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Please note: The Frank Talk articles listed below contain historical material. The data provided was current at the time of publication. For current information regarding any of the funds mentioned in these presentations, please visit the appropriate fund performance page.

Gold, World War II and Operation Fish
June 5, 2018

Darkest Hour I recently had the opportunity to see the excellent 2017 film Darkest Hour, about British Prime Minister Winston Churchill’s struggle to keep the United Kingdom in the fight against the Nazis, even as members of his own government pressured him to capitulate. Gary Oldman’s portrayal of the tough-as-nails leader is at turns tender and rousing—and very well deserving of the Best Actor Oscar.

I’d recommend the film to anyone, whether they’re a student of World War II or not.

It got me thinking, though, about the important role gold played in how the war was financed, as well as the U.K.’s daring efforts to prevent its gold holdings from falling into Adolf Hitler’s hands, should Nazi forces successfully invade the island and ransack its central bank. After all, Germany had done as much in a number of Central European countries before threatening the U.K.

Although not directly addressed in Darkest Hour, the U.K. ended up evacuating billions of dollars’ worth of gold bullion and other assets across the Atlantic, all to be kept safely in Canada. The mission, codenamed “Operation Fish,” is still the largest movement of physical wealth in history.

Germany’s Economic Straits

So why was Hitler so interested in acquiring gold?

To answer that, we really need to go back to the 1920s. At the time, Germany was in serious economic straits. It faced unprecedented hyperinflation, among the very worst such incidents in world history.

This was clearly a problem for Hitler, who, soon after being appointed Reich Chancellor in 1933, set in motion the remilitarization of Germany, in direct violation of the Treaty of Versailles. Because the Western European country is not particularly resource-rich—the one exception is coal—everything from aluminum to zinc would have to be imported to manufacture the guns, tanks, ships, and warplanes needed to wage an extended conflict in the age of advanced machines.

But this was the Great Depression, which had suffocated the German economy as much as it had the United States’. Unemployment climbed to as high as 30 percent. In his inaugural address via radio, Hitler vowed to “achieve the great task of reorganizing our nation’s economy” through “a concerted and all-embarking attack against unemployment.”

Much like Roosevelt’s New Deal in the U.S., Hitler’s government tackled unemployment by dipping into deficit spending. It financed great public works projects such as the autobahn, railroad, housing and more.

The plan worked. Within four years, just as promised, unemployment was virtually thwarted. It’s been said that, had Hitler stopped in 1936 or 1937, he might today be remembered as one of the 20th century’s most admired leaders.

However, Hitler assumed a much more aggressive stance toward national rearmament in an effort to reclaim lost dignity—the Treaty of Versailles be damned. What stood in his way was not only his country’s lack of natural resources but also the fact that many supplier nations would not accept Germany’s worthless currency. They insisted instead to be paid in their own currency; some other international, convertible currency such as Swiss francs or U.S. dollars; or hard currency.    

How then would Germany pay for Sweden’s iron ore? Romania’s oil? Turkey’s chromium? Portugal’s tungsten and Spain’s manganese?

Enter gold.

In Gold We Trust

Before we continue, I want to make it clear that Hitler had no respect for the yellow metal, any more than he had for human life. Gold as a currency is built on trust, of which Hitler had none. He hated the metal and all it stands for—but he needed it to push forward his rearmament strategy.

during world war II, Germany's suppliers preferred gold to the reichsmark

Walther Funk, the Reich’s minister of economics and president of the country’s central Reichsbank, echoed this resentfulness at having to rely on gold:

“As far as currency is concerned, gold is unimportant to us,” Funk said in 1940. “We don’t need it as backing for a currency—which is being managed by price, volume, and wage control—but only to pay clearing balances.” 

In other words: We have absolutely no need for gold—until we need it.

But here another problem emerged: Just as it had few natural resources of its own, Germany laid claim to a relatively small gold reserve. In 1933, the Reich’s official holdings stood at only $109 million—not nearly enough to finance the kind of force Hitler envisioned.

