Martin’s Capital Market Observations
Half a year has passed since my last reflections – a turbulent stretch that opened up entirely new economic scenarios. Some of them I had already touched on back then.
This time I have once again invested many hours and worked with charts in order to visualise this complex tangle of factors.
In mid-April the official inflation rate stood at what was then an “unbelievable” 7.2%. Unbelievable because the chief strategists at the ECB had still been saying in the autumn of 2021 that there would be no inflation – and if any, only “moderate” and “temporary”. Well, now at the end of October 2022 we are officially at 10.4% – so not “moderate”. With a current bond yield of around 2%, roughly 8.4% of purchasing power is being lost right now. How long “temporary” will last is left to the reader’s imagination, because the ECB is plainly wide of the mark here too. The real yield is more deeply negative than ever before (right-hand chart).
And one must not forget that the loss of purchasing power incurred up to now remains in place, even if the inflation rate were to fall back to 2–4%. Why? Because the price increase has already occurred and has pulled the overall price level sharply upwards. Which in turn means that a reduced inflation rate, applied to an already high level, still drives prices further up. But if the inflation rate does not soon turn away from this high level, then galloping inflation and even hyperinflation can follow. Anyone who wishes to look into this topic more closely should take their time with Frank Stocker’s book “Die Inflation von 1923 – Wie es zur größten deutschen Geldkatastrophe kam” (“The Inflation of 1923 – How Germany’s Greatest Monetary Catastrophe Came About”). It describes the path and the events very simply and vividly; back then, too, hyperinflation did not arrive within a couple of months.
I am not saying that such a scenario will recur, but I do think it is at least important to raise it now.
For in the wake of this enormous inflationary development the central banks are trying to counteract it through interest-rate rises. This, however, will bring only brief and limited success, because the inflation did not arise from rising energy and food prices, but from the uncontrolled money-printing after the financial crisis of 2008/2009. That is some years back now, but it shows once again how important it is, in any economic analysis, not to lose sight of the lag effect. In this case one can picture it like a tsunami, pushing ever more water ahead of itself unnoticed before the wave strikes land (= resistance). As I see it, the wave is still building.
What effect the rate rise has on bonds is described very nicely in the current “DEGUSSA Market Report of 26 October 2022”:
HOW BOND PRICE AND MARKET INTEREST RATE ARE LINKED
Between the bond price and the return the investor earns on the bond there is an inverse relationship: when the bond price rises in the market, the yield falls; and when the bond price falls, the yield rises. Let us consider an example. You buy a ten-year bond paying an annual coupon of 1 per cent on the par value of 100 euros. At a market rate of 1 per cent the market price of the bond is 100 euros. If the market rate subsequently rises to, say, 2 per cent, the market price of the bond falls to 91.02 euros – a (paper) loss of almost 9 per cent. If, however, the market rate rises to 4 per cent, then the bond trades at only 75.67 euros – a price loss of nearly 25 per cent. And if the bond price falls to 63.20 euros, then the market rate has climbed to 6 per cent – and the price loss amounts to 36.8 per cent. The level of the prevailing market rate continues to play an important role in the extent of the bond’s price movements. If market rates are at 1 percentage point, for example, a rate increase of 1 percentage point leads to a much sharper fall in the bond’s price than if the 1-percentage-point increase occurs in an environment where the market rate is at, say, 3 per cent. What makes the current rate increase so dramatic (i.e. leads to very large price losses on bonds) is the fact that the sharp rise in rates occurred in an environment of extremely low interest rates – inflicting on investors enormous (paper) losses of a kind not seen since the end of the Second World War.
What this looks like in practice can be read off very clearly from the 100-year Austrian government bond, which came to market in 2020 twelvefold oversubscribed and – while rates continued to fall – even rose to a price of 139, before reaching its low point at a price of 39 in June 2022. The chart is not that of a share:
How the turn in interest rates affects the home builder you can see here:
This chart shows the development of mortgage rates for different maturities over the past 15 years. One can see very clearly the enormous jump in mid-January 2022, after which a 10-year mortgage rose within a few months from around 1.00% to now just under 4%.
