amount of debt that other countries have taken out on the dollar, and with the constant cash injections we see occurring in the repo market we can see there is a clear avoidance of a deflation. This can result in the slowing of what is yet to come, for there are several long-term foreseeable outcomes. A switch in global monetary policy will allow for the avoidance of the previous debts and the oncoming deflationary crisis. Switching systems however is never a quick and easy process, it occurs over a number of years and it may just be that cryptocurrency may be the way forward as we have seen the introduction, innovations, and adoption all take place. The only limiting factors we really see if scalability, and sustainability whilst being able to retain the trust in the protocol. The last monetary shift we saw was from Britain being the world reserve global currency from 1815 to 1920. If there is one thing, we can take away from recorded history is that the world reserve currency always resets once every 80–110 years, and currently with we are at the 106 years mark.
From what we remember we can look back and see that there was a massive panic in the stock exchange when WW1 (world war 1) was officially declared, New York stock exchange was closed to prevent foreign investors from redeeming their money to exchange it for gold. Now from this when the war now kicked off America did not join WW1 until April 6th, 1917, just 3 years after the war began. During this period of neutralism, America was trading resources and products for gold, so by the end of the war, America had ended up having 2/ 3rd of the world gold supply. This being the case the American dollar was then agreed to be pegged to the dollar and all other global currencies were to be pegged to the dollar and dollars were given to each country in their reserves. (the brief history is very brief, as there were actually two reserve currencies, the sterling, and the dollar, and they were competing with occasional switches on which one gained the upper hand. The second world war was started before England had fully recovered economically! On top of this England had suspended gold shipments; back then paper was not money, it simply meant that you were owed money! This being the case there was no way that England could then be able to retain its position as the world reserve currency and power was then relinquished to the dollar.) In 1944 the Bretton woods conference that was then the hand over for the dollar beginning its reign as the reserve currency as it was put formally on paper, however over time there was the slow transition towards the dollar.
NEXT PHASE: The First cracks and plasters.
After the global gold rush on America, Nixon had taken the dollar off the gold standard, leaving all the currencies pegged on the dollar that was pegged to nothing. So how would the USA retain its position? They then turned to Saudi Arabia and made an agreement in 1974 called the petrol dollar that all oil that is to be sold will be done in the currency of dollars, thus enforcing and consolidating dollars position as the reserve currency. This now means that the US dollar is pegged by oil and when oil prices crash there is always such a massive panic!
Brad Sherman, wanted to make the cryptos illegal as it undermines the dollar position and the US dollar's ability to be used as a weapon by slapping sanctions. The reason why America can print so much money without the worry about an over inflation is that they are the world reserve currency, and they are also backed by oil!
So far, we have seen 23 countries engage in bilateral trade agreements. What does this mean? Simply put they are not circumventing the dollar and trading directly for example china and Russia will use the Rubel and yuan, instead of dollars for their trades, boosting their currency indexes and diminishing the dollar in the long run. As more and more individuals begin to engage in these types of trade and abandon the swift banking system which is executed in dollars, we will slowly see the US dollar fall apart and watch the new move to the next reserve currency rise up. One major advantage and reason why the US used to engage in so many wars over oil was that it was fighting for its position as the worlds reserve currency, giving the Saudi Arabians privileges was because of the oil agreement, but over the years we have seen other countries strike oil reserves and they do not have the petrol dollar agreement with America: the power The dollar once had has greatly diminished as global trade is now undergoing a paradigm shift that will now
RISE OF THE UNDERDOG: Petrol Yuan
As Iran faced economic sanctions from the US for trading oil outside of the dollar, other countries were warned not to trade with them, but now China has stepped in and stricken a deal as America has with Saudi! Now on top of this, we have to also look at the current status of the economies of different nations. China has become a creditor nation, as they have diversified their portfolio and positioned themselves for the win in the long term whereas a country like America have turned into a debtor nation with the short-term outlook of holding onto their position as the global reserve currency holders which is currently under attack as Russia, had increased the supply of oil when the price had already tanked, this can be seen as an effort to devalue and cause internal turmoil of the dollar. Furtherly increasing the recovery time needed for them to recover allowing China more time to solidify its positioning as will be discussed later on in this report.
Bonds:
One thing to takeaway is that we have heard from numerous American politicians that the bonds of America are a safe investment as they can never default on the bonds as more money can always be printed. This holds true due to their status as the global reserve currency; however, this will not hold true for very long! First, let’s look at why investors will even use bonds; Bonds are used for 3 main reasons, capitol protection especially in hard times. Diversification, allow you to protect yourself to overexposure to particular markets and for income, as bonds have yields that payout on a regular basis, of which the dividends can be used for further investments or payments on swap premiums for example.
