October 05, 2017

October 2017 Investor Letter

October 05, 2017/ Brian Delaney

Strategy Performance

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.

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

The stock market continues to climb higher on record low volatility. If this trend continues, European stocks will break out above 17 year resistance levels to new all time highs. If this breakout occurs (and holds), the Active Asset Allocator will take a position in European shares. The risk will be modest. Above 400-415 on the Eurostoxx 600 Index and I am a buyer. A meaningful close back below 400 and I will close or significantly reduce the position. I will let the charts be my guide. Apart from valuation concerns, stocks continue to exhibit bullish characteristics. I have pointed out a few areas of concern in recent Investor Letters, including a decline in the number of stocks making new highs versus new lows and have highlighted another area of potential weakness/divergence in this month's investment update. It is worthy of continued observation in the months ahead. For now, 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.

Turning to precious metals, Sprott Asset Management has agreed to acquire the common shares of Central Fund of Canada Limited (CFCL) and the rights to administer and manage CFCL’s assets. Upon completion of the transaction, all CFCL Class A shares will be exchanged for units in a new Sprott Physical Gold and Silver Trust. US$300 million in value is expected to be realized for CFCL class A shareholders, relative to 9% pre-announcement net asset value (“NAV”) discount. Good news for existing holders of Central Fund of Canada shares. The 7-9% discount has reduced to 2% and will be eliminated once the deal closes. Also please note, a Gold Trader performance update will follow shortly.

Finally, for the history buffs amongst you, I posted an article in the Research section of the website entitled "The 1929 Parallel", written by John Kenneth Galbraith and published in the January 1987 issue of The Atlantic Magazine. The article is interesting both for its content and the timeliness of its publication in January 1987.

Stock Market Update

“The combination of central banker-applied brute force (buying everything in sight) and deity-like central banker pronouncements has dampened market volatility and frisky free-lancing, but at the same time it has encouraged risk taking (in market positioning, not it business formation). We have thought, and still think, that confidence in central banks and policymakers has been unjustified and thus could erode or collapse at any time. Since the major financial institutions which comprise the financial system are still way overleveraged and opaque (in fact with record amounts of debt and derivatives at present), such a break in confidence could happen abruptly and without warning. Investors should come to grips, intellectually and viscerally, with the likelihood that most fiscal and monetary policymakers’ knowlege of the world is somewhere between “close to nothing” and “way less than zero,” and that their pronouncements and policies usually range from “silly but harmless” to “dumb and dangerous.”

— Paul Singer, Elliott Capital Management

Paul Singer, who runs one of the world's largest and most successful hedge funds, is certainly no fan of central bankers and the controlling influence they exert over financial markets, that's for sure...... and who could blame him. Since the start of 2016, the ECB has expanded its balance sheet by 57% or €1.55 trillion. They are adding another €250 billion in 2017. Not to be outdone, the Bank of Japan has expanded its balance sheet by 34% to $4.6 trillion. Notably however, the Federal Reserve has signaled its intention to start withdrawing liquidity from the banking system this month in a significant shift in policy away from Quantitative Easing (QE) to Quantitative Tightening (QT). They are starting slowly at a rate of $10 billion/month in October and increasing to $50 billion/month in 2018, market permitting.

Despite Singer's reservations, stock markets around the world are climbing steadily higher. Money flows where it's treated best and so far, stocks continue to attract record inflows, particularly into passive, indexed tracking funds. This bull market has now become the second largest in history with the S&P 500 returning +275% since March 2009 in USD terms. Only the decade-long run of the 1990's has done better, +400%. US stocks now account for 52-55% of the global equity benchmark, depending on the benchmark you follow.

The recent climb higher has come on record low volatility. The next chart shows the Dow Jones Industrial Average. The volatility of the weekly price moves is captured in the lower half of the chart. If you look closely, you will see that volatility has reached a multi-decade low. A rise in volatility does not necessarily have to coincide with a collapse in stock prices (1996-2000 for example), but it could (2008-2009).

In 2017 YTD, global equities have returned +3.7% in euro terms. Stock markets have navigated the historically volatile month of September with ease. If they continue to trade in bulletproof fashion in October, we may see a run higher into the end of the year. Apart from valuation concerns, stocks continue to exhibit bullish characteristics. I have pointed out a few areas of concern in recent Investor Letters, including a decline in the number of stocks making new highs versus new lows. I have also highlighted another area of potential weakness/divergence below. Here is a chart of the FTSE World Index, the global equity benchmark, priced in euro terms. The Index made a higher high in 2017 but on weaker relative strength (RSI) and falling momentum (MACD). This suggests the uptrend is weakening, which usually occurs towards the end of significant moves. It is worthy of continued observation in the months ahead.