For a mortgage of, say, €100,000 this means an additional monthly burden of €250. Doesn’t sound like much, but on €500,000 it is then a full €1,250.
On top of that comes a repayment rate that should be at least 3%, so that the loan can be paid off within a reasonable period. An annuity of 7% (4% interest + 3% repayment) would then mean a monthly burden of a good €2,900. Fifteen years ago it would still have been around €1,660 a month.
So one can readily imagine that a great many would-be buyers are no longer able to finance a property at all, which – according to supply and demand – will have a marked effect on property prices, and already has after just a few months.
But for existing property financings, too, the coming months will be interesting.
If someone took out a property loan of €500,000 in June 2012 with a fixed rate of 2.96% for 10 years and a repayment of 2%, then at an unchanged interest level (follow-on financing etc.) they would need until at least 2043 to repay it at an unchanged rate. The rate, however, is already higher now at just under 4%.
This mortgage now falls due with a residual debt of around €383,000. By now €117,000 has been repaid and around €132,000 paid in interest (at a historically low interest level). And after a further 10 years there is still around €230,000 on the clock.
How is someone on a “normal” income still supposed to afford such financings?
At what interest rate most mortgages were taken out you can see in the following chart, and then calculate when existing financings with follow-on financing will run into trouble, unless rates fall again:
Making matters worse is that this does not even take into account the likewise sharply risen electricity and heating costs, which further significantly narrow households’ financial room for manoeuvre.
Now you might object: “doesn’t bother me” – I’m not buying a property anyway and would rather stay renting. “Fair enough”, but then you should take a look at how your unit of payment – known as the EURO – has developed since its introduction.
For that, let me show you this chart:
Since its introduction the EURO has, over and above the perfectly normal 2% inflation planned by the ECB (we are now currently at 10.4%), briskly lost more than 30% of its purchasing power. Had you been a clever clogs and exchanged your good old Deutsche Mark into gold – instead of into euros – you would have been spared a loss of purchasing power of 85%. Just think about that! Against US equities, too, the “so stable” EURO lost 70%!
Now you might counter that you do not pay for your goods and services in USD or the like, but in EURO. True, but here in Germany we have to buy all the raw materials for producing goods from abroad – and with an ever-weaker EURO (this should have been clear to everyone since the Ukraine war at the latest…). If, to gauge this issue, one takes the two commodity-based currencies of the Canadian dollar and the Australian dollar, one will notice that here, too, between 20% and 25% of international purchasing power has been lost.
Incidentally, over the past six months the EURO has even lost 20% against the (sanctioned) Russian rouble!
A currency will be accepted as a means of payment only for as long as economic actors have confidence in that currency…
I will say more on this below in relation to the USD.
To assess and evaluate the currently difficult and confusing situation on the capital markets – triggered by sharp inflation increases, marked rate rises, exploding electricity and energy costs and politically extremely uncertain developments – the following chart helps:
According to it, since 1926 there have been only two years that delivered results on the capital markets similar to those so far in 2022. Shown here are the returns of US equities and US bonds. In 2022, for example, US equities posted a loss of around 22% and US bonds likewise a loss of around 10%. This means that even if you achieved a fine spread of your investments (as in previous years too), with a 50/50 allocation you reached a loss of around 16%. At an equity quota of around 30% it would still have been a loss of around 13.6%!
But one can also see that most years are found in the upper-right quadrant, with the years 1985 and 1995 performing best. Even in the extremely poor equity year of 2008, a return of around +2% was achieved at a 30% equity quota. So it does make good sense to invest in a diversified way on the capital markets and not to leave the money (inflation!) sitting only in a savings account.
In doing so, however, one should also bear in mind that with bonds, in addition to the risks described above, a “phenomenon” arises that is mostly “forgotten” or overlooked. One must in fact also calculate and assess the liquidity – that is, the tradability – of the bonds. This matters precisely when you want to sell the bonds but nobody wants to buy them. The following two charts show, on the one hand (left), that liquidity has fallen off sharply, and on the other (right), that the losses on bonds relative to global gross national product have reached a post-war level.
