The one asset you must own if a "crisis of confidence" grips financial markets

In 2019, veteran investor Donald Amstad dropped one big call after another. In an 18-minute video on this very website, Amstad argued that the unorthodox monetary policies seen in Western economies were helping to create a crisis that would touch all of our lives. In that video, he argued that the dominant approach by central banks to either cut interest rates or flood economies with stimulus was nearing the end of its life. 

If you missed that video or you want to refresh your memory of what he said, you can watch it here:

While Amstad could have never predicted what came after it (COVID-19), his predictions more or less came true. The US government continues to borrow money at an exorbitant rate, bond and equity bubbles have burst, and volatility has surged at numerous points over the last four years. 

But even after all that, Amstad still thinks the bigger crisis is yet to come.

Amstad, who is now retired after 15 years at abrdn and more than 40 years in markets, joined me recently from London to update his views.

This interview is now also being released as an episode of The Rules of Investing. You can click here to listen to the show itself:

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The other consequence of the QE experiment

Fifteen years of quantitative easing and an era of politicians "being used to making promises and writing blank cheques" have undoubtedly helped fuel the inflation problem we are experiencing now. 

"The borrowing game is over," Amstad said.

But the biggest consequence we have yet to see from the quantitative easing era may still be coming - the fight to establish what role the government has in the future economy.

"The weakest people, politically, are the poor and the young. And there is a real risk that the burden of fiscal adjustment is going to be thrown onto them at the expense of companies and better-off people who really can afford to pay," Amstad said. "Our political system is just very poorly designed to have a real conversation [about reform]."

In the UK, where Amstad is based, there is an even larger problem. A significant portion of the UK's government debt is linked to retail price inflation - a measure of price increases that tend to run one to two per cent above the more commonly quoted consumer price inflation. This makes the cost of servicing liabilities even more expensive.

"The government is still running an enormous fiscal deficit here," Amstad said. "And it is getting worse because of Brexit. This signals to me that we are very close to a Sterling crisis here," he added. 

Any crisis for Sterling may not just be a UK problem

Amstad's concerns about a crisis of confidence in the United Kingdom's currency do not just end in Westminster. 

"This becomes a crisis for fiat currencies," he said. 

"We're coming to a moment of truth for fiat money, which only trades on trust and confidence. It seems to me that trust and confidence are in rather short supply at the moment," he added.

Amstad said he does not know what the tipping point will be but he does admit one possible resolution of this looming crisis is de-dollarisation.

The de-dollarisation trend is a term used among geopolitical experts to describe countries that are reducing reliance on the US Dollar and its reserve currency status. The trend tends to impact emerging markets and the 'economic south', where countries such as Argentina and Bolivia have actively considered switching from the greenback to the Chinese Yuan as their main currency of choice when conducting international trade. 

"The ball is in China's court and the global south's court now to come up with another trading system," Amstad argued.

The 'new' portfolio protection

While the US Dollar and the Japanese Yen have been traditionally viewed as the "safe haven" currencies among financial market participants, he argues a new crisis needs a new portfolio protection mechanism. 

"I think gold is the stand-out potential beneficiary," Amstad remarked before adding that he does own gold in his personal portfolio. "Cryptocurrency may very well be another beneficiary. I don't own any cryptocurrency but I can see the rationale even though I personally don't believe it," he added.

The only problem with the gold-owning theory is that gold does not, per se, produce a regular income. This forms the launch pad for the next part of our conversation.

A 10-year yield of 5%

For most of the last decade, professional and retail investors alike had one problem. Growth through owning equities at all costs is fantastic, but what happens when it all falls over? The standard answer was to buy bonds. But for most of the last 15 years, a US 10-year bond never fetched you more than a 4% yield. That all changed dramatically this year.

Now, the dominant question in markets is whether investors believe a 5% yield on a long-duration bond is good enough to buy into. That is, do you want to buy in at 5% or do you believe you can get an even better yield by holding out?

"If you have confidence in central banks that they will get inflation under control, then a 5-year or a 10-year Treasury yielding 5% is a decent bet. The risk you are taking is that central banks are not able to get inflation back down under control and that we have another surge," he said.

"I don't think it'd be wise to put all your chips back into the bond market," Amstad said. "I'm not sure I would have the confidence to go very long here," he added.

A final word on equities

Like most equity market bears, Amstad has been left stunned by the performance of the Magnificent Seven this year. One of the reasons he thinks this has been the case is that companies report nominal earnings, whereas bond traders tend to focus on both nominal and real (nominal plus inflation) yields. 

And while equities may not be Amstad's forte, he still has some sage words to offer:

"If you're in equities in times like this, then the good old-fashioned "stick to quality" or Buffett-style approach is absolutely the safest way to go," he said. 

"Growth looks like it's going to struggle again and this is the time to switch back into value [stocks]," he added.