Never Mind the Yield - Feel the Sentiment !
Scenario: Asset A and asset B were trading at 50 last week. Today asset A is priced at 100 and asset B is priced at 25.
Question: Which one would you buy?
Answer: for the short term buy A, but for the longer term buy B.
Next Question: Why?
Note that no information about earnings has been presented. Also no balance sheet or management pedigree is available. So how is it possible to answer the two questions I posed above?
Here is an added piece of information: sovereign bonds with a ten year term yield 3.5% per annum. The assets above both have zero yield, that is to say, there is no dividend.
So with zero earnings, vs 3.5% earnings in an alternative asset, a comparison between available assets valuation can now be made, producing an implied valuation for asset A and asset B.
On the basis of this understanding, and the yield from LIBOR for cash deposits, the assets of the world have been priced, and by comparison these valuations have been extended via correlation trading arbitraging algorithms into every asset.
There is a problem with that.
The bonds which were used just now to create a comparative price are priced by a Central Bank which is in effect selling them to itself. It is thereby creating it’s own prices, not free market produced prices.
And LIBOR has been proved to be a suspect pricing mechanism.
So we go back to my first two questions plus a couple more.
What are assets A and B worth?
What is gold worth?
Do you know why I offered two different answers above, to these questions?
Are you making due allowances for what you don’t know?
Here are some of the “don’t know” items:
At some undetermined time bonds will revert to a valuation not created by their issuers.
The value they revert to may differ by an undetermined amount from their price prior to that, or their current price.
This will alter valuations of many other asset classes as the revised comparator value becomes arbitraged into correlated assets to bonds, and the revaluation ripple spreads across the pool comprising all assets.
Is this a significant line of thought to follow?
That depends upon the reader’s point of view. You see, if the best value estimate of an asset is a function of these two things:
it’s risks balanced against it’s earnings,
and it’s growth potential
In that case, why does Bitcoin which has no growth, and no earnings have any value at all? And it definitely has a value, which changes violently from day to day, but a real value.
Well the answer is that an asset may have no value at all, but if the owner can resell the asset to another person, then that resale value becomes the value of the asset.
So now we have three factors: earnings/yield, growth potential, resale value when it is required to sell.
Please take note that the final component of our valuation formula trumps the others.
Also note that when an asset has zero of the first two, like BTC, and it relies totally upon resale-ability, lets call that desirability among buyers, then it’s value becomes very volatile, and may fluctuate violently.
At this point we need to look very hard at the bond markets.
Yield – very low, almost zero
Growth potential - negative
Desirability – currently ok.
This is interesting, as it places bonds in a similar class as Bitcoin. But bonds are considered stable and safe assets to hold. Therefore, where is the stability of bonds going to go in the future?
Also, the bond markets are beginning to have the odd flash price change. This is surely and early sign, a creeping appearance of something new, a beginning of the new bond environment.
In the light of those considerations, yields are going to rise, as new risk of volatile price change is priced into bonds. Therefore many other assets will change value too. For the moment there are two bond markets. A bond market in which central banks sell their own bonds to themselves, setting the price, and at the side of that market, another parallel bond market in which other buyers buy bonds from the same central banks, or their agents, at prices based upon the price of the first bond market.
Big money is pulling back from bonds. Creation of money – printing of fresh sovereign bonds to be sold back to the sovereign is rife. Monetization of sovereign debt is replacing invested capital.
So who will set the yield against which everything will be valued?
What is gold worth in such a case that yield no longer functions to put a value on assets?
Gold has no earnings, not yield (if one does not lease away). We are left with the desirability among other buyers to acquire that gold as the ultimate factor governing price.
This is called sentiment.
I posit that sentiment is slowly increasing in importance as the key valuation factor for all assets around the globe. This is due to the central banks’ zero interest rate policy moving from it’s original short term, through medium term, and achieving permanent policy status. Teeny micro tapers don't count. And pure sentiment valued objects, you know, things like bitcoin, tulip bulbs, stock in the Mississippi Company, junk ... err ... bonds .... sorry about that ... can alter their values quite dramatically.
So Welcome to the new world of Crowdsourced Central Bank Policy Creation.
We arrived here a while ago, but now it’s gradually becoming increasingly obvious to ... (cough) ... the crowd. If this is correct, then the debt markets will soon develop a certain reminiscent quality which might remind one of the adverts for new cars, or fashion goods. I believe Japan has gotten there already. They are so innovative, leading bravely where the west will follow.
Actually the Japanese Ministry for Finance got to that point THREE YEARS AGO. And since then gold, priced in Japanese Yen has never fallen below the price as of that time, even despite the bearish period for precious metals from 2011 through 2013.
Now just because I see similarities between a country's bond market which depends upon emotive selling points for sovereign bonds and a rising price of gold in that country's currency, does not make this true for everywhere. (Though it might turn out that way.) For instance a different country might take the view that marketing like that would not work among it's subjects. They might prefer to, say, put retirement funds into government bonds by legislated mandate instead, or something like that.
A Wonderful Wall St opportunity
In the circumstances, we might need a new chart to work our analysis upon in future years. This would be the LongBond:Cryptocurrency Conversion Rate. They are such similar assets, it's sure to be all the rage. Everyone will want to switch between them and back again. Think about the derivatives opportunities and the massive profits for the early birds! Think of the Paris shows! The movie rights! Jamie Dimon's pals will want to buy the patent rights! Every pension fund on the planet can be stuffed full of them! There's gonna be a Bond-CryptoFX ATM machine on every street corner. We'll all be so rich!!
And remember, you read it here first! :-)