Not All “Safe Havens” Are Safe – August 30, 2019

Not All “Safe Havens” Are Safe – August 30, 2019
Morgan Lewis Posted on August 30, 2019

Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

Not All “Safe Havens” Are Safe

As summer starts to wind down and we at MWM begin to put away our short-sleeve shirts, the market environment continues to be unprecedented. The investing public is focused squarely on the possibility of escalating trade tensions with China and the implications for the global economy. On any short-term view, reacting and responding to this market is a recipe for adverse outcomes. Earnings estimates are all over the place, and you can drive a truck through the disparity of outcomes. High correlations, high uncertainty, and a market environment dominated by global macro and politically induced calamities are seemingly the new normal.

The obvious big winner in a market environment such as this has been gold. It has served well as a safe haven, as well as a great hedge against global negative real rates and a Federal Reserve that will be forced to be accommodative in response to declining consumer confidence, decreased capital spending due to the uncertainty around the resolution in trade, global competitive currency devaluation, and ultimately slowing domestic growth – whether it chooses to be politicized or not. The nature of the market has us continuing to pursue building out the gold equity portions of the MAPS strategies with a very incremental approach. We believe there is at least some momentum/hot money that has chased one of the few asset classes that has been able to perform well in a difficult market environment.

As far as gold companies are concerned, one pattern we have identified is that recently we are starting to see hedges emerge in the form of costless collars being put on by producing companies. This serves to mitigate downside, but also caps upside. Our mindset has evolved in this regard. Historically, we have been purists around hedging. Given how gold companies have struggled to generate cost of capital returns over a commodity cycle, we have struggled to understand why you would give up any upside leverage to gold prices given that investors have suffered years of losses if they’ve invested in gold “for the long haul.” In general, the investment community will buy gold stocks because they want as much earnings and cash flow momentum as possible when gold prices are rising. However, at present, we very much look at this on a case-by-case basis, and believe there are situations in which shorter-term hedges can make some sense.

For example, in the case of companies that are in a project debt repayment phase, where they have a fixed cost they need to be sure they can meet in any gold price environment, we would support that decision. It protects the equity holders if the price of gold takes a leg down. On the other hand, we would discourage companies from trying to “play” the gold market, and take the job of the investor or even speculator away from them. We would caution companies and encourage management teams to look at this through the eyes of an investor who may have sat patiently for gold to once again be in favor, and explain carefully their rationale around removing or capping any upside for shareholders.

It has also been a challenge to allocate capital in interest rate-sensitive hard assets areas such as infrastructure (ex energy infrastructure) and real estate. Collapsing global yields have investors chasing anything and everything with yield, particularly anything defensive, high-quality, and moaty, which is our sandbox for MAPS. Not surprisingly, we are beginning to see numerous income “vehicles” that have high degrees of payout and yield emerge of varying quality and structure. Investors would be well served to ask a lot of questions and take a “caveat emptor” mindset when evaluating the value propositions for these vehicles. The fees are high, the counterparty risk may be significant, and there isn’t a great deal in terms of either asset quality or degree of inherent leverage that allows for this degree of payout. We prefer to patiently await opportunities in more transparent asset classes with stable business models and visible cash flows.

We continue to be confounded by the unloved and exceedingly out-of-favor energy sector, particularly energy infrastructure. When you factor in a declining domestic rig count, escalating tensions in the Middle East, and rising breakeven costs, on an all-in cost basis we see increasing evidence that the world needs $60 oil in order to stimulate investment. Energy infrastructure in particular is interesting because in many cases contracts are structured as take-or-pay, leverage has declined considerably, and valuations are attractive particularly relative to other companies that pass through income. While we see opportunity in this area, the macro backdrop and market environment dictate a cautious, disciplined, and incremental approach to adding in these areas.

Once again we thank you for your continued support and look forward to seeing many of you in Durango from September 12ththrough the 14th.

Best Regards,

David McAlvany
Chief Executive Officer

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