23 Sep 2010, 5:09pm
reflections
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  • the Autumnal Equinox, when the light surrenders to the darkness

    Autumn tree in Rendlesham forest

    Autumn tree in Rendlesham forest

    Today is the Autumnal equinox, the process of decline is in full swing. There is a sweet smell of the decaying leaves in the air, and the winds blow as the forces of light and darkness find their balance. It is the time of harvest, of plenty, but it also holds the bittersweetness of the long and lonely night of Winter yet to come.

    This cycle is needed, no natural system can run flat out all the time. There needs to be the time to project force, to conquer, to overcome. Less clear is the need to retreat, to survey the field, to reflect, draw down the reserves. In that time to come, some will find that the reserves are not enough, and for them the winter will hold no spring.

    Not all of these sparrows will see the returning warmth of spring

    Not all of these sparrows will see the returning warmth of spring

    Capitalist economies also seem to need phases of creative destruction – and every so often they seem to have spasms that destroy accumulated paper wealth. There is a theory that as the people that weathered the last Depression start to die off, people forget the reasons for the controls being there. Clinton’s repeal of the Glass-Steagall Act seems to be one such event. This paper describes the poetic concept of the Kondratieff Winter, where the assumptions that underpin the economic system begin to fray at the edges, then begin to fail under the weight of their internal contradictions. In particular, the skyrocketing debts, both personal and more importantly sovereign debts described in that article do seem to be taking place.

    It seems to me to be a wider metaphor for the coming storms on the economic horizon.  In terms of my shares ISA Britain is booming – indeed for all the talk of emerging markets a sturdy old investment trust I bought in July has appreciated by more than 12%. I wish I knew why – I bought it as part of a re-orientation of my portfolio towards being able to produce an income without having to sell slices of it off. The reasons I bought it were the NAV, yield and the fact that its aims seemed to broadly align with what I would do if I had, say, Monevator’s more detailed knowledge. This article of his describes the particular qualities of ITs.

    Compared to the 5% performance of my Emerging markets ETF in a country with a young population and decent alternative energy prospects doughty old Blighty seems to deliver at the moment. Some part of me suspects this is because I am being paid in an increasingly worthless currency that has depreciated by about 25% in the last year, presumably as a result of QE. This should, however, pump up the ETF too.

    The reason I don’t feel good is because though finance may recover this feels awful from the point of view of the people of this country. Perhaps with the exception of the wealthy 😉 And possibly the debt-free, which I have managed after 30 years of working.

    There are two areas things seem set to really get worse. One is the horrific state of employment in this country. We don’t have jobs for many of the the graduates pouring out of our universities. One in three call centre workers in the UK has a degree. You don’t need a degree to work in call centre FFS, and on minimum wage it’ll take a while to pay back the student loan, plus of course you have the opportunity cost of three years not working.

    The other area is the continual train wreck that is housing in Britain. Half the population can’t buy a house, the other half seems scared to death that their mortgages will be more than the amount their houses are worth. While I do feel that some of the latter have got only themselves to blame I am not devoid of compassion for them. In the end this is a zero-sum game, for one group to gain the others must lose.

    Something that will clearly be toxic in times to come is debt. Of all forms, including mortgage debt. Just as in normal times, non mortgage debt is toxic because the underlying assets or purchases do not have a value that can settle the debt, now the same will apply to mortgage debts. Credit controls will mean that remortgage costs may be prohibitive, and I am glad to see that finally the interest-only mortgage is to be challenged. It staggered me when I moved in 1998, increasing the mortgage by 50%, that the  broker waved a cheery ‘don’t worry about it’ when I raised that half the capital was not covered by the endowment. I had to push to get the mortgage on a part interest only/part repayment basis.

    Is a Kondratieff Winter looming?

    During the Kondratieff winter the economy dies because the debt bubble, which has been massively inflated during the Kondratieff autumn, explodes. Effectively, this destroys both creditors and the debtors alike.

    Ian Gordon, longwavegroup.com

    I had reason to consider recently how I could preserve enough cash to pay my way for five years without working. I have assets equivalent to about three years running costs which I saved the ERE way in two years. Some of that is in shares ISAs which the oncoming Kondratieff Winter * could write off. Some of it is in cash ISAs which are already dying slowly, as the interest, though a decent tax-free 3.2% isn’t enough to compensate for the corrosive effects of inflation. N&SI index-linked certs carry a little bit of the rest, but I was trying to create a laddered sequence of these to mature over the period I want an income. What I didn’t allow for was the fact that the buggers would can these.