The Greatest Gold Heist in History

So began the Reich’s looting of Europe’s gold reserves, beginning with Austria’s in 1938. At the time, Germany’s coffers were nearly empty. The infusion of Austria’s 90 to 100 metric tons of hard currency gave Hitler the boost he needed to continue his plundering.

Today we remember the Nazi’s gold heist as “one of the greatest thefts by a government in history,” in the words of Ambassador and Undersecretary of Commerce Stuart E. Eizenstat, spoken during his 1997 hearing on the status of Holocaust assets. Although estimates vary, and although the gold price fluctuates over time, it’s believed that as much as $600 million—now valued in the billions—were seized from the central banks and vaults of neighboring, occupied countries, including Austria, Poland, Belgium, Holland and the Netherlands. Millions more in silver, platinum, diamonds, artwork and other assets were stolen as well.

Operation Fish

Not every country’s hoard was pilfered, however. Once it was clear what the Nazis were up to, many outlying European countries had the prudence and foresight to secure their own reserves and keep them falling into Hitler’s hands.

And this is where we catch up with the timeline in Darkest Hour. In July 1940, as fears of a Nazi invasion intensified by the day, the U.K. shipped as much as 1,500 metric tons in gold—worth a mind-boggling $160 billion in 2017 dollars—across the Atlantic to be stored in Canada’s central bank in Ottawa.

one of the gold-bearing ships, the HMS enterprise

Codenamed “Operation Fish,” the evacuation was one of the greatest gambles ever. Writes Ottawa-based historian James Powell:

The only way to transport the tons of gold and securities was by ship across the U-boat infested North Atlantic, where 100 Allied and neutral merchant ships had been sunk in May 1940 alone. History was also not reassuring. During World War I, the SS Laurentic, carrying 43 tons of gold from Liverpool to Halifax, had been sunk in 1917 by a German U-boat off of Ireland. The loss of even one treasure ship would have major negative consequences. To buy weapons and other war materiel that it sorely needed from neutral United States, Britain had to pay in gold or U.S. dollars; no credit was permitted under the strict Neutrality Act in effect in the United States at that time.

Britain’s gamble paid off. Every last ingot made it safely across the Atlantic and was prevented from being used by the Nazis to extend their reign of terror a single day longer.

Germany Today a Gold Powerhouse

Although Hitler’s goals were despicable, his absolute need for gold reflects the precious metal’s centuries-long role as a widely accepted and trusted currency.

It’s a lesson Germany hasn’t forgotten, even today.

The country’s official gold holdings stand at 3,372 metric tons, more than any other except the U.S. Gold represents a whopping 70 percent of its foreign reserves—again, second only to the U.S. This has helped Germany become one of the most powerful and stable economies in the world.

More recently, Germany has emerged as the world’s largest gold investor. Although China and India still outpace the European country in total amount of gold consumed, Germans are ploughing more money into gold coins, bars and exchange-traded commodities (ETCs).

Interested in reading more about the history of gold? Check out some of my other posts below!

 

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. By clicking the link(s) above, you will be directed to a third-party website(s). U.S. Global Investors does not endorse all information supplied by this/these website(s) and is not responsible for its/their content.

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GO GOLD! Inflationary Tariffs Could Supercharge the Yellow Metal
June 4, 2018

Global sales of semiconductors crossed above 400 billion for fisrt time in 2017

Ready for inflation?

Just days after Treasury Secretary Steven Mnuchin reassured markets that a trade war between the U.S. and China was “on hold,” the Trump administration announced that it would be moving forward with plans to impose 25 percent tariffs on as much as $50 billion worth of Chinese exports to the U.S. Beijing has already suggested that it will retaliate in kind.

The White House also reinstated tariffs on imports of steel and aluminum from Canada, Mexico and the European Union (EU) after allowing earlier exemptions to expire. Again, there’s a big chance the U.S. will see some sort of tit-for-tat response.

