The Phaserl


BFI Insights: The Zulauf Perspective

by Dirk Steinhoff, Mountain Vision:

… The economy moves in cycles. Currently, the industrialized world and a large part of the Emerging markets are in a down cycle. Government interventions are failing to bring the economy back on a growth track, and the mid-term assessment is that the world will somehow continue to “muddle through” for another few quarters.

The recent Brexit vote has brought to light the widespread and growing public discontent with the establishment and presented real challenges and concerns over the future direction of the EU. Additionally, significant risks are arising from China, that could trigger another downturn for the world economy. These factors, combined with geopolitical tensions and systemic problems in Western economic structures, raise concerns that sometime within the next 3-4 quarters, and the years thereafter, we could see another major economic crisis beginning.

Brexit Aftermath

The surprising victory of the Leave campaign in the UK referendum was a clear manifestation of the growing disillusionment and discontent of large parts of the population against the establishment, a trend that is also present in most industrialized countries. The Brexit vote, far from being an isolated incident, is in fact part of a process at work: the democratic process, whereby the public can express their disagreement with the direction of the European project. This type of populist movements could persist in years to come, and increasingly affect capital markets. It is therefore important to monitor closely both the institutional and market reactions, as well as the developments in political and economic policy directions.

Even after the initial Brexit shock is overcome, the EU will still be faced with an historic challenge: Reevaluating its political and economic strategy and aims, rethinking and reshaping the monetary union into a more sustainable entity and addressing the public’s and the market’s concerns could be decisive in shaping the future of the EU.

Concerns over China

In response to the 2008 crisis, China unleashed a stimulus program of an unprecedented scale that kept the world economy afloat. This move, however, led to a gigantic investment and credit boom, which in turn created an excess, and overcapacity of dramatic proportions. At some point, this will have to be addressed, by supporting restructuring. This policy direction will require substantial liquidity for the banking system to support the necessary write-offs, which could lead to a lower Yuan in the currency markets: that would be seen as a devaluation of the Chinese currency. Since China is the largest exporter in the world, a devaluation would put pressure on earnings of its competitors and on profit margins, and it would increase the deflationary pressure on their economies.

Impact of the US Fiscal Policy

Uncertainty and doubts are steadily increasing over the promised rate hike that now seems unlikely to be enforced in the coming months. Although new highs in the S&P500 are possible in the short-term, we do not see this move supported by improving fundamentals at the moment. Current valuations are elevated and any further increase carries the seeds of an exhaustion that could lead to a temporary trend reversal and ensuing medium-term correction sometime later this year.

Structural problems, however, remain lodged at the core of the American economy; a major restructuring of the tax system, addressing the debt burden, reducing the size of government, would be necessary steps to allow the economy to “breathe”. Tackling such issues, however, would without a doubt require fiscal support, which could take the form of government projects and much-needed infrastructure investments.

Gold Prospects

Loose monetary policy adopted by all central banks and rising uncertainty over when the monetary direction will be normalized, have contributed to a renewed interest in gold, even after the latest correction. It could trade erratically in the short-term, however, the longer-term expectation is that we will see a gradual upward trend in the gold price, towards our target level of $1400 and later even beyond that. Therefore, a strategic bullish position is recommended: As long as the overall sentiment of unease continues about the monetary excesses by central banks around the world and about the rising political uncertainty, investors are likely to seek refuge, for at least part of their capital, outside of the credit and banking system.

Investment Implications

Overall, the long-term view is that in the next five years we could see vast changes in the world economy and financial markets. Agility, adaptability and an open mind will be essential tools for investors. In the grim period that lies ahead, it could become increasingly difficult to earn decent returns with traditional assets. It is unlikely that equities will generate returns similar to historic levels without a major technology or innovation boost. Treasury bonds can also no longer be considered the go-to “conservative investment” option that they once were. Bond yields are so low that inevitably they will have to pick up at some point, which would translate as a severe blow to bond holders.

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