A similar divergence occurred in the US Treasury bond market before a sharp decline in prices in 2016....

While stocks continue higher, a declining number are trading above their long-term 200-day moving average. 81% of stocks were above their long-term trend in late 2016. Today, just 70% are in confirmed uptrends. Below 50% and the stock market would get into difficulty.

What if I'm wrong? What if stock markets melt up for two more years, or longer? Central banks have already printed trillions and that money is sloshing around the system. What happens if money continues to flow into equities each month with no regard for valuation? I don't expect it will happen but it might. We are operating in unprecedented times. So here is my plan.

European stocks in aggregate trade at a valuation discount to US companies. Many European stocks are household names (Siemens, SAP, Unilever, Total, Allianz, Anheuser Busch Inbev) yet are under-owned relative to their US counterparts. Eurozone stocks for example account for just 11% of the global equity index (17% if you include the UK), compared to 55% for the US.

European stocks, as measured by the Eurostoxx 600 Index, have traded in very broad range for the last 17 years. The Eurostoxx 600 Index hit a resistance zone of 400 in 2000, 2007 and again in 2015, failing to break out on each occasion. We are approaching that resistance zone again today. The Index reached 390 this week. The market may be strong enough to break through this time. A confirmed break above a 17-year resistance zone would be significant, and quite bullish for EU stocks.

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

The current asset mix of the Active Asset Allocator is 20% global equities / 20% EU government bonds / 15% inflation linked bonds / 5% EU aggregate bonds / 30% precious metals / 10% cash. If we get the breakout in European equities, I will make the following trades:

Equities: Sell 10% Global Equities, Buy 30% EU Equities

Bonds: Sell 10% EU government bonds, Sell 5% EU aggregate bonds

The revised asset mix would be: 10% global equities / 30% EU equities / 10% EU government bonds / 15% inflation linked bonds / 30% precious metals / 5% cash.

One final comment. Passive fund flows are dominating the industry. Almost $500 billion flowed into passive funds in 2016 according to Morningstar, while $200 billion flowed out of active funds last year. That is almost three quarters of a trillion dollars... In one year! One of the unfortunate side effects of this trend has been that the industry is losing talented and thoughtful leaders in active management and none come more talented than Hugh Hendry, of Eclectica Asset Management. Hendry closed his Global Macro Fund last month after suffering a tough period of sub-par performance. His Fund returned -10% YTD through 31 August. Hendry was interviewed recently on the Adventures in Finance podcast. Well worth a listen.

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

While 2 and 5 year UK and US bond yields have risen a little in recent months, 10 and 30 year bond yields remain firmly in downtrends across the world. We could be getting close to a break out higher in longer-dated government bond yields in some regions, but not yet.

Inflation-linked bonds meanwhile remain in broad multi-year uptrends. UK and US IL bonds were adversely impacted in recent months due to currency movements, but the longer-term trends remain intact. The Active Asset Allocator may tilt the exposure towards inflation hedging via ILB's, precious metals and an increased EU equity allocation and away from deflationary hedges (cash and fixed interest rate bonds) if markets start pricing in a more inflationary bias. I do not see that happening quite yet, but the trend may be turning in that direction.

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

As noted in a recent Market Alert, Sprott Asset Management agreed to acquire the common shares of Central Fund of Canada Limited (CFCL) and the rights to administer and manage CFCL’s assets for C$120 million in cash and stock. Upon completion of the transaction, all CFCL Class A shares will be exchanged for units in a new Sprott Physical Gold and Silver Trust. US$300 million in value is expected to be realized for CFCL class A shareholders, relative to 9% pre-announcement net asset value (“NAV”) discount. Good news for existing holders of Central Fund of Canada shares. The 7-9% discount has reduced to 2% today and will be eliminated once the deal closes.

After a sharp -12% decline this year, the US dollar is attempting a long-overdue bounce. I am not expecting much of a rally, rather a consolidation around current levels before the next leg lower.

