The Robots Are Coming, Slowly.

August 2016 Investment Report

 

Summary of contents

• The rate of technological development is slowing and whilst robotics is another advancement, technology has created an over confidence in what it can achieve that has encouraged more debt with which to invest in that technology. Governments and central banks are becoming compelled to inflate that debt away. The slowdown in the development of technology is itself inflationary as productivity gains will be lost. 

• Low growth in nominal GDP would cause disaster and central bankers are prepared to take high risks to stimulate growth and inflation so as to avoid the defaults that threaten both corporate and sovereign bonds.

• Whether the economy holds up or not, the yield curve could steepen markedly sooner or later, undermining both bond and equity markets.

• Real assets such as land, gold and tangible plant and equipment at a discount are favoured asset categories.

• Traditional asset diversification may not protect to the same extent that it has in the past. Greater market dislocation would be welcome as high volatility is frequently an omen of opportunity.

• A decisive flick of the fiscal switch to loosen austerity would herald a stampede from the best performing sectors of global markets.

• Ideally an asset should possess two key characteristics: good cash flow visibility and stability: and an embedded inflation hedge.  That tends to lead you to hard assets rather than financial assets.

• Robert Louis Stevenson wrote: ‘Sooner or later everyone sits down to a banquet of consequence’. That moment is coming.

• Certainly there will be a further backlash against the establishment, capitalism, big business and the banks. There will be a rise in international tensions, protectionism, taxes and inflation. The value of shares, pensions and property will fall. Companies and countries will go bust.

• The current path of monetary and credit expansion is unsustainable and will eventually burst, leaving investors struggling for the return of their capital, instead of return on their capital – an extremely bullish scenario for gold and other real assets.

• A dangerous slippery slope that paper cures miss is that they ‘eventually converge to their intrinsic value: paper’ as Voltaire warned.

• In the 1930s, US gold reserves were only valued at $35 per ounce and still represented 26% of outstanding dollars. Today at $1360 per ounce, reserves represent a measly 1.5%. With the world’s gross national product at $75 trillion and the world money supply at around $83 trillion, which is ten times the level at the start of the millennium, Crispin Odey argues that gold prices should move much higher.

• Protectionism is rising which leads to increased prices as local businesses are able to increase prices more easily. Current increased money supply should lead to higher inflation.

• Global oil demand is quite healthy. The market could become increasingly tight, with prices in the $70s in 2017.

• Consultants McKinsey estimate that the energy storage market will grow a hundredfold to $90bn a year by 2025. Renewables generated 18% of UK power last year, and this is expected to double by the late 2020s as wind and solar capacity reach 50 gigawatts (GW). The latest official data shows that the renewable share of UK power surged to a record 25.1% in the first quarter of the year. Half of this was wind.

 

Robotics and Technology

 

The economist – ‘(Artificial Intelligence) AI systems are impressive; they can perform only very specific tasks: a general AI capable of outwitting its human creators remain a distant and uncertain prospect. Worrying about it is like worrying about overpopulation on Mars before colonists have even set foot there, says Andrew Ng, an AI researcher. The more pressing aspect of the machinery question is what impact AI might have on people’s jobs and way of life. This fear also has a long history. Panics about ‘technological unemployment’ struck in the 1960s (when firms first installed computers and robots) and in the 1980s (when PCs landed on desks). Each time, it seemed that widespread automation of skilled workers’ jobs was just around the corner. Although a much-cited paper suggests that up to 47% of American jobs face potential automation in the next decade or two, other studies estimate that less than 10% will actually go.’

 

Robin Harding, FT – ‘An oddity about the gangs of robot labourers that are supposedly about to take our jobs, leaving humanity to watch daytime TV and survive off a universal basic income, is that people who make robots for a living tend to talk them down. Junji Tsuda should know. His company, Yaskawa Electric, sells $3bn worth of robots a year to car factories. ‘The robot brain is developing incredibly fast. The biggest problem is the hands that do the work,’ he said last year. ‘They’re not going to develop on an exponential curve, like computers. It’s going to be linear, steady growth.’

 

James Titcomb, Telegraph – ‘According to the latest International Technology Roadmap for Semiconductors, a joint report from chip giants including Intel and Samsung, by 2021 transistors will shrink to a point at which it is no longer economically viable to make them smaller.’

