This week, gold briefly climbed above $2,000 per ounce. The precious metal is commonly thought of as an inflation hedge, but also serves a different function in times of financial stress. Gold can be a safety trade.

 

Gold is a highly speculative asset in the best of times. But, unlike bonds and stocks, it has one redeeming factor in times of economic slowdown, financial instability, and geopolitical tension. It does not carry the risk of an issuing entity collapsing, such as a bank or a government. There have been many examples of this throughout history.

 

The latest example was back in February 2022, during Russia's invasion of Ukraine. Gold spiked to $2,078 per ounce within the next month. Historically, gold has also functioned as an inflation hedge. In the aftermath of the Russian invasion, supply chain disruptions, especially in energy, food, and materials, pushed prices and the inflation rate higher. That aided and abetted the precious metals safety trade for a brief time.  

 

But gold's shine was diminished quickly when central banks around the world announced a tightening of monetary policy to combat rising inflation. Higher interest rates have always been kryptonite to the price of gold bullion. Gold bullion is stored for a fee, and that fee is based on the going rate of interest. Gold prices fell to $1,618 by November 2022. Higher interest rates ultimately trumped the safety trade.

 

As interest rate fears rose in 2023, gold continued to fall. It was largely dead money since the start of this year, trading at $1,832 per ounce just a month ago. The collapse of Silicon Valley Bank and Signature Bank in the U.S., and Credit Suisse's forced demise in Switzerland last week suddenly changed the calculus in gold investing.

 

As investors worried that money deposited in banks was suddenly at risk, they rushed into gold. The largest exchange-traded physical gold fund, for example, added 20 tons of gold to its ETF in a week. That was the largest single inflow of demand for gold since the Russian invasion. At the same time, yields on interest rates plummeted, as bond prices also jumped. The combination of lower rates and elevated risk provided a double boost to the gold price.

 

Investors need to realize, however, that in any safety trade, there is an implied risk premium that is embedded in the asset, in this case, the value of gold. The greater the risk, the higher the premium. Market Risk Advisory, a Japanese-based research firm, figures that based on historical interest rates, the price of gold should currently be trading around $880 per ounce in a riskless world. That would mean that the present risk premium, plus the impact of the decline in yields, is more than $1,000 per ounce of gold.

 

This week, due to the actions of the Federal Reserve Bank, the U.S. Treasury, the FDIC, as well as similar institutions in Europe, the fear of the investing public had been somewhat reduced. As a result, stocks went up and yields on most government and corporate bonds fell. As that happened, the price of gold fell more than $42 per ounce or 2.12 percent in just one day.

 

Does that mean that if the perceived risk of additional problems in the banking sector diminishes, the price of gold will fall further? It should--all else being equal — but all else is never equal.

 

Many believe that it will take some time before the banking sector returns to normal. U.S. Treasury Secretary Janet Yellen has said that she has not considered or discussed "blanket insurance" to U.S. banking deposits without approval by Congress. As such, some risk premium will likely remain in the price of gold going forward.

 

There is also the question of interest rates. The fear of financial contagion could deter further interest rises by the Fed in the months ahead. In addition, if the Fed feels they have tightened enough to slow the economy and reduce inflation, that would relieve the rate pressure on the price of gold. The direction of the U.S. dollar is also important to watch since gold has an inverse relationship with the greenback. The bottom line, there are more than enough reasons that could keep gold in play in the months ahead.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

The global banking sector took center stage as three U.S. banks bit the dust and a fourth large bank in Europe floundered. This puts the Fed between a rock and a hard place.

 

The Federal Open Market Committee meets this coming Wednesday and, before the collapse of the Silicon Valley Bank, was expected to raise interest rates by 25 to 50 basis points. Today, expectations are split between no rate hikes at all, and maybe one more hike of 25 basis points and then a pause.

 

Investors large and small held their breath last weekend in the wake of three bank failures. Fears of financial contagion swept the country throughout the week. Regulators acted on several fronts to contain the potential fallout. The FDIC announced that they would fully protect all depositors, while President Biden assured the nation that U.S. banks were solid.

 

The Federal Reserve bank also announced a new $25 billion bank term funding program that offers one-year loans to banks under easier terms than it typically provides.

 

Investors on Monday responded positively to the news, but the near collapse of yet another bank later in the week, this one a large European bank, Credit Suisse, had traders once again running for the hills. Banking stocks tumbled again.