Perhaps one should – in order to avoid further price losses on bonds in the event of further rate rises – bet on equities and cash (where, apart from the loss of purchasing power, one no longer loses anything now that the penalty interest is over again).
But for that one should also know that in the USA, for instance (where the longest data series are available), a full 24% of the companies in the Russell 3000 Index (the largest listed public companies) are designated so-called zombies (nothing to do with Halloween). This expresses the fact that these companies no longer even generate enough income to cover just the interest expense on outstanding loans!
What is remarkable here is the significant increase since 2020 – at a time when interest rates were still negative. What will happen now that rates have – as described earlier – risen so sharply? How long before insolvencies explode here?
The level is almost 50% higher than at the time of the dot-com bubble.
At present there are also additional burdens in the form of electricity-price increases, heating-cost increases, payment defaults, wage rises from strikes and so on. In Germany this mainly affects small businesses (butchers, bakers, etc.) as well as mid-sized companies with several thousand employees (and thus their families too), some of which are world market leaders in their lines of business.
On account of the enormous future additional costs described above, as well as the bureaucracy that has been spilling over for years, these businesses (mostly family companies going back decades) are closing, being sold (to the Chinese) or relocating their operations to cheaper and more business-friendly countries abroad (Canada, USA, etc.).
As soon as these businesses cease to exist, the unemployment figures rise and Germany’s competitiveness suffers. Of course you will not notice this immediately in the coming year, but rather in 5–10 years’ time (when you want to retire; but more on that in the next report).
In the private sphere, too, dramatic situations are emerging. The following chart shows the development of the savings rate (red) and consumer credit (blue) for the USA. During the first lockdowns the savings rate rose and spending fell enormously – something that reversed completely from around mid-2021.
The Black Swan
Alongside these known and widely documented hard facts, there are also many non-obvious and hard-to-find facts that can strike and influence the economy “out of a clear blue sky”. One then speaks of the “black swan”.
In recent months I have heard again and again in many conversations that there are so many black swans that one cannot even know what will really come and what one ought to prepare for. That is of course not true, because these topics are already known and must be assessed and analysed according to the respective situations. They are therefore not black swans.
BUT: one black swan with considerable collateral impact could be the Swiss major bank Credit Suisse. Just a week ago, practically over the weekend (21–23 October), the bank sold off its stake in a profitable fund platform in an auction process for around €330 million in order to raise capital. According to the news agency REUTERS, the bank needs around USD 9 billion for an urgently necessary reorganisation. The Savoy hotel in Zurich’s prime location is also said to be up for sale, though I cannot judge how much could be raised for it.
Far more important to me is the question: how desperate must Credit Suisse’s board be to take measures that, in light of the data, can safely be described as “a drop in the ocean”. If the bank fails to find investors willing to inject additional enormous sums, things will probably become rather tight.
Now you might counter: what do I care about this Swiss bank, I have my account, say, at a local Sparkasse or cooperative bank; and if something happens there, there is after all a deposit-protection fund. True, but then you are forgetting or neglecting the domino effect, because ALL of the world’s major banks are interconnected (at the very least via countless derivatives with astronomical volumes that exceed their equity many times over). If derivatives topple, then funds have to be raised (margin obligations) and margin calls in the billions/trillions settled. This would then, inevitably, also hit a Deutsche Bank, which in turn has astronomical derivatives on its books, and so on.
This concerns globally operating major banks, but the deposit-protection fund mentioned earlier is itself only a “pacifying device” for singular, regionally occurring payment difficulties of your Sparkasse or cooperative bank in the event of trouble with their lending business. But the deposit-protection fund is not designed for supra-regional, Europe-wide or even global bank failures. In that case you would get nothing of your balances either. Incidentally, your deposits at the bank are not your assets but a loan to the respective bank; have you actually received any security for this, as you would when taking out a loan from the bank yourself? This is no joke or any irony on my part!
