January 2018 Investor Letter

Strategy Performance

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Investment Philosophy and Approach

The Active Asset Allocator investment strategy is designed to deliver a consistent level of positive returns over time with a strong focus on capital preservation. I follow a multi-asset investment approach, actively allocating between global equities, bonds, precious metals, currencies and cash. I always invest with the primary trend of the market and do not follow a benchmark. Instead, I manage the market risk for clients. This strategy has returned +10% per annum net of fees since inception with a lower level of risk than the average multi-asset fund. My active asset allocation approach is best illustrated in the following chart.

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Gold Trader focuses on capturing the strongest and weakest parts of gold's daily cycle, buying daily cycle lows, selling daily cycle highs and holding for 10-20 trading days, depending on the cycle count. This approach allows me to effectively manage risk. The strategy aims to capture +5%-6% profit per trade while risking 2%-3% each time and has a win rate in excess of 70%.

Executive Summary

Happy New Year folks. 2017 closed with the Active Asset Allocator returning a modest +1.2% for the year, Gold Trader +12% (tax free) in a year when gold, priced in euros returned -0.4% and Gold PowerTrader +22% (tax free). We enter 2018 with US equities surging higher, the US dollar accelerating lower, EU government and inflation-linked bonds holding steady and precious metals coming to life. I cover my expectations for each asset class in more detail in this month's Investor Letter. 

US equities may be entering a melt-up phase according to one highly regarded US investment strategist, but with the USD plunging, risks are running high. I outline a possible long entry in European stocks if the correct set up presents and also reiterate my $1,900 price target for gold by 2019. 2018 looks like it will be a very eventful year and I look forward to discussing the markets in detail with you all in the months ahead. For now, the Active Asset Allocator maintains an allocation of 20% global equities / 20% EU government bonds / 15% inflation linked bonds / 5% EU aggregate bonds / 30% precious metals / 10% cash.

Stock Market Update

I find myself in an interesting position for an investor from the value school. I recognize on one hand that this is one of the highest-priced markets in US history. On the other hand, as a historian of the great equity bubbles, I also recognize that we are currently showing signs of entering the blow-off or melt-up phase of this very long bull market.
— Jeremy Grantham, Co-Founder & Chief Investment Strategist, GMO, 3 January, 2018

Are we entering the 'blow-off' phase of this equity bull market, which could last another year or two? Jeremy Grantham thinks it's a distinct possibility. In his latest 'Viewpoints' entitled "Bracing Yourself for a Possible Near-term Melt-Up", he discusses the potential for a final acceleration higher in equities and also quantifies the possible move - a minimum of +60% over 21 months (from the start of the acceleration point) - based on his study of prior bubbles. Grantham concludes that the S&P 500 could melt-up for another 9 to 18 months to a range of 3,400 to 3,700. Grantham also points out that +60% is a minimum based on past bubbles. Some ran +100% before topping out and then collapsing. Exhibit 1 below highlights Grantham's analysis of past bubbles.

 
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The S&P 500 is certainly showing signs of acceleration, particularly since Trump's election in November 2016. Corrections have been shallow with each dip being bought aggressively. This rally has been powerful, triggering record readings in the relative strength and momentum technical indicators. Grantham's analysis is interesting, though I think we are already 14 months into this acceleration phase. Since November 2016, the S&P 500 has rallied +32% in USD terms.

 
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The sharp move higher in US equities has been exacerbated by a -15% plunge in the USD over the same period. The dollar is in trouble. I am of the firm view that the USD formed a multi-year top coincident with Trump's appointment to the White House and is in for some rough sledding in the years ahead. New all time lows lie somewhere in the US dollar's future. I expect 71.33 will be broken on the USD Index (see below chart) as the United States gradually loses its position as holder of the world's reserve currency. (I expect gold will explode higher, delivering bitcoin-like performance when the decline in the USD accelerates, but that is a few steps ahead of us yet.)

 
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Priced in Euros, the performance of the S&P is still positive, but note the diverging relative strength and momentum indicators on the chart below. 

 
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It is the same story for the global equity benchmark, the FTSE All World Index; higher highs in price but on falling relative strength and momentum. Either the acceleration picks up strength shortly or a correction begins.

 
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The VIX Index, a measure of stock market volatility and investor confidence, made a new multi-decade low in November 2017 reaching 8.48 but has since reversed higher. Have we reached peak investor complacency? There is certainly no fear about.

 
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On the positive side, new highs in the stock market continue to outpace new lows, though the relative trend has weakened over the last 12 months.

 
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Also, the percent of NYSE stocks trading above their long-term 200-day moving average remains a very healthy 73%. Significant stock market declines do not generally occur until this percentage falls below 50%. My Technical Trend Indicator also remains in bullish mode. 

 
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In my last Investor Letter, I highlighted a potential low-risk opportunity to invest in European stocks. I discussed the valuation discount that European stocks trade at compared to US companies and highlighted the fact that Eurozone stocks account for just 11% of the global equity index (17% if you include the UK), compared to 55% for the US.

