Scarce assets such as gold and bitcoin were among the best-performing investment categories of the past year. Yet, they received barely any attention in the endless series of (dull) outlooks from major investment banks and asset managers. Fortunately, there are always exceptions that prove the rule.
At the beginning of this year, analysts from JP Morgan, led by Nikolaos Panigirtzoglou, published a report in which they predicted that the “debasement trade” still has a long way to go.
The debasement trade refers to investments in (scarce) assets that offer protection against the ongoing devaluation of fiat currencies caused by inflation, rising debt, and geopolitical tensions.
It does not take much searching to conclude that there is no shortage of any of these three factors. In the Netherlands, inflation has risen above 4 percent, and globally, currency devaluation remains a persistent problem. Meanwhile, budget deficits of 5 to 6 percent have become commonplace—with the exception of countries that actually could afford to spend more. The Netherlands is one such example.
Political tensions are also plentiful, with clear signs of further polarisation. Unfortunately, the Trump factor offers little relief in this situation. Combined with the fact that most investors still hold minimal amounts of scarce assets in their portfolios—the traditional investment industry stubbornly clings to a system of exclusively stocks and bonds—JP Morgan believes this means the rally in the prices of scarce assets is far from over.
Hard data
The arguments made by Panigirtzoglou and his colleagues hold water, of that I have no doubt. In fact, I would go even further. The need to strategically adjust (multi-asset) portfolios is not only determined by rising risks related to prices, debt, and politics.
Even from a traditional perspective, the case for increasing the weighting of scarce assets at the expense of bonds is becoming increasingly compelling. By traditional perspective, I mean constructing strategic portfolios based on historical data. Even with this somewhat conservative hedging approach, sticking solely to stocks and bonds does not yield the best results.
For example, a 60-40 portfolio with 40 percent gold instead of 40 percent bonds has achieved a comparable Sharpe ratio over the past 50 years. During shorter periods, the alternative portfolio with gold even outperforms.
Other examples include the fact that the volatility of bonds relative to stocks has risen to its highest point in over twenty years, and that the correlation between stock and bond returns is historically, on average, positive. When you factor in inflation to determine the right mix, you must look back more than twenty years to find even a reasonably decent return. When all this hard data is fed into a “neutral” optimisation model, it is unlikely that bonds will still receive a weighting of 40 percent.
The Great Rebalancing
The combination of developments in the (financial) world and hard data leads me to define the structural shift within investment portfolios as The Great Rebalancing. While the ongoing debasement of fiat currencies is certainly a part of this, I believe this term better captures the full picture. Think of it as a strategic reorientation of the portfolio mix, driven both by the industry itself and by external factors.
The conclusion is clear: in the interest of your clients, ensure that you are not the last to act.
Jeroen Blokland analyses striking, topical charts about financial markets and macroeconomics in his newsletter The Market Routine. He is also the manager of the Blokland Smart Multi-Asset Fund, a fund that invests in stocks, gold, and bitcoin.