Confidence in currencies and markets
As you may know, I have followed the capital markets for almost four decades and have repeatedly found information and people that are not always readily findable, and therefore analysable, on the spur of the moment. One of these people is Robert Kiyosaki, who in his life has also experienced many situations that would be unthinkable for other people. Four weeks ago I came across this video, in which he interviews Andy Schectman, an absolute “capital-market veteran”:
4 Signs the U.S. Dollar May Be Toast – Robert Kiyosaki, Kim Kiyosaki, Andy Schectman – YouTube
In this English-language interview there were so many “aha” moments that I decided to write down the content for you in note form, because the world is just beginning to shift:
> Why is the USD the world reserve currency? → Kissinger with the Saudis: we protect you,
and in return oil is invoiced globally in USD
> What are the Saudis doing right now and why? → joining BRICS
> What happened in Afghanistan?
- Withdrew within the shortest time
- Left allies behind
- That would never have happened in the past
- Globally therefore no more confidence in the USA → and no longer in the
USD
> Besides Russia, now Nigeria (!) and other states are also selling their oil to
China and receiving in return yuan bonds that are immediately convertible into gold
> In the past three years as many USD have been printed as in all previous
years combined
> The money flowed into assets (equities, bonds, property, art, etc.)
- Asset bubbles have formed → crack-up boom (Austrians)
- This flood of money in combination with low interest rates produces strongly rising inflation
> The FED (Powell), however, does not want to go down in the history books as the one who destroyed the Americans’ prosperity
- so they will raise rates in the USA only slowly
- This means really negative rates: at 9% inflation and 2.5% interest this gives a real rate of -6.5%.
- By the calculation method of the 1980s, however, this would be an inflation rate of around 16.6% → so here too, through the permanent changes to the basket of goods, an illusory world has been created > Sanctions against Russia, too, are driving other countries out of the USD, because they fear becoming the next target at some point > 85% of the global population still trade with Russia despite sanctions
> Russia, India, Iran as well as Turkey, Egypt and the Saudis are joining BRICS – away from the West
> The BIS (the central bank of central banks) has raised gold as bank collateral to security level 1
> In the first 7 months China sold USD 100 billion of US bonds in order to make itself economically more independent of the USA; which does not mean that they no longer trade with the USA, but simply that existing holdings and future proceeds from business relationships are no longer invested in USD
> The 147 countries on the “New Silk Road” dominate the future
> As early as 2015 Russia introduced its own payment information system (Mir) in order to be independent of the Western SWIFT procedure; China too has an extra system in “Union Pay”, which is why sanctions also achieve nothing at this point
> The Saudis will in future be protected by the Russians and China (my enemy’s enemy is my friend)
- Over a weekend (like the abolition of margin taxation on silver coins two weeks ago in Germany) these countries will agree to invoice oil, alongside the USD, mainly in other (gold-backed?) currencies
- everyone sells USD
- hyperinflation
- interest rates rise
- currencies, equities, bonds, property lose dramatically in value
- except commodity-based currencies (such as CAD, AUD, etc.)
It could be that the slow decline of the USD has thereby been set in motion.
A further word on the situation regarding physical precious metals
Many investors are wondering whether they should sell their gold and silver bars and coins, because they have not “earned” anything with them. The question, however, is what one understands by “earning”.
Interest there was none, dividends only with considerable fluctuations in the underlying shares, rents could not keep pace with the enormous increases in property values either. So the so-called cash-flow investments are pretty much exhausted.
Direct corporate holdings and investments not accessible to the broad mass of investors are deliberately not assessed here, because they are not investable.
Investments in physical gold or silver, however, have brought in handsome returns in euro terms, though here too one had to accept quite some fluctuations.
