Tale of Two Bulls

Bull Markets are born on pessimism, grown on skepticism, mature on optimism, and die on euphoria.
— -Sir John Templeton

2016 has truly been a tale of two bull markets. With a nod to Sir John Templeton, we’ve seen a young bull market in metals (particularly notable in the precious metals) born in the depths of pessimism. At the same time the biggest old bull of them all, the global bond market has staggered to new highs as talking-heads muse about “permanently low interest rates” and ask absurd questions (“is inflation too low?”). Investors these days want bonds so badly (euphoria), they are willing to guarantee themselves a loss in order to own them. Astounding!

Gold Bull

Gold began its new bull market back in January of this year. At the time, pessimism toward gold stocks was off the charts. Miners were absolutely hated and had been battered to thirteen year lows. Many of the companies were trading at levels last seen when gold traded near $300 per ounce. From that depressed level the precious metals mining stocks have run dramatically higher dwarfing the performance of other asset classes.

Are precious metals miners over-bought and over-valued now after that tremendous run? While they are certainly due for a breather (and many are in fact correcting as this note is being written), we feel that precious metals mining stocks remain a favorable asset class from a long-term perspective for three reasons:

  1. Their product, gold and silver, have tailwinds. Investor confidence in extreme monetary policy is waning. The commodity bear market has ended with generally beginning to rise as supply cuts take effect. Additionally, gold’s inverse correlation with other financial assets shines in an environment where investors are looking to insure against trouble in their other portfolio holdings.
  2. Mining company fundamentals are improving. The carnage in the sector in recent years forced much needed operational discipline and an emphasis on cost control. These efforts are now beginning to show with improved cash-flows and bottom line profits.
  3. The relative valuation of mining stocks compared to the price of the metal is coming off a 20-year nadir and still has room for substantial upward mean-reversion even after recent price gains. (As an aside, the Producer:Product ratio can be a good long term sentiment indicator. In the case of oil producers, the ratio is high relative to trend indicating some persistent optimism)

Bond Bull

In marked contrast to the young metals bull, the bond market has been going up (with interest rates going down) as long as anyone can remember. That mildly flippant observation isn’t really as much of a stretch as it might initially seem. Imagine a young twenty-five-year-old analyst starting a Wall Street career back in 1981 when the last major bond bear market ended. Our young analyst would now be nearing retirement age having NEVER seen persistently rising interest rates.

The Financial Times reported in early August that the global “pile” of bonds bearing negative interest had reached $13.4 Trillion. We discussed the extreme nature of such events in our late-April commentary (http://www.svanecapital.com/perspectives/2016/4/29/negative-interest-rates) when this number was a “mere” $7.8 Trillion. The degree of enthusiasm and belief in bonds as an asset class tends to take a long time to develop (the bull ages). Thirty-six years ago, in the infancy of the bond bull market, bonds were commonly referred to as “certificates of confiscation” and bond investors were labeled “vigilantes”. It is noteworthy that this disparagement was loudest with bond interest rates in the high teens. In hindsight, those rates proved to be historic bargains and a long bull market was being born.

Recently, the general decline in interest rates, and hence the bond bull market, has continued even as commodity prices, real estate prices, wages, and rents (all directly or indirectly major components of the CPI) have begun rising. Former Fed Chair Alan Greenspan was recently quoted telling Fox Business’s Maria Bartiromo that he suspects inflation is beginning to rise: “I think we are on the edge now of a significant change in the global outlook.  And it’s a very slow and very turgent but very persistent move from deflation to inflation.  We’re seeing the very early signs of a process of inflation rising.”

Time will tell...and that's no bull!


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