Tri-Annual Outlook, April 2016 Update

After raising rates for the first time in nine years, the Fed has held back from further hikes in 2016, bowing to market tantrums. The Fed is struggling to focus on the strength of domestic fundamentals such as the strong labour market or increasing inflationary pressures and is reluctant to move too far from other central banks that are still in easing mode.

James Butterfill, Head of Research and Investment Strategy at ETF Securities said:

“The risk of waiting too long to raise rates is greater uncertainty. Such a situation seems circular, with markets fretting over Fed decisions and the Fed concerning themselves with market volatility – an issue outside the scope of its mandate.”

“Real GDP trends indicate that the pace of US economic growth is solid. While the growth path of real GDP is not as strong as pre-crisis levels, there is no evidence of a slowdown. Such a growth path warrants tighter monetary policy. Without a monetary check on inflationary pressures, even a gradual one, expectations threaten to become unanchored, something that only aggressive rate hikes can then cure. We believe that the current guidance on rate hikes will be insufficient to rein in prices and could lead to the Fed having to tighten more aggressively later in the cycle. This could lead to further unintended consequences.”

Key trends to highlight:

A global economic recovery is likely to provide a tailwind for industrial precious metal prices (silver, platinum, palladium)

Part of the reason that these industrial precious metals have been falling since 2011 is due to China’s moderating demand, as it adjusted to a slower pace of economic growth. However silver, platinum and palladium have started to recover this year, rising 14%, 11% and 7% respectively and we expect demand for these metals will likely continue as China’s industrial output appears to have found a base.

Furthermore, all three of these metals have been in a supply deficit during the past three years. 80% of platinum and close to 40% of palladium are produced in South Africa and as the Rand depreciation abates and miners cut back on activity, supply deficits for these metals are likely to grow.

Central bank policy remains a supportive influence on gold

Along with the Swedish Riksbank, Danish National Bank, Swiss National Bank and the Bank of Japan, the ECB has adopted a policy of negative interest rates (NIRP). We argue that NIRP, whether in nominal or real terms, is positive for gold prices. Historical data suggest that there is a relationship between negative interest rates and the gold price. Gold has risen more than 15% year-to-date and is likely to rise further as US inflation increases.

Emerging Markets sentiment improves

While emerging markets (EMs) have been in the doldrums for some time, pessimism around EM bonds is overdone. Investors are being overcompensated for emerging market credit risk and this presents a buying opportunity. The emerging market bond yield spread over Bunds stood at 4.6% and emerging market bonds yields show less volatility than US High Yield bonds. By contrast, yields on many money markets hover around 0%, and yield spreads of US Investment Grade Corporate bonds over Bunds stands at 3.1%. Investing in EM bonds remains compelling in our view, as valuations appear cheap.

An upturn in EM bond demand will also have a positive impact on their respective currencies. EMs are a heterogeneous group. On the premise that investor flows search for returns within high growth and low inflation economies, emerging Asian currencies appear to be the best placed for strength in 2016. However, emerging Asian currencies do appear overvalued and from a valuation perspective we favour emerging European countries as they have relatively low levels of debt compared to their Latin American and Asian counterparts.

The recent equity market sell-off highlights an opportunity in Cyber Security

Cyber security is better positioned than overall technology, because the subsector benefits from a more diverse revenue stream owing to a wide range of products that appeal to a large customer base. Cyber security incidents are growing at a compounded annual growth rate (CAGR) of 66% since 2009,and are transpiring into profitability for cyber security companies.

The global equity market rout since the start of 2016 failed to spare cyber security stocks, but it brings their relative valuation versus the technology sector down to their historical average rather than the 70x price to earnings perspective (P/E) witnessed in December 2015.

The distinctly low beta in Cyber security stocks allows investors to get exposure to one of the fastest growing segments of technology at a comparatively low risk. The record investment in financing and deal making in 2015 is testament to the opportunity cyber security presents.

Rising ETP Industry flows

ETFGI’s March 2016 global ETF and ETP preliminary industry insights report highlights ETF Securities’ impressive performance since the start of the year, having amassed the second largest share of net ETP inflows in Europe at US$2.11 billion.

Mark Weeks, CEO at ETF Securities commented:

“During Q1 2016 we have seen strong inflows across our diverse European product range, including $2.06 billion into our commodity complex, of which $1.56 billion was into gold. Alongside our in-depth market research and commitment to investor education, this reinforces our position as the leading specialist ETP provider in Europe

“As reported in the Outlook, we believe that despite recent market turmoil, compelling opportunities continue to exist for investors and we continue to work hard, often in partnership with leading third parties, to make these opportunities across commodities, FX, thematic equities and fundamental fixed income available to all European investors.”