US dollar trends typically last years once they get going. Following the Plaza Accord in 1985, the USD fell sharply and remained in a downtrend for 10 years. The USD Index then rallied from 1995-2001 before the next sharp decline from 2001-2008. Following a choppy move higher from 2008-2016, the USD Index has reversed sharply lower in the first nine months of 2017. I believe this is the start of a multi-year trend lower.

Gold is waking up to the USD reversal. From 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 we could see something similar this time around. Gold has broken its multi-year downtrend and is now back-testing the prior resistance zone. I expect resistance to become support as gold builds the energy to launch higher over the next 12 months.

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.

August 03, 2017

August 2017 Investor Letter

August 03, 2017/ Brian Delaney

Strategy Performance

Investment Philosophy and Approach

Executive Summary

Since my last report published on 17th May (apologies for the delay in getting this one out), global equities have declined -1.1% in euro terms, Eurozone government bonds have rallied +0.4% and gold priced in euros has fallen -4.8%. Currency moves have negatively impacted Active Asset Allocator returns in recent months with the USD falling -6% and GBP falling 4% versus the Euro during that time. All is not lost however and this month I highlight my bullish expectations for precious metals for the second half of 2017 and beyond. I think gold is on the cusp of a significant move higher.

This month I also review Bob Farrell's 10 rules of investing and discuss how they apply to the markets (particularly the stock market) today. Farrell is a stock market veteran who cut his teeth on Wall Street during the 1950's and experienced many of the equity booms and busts that followed over the next five decades. Farrell crafted his 10 rules of investing based on those experiences and lessons learned. For now, I remain defensively positioned in the Active Asset Allocator with 20% equities / 40% bonds / 30% precious metals / 10% cash.

Gold Trader Trade 14 (-2.6%) and Trade 15 (+0.6%) closed in July. Trade 16 is open and +1% so far. Click here to view the August 2017 Investor Letter.

Stock Market Update

I was reminded recently of Bob Farrell and his 10 rules of investing, wisdom he accumulated over an illustrious career on Wall Street spanning five decades. Farrell joined Merrill Lynch in 1957 as a technical analyst after completing a Masters degree at Columbia Business School where he studied under Benjamin Graham and David Dodd, authors of the investment bible 'Security Analysis'. Farrell witnessed many bull and bear markets throughout his career and crafted his 10 rules of investing based on those experiences and lessons learned. This month, I review Farrell's 10 rules and see how they apply to markets today.

1: Markets tend to return to the mean over time. Trends in one direction or another eventually exhaust themselves and price moves back to test the long-term moving average. This generally happens every few years. The epic bull run in stock markets has swung from oversold in 2009 to overbought today. Even in strong bull markets, investors should expect the long-term moving average to be tested every couple of years. Today, the S&P 500 is 20% above its long-term moving average, while the Eurostoxx 600 is 7% above its long-term trend.

2: Excesses in one direction will lead to an opposite excess in the other direction. Markets that overshoot on the upside will also overshoot on the downside. The New York Stock Exchange publishes data for margin debt at the end of each month. Margin debt represents the extent to which investors borrow to invest in the stock market. Bull markets breed (over)confidence and confident investors borrow to invest in the stock market. Margin debt surged on three occasions since 1995 coinciding with the last three bull market peaks. Today, NYSE margin debt has never been higher. Ever!

3: There are no new eras – excesses are never permanent. There are always hot stocks and sectors of the market that attract speculative capital. Some lead to speculative bubbles but they never last. Today, internet sensations Facebook, Amazon, Netflix, Google and the cryptocurrencies Bitcoin and Ethereum fall into this category. They are attracting a lot of hot money but chasers will be punished, eventually. It always happens.

4: Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways. Bullish and bearish trends generally last longer than expected. However once the trends end, they are followed by sharp reversals. The Shanghai Stock Exchange Composite and Nasdaq 100 indices are two examples of exponentially rising stock markets followed by sharp reversals. In China, this occurred in 2008 and again in 2015. In the US, the Nasdaq bubble popped in 2001 and again in 2008. Another appears not too far away.

5: The public buys the most at the top and the least at the bottom. The average investor is most bullish at market tops and most bearish at market bottoms. When the marginal buyer turns into the marginal seller, a bear market begins and endures until panic sets in, the speculative buyers have been forced to sell and investor sentiment turns pessimistic. This roller coaster of sentiment and emotion is what defines a market.

