A Macro Hypothesis:: Trade Of The Decade



A good way to think across markets is to remove the currency factor. For example, if you were to go back to 1999, a good “trade of the decade” was to sell Dow (at 11,000), and buy Gold (at $ 258). In 2009, you would have a huge profit on both legs of the transaction. Mind you, you sell the Dow for Dollars and use the same Dollars to buy the gold, but the Dollars are out of the equation.

Declaimer: This article written was originally in August 2014, and some of the data points may be outdated.

Explain the Macro hypotheses

Traders use these ratios to set up big “macro-hypotheses”. Popular ratios are the Gold: Silver ratio, which has fluctuated 98% of the time since 1900 between 0.58 and 0.72. Rarely, as during the Hunt Bros manipulation, the Iran Crisis, or the 2011-12 silver boom, is the ratio violated. At that time, the intrepid investor who has the cash and the patience makes a killing. Such “big trades” need only be done once in a lifetime.

Other ratios are the Gold: Oil ratio (which tracks the real value of oil), and the Gold: Copper ratio, which tracks global economic growth. Then there is the Copper: Aluminium ratio, which tracks the relative composition of global economic growth, and the Dow: Oil ratio, which tracks the impact of oil on economic growth. The possibilities are endless; what you need is a long-term forecast, which is accurate.

Mostly, you will notice that currencies are not part of these equations, and for good reason. While the production of commodities like gold cannot be increased at will, the issue of currencies can be increased by fiat (which is why they are called fiat money). The valuation of such currencies in terms of commodity (i.e. $ per unit of gold) can be subjected to many unpredictable shocks, based on the changing priorities of Central Banks and their respective Governments. But the ratio of Gold: Copper, or Gold: Silver cannot be so changed…..

That is why good traders like to trade 2 legs, which cancel out the currencies from the equation. I might be buying the Nifty (or Indian equities) for Rupees, which I got by selling the Dollar. And I bought those Dollars by selling gold.

Gold          Dollar           Rupee           Gold

——–   X ———–  X ————–  =    ——–

Dollar        Rupee          Nifty              Nifty

The Structural economic growth

So you sell Gold to buy the Nifty, if you believe that India is going to see some genuine, structural economic growth. That is the trade of the decade, a.k.a. the Modi Decade.

If you believe in the Modi story, then keep trading these 3 pairs, i.e. sell Gold to get Dollars, which are then sold to get Rupees, which are then sold to buy Indian equities.

You now have 3 engines of profit, with just one source of Risk. If your hypothesis turns out to be correct, then your eventual Risk will come out to be zero, while your Risk-adjusted returns will go to infinity.

To back-test this, go back to 1999 and consider the big “trade of the decade” by the now-famous Gold Bug, Bill Bonner. He asked the world to “sell Dow, buy Gold”, basically saying that the US economy would slow down, in reaction to which Greenspan would drop interest rates, which would cheapen the Dollar, which would fall against Gold, i.e. Gold would rise against the Dollar. Fairly simple and predictable…..and following the simple laws of economics, don’t you think?

If you had cut through all that noise between 1999- 2008, and stopped watching TV or reading the newspapers, you would have done very well. The returns worked out to 1100% over 9 years, in DOLLAR terms, not counting the effect of leverage (since the Dow selling would have to be done on margin).

The Macro Hypothesis

Let us now look at the problems of Europe. Besides the structural problems of the single currency and the challenges of managing the politics of the 18 (out of 28) nations that use the currency, there are other problems leading to the “Perfect Storm” for the beleaguered currency. For example, the demographic decline of most of its major economies INCLUDING Germany (besides Italy, France, and Austria) puts its fertility on par with China (1.55 births per woman), which follows the one-child policy. India, by the way, is at 2.45, while the ‘replacement rate’, the rate at which population is constant, is 2.1. No country in history has EVER pulled back from a demographic decline. So that is one trend a trader can trust, no Central banker is going to start making babies……

If a population declines, so will GDP……especially if the population is ALSO aging. As the decline slows down (like we see in Japan), unemployment will drop, leading to wage inflation, which will push up overall inflation. This is unlikely in Europe because of phenomenally high levels of youth inflation. In either case, the Central Bank will be forced to print money, which will push down the value of the currency against Gold.

Now think of a country that is doing the reverse. India, with no shortage of babies, actually has the opposite problem…..of raging inflation, which it is fighting. If you trust the new Modi- Jetley- Rajan (MJR) combination with their new stances, we will see a drop in inflation, and consequently, interest rates/ cost, which will push up equities.

So let us take the above equation, and replace the Dollar with the Euro, thus:

Gold         Euro           Rupee             Gold

——–   X ———–  X ————–  =    ——–

Euro        Rupee          Nifty                Nifty


If we don’t like selling Gold against the Euro, we can leave it out, in which case we get

Euro            Rupee             Euro

———–  X ————–  =    ——–

Rupee          Nifty                Nifty

This violates the principle of trying to leave currencies out of the equation altogether, and the only Risk here is that the Rupee does worse than the Euro, which will take some doing. I would have still trusted a Congress Govt to manage that, but I am betting on long tenures for the MJR combine.

Take any combination that you are comfortable with, provided you can predict the underlying macro-trend. Remember, the trend should stand a leg you can trust, like demographics or culture. Japan, for example, can be counted on, to remain insular and will resist immigration to the terminal stages…..the US, on the other hand, is a natural melting pot, with no big mental blocks to people from other cultures. So Japan can never take on its demographic problem by allowing immigration (the current target is 6%)…..you can then rest assured that its GDP growth rate will never rise sustainably above 2%, say.

Europe has not erected such high barriers as Japan, but they are certainly not as open as the US. Given the apples, oranges, and bad eggs in the same basket, you can rest assured that the EU is also looking at a maximum GDP growth rate of 2%. The US has a potential GDP growth rate of 3.5%, conservatively speaking.

Productivity growth cannot accelerate in Europe because it simply does not have the disruptive industries that the US has. In this respect, even Japan is better at Robotics, for example. Unemployment will never drop as precipitously as it has in the US, where whole new industries can come up in the matter of half a decade….look at the shale oil industry, for example.

The difference between  Cyclical and structural Slowdown

It is very important to be able to distinguish between a cyclical and a structural slowdown. In the case of Europe, its problems are mostly structural, be it politics, a crisis of leadership, infighting while the boat is going over the cliff, demographics, insularity, and ghettoism. These are not going to change overnight…I don’t see them changing even if they drop down in the world order.

And who is on the other side of this seesaw? China and India, in that order. China is handling its adjustment problems and should be back on an even keel in 2020, while India will be accelerating as it gets the good governance that has been missing over the last 68 years. China’s determined march into consumerism and Clean Tech will be done the same way that it set up its huge production infrastructure and investment machine. India’s entrepreneurship will flower as its sloth and bureaucracy are fettered by good governance.

It is easy to bet that India’s inflationary fires will come under control, while Europe will create inflation through money printing. So Europe will have low growth, low inflation (which the Central Bank will pump up), and high unemployment, which will dampen inflation further.

India will have high growth, high but falling inflation, and high unemployment, which will keep wage inflation down. Both these will be dependable trends to bet on……



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