Welcome to Finance and Fury, the Say What Wednesday Edition
Back to answering individual questions - Two questions this week – follow up to recent eps on gold and economy
First from Mario– just a quick one - I listened to a recent podcast you made about gold and wanted to understand why people would own gold outright and keep in their possession? Is it purely because they don't trust keeping in a vault? Also with Gold ETFs in the case of a crisis gold ETF doesn't really mean much do they.
Why hold gold personally over a vault? The major reason to hold gold personally would come down to personal preferences and insurability, rather than not trusting a physical storage vault. The gold can be hard to personally insure and requires special additions to a standard home contents policy. The issue can come back to the valuation of gold, as the insurance policy might value up to $10,000 but the price of gold changes and might be higher than the insured value. people would need to constantly be updating their policy and paying additional premiums. When purchasing through a vault, this along with the storage is taken care of by the company (at a cost). The thing to watch out for is purchasing physical gold through a financial institution, as this can be expropriated (such as the FDR gold buy backs in the USA). That is why most gold companies as non-banks. Gold ETFs viability all depends on how bad a crisis gets. A market collapse like in the GFC is okay for a Gold ETF, as the price fluctuations/volatility are where losses can occur (or gains historically when looking at a share correction). If the financial system was to collapse and the financial institutions (such as HSBC) were to default and become bankrupt, then the risk of the gold held on your behalf may be at risk. This is known as counterparty risk -
Second part – Adam’s question
- I was listening to your episode about gold and precious metals just recently and it got me researching. Like you and many others have indicated there will be a correction soon and I am considering changing my super from high growth to conservative for a few years, so it's mainly in cash and bonds as well as selling half my ETFs to keep in cash. Not asking personal advice but general advice is it a bit drastic to protect my super for a few years while the market is overheating at the moment?
It depends on what allocation is considered conservative
– Balanced portfolios have overvaluations (Twin peaks)
Cash and Bonds, in my opinion, won’t be the best assets, mainly due to lowering interest rates and the potential risks now associated with 'Bonds'. Cash – Obvious – real returns aren’t good – mostly negative once inflation or tax is taken out Bonds - A lot of Industry super funds have a bit of a disingenuous description when it comes to their 'Bond' Allocations. These Bonds are actually invested throughout fixed interest investments that contain assets that are not considered bonds or, that conservative. Example - QSuper have the following descriptions for what their Bond fund invests in, as this investment is managed by QIC and invested in the QIC Diversified Fixed Interest Fund: Fixed interest is defined as any interest-bearing security or equivalent derivative instrument – Not just bonds Lack of transparency to where they actually invest the funds (outside of 44% to Corporate Fixed Interest), I believe that a lot of the fixed interest allocations are in Corporate Capital notes, the same ones covered in the 'Where not to Invest' episodes covering the bail-in legislations. There is also the increased risks of default on Semi-Government Bonds Think about the size of Debt – 315% to global GDP – US will never be able to pay back $20trn debt Options for debt – default! So bonds are worthless Share allocations in indexes - Personally, I am sticking clear of ETFs, do have smaller allocations to MF index – Aus index issue is allocation of shares in the Banks/Financials - assets that I think may not survive another large correction too well Think about GFC – USA banks ran into issues – narrative our banks were solid thanks to Basel 3 – but still lost 68% NAB $41 to $17, CBA $61 to $26 – Back when banks could make money on major assets = loans – now lowering rates doesn’t help that at all Compare to WOW - $33 to $24 = 27% loss, CSL $41 to $38 = 7% loss = much lower – our index dropped due to banks Also - Now Central banks have little printing power left to Bail Out of banks – hence Bail Ins This all being said, there is no way to really time the market and if Australia enters QE territory, our share market may rally to 7,000 in which case you would miss out on gains if you held all your assets in cash. I always have some allocation of surplus cash inside my super to dump into the markets if they go down, while being allocated to shares and funds which invest in business that should remain in business if a crisis were to hit. Higher Growth investments will experience volatility but the major consideration to take is 'what are the chances of 100% losses?'. Superannuation specific - If you have a long timeframe and will be getting employer contributions along the way, additional volatility on the downside means that you are purchasing these investments cheaply. The issue with Industry Funds is that they don’t provide specialised investments outside of mostly index funds, which in Australia has an overweight position to Financials. Option – I do this – hold a reserve of allocation in cash like investments in super – buy into higher growth funds if the market has a larger correction in a short timeframe.
Ask yourself the questions - What assets will survive a financial correction – it will be those that people still have confidence in and those without massive counterparty risks -
Confidence is key – Confidence in any asset is what is needed – but also confidence in the counterparty
Why is confidence important?If a lack of confidence/panic is what causes prices on assets to drop heavily –
Then the solution is to be in assets that while may be impacted in prices (short term volatility) – will not go to zero Asset goes down in value – so what if you have a long time horizon Depends on type of asset and what you do, and what those investments are to you But - Never sell after the fact - Shares go down in value - You sell – crystallise losses Also, an issue for selling before – Losing 22.5% in tax on the gain is no worse than shares going down by the same values Worst case - shares keep going to zero – which is why confidence is important – but also diversification
Solution – Step 1 - Buy good companies, diverse business models, diverse markets and lot of different companies – diversification. Step 2 – Don’t panic sell and have enough cash (not all) to survive market corrections – easier longer your investment timeframe is
If you are worries - Buy alternative asset classes –
Gold/Silver/Palladium/PlatinumTypes of assets to watch out for Shares in Financials or FAANG/Passive index funds - Financials - Been reducing my allocation to Financials over past few weeks – NAB and WBC at $30 Any Shares with Margin Loans – higher LVR levels Run up of leverage causes a lot of bubbles, then corrections Property that is highly leveraged Not PPR – not forced to sell that hopefully But if people are losing jobs, rents may come down or be non-existent – your cash flow needs to cover repayments ‘debt instruments’ – MBS, Managed funds marketed as ‘Income Funds’ – massive counterparty risks here - CDOs Corporate notes/hybrid securities Derivative exposure on these as hedging or absolute return funds won’t hold up if counterparties providing the hedge also default
Summary – Assets that while not retaining value like you could want (drop in price) – if you hold you can survive Have a range of investments (not just bank shares or passive funds) Some physical assets – Gold, metals Shares in companies that people will still use – not fad companies or ones build on people’s discretionary spending Land values – That you can hold and not need to sell Make sure they are quality assets and hold some cash reserves Cover expenses and not at margins meaning you need to sell Take advantage of market losses -
Thanks for listening – eps are for you all – if you have questions – let me know at FF.com.au on the contact page