 

Berenberg Investment Bank – The monthly Robot story count on Bloomberg is currently at a record dating back to 2000. Previous peaks occurred near stock market peaks in 2000 and 2008. I believe these stories increase at these times as the pedlars of these stories get caught up in the excitement and many use the information as a method of justifying high stock market valuations which are not sustainable.

 

My Conclusion – The rate of technological development is slowing and whilst robotics is another advancement, technology has created an over confidence in what it can achieve that has encouraged more debt with which to invest in that technology. Governments and central banks are becoming compelled to inflate that debt away. The slowdown in the development of technology is itself inflationary as productivity gains will be lost. 

 

Stock Market Warnings

 

Alastair Laing and Peter Spiller – Capital Gearing Trust PLC

‘Financial markets are as distorted as any time in history, as evidenced by one third of all government debt trading on negative yields. That in turn reflects the extraordinary fiscal and monetary policy that has been deployed by governments and central banks. All this is an effort to avoid the natural consequences of the excesses that preceded the Great Financial Crisis. The most significant of those excesses was the level of debt which rose alarmingly in the developed nations up to 2008. For the world as a whole, debt has risen much further as a percentage of GDP since the crisis, exacerbated by an extraordinary expansion in China. The solution to the problem has been more debt.

 

Against this background, low growth in nominal GDP would cause disaster and central bankers are prepared to take high risks to stimulate growth and inflation so as to avoid the defaults that threaten both corporate and sovereign bonds. It is unclear if the world economy is entering a period of weakness, but if it is, then the central banks will be tempted by the next extension of QE, namely monetary finance. That involves increasing government expenditure on infrastructure, or tax cuts, or simply handing out cash to citizens, financed by printed money. Such a policy would surely succeed in raising both growth and inflation; the difficulty is in calibrating the latter. Governments can always promote inflation if they are aggressive enough, just not 2% inflation.

 

Whether the economy holds up or not, the yield curve could steepen markedly sooner or later, undermining both bond and equity markets. The latter looks particularly vulnerable as valuations only make sense if current low interest rates persist indefinitely. Implicit in persistently low interest rates is persistently low nominal GDP growth which means current record high levels of corporate profits would prove unsustainable.’

 

Bill Gross – Janus Capital

‘I don’t like bonds; I don’t like most stocks; I don’t like private equity. Real assets such as land, gold and tangible plant and equipment at a discount are favoured asset categories. Central bank ‘promises’ of eventually selling the debt back into the private market are just that – promises/ promises that can never be kept. Nominal growth needs to reach 4% to 5% in the US, 3% to 4% in Europe and 2% to 3% in Japan before the global economy devolves into Ponzi finance, and at some point implodes.’

 

Sebastien Lyon – Troy Asset Management

‘We repeat our warning that in an environment of near-universally overvalued asset markets it is likely to be easier to navigate the post-market falls than to avoid the falls themselves. This is because, with both equities and bonds vulnerable, traditional asset diversification may not protect to the same extent that it has in the past. We would welcome greater market dislocation as high volatility is frequently an omen of opportunity’.

 

Michael Mckenzie – FT

‘Investors such as pension and sovereign wealth funds are pumping money into emerging market bonds at a record pace, lured by yields that remain above those of developed world sovereigns. The result? A classic crowded trade and, as market history tells us, these episodes never end well. A decisive flick of the fiscal switch to loosen austerity would herald a stampede from the best performing sectors of global markets. The ensuing surge in market volatility would prompt investors to sell their holdings based on risk management models – known as value-at-risk (Var) shock – in order to avoid losses. ‘There’s clearly a push away from austerity towards fiscal stimulus and a Var shock is a risk here and could be evolving as we speak’ Chris Watling of Longview Economics.  We have felt the Var tremors before, notably during the summer of 2013 with the taper tantrum and then, from last April, when the 10 year German Bund yield rose from just above 0% to near 1% by early June. As yields and volatility rise, investors embark on a rotation into cyclicals but, as we saw last summer, this type of churning in equities is subsequently overwhelmed by broader market turmoil. The push for sustained fiscal measures as monetary policy reaches its limits, remains more talk than action. The potential for sparking a rush for the exit from what has been a relentless search for yield cannot be ruled out. One can only hope that markets experience another tremor and not the big one.’

