Fund Management Diary Meeting held on 4 October 2016 History and Theory of Money From mankind s earliest days the need to exchange goods and services was an overriding consideration in order to build a localised economy. While, in some cases beads provided the method of exchange, not unsurprisingly, the need for the respective currency to have value was of prime importance and the natural selection was precious metals, with gold and silver heading the list. While the methodology varied from country to country, with the Lombard s being the first to establish a banking industry, the overall directions were provided by the early rulers of the various fiefdoms. Gold, due to its rarity became the primacy of choice assuming a global importance. This was significantly demonstrated in mediaeval times and with the Spanish discovery of the New World with its treasure trove of gold, this led observers to note the direct relationship between the quantity of money/gold in an economy and the level of prices of goods and services. As the amount of bullion found its way into the old world, either from Spanish galleons or British privateers taking prizes, it became evident that this had an inflationary effect on prices and when storms or military action curtailed bullion supplies, the prices of goods and services fell. Effectively, this created economic cycles which eventually led to economists deriving the formula MV=PY, where the increase in monetary velocity had a direct effect on the price level P and the growth in the economy Y. In our opinion, the next dramatic effect originated from the American War of Independence (1775-82) which, broken down simply, was somewhat of a stalemate over the first 3 years, with the British being content to hold the principal cities rather than take the initiative when Washington s army came close to defeat; due to lack of supplies and provisions. It was at this time that Alexander Hamilton, a General in the US Forces, but also a Director of the National Bank, in 1779 raised $10 million, despite only having a fraction of money in deposits. However the patriotism allowed Washington to re-equip, as rich patriotic land owners soon became forthcoming to provide deposits to the bank, on a promise of full repayment of the balance over 10 years. The outcome was to achieve one of the most significant events in world history and Alexander Hamilton, not only being one of the founding fathers of the constitution was appointed in 1789 as the first Secretary to the US Treasury. This date was particularly important being 10 years after the National Bank s loan, but also the overall cost of the war had created a substantial additional debt mainly to wealthy land owners. It was at this time that Hamilton created bonds to swap for the debt also giving interest, which immediately allowed the debtors to obtain significant income and therefore not demand repayment. Bond markets had now been created with the nation being provided with the ability to service debt efficiently, while investors could exchange for low risk sovereign debt, accessing a secure income over time, which could readily be exchanged back into cash. As can be seen, security and income are a prime importance to investors and with this in mind, the gold specie standard had global acceptance as a currency. The first formal standard adopted this in
1821 with gold sovereigns being produced by the new royal mint at Tower Hill. This was followed by other nations in 1873 with the most important being the USA and Germany. All this was to change with World War 1, with many countries suspending or abandoning the gold standard. After Germany unconditionally surrendered, it totally withdrew following the Treaty of Vienna due to being forced to pay extensive war repatriation, with the Weimar Republic resorting to the printing presses, creating hyperinflation. During the war the bank notes had replaced the circulation of gold sovereigns with exchange controls having been imposed and in 1925 gold specie coins were withdrawn, with the bank promising to pay the bearer on demand. However, as the great depression deepened causing speculative attacks on the pound, the gold standard was abandoned in 1931 with many economists, in particular John Maynard Keynes, blaming the concentration of wealth for the decreasing standard of living amongst the poor and middle classes. His remedy was utilisation of fiscal policy to get people back into productive work, especially on infrastructure products with the additional financing producing aggregate demand (this sounds familiar). After the Second World War under the Bretton Woods Agreement, a gold exchange standard was established with countries fixing their exchange rates to the US dollar when pledged to hold gold at an official rate of $35 to the ounce. As inflationary pressures increased across the world, this became more and more unstable with countries such as the UK devaluing as they failed to hold their gold and dollar reserves, due to balance of payment difficulties. Also low quality goldmines in South Africa, the world s major producer, became unable to produce further gold at the prevailing price. In 1971 the USA ended international convertibility with gold prices by 2011 averaging $1,800 to the ounce. As we move forward into the 1980 s the major mature economies de-regulated their financial markets giving rise to retail banks being able to move into investment banks. The major players going into derivatives, foreign exchange, stock markets, commodity markets etc. etc. As is well known these abuses, particularly in the mortgage markets, led to the collapse of the banking sector in 2008. The rescue operations resulted in the re-financing, primarily of the banking sector, with Central Banks resorting to quantitative easing pushing