    * The theory of a Kondratieff Winter is a little bit too chartist for my own liking, but I’m open to the concept of historical parallels, even though they are depressingly hard to use for forward planning 🙁 “History doesn’t repeat, but it does often rhyme”

    The opportunity I was aiming for didn’t turn up. Since I am still working, I can live with eating the devaluation of my cash assets, though I can hardly say I am chuffed at the Government using inflation to destroy my wealth so they can sub homeowners that paid too much for their houses via low interest rates. This would hack me off a lot more if I were retired and relying on this cash.

    In my ISA I also hold a significant gold ETF position. Reflection has shown me that this is not a good investment to hold for gold in particular. Gold’s pure purpose in a portfolio is to act as a store of value, representing cash of last resort.

    For stock market indices, an ETF is a reasonable market proxy. Under the sort of turmoil that would lift my gold holdings to about 50% of total shares ISA investments, ie the conditions where this would matter, it is quite likely that the ETF provider would be destroyed. Gold is about insurance, and insurance that is likely to fail you in your hour of need is worse than not having insurance at all. In the latter case, at least you know you are hosed.

    I will sell this ETF holding and try and get my head round the more fundamental methods of investing in gold which, in an ISA, usually means mining shares which have unusual pathologies of their own. As a slightly peak oiler I am a commodity bull, particular when I read of this sort of aggro going on (interestingly a parallel drawn with Smoot-Hawley by the longwave paper), or even this. But in the end my paper assets are not part of my tin hat portfolio. Under certain wintry conditions I should be resigned to seeing them become worthless, or at least so illiquid as to be effectively worthless. Then it will be the time for other things and skills I am investing in. I expect a long winter ahead. The last one, from 1933-1949 took 16 years, so if the pattern were to repeat itself it would take until 2026 to come good. We may be facing other resource challenges by then…

    Lovely intro. It’s certainly a useful exercise to ponder the dark side once in a while, but I can’t get so pessimistic. I’ve no doubt that the gold effect is real in nervous markets, but in worse times it seems to me that iron and copper, not to mention neodymium etc., will beat the glittery stuff (and certainly, as you indicate, proxy ownership). Likewise foodstuffs and hydrocarbons.

    Like you I had a vision of building up a series of NS&I indexed certs (boo hoo) over the next couple of years — I only managed one tranche, but in default of that, I think a spread of defensive stocks, together with mining, energy and food, is a viable alternative.

    You have no mortgage, so you are missing out on low interest rates, but being debt free will undoubtedly pay dividends again and probably within a couple of years.

    Re gold and ISA – my advice (and practice…) is to hold gold as sovereigns. As coin of the realm they are exempt from VAT and CGT – so what does an ISA have to offer over that?

    Keep it in the ‘Royal Bank of Orthopaedic’ and your emergency fund is secure, no counter-party risk, and more liquid than your ISA – you can run down to the jeweller with a handful of gold and redeem it for real cash in an hour or so. I had need recently of a quick cash boost, and did just this – my cash ISA withdrawal still has another 27 days to go! The fact that I bagged a 25% profit on the sovereigns I sold was just icing really 😉 Definitely my preferred method for holding an emergency fund. And if things really HTF, then it’ll fit into a pocket and not slow me down if I have to run for my life…

    ETFs are not for me, I like to get physical 😉

    Wishing you a mellow and fruitful autumn.

    @SG You’ve got a point in that other metals will appreciate more provided the financial system remains, as China’s shenanigans seem to indicate. I’m not rich enough to hold a significant amount of gold, the ETF is 50% things are going to be pretty desperate. Hence the concern on the counterparty risk.

    I haven’t worked out whether the low interest rates and being MF is an issue, in some ways not being able to take advantage of the low interest rates is a bit like the old homebase spend & save card, you have to lose more (by having a loan) in order to gain by paying less on it…

    @Mac I didn’t realise the VAT and CGT issues, I’d assumed VAT would take a massive bite out of phyiscal gold on the turn. Though the bank location is one a lot of bad guys know about 🙂

    […] The autumnal equinox – Simple in Suffolk […]

    Yes, the VAT/CGT issue is an odd one, but let’s say I’d need an unfeasibly humungous rise in price to have to worry about CGT even if it were payable 🙂

    Silver bullion, however, does attract VAT, and that has been bit of an ‘ouch’ for me… but live and learn, I guess…

    As for interest rates, well, they are what they are. I’d rather be earning interest than paying it – whatever the rates 😉

    […] UK income in future. My bearish side comes out in some gold, though after some reflection that is in an inappropriate format. ETFs are real but exchange traded commodities are not the same thing at all. They are achieved […]

    […] PHAG ETF with this month’s saving while I think about what to do with my regular savings. As described earlier, these have no place in my tin-hat portfolio – for that I have to get physical and bury gold […]

    […] of index investing, albeit indirectly. And I believe that assumption is flawed, and that it will fail at some point when economic activity outstrips enough of its inputs. Yes, we have an infinite supply of human […]

     

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