Steel prices are already up 45 percent from a year ago. The annual change in the price of a new vehicle in the U.S. has been dropping steadily since last summer, according to Bureau of Labor Statistics data, but with the cost of materials set to rise dramatically, we could see a price reversal sooner rather than later.

US midwest hot rolled steel price up 45 percent from last year
click to enlarge

Next up, the U.S. government could slap steep tariffs on imported automobiles—and possibly even ban German luxury vehicles outright, according to a report by German business news magazine WirtschaftsWoche.

These decisions, if fully implemented, will have a multitude of implications on the U.S. and world economies. What I can say with full confidence, though, is that prices will rise—for producers and consumers alike—which is good for gold but a headwind for continued economic growth.

You Can’t Suck and Blow at the Same Time

US midwest hot rolled steel price up 45 percent from last year

Let me explain. I’ve often said that middle class taxpayers elected Trump president by and large to take on entrenched bureaucrats, cut the red tape and streamline regulations. People are fed up. A study last year by the Congressional Budget Office (CBO) found that government workers not only earn more on average than private-sector workers with similar educational backgrounds, they’re also guaranteed health, retirement and other benefits. Trump responded to these concerns by signing an executive order that eased the firing of federal workers.

He’s kept his word in other ways. Since being in office, he’s already eliminated five federal rules on average for every new rule created, according to the Competitive Enterprise Institute (CEI). He’s weakened Obamacare and Dodd-Frank, not to mention slashed corporate taxes.

In 2017, the number of pages in the Federal Register, the official list of administrative regulations, dropped to 61,950 from 97,069 the previous year. This is especially good news for productivity. Research firm Cornerstone Macro found that Americans were more productive when there were fewer rules, less productive when there were more rules. 

productivity decreased as the number of federal rules and regulations grew
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These are all positive developments that should help boost the economy. The problem is that they could be undermined by tariffs, which are essentially regulations. We believe government policy is a precursor to change, and history suggests that rising tariffs and regulations hurt the economy.

Consider automobiles. U.S. automakers are the second largest consumer of steel following construction. In March, the Wall Street Journal estimated that the tariffs could add at least $300 to each new vehicle sold in the U.S. And speaking to Bloomberg last week, a spokeswoman for the Alliance of Automobile Manufacturers said the tariffs on steel and aluminum imports will make cars more expensive. “These tariffs will result in an increase in the price of domestically produced steel—threatening the industry’s global competitiveness and raising vehicle costs for our customers,” Gloria Bergquist said.

Do tariffs on imported vehicles threaten united states auto sales
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Higher Inflation Has Historically Meant Higher Gold Prices

The good news in all this is that higher inflation has historically been supportive of the price of gold. In the years when inflation was 3 percent or higher, annual gold returns were 15 percent on average, according to the World Gold Council (WGC).

gold has historically rallied in periods of high inflation
click to enlarge

When gold hit its all-time high of $1,900 an ounce in August 2011, consumer prices were up nearly 4 percent from the same time the previous year. The two-year Treasury yield, meanwhile, averaged only 0.21 percent, meaning the T-note was delivering a negative real yield and investors were paying the U.S. government to hang on to their money. This created a favorable climate for gold, as investors sought a safe haven asset that would at least beat inflation.

CIBC: Major Gold Firms to Generate Strong Free Cash Flow and ROIC

gold has historically rallied in periods of high inflation

Finally, I want to draw attention to an exciting research report released last week by the Canadian Imperial Bank of Commerce (CIBC). I’m a huge admirer of the work CIBC does, especially that of Cosmos Chiu, director of precious metals equity research. Chiu and his team write that the “future looks brighter” for gold equities on improved free cash flow and return on invested capital (ROIC). Both factors are among our favorites. I recently shared with you a chart that shows that, over the past 30 years, ROIC outperformed other factors by as much as one and half times.

With gold trading near $1,300 an ounce, producers are currently posting positive margins, according to CIBC. As a result, every stock in the bank’s large-cap universe, with the exception of Kinross, is expected to generate positive free cash flow through 2019.