 

Abdallagh Nauphal – Insight Investment CEO

‘The problem has not been solved. There has been over-investment funded by debt that has created a world in which there is an excess of supply relative to demand. That is supported by a mountain of debt collateralised by over-inflated assets. It takes more debt to create the same amount of GDP. This process of debt accumulation must surely become unsustainable. The question is: how close are we to that tipping point? You could buy 75 cents of GDP for one dollar of GDP in the 1970’s. Today, you can buy approximately 27 cents of GDP for one dollar of debt. There has been a substantial drop in the productivity of debt and this is really problematic. Ideally an asset should possess two key characteristics: good cash flow visibility and stability: and an embedded inflation hedge.  That tends to lead you to hard assets rather than financial assets; though there are parts of securities markets that also have these attributes. Robert Louis Stevenson wrote: ‘Sooner or later everyone sits down to a banquet of consequence’. That moment is coming.

 

John Longworth, former director general of the British Chambers of Commerce and chairman of the Vote Leave Business Council – ‘My worry is that the weight of global debt will exert a gravitational pull that is too strong for the world economy to escape. The tide is going out, especially for central banks that have run out of room for manoeuvre. Interest rates can’t go much lower and QE just adds to the debt pile, inflates asset bubbles and worsens moral hazard in the financial system. There are a number of things financial institutions and governments could do but they probably can’t be pushed through until we are in the grip of a full-blown crisis. The first would be a huge increase in public spending. The second, which would have side effects but would erode the debt mountain, is inflation. The third is manged default. All of these options are ugly. All of this may be overly pessimistic. Perhaps China isn’t in a pickle and the world’s central banks can paper over the cracks while China adjusts to internal growth, the US finds domestic growth and Germany continues its pursuit of hegemony. But, if that doesn’t happen, the implications of a mega-crash in a globalised, terror-ridden, nuclear-proliferated world are incalculable. Certainly there will be a further backlash against the establishment, capitalism, big business and the banks. There will be a rise in international tensions, protectionism, taxes and inflation. The value of shares, pensions and property will fall. Companies and countries will go bust.

 

Jamie Chisholm, FT – ‘Since mid-2012, UK earnings on a trailing basis have fallen about 50%, Citi notes, but over the same period, trailing dividends per share have risen about 20%. This is unsustainable.

 

US corporate cash flow trailing 5 year percentage change is at 3.31% which is the worst level in the last 68 years. Market tops normally occur at these extremes.

 

My conclusion – Sell stock markets, property and bonds.

 

Protectionism

Shawn Donna – FT – ‘Since 2008, according to the WTO, G20 economies have introduced 1583 trade restricting measures and removed only 387. Between mid-October 2015 and mid-May of this year they introduced 145 protectionist measures – a monthly average of just under 21, the worst seen since the WTO began monitoring G20 economies in 2009.

 

My conclusion – Protectionism increases costs, as local businesses are able to increase prices more easily.

 

 

Inflation

Simon Ward from Henderson Global Investors said his gauge of the worlds’ money supply – real six month M1 money – is growing at an annual rate of 10.5%, the fastest since the blitz of stimulus after the Lehman crisis.

 

My conclusion – Increased money supply should lead to higher inflation.

 

Government Pension Schemes

Patrick Jenkins, FT – ‘Citi found the value of unfunded or underfunded liabilities for 20 OECD countries is $78tn – nearly double the $44tn published national debt number.’

 

Energy

The International Energy Agency estimates that global demand for crude rose a respectable 1.2m barrels a day in the second quarter to 96m, driven by the fastest rise in oil consumption by the rich OECD countries since 2010. The IEA expects the momentum ‘will be roughly matched through the year as a whole’.

 

Richard Mallinson from Energy Aspects said excess stock built up by refineries was the trigger for the recent slide in crude from $50 to $40 a barrel, but this disguised an underlying shift in the market balance that could ultimately lead to a future supply crunch.

 

Output has slumped by 400000 barrels a day in China over the last year, yet the country is stepping up purchases for its strategic petroleum reserve by roughly the same amount. The scissor effect of those opposing trends may be enough to flip the market from surplus to deficit before long. Global demand is quite healthy. ‘We think the market will become increasingly tight, with prices in the $70s in 2017’, he said.

 

FT – ‘The head of the International Energy Agency, Faith Birol, pointed out last week that the share of the world’s oil supplies coming from the Middle East had risen to its highest since the 1970’s and was likely to continue to grow. Consumers and businesses have been encouraged to make investment decisions that lock in demand. Sales of gas-guzzling SUVs have been booming in both the US and China. The more the world becomes accustomed to the idea that oil prices will stay low, the worse the pain will be if they rise sharply. The volatility of the Middle East, and other producers such as Venezuela, means that a sudden disruption to supplies is always a risk. Oil consumers also need to recognise that they are tied in a co-dependent relationship with the Middle East and are likely to remain so for decades to come.  