From among many pieces of information and publications, this analysis from last week stands out:
COMEX Deliverable Silver far less than imagined as 50% of ‘Eligible’ is not Available (bullionstar.com)
Here it is analysed very precisely, on the basis of official data from the underlying exchanges that trade physical precious metals – “COMEX” (USA) and “LBMA” (London) – where the difference lies between the prices of physical precious metals and “paper precious metals”.
As you know, there are corresponding exchanges for price discovery. With precious metals, however, one must distinguish between what is traded and valued on paper (spot price) and the prices for precious metals with physical delivery.
This can be shown very clearly on the two charts for gold and silver:
The dark lines are the prices for coins and the light lines the prices for bars. When the premium is high, it means that delivery is difficult or almost impossible, because the price (from supply and demand) is fluctuating. With silver in particular it is becoming apparent that physical delivery entails considerable additional effort.
The enormous rise in silver coins (dark line) is also connected with the fact that the Federal Office of Finance decided at the beginning of October, over a weekend and without prior announcement, to abolish margin taxation for coins from outside the EU (i.e. Canadian Maple Leaf, etc.) – and retroactively at that. I am rather curious about the legal appraisal of this, but it shows how desperately the federal government is trying to collect money…. Such a thing was known in the recent past only from the Greek crisis, when (savings) balances were expropriated overnight/over a weekend, and in Cyprus too one could withdraw only €20 of “one’s money” (as described above, a loan to the financial institution…) per day from the cash machine.
I am curious to see what will yet be dreamed up here in view of the recent orgies of debt.
Alongside the marked jumps in the premium, there is also the fact that gold and especially silver (as an industrial metal) in physical ownership has gained enormously in importance. This is impressively demonstrated by the following charts from the COMEX:
Here, in the upper part, one can read off very clearly how the (paper) silver price nearly doubled in May/June 2020 from well under USD 15 per ounce to almost USD 30 per ounce, and has since, with fluctuations, approached the USD 20 mark.
Far more interesting, however, is the lower chart, from which one can read that, together with the paper-silver jump, the physical storage at the COMEX had also surged, but then, from February 2021, shrank from 150 million stored silver ounces to only 38 million. This means that investors had their (paper) silver holdings paid out in genuine bars and coins and transferred them to storage locations (I can offer ideas). There is not much physical silver left there!
At present, however, the COMEX still has 265 million ounces of silver on paper on its books as deliverable, which evidently is no longer the case. So they now reckon, like the banks, with a certain residual base (50%) that is always present and does not have to be delivered. That is of course naive, and this misjudgement could drive the COMEX into bankruptcy.
“Registered Silver” is provided with a warrant, “Eligible Silver” is not… hence for the public it was the “quiet” reserve, which was supposed always to represent as large a reserve as possible so that no one would get any wrong ideas! Yet around 50% of this reserve is not freely available… and with the dramatic outflows of the past 12 months it is now getting interesting.
How dangerous an investment in precious-metal funds (mostly ETFs) claiming entitlement to delivery of physical precious metals can be is illustrated by the following overview. According to it, the largest silver ETF (iShares Silver Trust) holds 486 million silver ounces, of which 103 million are stated to be with J.P. Morgan in New York (COMEX). BUT J.P. Morgan has stated, for all available silver ounces at the COMEX, only 143 million. That would mean that on a complete delivery (to the customers of the Silver Trust) of the ounces stated at J.P. Morgan, only around 40 million would remain available for all of J.P. Morgan’s other customer deliveries.
So if the customers of just one silver ETF wanted their claims delivered in physical silver, around 40% of the silver would already be gone – and others would not yet even have asked. Here you will find the full article:
COMEX Deliverable Silver far less than imagined as 50% of ‘Eligible’ is not Available (bullionstar.com)
How long it will take, though, until the paper price (spot) adjusts to the price of precious metals actually available, I cannot say. But if one is interested in diversifying one’s money there, the timing should not be bad. It also works with savings plans!
Martin Dilg – 0172 / 86 11 97 8
This analysis makes no claim to completeness, nor does it constitute a call to action.
The information provided is likewise not part of any investment advice!
For personal questions I am very glad to be available individually.
31.10.2022