Go Gold! Royalty/Streaming Companies Deliver the Profits

The bank has even better news for royalty and streaming companies, particularly Franco-Nevada, Royal Gold and Wheaton Precious Metals. For one, the three big royalty names delivered combined shareholder returns of 6.2 percent between 2013 and 2017, outperforming both senior producers and physical gold.

Three largest royalty and streaming companies forecast to deliver strong return on invested capital
click to enlarge

Now, CIBC forecasts the royalty group will generate strong ROICs, “steadily inching higher over the next decade… to average between the 5 percent and 8 percent mark from 2018 – 2023.” ROIC measures how well a company can turn its invested capital into profits.  

Loyal readers already know we’ve long been fans of Franco-Nevada, Wheaton Precious Metals and other royalty/streaming names. 

 

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. Some links above may be directed to third-party websites. U.S. Global Investors does not endorse all information supplied by these websites and is not responsible for their content.

Holdings may change daily. Holdings are reported as of the most recent quarter-end. The following securities mentioned in the article were held by one or more accounts managed by U.S. Global Investors as of (03/31/2018): Franco-Nevada Corp., Royal Gold Inc., Wheaton Precious Metals Corp.

Free cash flow is the cash a company produces through its operations, less the cost of expenditures on assets. In other words, free cash flow or FCF is the cash left over after a company pays for its operating expenses and capital expenditures or CAPEX.

Return on invested capital (ROIC) is a profitability ratio. It measures the return that an investment generates for those who have provided capital, i.e. bondholders and stockholders. ROIC tells us how good a company is at turning capital into profits.

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Spinning Italy's Distressed Debt into Gold
May 30, 2018

Spinning Italy’s Distressed Debt into Gold

Serious gold investors know that May has historically been a weak month for the price of the yellow metal. For the 10-year and 30-year periods, the month delivered negative returns. The general decline in enthusiasm comes before the late summer rally in anticipation of Diwali and the Indian wedding season, when gifts of gold are considered auspicious. In the past, the fifth month has provided an attractive buying opportunity.

This particular May, the price of gold also had to contend with a stronger U.S. dollar, which appreciated against the euro as political strife in Italy spread throughout the entire continent. Priced in euros, then, gold is performing well, having closed at a nearly one-year high of 1,125 euros on May 29.

gold priced in euros at one-year high on political uncertainty in Italy
click to enlarge

Italian government bond yields surged dramatically following President Sergio Mattarella’s decision to block the opposition parties’ pick for economic minister, a euroskeptic who supports Italy’s exit from the eurozone. The two-year bond in particular plunged the most since the creation of the bloc’s common currency in 1999.

italian government borrowing costs surge
click to enlarge

With no working government at the moment, it appears likely that Italy will hold another election soon, raising the odds that either the Five-Star Movement or the League—both populist, anti-establishment parties—could take control. Although at opposite ends of the political spectrum, the two parties have expressed interest in at least opening an earnest discussion on the idea of ditching the euro.

Déjà Vu All Over Again

Italy’s appetite for change fits into what I see as a global trend right now. Based on what I’ve heard during my travels, middle class taxpayers, in the U.S. and elsewhere, are increasingly fed up with special interests and entrenched bureaucrats. As a result, the U.K. elected to end its complicity with failed socialist rules and regulations from Brussels. Donald Trump, an outsider and disruptor, was recognized by American voters as the right candidate to take on the beltway party.

Similarly, it’s possible that Italy could end up being next to say addio to further European Union (EU) control and take back its own economic and political destiny.

That said, the fear of another government debt crisis, similar to Greece’s, has naturally rattled markets. Because Italy, the eurozone’s third-largest economy, already has the highest debt-to-GDP in the bloc after Greece, and because Five-Star and the League both support ending austerity and challenging Brussels’ limits on government borrowing and spending, financials were the worst performing sector in the U.S. market, falling close to 4.5 percent for the week ended May 29. The Euro Stoxx Banks Index was down 5 percent for the same period. Italian banks fared even worse, collapsing nearly 25 percent since their high in late April.

italian banks get crushed
click to enlarge

Gold Seeing a Boost on Safe Haven Demand

Gold is trading above $1,300 an ounce again, but there could be bigger upside the more investors realize the full and global implications of Italy’s political turmoil.