 
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European stocks, as measured by the Eurostoxx 600 Index, have traded in very broad range for the last 20 years. The Eurostoxx 600 Index hit a resistance zone of 400-415 in 2000, 2007 and again in 2015, failing to break out on each occasion. We are still below that resistance line today but getting close again. The Index traded at 390 in October 2017 and is back at 398 this week. There is a negative divergence appearing on the Relative Strength and Momentum indicators, which is interesting given the strength of stock markets in general. I am watching this closely. If we get Grantham's melt-up in stock markets over the next few months, the Eurostoxx 600 will break out above a 17-year resistance zone, which will be a significant and bullish event.

If the Eurostoxx 600 Index can close at a new all time high and turn resistance into support, the Active Asset Allocator will take a position in European shares. The risk will be modest. Above 400-415 and I am a buyer. A meaningful close back below 400 and I would close out the position. I will let the charts be my guide.

Emerging market equities are also performing well and recently broke out to new all time highs, when priced in Euros. Emerging market equities have historically delivered strong performance in times when the USD has been weak and I expect this trend of USD weakness to continue in 2018 and 2019. 

 
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For more information on my stock market analysis, please get in touch. You can reach me at brian@secureinvestments.ie or at 086 821 5911.

Bond Market Update

 
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In Germany and the UK, 2, 5 and 10 year yields have edged higher by 10 basis points since my last Investor Letter in October 2017. 30 year yields have remained unchanged in Germany and have actually fallen by 10 bps in the UK. Japanese yields haven't budged in the last three months either. The most significant change has taken place in the United States where 2 and 5 year yields have rallied 50 basis points following recent interest rate hikes by the Federal Reserve. US 10 year yields are 20 basis points higher than last October, while 30-year yields in the US are unchanged.

This has resulted in a sharp flattening of the yield curve, generally a precursor to recession. The gap between 2 and 10 year yields has declined to just 55 basis points. Another 50 basis points hike in the Fed Funds rate will tip the yield curve into negative territory. This happened in 2000 and 2007 in advance of the last two recessions. With the Fed Funds rate at just 1.5% today, the Federal Reserve has limited room to cut rates in the event of another recession hitting, which is why they are so keen to hike short-term rates now while they still can. 

 
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I continue to maintain a 20% allocation to long duration government bonds in the Active Asset Allocator. Bonds have held up well to date, despite the risk-on rally in global equities. Should stock markets roll over in the months ahead, safe haven government bonds will likely attract new capital inflows. Alternatively, if we experience a breakout in EU equities to new all time highs, I will reduce the allocation to bonds and cash in favour of equities, at least for a trade.

Inflation-linked bonds also remain in broad multi-year rising trends. UK and US inflation-linked bonds have been impacted by adverse currency movements in recent months. The sharp declines in USD and GBP should lead in time to rising inflationary pressures in both countries, which should feed through to rising prices from inflation-linked bonds. 

 
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For more information on my bond market analysis, please get in touch. You can reach me at brian@secureinvestments.ie or at 086 821 5911.

Gold Market Update

Gold ended 2017 at $1,303, +13% for the calendar year in USD terms, but flat when converted back to euros. I expect that to change this year. Gold is waking up from a four year bear market. The USD is in trouble and I expect gold will accelerate higher in 2018. During the last major bear market in the USD (2001-2008), the USD Index fell -43% from 126.21 to 71.33. During that period, Gold rallied over +600% from $250 to $1900. I think the USD started another major bear market in 2016 and has years to run. Trump will run the US like he ran his companies - badly! Debts and deficits as far as the eye can see - both USD bearish. 

Last August, I set out my forecast for the gold price over the next few years. I expected a break above the downward sloping 4-year resistance line, followed by an eventual move to $1,900 by 2019. Gold is starting to gain some momentum now and I see no reason to adjust my price target. Once $1,923 is breached, I think we could see some really wild (bitcoin-like) action in precious metals prices.

 
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Silver is a more volatile precious metal than gold and generally rallies and declines at a much faster rate than gold. I see an inverse head and shoulders pattern on the silver chart and I expect a strong break out higher shortly. The Central Fund of Canada currently holds a 63% allocation to gold bullion and a 37% allocation to silver bullion and is ideally placed to take advantage of the move in precious metals that I see unfolding.

 
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Finally, a note on Gold Trader. While gold priced in euros returned -0.4% in 2017, Gold Trader ended the year +12% and Gold PowerTrader returned +22% for investors, TAX FREE! I have spent the last couple of months reviewing my trades for 2016 and 2017 and have made some refinements to the strategy, which I think will improve performance in 2018. I widened the stop loss from 2% to 3% last year, which resulted in an improved win rate per trade, up from 63% to 75%. I have also noticed that on average, I have entered trades 7 days too early, so I will be exercising more patience on each trade this year.

I entered Trade 19 on 18th December at 1,258 and this trade is still live. Gold closed today at 1,340 and I think we could still have 1-2 weeks of rising prices before the first daily cycle peaks and roles over. Stay tuned.

For more information on my gold market analysis, please get in touch. You can reach me at brian@secureinvestments.ie or at 086 821 5911.