down interest rates to abnormal levels, while increasing their balance sheets to purchase bonds and in some cases equities. However, far from this increasing the money supply it had the opposite effect and many commentators believe that currently this has created more problems than answers, with the Fed being between a rock and a hard place. The Fed s balance sheet may be in danger, if yields rise, while the simple answer to creating inflation may be to increase the real money supply together with a fiscal stimulus. In our opinion, the election of the next President of the United States will almost inevitably lead to this solution with a full economic recovery, becoming the number one priority. Our overall conclusion is that investors priorities are to maintain the value of their savings and at the same time obtain a realistic return, which is more than emphasised by our charts at Appendix 1 showing the value of gold since 1970, together with the yields that have been returned from the 10 year US Treasury bond. Recently, both bonds and gold have been increasing in value and this, in our opinion, could be indicating a long term inflection point. Historically, interest rates move over a long period of time from cheap to expensive, which can be seen from the chart (in appendix 1) and while within the period there will be short term cycles, overall the
super-cycles tend to cover a period of 60 to 80 years. We have previously published the Kondratieff Cycle which was constructed taking into account three of these overall cycles and once again this has been set out in Appendix 2, so that our readers can make their own appreciations of the outcome and potential going forward. Strategy Our diary confirms last week s belief that the US election on the 8 th November should be the start of a change in US financial policy with the likelihood of a move to both an increase in the money supply and fiscal stimulus, which should be inflationary. This will favour investing in real assets as being important, confirming our overall strategy favouring equities providing earnings and dividend growth, while looking to areas such as infrastructure could be particularly important at this time. Our caution in bonds is reflected in our portfolio positioning, where we have been investing in special situation bond funds (short duration and inflation linked) for some time. Appendix 1 - Gold Price in USD v Yield on 10 Year US Treasuries
Source: Bloomberg Appendix 2 Kondratieff Cycle (Acknowledgement: North Coast Investment Research)
Historical Fiscal Cycle Source: Fidelity Research Deflation
Providence Sells have been made to rebalance the equity portfolio following strong market rises. The SLI European Equity Income fund has continued to be strong along with the M&G Global Dividend holding. The Premier Income fund has recovered slightly in the short term and the manager states that relatively weaker performance has been as a result of the funds value bias. The manager looks to invest in dividend paying companies with strong potential to weather the different stages of the business cycle. We continue to believe this holding adds a good level of diversification to the portfolio and we are not looking to make any changes in the short term; however the holding will be monitored closely going forward. Asia Pacific UK Equity Income 41% Bonds 31% Other 3% Europe 5% Cash / Money 14% Select Sells have been made to rebalance the equity portfolio following strong market rises. The Jupiter UK Special Situations fund has been strong which has worked well alongside the SVM UK Growth fund which has been weaker during the recent period of market volatility. No fund changes are being considered at present. USA 12% Asia Pacific 11% UK Equity Income 20% UK 19% Europe 10% Bonds 14% Cash / Money 8% Emerging
International Consideration is still being given to the Legg Mason Martin Currie North American fund which has weakened further relative to the sector over the previous week. The European holdings have been weak over the short term and the team are looking into the drivers behind this but are not looking to make any changes at present. USA 35% Asia Pacific 12% Cash / Money 4% Emerging 10% UK 14% Japan Europe 19% Venture The investment committee are not looking to make any fund changes at present and are maintaining a slightly higher cash weighting which was raised following the market rises shortly after the Brexit referendum. Specialist Other 5% UK USA Asia Pacific 34% Europe 9% Emerging 28% Cash / Money
Important Information Please note that the contents are based on the author s opinion and are not intended as investment advice. This information is aimed at professional advisers and should not be relied upon by any other persons. Any research is for information only, does not constitute financial advice or necessarily reflect the views of the author and is subject to change. It remains the responsibility of the financial adviser to verify the accuracy of the information and assess whether the fund is suitable and appropriate for their customer. Past performance is not a reliable indicator of future performance. The value of investments and the income derived from them can fall as well as rise and investors may get back less than they invested. Important information about the funds can be found in the Supplementary Information Document and NURS-KII Document which are available on our website or on request. Issued by Margetts Fund Management Ltd Margetts Fund Management Limited is authorised and regulated by the Financial Conduct Authority For any information about the company or for a copy of the company's Terms of Business, please contact the company on 0121 236 2380 or at 1 Sovereign Court, Graham Street, Birmingham B1 3JR You can e-mail us at admin@margetts.com