The country’s public debt currently stands at 132 percent of GDP, and ratings agencies are reviewing a possible downgrade of its credit rating. Should it default on its billions of dollars in loans, a chain reaction could quickly spread to financial markets all over the world.

This is a worst-case scenario, but it’s for these reasons I think it’s prudent to have a 10 percent weighting in gold, with 5 percent in physical gold and the other 5 percent in high-quality gold stocks, mutual funds and ETFs.

 

The EURO STOXX Banks Index is a free float market capitalization index which covers 30 stocks of banks market sector leaders mainly from 12 eurozone countries: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain. The FTSE Italia All-Share Banks Index is a free float market capitalization index of Italian banks.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.

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Building a Better U.S. Economy
May 29, 2018

Global sales of semiconductors crossed above 400 billion for fisrt time in 2017

This shouldn’t surprise anyone, but public trust in the federal government is eroding. Sixty years ago, 75 percent of Americans expressed faith in the government to do the right thing “most of the time” or “just about always.” Seventy-five percent! You can’t get 75 percent of people to agree on anything now, as the recent “Laurel or Yanny” video proved.

Today, only one in five Americans, or 20 percent—a near-record low—believes our leaders make decisions in the country’s best interest. If you’re reading this, you might very well be in the camp that has some serious doubts.

United States public trust in federal government near historic lows
click to enlarge

The polling data, provided by the Pew Research Center, was shared by Pulitzer Prize-winning biographer Jon Meacham, who spoke last week at an Investment Company Institute (ICI) meeting in Washington, D.C. Although no fan of the president, Meacham believes, as I do, that fed up, disillusioned voters turned to Donald Trump to take on the beltway party and career bureaucrats and roll back out-of-control regulations.

Government Policy Is a Precursor to Change

This anti-establishment discussion isn’t just happening here in the U.S., of course. Brexit in the U.K. was a populist backlash against excessive rules from unelected bureaucrats in Brussels. Last year, France nearly elected the far-right Marine Le Pen to the president’s mansion. And in Italy this week, tax-paying middle class, euroskeptic voices are getting louder following President Sergio Mattarella’s veto of their pick for economy minister.

Love him or hate him, Trump has so far stuck to his word, and he doesn’t seem to have any reservations about whose applecart he upsets. He’s an equal-opportunity disruptor, and for that he has opponents on all sides of the political spectrum, including the beltway.

It's little wonder, then, that “Trump” is likely the most spoken word in the English language right now, according to Meacham. Just don’t tell Trump that.

Presidential biographer and historian Jon Meacham

The presidential historian—who last month delivered the eulogy for former first lady Barbara Bush—also reminded the audience that, as bad as many people believe things are right now, they used to be much worse. Remember slavery? Remember Jim Crow?

Some people believe Trump is determined to weaken First Amendment protections, but he’s not the biggest threat to free speech this country has ever seen, Meacham said.

A little over 100 years ago, in preparation for America’s entry into World War I, Congress passed and President Woodrow Wilson signed the Espionage Act, which gave the U.S. government sweeping new authority to control and censor the press. Overnight, it became illegal to “convey information with intent to interfere with the operation or success of the armed forces of the United States or to promote the success of its enemies.” Hundreds of communist and pro-German newspapers and magazines were banned or otherwise forced to shut down.

It’s important to put things in perspective. Trump might regularly criticize what he perceives as “fake news,” but at least those outlets—the New York Times, Washington Post, CNN and others—are allowed to continue operating.

 

 

Trump Maintains a One-In, Five-Out Pace for Regulations

Many attendees of the ICI meeting, all representing investment and wealth management firms,  weren’t so optimistic about their ability to communicate effectively with shareholders and potential clients. Some of them shared with me their observation that regulators are increasingly getting bolder about what financial firms can and cannot say, and the interpretation of rules keep piling up.