The graph above shows the comparison between investing in the S&P500 index versus investing in the bond markets. We can see that the pay-out for the S&P is significantly greater, however;
As an investor, you want to aim for longevity as opposed to being one-sided and focused on returns. The graph above displays the drawdowns from the all-time highs for both the S&P500 and a 10Year treasury. The zero on the Y-axis shows the all-time high and then the percentage drop it has from that high, and we can see in times of economic hardships bonds tend to enable you to reduce your risk significantly and the time of recovery is also significantly shorter as well. Knowing this we can be able to understand why during economic hardships that investors of all kinds will flock towards bonds before they consider precious metals, as shown in the segment above regarding the federal reserve; Gold is used as a scapegoat, and bonds allow you to minimize drawdown so when the price of gold declines as short selling and mass selling of bank reserves commences, you can begin to buy and position yourself at the bottom waiting patiently for the bull run that is yet to come!
Stocks:
The American economy= the stock market… This statement simply means that the vast majority of the economy is based on consumer spending. If we take a look at the companies that are really big and the industries that base their operations in America, they are majority service-based companies, like uber, WeWork & Airbnb. These three companies bleed money at the present moment and have always done so even through the good times, imagine how they are forced to endure economic hardship when demand drops off due to a virus.
We first need to look at what is often referred to as the buffet indicator which is the market cap to GDP, to show us how overpriced assets currently.
The buffet indicator here shows that the amount of money that is in the stock market currently outweighs the GDP of America by 38percent, which is just shy of record highs. If we see a correction leading us to the same lows as the 2008 crisis, we can expect a huge devaluation as $27 trillion dollars will soon be $13trillion. The devaluation of the stock market generally means the overall economy will follow suit, and when asset prices go down unemployment increases, and with the increase of unemployment there is a loss of purchasing power, which leads to further unemployment to bigger losses of purchasing power. This dreaded cycle can typically continue until there is a level the free markets can decide to reach unless there is an intervention of the Central banks.
What can we expect to see as there are many investors already pulling money out and into the bonds and precious metals markets? Well the FED really only has two options when easing an economic collapse, Interest rates, and money printing (QE). As the interest rates are already so low that slashing them at this point really does not make any difference, there is one solution; Printing money! The money can be printed but cannot be brought directly by the FED, so what happens is when money is then created, it will go into the retails bank reserves that they are required to have by law with the FED (to prevent bankruptcy via bank runs). This presents the retail banks with two options, they can now buy the shares themselves, or they can take that money and lend it to hedge funds and other financial institutions so they can take on the associated risks.
There have been announcements of Payroll tax cuts for a whole year, which adds up to as shown in the chart above 30% and as more and more people opt to work, this percentage only grows. From here we can identify that there is a massive increase in the deficit which can easily double to $2trillion.
Cryptocurrencies:
China has also had plans to release its new cryptocurrency they have roughly 20,000 tonnes of Gold and they are planning to launch a gold back cryptocurrency; this will mark the beginning of the move back to the gold standard! Though Gold and fiat may be inferior to bitcoin; there will still be a need to have some form of precious metal as this period of transition can result in serious fluctuations in asset prices. China has released the digital currency electronic payment (DCEP) which allows the people's bank of china to issue currency to the retail banks. This massive move forward as they are already in the beta testing phases will soon render swift payment obsolete!
Now we have assessed that we are nearing an economic collapse and with all the efforts the world central banks are doing to slow this oncoming disaster, we have really never seen the performance of any cryptocurrencies during a time of economic unrest. When looking at Ethereum, we can be able to look at the selling pressure based off the 54 largest token sales we can see that there a large number of tokens being sold and being sent to the exchanges. This can trigger a self-perpetuating downward loop as the tokens were sold to hedge against the falling price of Ethereum so that projects can remain active but this only incentive other projects to also liquidate their tokens thus increasing the selling pressure, however, we have seen more of stabilization from this area, though the price fluctuations we have seen of recent months stems from a different issue that shall be addressed later in the report.
The chart above shows the project wallet addresses and how they had raised 16.25million Ethereum (approximate total) but this graph shows the selling pressure as the amount of Ethereum is along the y-axis and the time across the X; In the short term there is still yet selling pressure however the amount of pressure that suppresses Ethereum’s price has reduced gradually over time. The only real concern is the long-term model for the asset as it is heavily reliant on transaction fees, which is a big win if the mass adoption is achieved within the next few years. However if it becomes apparent that Ethereum is unable to survive with its current business model it can always launch a hard fork to increase the incentive for miners by expanding its currency supply, this will then cause a dip in price which can be explained as we would expect the smaller ICO’s that are not yet profitable, to sell off tokens.
