Monday, January 26, 2009
Another weekend, another attention-grabbing headline in the UK Sunday press. Outgoing BOE Cassandra David Blanchflower observed that unemployment in Britain is likely to reach 3 million (from the current 1.92 million) and that rates are "obviously" going to zero. This is the same chap that forecast UK unemployment of 2 million by year-end 2008 months before Merv the Swerve claimed that the severity of the economic and financial downdraft was unforeseeable. Cassandra, indeed.
In any event, running the latest UK labour figures through Macro Man's single-factor BOE model does indeed generate a forecast of sub-zero base rates. This is obviosuly an overly simplistic methodology for dealing with a lognormally-distributed (i.e., cannot go below zero) macro-economic variable, but it nevertheless suggests that further rate cuts wouldbe consistent with the MPC's historical reaction function. So sterling predictably got splattered in Asian trading, though as last week demonstrated, early gaps are not always reliable. In any event, welcome all and sundry to the year of the Ox- a castrated bull. Is the Chinese zodiac offering a glimpse into what to expect for 2009 (i.e., more fo the same as 2008)?
While there are no shortage of talking heads willing to appear on CNBC pimping the view that stocks are "cheap" and "a screaming buy", Macro Man is reminded of the old market aphorism that "those who say don't know, and those who know don't say." (Quite where this leaves him, an anonymous purveyor of general investment thoughts and the occasional dodgy poem, is a consideration for another day!)
In any event, those who have been forced to mark-to-market have learned that holding most non-government bond or short-end instruments has been a decidedly losing proposition. Macro Man has updated his simple pension fund performance model for the end of 2008, and unsurprisingly the three-year return has turned negative in each of the G3 markets. Those confidently predicting a nearby bottom for financial markets might wish to consider that despite much worse global macroeconomic fundamentals, rolling risk-adjusted returns of pension portfolios remain well above the early-Noughties nadir. From Macro Man's perch, more downside lurks.
While Macro Man traditionally been sceptical of the gold bug argument, he has to concede that it is more attractive now than at any other point in his career. If one takes the not-outlandish view that global short rates will converge at zero, give or take, then the opportunity cost of holding gold becomes very low indeed- particularly in the absence of any other higher-return asset that does not run a susbtantial risk of default.
While Macro Man does not necesssarily subscribe to the view that hyper-inflation is an axiomatic outcome of global QE, he does concede that inflation is an eventual risk should global monetary velocity stage a quicker-than-expected recovery. At the same time, he is amply aware of a small but highly-convicted cadre of punters that believe that global fiat currencies will ultimately be discredited by the time the current financial and economic crisis is resolved.
Just as the Bretton Woods system of fixed exchange rates was the outcome of the Depresssion/WWII, what odds that the outcome of a global effort to beggar-thy-neighbour is a return to the gold standard for major currencies (including the RMB)? Pretty small, in Macro Man's view, but not zero.
More prosaically, if this is a view that is being articulated in the market, then there may be a profitable trading opportunity. It is quite remarkable that gold has completely divorced itself from EUR/USD; after exhibiting an r-squared of 0.32 in 2007 and 2008, gold and the euro have exhibited zero correlation so far this year.
Indeed, the chart of EUR/Gold looks pretty bullish, as it last week closed above the prebious all-time high. While Macro Man has yet to be convinced that gold is a buy and hold from current levels for the long term, he will readily concede that it looks worth buying for at least a tactical punt.