Within the past year, we were asked to add disclosure under a picture of Elvis Presley in many of our gold presentations, if you can believe it. And during the conference, a fund manager said he found it ridiculous that, in a company slideshow, he was asked to add disclosure beneath a picture of Aristotle to inform clients that the ancient Greek philosopher was not, in fact, affiliated with the fund in any way.

It raises the question: What reader would assume that Elvis and Aristotle—the former having been dead 40 years, the latter 2,000 years—are affiliated with an investment firm?

It’s common knowledge in the business that the number of investment advisors and brokers is shrinking day-by-day. You would think that the number of rules and regulations would likewise shrink, but that doesn’t appear to be the case. In such a climate, the only ones who manage to stay ahead are the Vanguards and BlackRocks of the investment world. (Similarly, the number of seats in Congress has not changed in over 100 years, and yet we’ve seen a growth in the power of unelected bureaucrats.)

This has created an unlevel playing field that favors the Vanguards and BlackRocks of the investment world.

I believed that this is one of the key reasons why many people voted for Trump—to cut the red tape and rein in rampant bureaucracy. Here again, he’s kept his word, having so far eliminated, on average, five federal rules for every new rule created, according to the libertarian think tank Competitive Enterprise Institute (CEI).

Bye Bye, Dodd-Frank. Hello, Economic Growth?

Case in point: The week before last, he signed legislation that severely weakened the Dodd-Frank Wall Street Reform and Consumer Protection Act. The behemoth 2010 law, intended to prevent another financial crisis, is believed to be directly responsible for the failure of a number of small and regional banks, which small businesses and rural families depend on for loans and other financial services.

That’s why I named Dodd-Frank one of the five costliest financial regulations of the past 20 years. Barney Frank himself, the former chairman of the House Financial Services Committee and one of Dodd-Frank’s chief architects, acknowledged he “sees areas where the law could be eased.”

With the most restrictive parts of Dodd-Frank gone or amended, annual economic growth in the U.S. might finally be able to break above 3 percent, a rate we haven’t seen since 2005.

In the meantime, asset management firm AllianceBernstein shows that, over the past 30 years, the best performing factor has been return on invested capital (ROIC). According to the firm, ROIC outperformed return on equity (ROE) by one and a half times, and gross profitability by nearly three times.

Trading return on invested capital has been most successful over much of the cycle
click to enlarge

Seeing this chart was particularly vindicating for us, as ROIC is among the most important factors we pay attention to when making our investment decisions.

Government Policy Right Now Favors Small-Cap Stocks

The Dodd-Frank rollback is just the latest move by the Trump administration that should benefit smaller businesses. Quarter-to-date, the small-cap Russell 2000 Index is up more than 6 percent, compared to the S&P 500 Index, which is up 2.8 percent. Meanwhile, small business optimism , as measured by the National Federation of Independent Business (NFIB), remains near a historic high, posting 104.8 in April, up a hair from the previous month.

Small cap stocks continue to climb as business optimism strengthens
click to enlarge

I often say it’s not about which party is in power but rather the policies that matter. Whether the Republicans or the Democrats control Washington isn’t the point. There are ways for investors to make money in either case, and right now, government policy favors domestic small-cap stocks that have limited exposure to overseas markets. The trend is your friend, as they say, and with respect to small-caps, that certainly seems to be the case.

 

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. By clicking the link(s) above, you will be directed to a third-party website(s). U.S. Global Investors does not endorse all information supplied by this/these website(s) and is not responsible for its/their content.

The Russell 2000 Index is a U.S. equity index measuring the performance of the 2,000 smallest companies in the Russell 3000. The Russell 3000 Index consists of the 3,000 largest U.S. companies as determined by total market capitalization.

The small business optimism index is compiled from a survey that is conducted each month by the National Federation of Independent Business (NFIB) of its members.

Return on invested capital (ROIC) is a performance and profitability ratio indicating how much investors in a business are earning on the capital.

Return on equity (ROE) is the amount of net income returned as a percentage of shareholders equity. 