When It comes to Bitcoin, we have seen that it is a store of value, though it has shown to have unstable prices. This is not such a concern as the price fluctuations over time since its inception has decreased (in percentage swings). This being the case long term we can look to see bitcoin to hold its value and potentially enter into a bull run. One thing to note is that if we enter into a potential financial meltdown energy prices could surge, this can make mining bitcoin highly unprofitable for most miners. This can cause bitcoin to do one of two-three, increase the incentive via transaction fees, increase in price against fiat to cover the increased expenses of mining the coin. Or a hard fork can be launched to switch to a more economical means of validating its decentralized network; (proof of work to a proof of stake model) but this being an area of concern is not something to worry so much as there will again be a short term dip in its price, but the recovery will be swift as there really is not enough selling pressure to send bitcoins price to new lows.
One good thing about these two cryptocurrencies is that they are both decentralized and offer a high level of accessibility and control over finances! They also have the ability to adjust and are still on their way to be ready for the mass adoption because when people have been making their predictions about cryptocurrencies going to $1million dollars per Bitcoin, they seem to be doing the raw maths and economic models which do work thus far; this only shows part of the picture, one thing I never see being asked is “are these cryptocurrencies ready for mass adoption? Can they yet handle the strain of having such an influx of users on a daily basis? At what point is the technology going to be capable of launching said amount of transactions per minute?”
My option: Potential trends and recommendations and areas to watch!
Based off what we are seeing the markets with the FEDs bid to retain power as the supplier of the global reserve currency they are making frantic moves that can and currently seem to be impactful; this, however, is not really the case as the crisis may be able to be averted but within the next 10years I believe China will be taking over the position of the global superpower, them or Russia but China is more probable. An area to watch is the Chinese bond market as the yuan is looking very bullish over this next decade in the same way the dollar did back in the 1930s.
One thing when we transition over to a cryptocurrency-based system for a new monetary policy instead of the dying fiat system is that the current cryptocurrencies will either die or thrive as there will be some that will not be able to compete in a very competitive environment, some will have their place as I can see coins like monero, Z-cash, and Dash reaching a wider adoption in highly censored countries like China and north Korea. This can make such coins a good opt-in as they currently have very low adoption rates, and as governments begin to turn to cryptocurrencies, we can expect the capabilities of certain coins to be the main driver for increased market capsizes. What we saw with Facebook’s libra and how stable coins already are achievable we can expect with already countries having their own forms of digital payments in African and Asian countries that we make the gradual shift over to crypto but this transition just like the reserve currency transition will come over a duration of time. Now as for there being so many different coins this can lead us to wonder which ones will be the ones to heavily invest in as we have seen bitcoin through dominant hold a good amount of risk!
How can I prepare myself for the oncoming transfer of wealth?
The first thing is first, ensure you have some precious metals silver more so than gold, as this metal as shown in the graph below has always outperformed gold in appreciation but also in depreciation. But the role of having a bigger stake in silver is so that you can be liquid so that when you have received a large return, you can redistribute that wealth into the other assets areas like gold, bonds, very few stocks and cryptocurrencies once the key drivers for the next system have been identified.
One thing that we must remember is that if we want to know what is going to happen, we must always look to what is happening with the biggest institutions in the biggest economies, and then identify patterns in history that have occurred in a similar fashion! Cryptocurrencies like Ethereum really hold a massive place in my opinion over bitcoin slimily for its ability to be coded, the smart contract capabilities, and how it is also currently cheap as the selling pressure has occurred by projects working on the blockchain with low liquidity and or with short sight being unable to see how valuable this token is and how it is on the path to changing the world and our relationship with technology. Though it has its downfalls none are as immediate like bitcoin and its 51% china threat, as the Ethereum token can and is always evolving and changing until the optimum protocols have been achieved!
Is your portfolio diversified enough?
There is usually one good way the investors will vet this by performing a stress test, we can take the average drawdowns of the past 11 crashes, across the different asset classes. This can allow us to prepare for the worst as we expect the best… now before we go ahead we should take not that cryptocurrencies have never experienced any market corrections or crashes, so we should be wary to how much exposure we give ourselves in this particular area based on your appetite for risk however we should also take their Sharpe ratio into consideration as the risk to reward is very handsome indeed. For cryptocurrencies, I would not advise any more than 10% for the average investor, you can go up to 45% when you have a piece of intimate knowledge about risks, updates, and vision but for the average investor that limit is at 10%. Bonds as these are the safest investments in times of trouble a range from 10–50% is defiantly advised, this will then depend on the amount of risk that you are willing to stomach! Stocks should not have any more than 50% depending on the means of investing; this part I would trade using margin, and only allocate 20% and have my risk in a particular market, I have seen great growth potential in the cannabis sector as it saw an 80% correction before corona killed of the economic growth. But if you are investing in indexes, ETFs, etc. Then I would say you can have a higher amount but if you are more specific and exposed to a single industry then no more than 30% is advisable. Precious metals, this part should be roughly 20–40% of your portfolio, and you want to stick to the lower side especially as the prices drop, when they begin to bottom out as expressed in the charts at the beginning of this report, can and are advised to liquidate other holdings like stocks and the regular currency you have in savings to safer assets like bonds, and precious metals in particular silver.