6: Fear and greed are stronger than long-term resolve. Human emotion is the enemy when it comes to investing in the stock market. Successful investing requires discipline, patience and a cool head. Sharp declines lead to fear; sharp rallies lead to overconfidence and investor complacency. The Vix index is an excellent barometer that captures fear and greed in the stock market. Low readings in the Vix Index go hand in hand with investor confidence and limited demand for insurance to hedge against stock market declines. Spikes in the Vix Index coincide with periods of sharp selling in the stock market as panic sets in. Today, the Vix index is trading near ALL TIME LOWS.

7: Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names. Stock market breadth and volume are important indicators of underlying strength of a stock market advance. When participation is broad, stock market rallies have endurance and momentum and are difficult to stop. When participation is confined to just a few large-cap stocks, rallies have less credibility, momentum and strength. Today, stock market breadth remains quite firm. The Advance/Decline line (lower left chart) continues to make new highs, signalling that the majority of stocks remain in an uptrend. However, initial signs of deterioration are showing up in the number of net new highs being made on the NYSE. This occurred just prior to every correction in the past.

8: Bear markets have three stages – sharp down, reflexive rebound and a drawn-out fundamental downtrend. The typical pattern in a bear market decline involves a sharp sell-off, an equally sharp reversal higher and then a long, slow grind lower until valuations become compelling once again. The reflexive rebound separating each decline is designed to keep the believers invested and encourage 'falling knife' catchers.

9: When all the experts and forecasts agree – something else is going to happen. If everyone's optimistic, there is nobody left to buy. Excessive bullish sentiment can be damaging to your financial health. If often pays to adopt a contrarian investment strategy and take a more defensive position when the herd becomes overly confident about the market's future prospects.

10: Bull markets are more fun than bear markets. This is true for most investors and fund managers who have long-only investment mandates and are typically fully invested all the time.

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

German 10-year bond yields have rallied 6 basis points since my last report while US 10-year treasury yields have fallen 7 basis points. Bonds continue to hold their own and are preparing for their next leg higher (and lower in yields) as the bull market in equities finally rolls over and a sharp equity bear market begins. The secular low in bond yields still lies somewhere in the future.

Meanwhile, the trend in inflation-linked bonds remains steadily higher, albeit at a relatively modest pace. Currency has impacted euro-denominated returns in 2017 YTD, as weakness in GBP and USD in particular have not fed through to higher inflation-linked bond prices in local currency terms. A weakening currency will lead to rising input costs, particularly in a country like the US, which is the world's second largest importer of goods and services ($2.7 trillion in 2016). Rising input costs are inflationary. I expect the inflation-linked bond allocation in the Active Asset Allocator to make a more meaningful contribution to performance over the next few years.

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 is setting up for a big move, so let me lay out my expectations for what I believe will happen over the remainder of 2017 and beyond. Gold's first task is to break above $1,300, which I expect will happen in August or September. A break above $1,300 would be significant for a number of reasons. Gold made a series of higher lows in 2017 since the washout decline to $1,124 in December 2016. Gold trading above $1,300 adds support to the view that the bear market in precious metals (2011-2016) has ended and a new bull market has begun confirmed by a rising trend in the gold price.

A break above $1,300 would also be significant as it would confirm a break out of the longer-term triangle consolidation that has been in place since gold topped at $1,923 in 2011. Once we get a good close above $1,300, I expect a sharp run higher towards $1,400 or $1,500 before the next consolidation. $1,500 represented strong support in 2011 and 2012 before it gave way in 2013, so I expect gold will take some time to get back above that level. After $1,500, I expect gold will challenge and ultimately exceed the all time highs above $1,900, probably in 2019. Once gold clears $1,900, I believe the bubble phase in precious metals will begin and gold will have a monster move higher in an epic bull market that will be a sight to behold..... but let's not get ahead of ourselves. $1,300 in August/September, $1,400-$1,500 by year-end and $1,900 in 2019, which is 50% above today's gold price.

I expect the bull market in precious metals will go hand in hand with a currency crisis in the world's reserve currency, the US dollar. I have shown the following chart on a number of occasions in previous reports. It is a chart of the USD Index from 1980 to today (red and black line) and USD gold (blue). The USD Index has made a series of lower highs and lower lows over the last 37 years. After it's run higher in 2014/2015, the USD Index appears now to have topped and started another multi-year decline, which should ultimately break to new all time lows in the years ahead.