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Yields Look Overextended and Ready for Mean Reversion
May 23, 2018

Bull and Bear market statue Frankfurt

The 10-year Treasury yield has been the topic of conversation lately among fixed-income investors. Earlier this month, the T-note closed above 3 percent for the first time since July 2011, prompting some market watchers to call time on the three-decade Treasury bull market. (Bond prices fall as yields rise, and vice versa.) For other investors, these concerns might extend into the $3.8 trillion municipal bond market.

I believe this bearishness is premature. Take a look at the chart below, which shows the 10-year yield’s daily standard deviation based on 10 years’ worth of data. As of Friday, May 18, the yield was up a little more than two standard deviations from its mean—suggesting that, while not guaranteed, there’s a high probability of mean reversion. Such a move would bring the 10-year yield back down to around 2.88 percent, a level last seen in mid-April. This would be similarly positive for muni bonds, though it’s important to remember that Treasuries, unlike munis, are backed by the full faith and credit of the U.S. government.

Year over year percent change oscillator 10 year treasury yield
click to enlarge

Muni Bonds Outperformed in Previous Rate Hike Cycles

Fixed-income investors might find munis more attractive than Treasuries right now for two additional reasons.

For one, muni bonds historically outperformed and were less volatile than Treasuries during previous rate hike cycles, according to Standish data. In the past, a 100 basis point rise in the 10-year Treasury yield—in response to higher interest rates—was accompanied by a rise of only 60 basis points on average in muni bond yields.

Take a look below. In each of the past seven rate hike cycles, munis outperformed Treasuries by at least 5 percent and sometimes as much as 10 percent or more. The Federal Reserve has raised rates six times since December 2015, with two more increases possibly slated for this year.

Munis have outperformed treasuries when rates rise
click to enlarge

Tax Overhaul Favors Munis

Second, because muni bonds are exempt from federal income taxes and often from state and local taxes (SALT) as well, they’re especially attractive to investors living in high-income tax states such as California, New York, New Jersey, Minnesota, Oregon and others.

You might think that the major tax reform bill signed into law at the end of last year would dampen demand for munis. But because the law caps SALT deductions at $10,000, wealthier taxpayers, in many cases, may end up paying more to Uncle Sam than they did before.

Some high-tax states are scrambling to create “SALT workarounds,” designed to help top earners cope with the new tax law and prevent talent from migrating to a state with lower (or no) income taxes.

The problem with these workarounds, though, is that many of them are highly complex. What’s more, filers may run into difficulties with the Internal Revenue Service (IRS), which has expressed disapproval of the workarounds.

You can probably tell where I’m going here. Short-term muni bond funds are a tried-and-true method to help preserve capital and also deliver income that’s tax-free at the federal and often state and local levels.

 

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.

Standard deviation is a measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher the deviation. Standard deviation is also known as historical volatility.

The Bloomberg Barclays 10-Year U.S. Treasury Bellwethers Index is a universe of Treasury bonds, and used as a benchmark against the market for long-term maturity fixed-income securities.

Thomson Reuters Municipal Market Data (MMD) AAA Curve is a proprietary yield curve that provides the offer-side of “AAA” rated state general obligation bonds, as determined by the MMD analyst team. The “AAA” scale (MMD Scale), is published by Municipal Market Data every day at 3:00 p.m. eastern standard time with earlier indications of market movement provided throughout the trading day.

 

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Net Asset Value
as of 10/19/2018

Global Resources Fund PSPFX $5.03 0.01 Gold and Precious Metals Fund USERX $6.95 0.07 World Precious Minerals Fund UNWPX $3.51 0.01 China Region Fund USCOX $8.08 0.12 Emerging Europe Fund EUROX $6.32 -0.01 All American Equity Fund GBTFX $25.37 -0.09 Holmes Macro Trends Fund MEGAX $18.05 -0.07 Near-Term Tax Free Fund NEARX $2.19 No Change U.S. Government Securities Ultra-Short Bond Fund UGSDX $2.00 No Change