 

My conclusion – In the short term the price of oil should rise which would be inflationary.

 

Renewable Energy

 

Ambrose Evans-Pritchard, The Telegraph – ‘Consultants McKinsey estimate that the energy storage market will grow a hundredfold to $90bn a year by 2025. Once storage costs approach $100 per kilowatt hour, there ceases to be much point in building costly ‘baseload’ power plants such as Hinkley Point. Nuclear reactors cannot be switched on and off as need demands – unlike gas plants. They are useless as a back-up for the decentralized grid of the future, when wind, solar, hydro and other renewables will dominate the power supply. ….. Renewables generated 18% of UK power last year, and this is expected to double by the late 2020s as wind and solar capacity reach 50 gigawatts (GW). Once the power can be stored for overnight use, there will be extended periods in the summer when no base-load is needed whatsoever. Perhaps the Hinkley project still made sense in 2013 before the collapse in global energy prices and before the latest leap forward in renewable technology. It is madness today. The latest report by the National Audit Office shows the estimated subsidy for these two reactors has already jumped from £6bn to near £30bn. Hinkley Point locks Britain into a strike price of £92.50 per megawatt hour – adjusted for inflation, already £97 – and is guaranteed for 35 years. That is double the current market price of electricity. The NAO’s figures show that solar will be nearer £60 per megawatt hour by 2025. Dong Energy has already agreed to an offshore wind contract in Holland at less than £75. The latest official data shows that the renewable share of UK power surged to a record 25.1% in the first quarter of the year. Half of this was wind.

 

My conclusion – Renewable energy is one of the cheapest sectors in the market and offers an excellent long term investment opportunity.

 

Gold

Diego Parrilla – precious metals specialist – ‘The current path of monetary and credit expansion is unsustainable and will eventually burst, leaving investors struggling for the return of their capital, instead of return on their capital – an extremely bullish scenario for gold and other real assets. The limits of fiat currencies are being tested. Unlike in the global financial crisis of 2008, this time there won’t be any monetary bullets left. Interest rates are already at record lows, asset purchases suffer from the law of diminishing returns, and competitive currency devaluations only increase underlying problems and global imbalances. A dangerous slippery slope that paper cures miss is that they ‘eventually converge to their intrinsic value: paper’ as Voltaire warned. Over the past few years we have witnessed the first stage of Gresham’s law, whereby ‘bad money displaces good money, and we are at the early stages of the second and final phase, whereby ‘good money displaces bad money’.  ……The inability or unwillingness of the US to normalise its monetary policy leaves the door wide open for gold to retake its reserve currency status and put an end to the monetary super cycle that started in 1971 with the end of Bretton Woods. It is a period in which the outstanding volume of paper money has grown disproportionately to the amount of gold that once backed it. …..Monetary policy without limits will lead to a very wild and bumpy ride and a larger crisis than the one we have been trying to resolve: a perfect storm for gold.’

 

Crispin Odey, Odey Asset Management

‘In a world where $13 trillion of bonds are negative yielding, where $4 trillion of investments are in ETF’s, is it wise that only $1.5 trillion of savings are invested to protect investors against a change in the weather?’ The billionaire hedge fund manager made homage to the US gold standard and noted that current gold prices do not properly reflect the domestic and global money supply. ‘In the 1970s, US gold reserves were only valued at $35 per ounce and still represented 26% of outstanding dollars. Today at $1360 per ounce, reserves represent a measly 1.5%’. With the world’s gross national product at $75 trillion and the world money supply at around $83 trillion, which is ten times the level at the start of the millennium, Odey argues that gold prices should move much higher.

 

 

The views reflected herein are those of Vertis Private Wealth Management Limited and should not be regarded as a recommendation to invest in any one product or service; before investing you should always consider personal investment advice.

 

Where you seek the advice of Vertis Private Wealth Management Limited we continually monitor markets and will advise you where there is a change in the findings of our research and provide advice and guidance on any alterations that may be required to the investment strategy that we have previously recommended.

Vertis Private Wealth Management Limited does not accept any liability whatsoever for any direct or consequential loss arising from any use of this report or its contents. Investors should be aware that the value and income from investments can rise and fall and that past performance should not be considered as a guide to the future.

 

Vertis Private Wealth Management Limited – August 2016