EXAMPLE:
I have a portfolio worth $100,000.
My allocation is simple, stocks (20) bonds (50) Crypto (15) precious metals (15)
· For crypto, I have to be ready for the long term as it is not ready for mass adoption, and from looking at price action we can determine that the cryptocurrencies being an uncorrelated asset will not really budge but for the worst-case scenario, there is a 10% drawdown ($1500).
· For stocks, the average drawdown happens to be 30% so the drawdown for the stress test is going to be ($6000)
· For precious metals this will be dependent on your balance between gold and silver, Gold has an average return of 8% when rounded up. Silver however has a negative yield of 14% during the crashes. This would mean if you have a 60/40 split in favor of silver here you would have lost ($1260 from silver and gained $480 with a net loss of $780)
· For bonds, during corrections bonds has shown to increase by an average of 8.7% this can now be looked at with our profits from this position being ($43,500)
From looking at the example used above we can see from the stress test there is still a net gain of ($35,220) which happens to be a 35.22% Gain! Now, this would be seen as an average all-weather portfolio but by going through stress tests again and again and again if you want to devise a portfolio that will perform in a bearish market then you must find the right ratios of what to have and when.
One thing we can take from this is that there is an all-weather portfolio that can give adequate returns over the long run however there is a means to optimize as I will show in the example below that in times of economic ease, there should be a reshuffling so that the maximum amount can be drawn from and then when economic unrest begins to be seen, immediate reshuffling is required! Greed is an investor's worst enemy if you decide to have two different portfolios because if you hold on to the bull run for too long you can end up being whipped out completely.
Bear market example: Still $100,000
· Crypto will have 10% allocating and this will be all in the mining, nothing will be brought. (No change)
· Bonds will remain at 50% giving the same net of ($43,500)
· Gold 30% ($24,000)
· Cash 5% (losing buying power however this is going to be used to buy stocks when the prices bottom out as part of the dollar cost average holding strategy).
· Stocks 5% ($1500) with the 30% devaluation of stocks on average this is a loss.
Here we see that the bear market example now stands to net a ($66,000) which is a 66% return in a scenario where the stock market is seeing a 30% correction. This is a very big win and also very hypothetical as this is a theory that is perfect and humans are not so discipline, research, and experience will all play crucial roles in ensuring that the best possible outcome is achieved. For the cryptocurrencies, the method of mining and powering it with biogas is being used hence the reason for no change in the loss side.
Please remember one curtail thing which is this is just a report, more research should be done on top of this before taking any action in your investing.
What is is the aim of this report?
The aim of this report is to highlight the current position we are in economically and the main factors that have caused the decline of the economy. The assets to be assessing (Gold, Bitcoin, Ethereum, Silver, fiat currencies, stocks *buffet indicator &bonds) will be looked at historically, how they have performed in the past, how they are currently performing and what is going on and what the forecast of the assets will be, and how would it fare to use different ratios of the assets and the differences in the performances based of backtesting.[kw1]
How well will your portfolio fare in the oncoming crisis? [kw2]
Which assets will I be assessing?
Gold, Silver, Bitcoin, Ethereum, Fiat Currencies and Stocks.
Which places shall I be drawing my information from?
From the FED and central bank sites, YouTube, Blog posts, Podcasts…
How will I present the information, terminology and different forms of presentation?
Defiantly I will be using written and visuals such as the graphs charts and tables, and side commentary, ideally, I will also be using different shades to highlight that this is related text but a new segment like an opinion of quote.
[kw1]Still some back testing has not been done, so I will leave this segment out of the report when I release the draft however it should be added in, as I should have as much facts, data and supporting evidence to ensure the trust of the reader and so that there can be clarity and trust that there is a correlation!
[kw2]This again is something to be added and looked at in the final conclusion, I will touch on this, however I believe that more detail should be taken when assessing this part of the report, very tempting to delay the report release date; the show must go on and updates will be sent out which the areas of change to be highlighted so that a swift skim can allow for efficient information absorption.