Well, a happy New Year to all.

It’s very interesting to monitor how financial markets start the New Year.

On that note, just one week in and it’s unusual for almost every asset class to have risen in the very first week of the calendar year. Investors seem happy to buy anything with risk.

This complete lack of fear as expressed by the VIX (volatility index) last week having traded at never seen low levels, again.

To assess global investors’ fearlessness, one needs to note that 2017 marked the 8th consecutive year of Global emergency stimulus from Central Banks around the world, despite calls to wind it up 3 or 4 years ago for fear of runaway inflation and nothing in the tank (interest rates) to cope with any future crisis, as there is sure to be.

However, asset price action from the end of last year and the beginning of this year is actually shaping up to show us the “true” results of this monetary experiment.

Depending on whose numbers we use and whether we include China, we’ve seen something like $14TRILLION in QE (money creation) and 700 rate cuts since 08/09 from Central Banks.

Expected outcomes of this emergency stimulus like goosed up stock markets and very low to negative interest rates were intended, but what about the inflation? Hope it doesn’t arrive? Work the numbers to convince punters “it” is not happening. Both of these “plans” appear exhausted.

Looking back, one can mark the start/first real inflation signs back to June 2017. Fixed interest/bond markets started to price in “inflation’ through rising rates and, so far, haven’t backed off. In fact, the process seems to be consolidating. Before we get to what this may mean for your portfolio let’s look at what was happening back then in 2017.
1. Fed Chair Janet Yellen publicly admitted that the Fed has no clue how inflation works.
2. The Bank of Japan (BOJ) announced it would continue its massive QE program despite clear signs of recovery.
3. The European Central Bank affirmed it would continue its own massive QE program despite evidence of economic stability!

Markets took the hint.
The subsequent rise in commodity prices over the last few months have only added fuel to this fire.

In response, the yield of the 10 year US Treasury (the “risk-free” rate that which all is measured) trades based on inflation (and economic activity) and if inflation is on the rise, the yield on this bond will also rise.

With this in mind, late 2017 was the first confirmed breakout of US 10 year yields in 20 years.

So, what does a rise in the single most important bond in the financial system signalling inflation mean to you?
Oh, and by the way, the German 10 year Bund has broken out too.

Firstly, Central Banks are now woefully behind the curve. Rates and emergency stimulus should have been let go years ago but unfortunately, there is now so much debt in the system (since 2007 an additional $68 trillion) that, as we’ve said before, the math does not support rising interest rate expense increases, both for public and personal entities.

On January 4, 2018, the Institute of International Finance (IIF) has released its latest global debt analysis, which reported that global debt rose to a record $233 trillion at the end of Q3 of 2017 between $63Tn in government, $58Tn in financial, $68TN in non-financial and $44Tn in household sectors, a total increase of $16 trillion increase in just 9 months.

All of the new said debt issued during this 8-year monetary experiment has been issued on the basis of low to no interest payable. Otherwise known as a bubble in bonds, intentionally created by Central banks to combat the GFC.

None of this new debt (think Aussie home loans now) can stomach a significant rise in rates.

Which is why, when realising this is happening central banks will backtrack very quickly on any QE easing.

As the chart below shows (some say the most important chart in the world), central banks are going to continue reducing their balance sheets, FOR NOW!!

Reducing balance sheets now may not have the desired effect, the excess liquidity is already in the system.

What’s important is what they (CB’s) might do once equities realise what’s going on. As the chart below shows, leverage (as well as valuations) in the US are at all time extremes!!

It just makes no sense. Look at this!!

So, what we are saying here is we could have rates rising with inflation as equity markets stall.

Once central banks realise the direness of the situation what do you think they’ll do??? Story for another day. We think if your only tool is a hammer you’d just hit harder.

Back to investors’ dilemmas.

If after 20 years of falling rates, they started to rise, what might happen to the 20 to 40% of an average balanced or Industry super funds exposure to Fixed Interest? If rates rise values fall.
Will this allocation be better in cash? Who knows, food for thought.

There is a whole generation that’s never seen a rising rate!

This brings us back to commodities. Back in early December, Jeff Gundlach (new Bond King, legend) published this chart below. Since then commodities have risen sharply but because of the low base and the real demand from China, we think this may well turn out a good place to be for 2018!! China spends $1trillion on its one belt, one road program creating bridges, roads, railways! The west spends trillions just trying to keep its financial system together. A simplistic but interesting analogy.

It’s also been discussed in may circles whether or not China/Chinese equities deserve a leadership premium.

It’s our view they most certainly do. An overweight position to a credible fund manager in this space may continue to be very rewarding.

And now to that useless, barbaric relic they call gold and precious metals. Although the low seemed to be in for gold back in October 2016, investors in precious metal producers are still rare!
For good reason!

Recently, the tail wagging futures markets have not delivered a midnight dump of paper gold equivalent to 10% of the worlds annual production in 2 minutes for a month or so now.

We expect price management to continue until it doesn’t and we suspect China moving to exert more authority over 2018 or any other kind of “unforeseen” financial event may test the tide for who is wearing clothes or not!!

We’ll leave our gold commentary on gold for that for now, we suspect Gold will correct once before finally being recognised as the buy of the century!!!

Even at these prices, some quality producers are finally being recognised for the asset quality they possess.

More on developing gold market stories next time.

Good luck to all for 2018.