 

Most Wall Street pundits blamed the Fed's rapid rate hikes over the last year for the banking fallout. As such, a rising chorus of alarmists is insisting that the Fed, needs to back off from any more rate hikes immediately. Over in the bond market, the vigilantes are betting that the new scenario is a "one and done" 25 basis point hike in March and then a pause. Some strategists are even expecting the Fed to begin easing its tight money policies by the middle of the year if not sooner.

 

The easing argument is that regulators (because of the bank failures) will soon be increasing the number of banking regulations in the financial sector, which will reduce their ability to lend money. If so, that would slow the economy, reduce inflation, and therefore do the Fed's job for them. In that environment, there would be no need to raise interest rates further.

 

As it stands, both the Consumer Price Index (CPI) and the Producer Price Index (PPI) for last month indicated some small progress toward slowing inflation. However, the data is not enough to dissuade the Fed from backing off its program. The economy is still growing, and employment is still much stronger than the Fed would like to see.

 

The question on many investors' minds is whether the Fed will back off at next week's meeting or risk further financial contagion and continue its interest rate hikes.

 

One indication that they will continue their program was the actions of the European Central bank (ECB) on Thursday. Beleaguered Credit Suisse was given a $54 billion liquidity lifeline by the Swiss National Bank. It may not solve the Swiss bank's problems, but for now, it appears sufficient.  investors still expected that the ECB's planned interest rate hike of 50 basis points would be delayed or even canceled.

 

Instead, the ECB hiked rates a half point and assured investors that the eurozone banking sector was resilient, adding that they stood ready to supply liquidity to banks if needed.

 

It was no accident, in my opinion, that U.S. Treasury Secretary Janet Yellen told members of the Senate Finance Committee almost the same thing assuring them that the U.S. banking system remains sound.

 

I am sure the Fed and the Treasury discussed the ECB's intended actions. In times of turmoil in the global banking system, central bankers confer with each other regularly, as do their counterparts in the Treasury. It seems to me that the odds favor Chairman Jerome Powell and the Fed following the ECB's lead and continuing with their tightening program.

 

Stocks have had a mountain of bad news this week and tested the 3,800 level on the S&P 500 Index, which was my downside target. From there, we bounced more than 160 points before falling back again. I expect markets will continue to trade in these wide swings until the Fed meeting in the middle of next week. From there, the market’s direction will be Powell-dependent. I am betting it is up.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

The recent calamity in the banking sector is complicated, but one issue stands out. Even the safest of investments have risk.

 

Understanding the relationship between bond prices and interest rates is extremely important. Bonds, overall, are considered safer investments than stocks and history indicates that bonds have been less volatile than stocks most of the time. However, when interest rates rise, bonds can get hurt for a variety of reasons, and credit risk is at the top of the list.

 

Credit risk refers to the possibility that a corporation (or a government entity) could default on a bond they have issued. That happens when the issuer fails to pay back the principal or cannot make interest payments. Normally, U.S. government bonds, called Treasuries, have lower credit risk. Presently, however, even Treasuries have some credit risk. If Congress refuses to increase the debt limit by this summer and allows the country to default, the consequences for our government debt could be grave.

 

However, all bonds have interest rate and duration risk. Bond prices and interest rates move in opposite directions. As interest rates fall (as they have for much of the past decade), the value of fixed-income investments rise. Since last year, interest rates have risen substantially due to the Federal Reserve Bank's efforts to combat inflation.

 

This is where duration risk comes in. Let's say you have long-dated U.S. Treasury bonds that do not come to maturity for 10, 20 or even 30 years from now. If you hold them to maturity, you will receive your principal investment back plus whatever interest rate coupon was promised. However, if rates rise (as they are doing now), and for whatever reason, you sell your bonds before their maturity date, you could end up receiving less than what you paid for your bond.

 

In general, duration is expressed in terms of years and generally bonds with long maturities and low coupons have the longest duration. These bonds are more sensitive to a change in market interest rates and thus are more volatile in a changing interest rate environment. Over the last year, the Fed has increased interest rates at its fastest pace in recent history, which has caused the price of bond holdings to decline substantially.

 

Enter the Silicon Valley Bank (SVB) stage left. SVB, like most banks, relies on a mixture of short-term and long-term financing. The short-term side largely consists of customer deposits. A bank's assets typically consist of long-term loans that get paid back with interest over time as well as bonds the bank purchases that pay out over the term of the bond.

 

More than half of SVB's assets at the end of last year were "safe" bonds issued by the U.S. government or federal mortgage institutions, which they had purchased before the Fed's tightening policies began. Safe from default risk, maybe, but not from the climbing interest rates. And most, if not all, of those bonds, were low coupon, and long-term in nature — a classic case of duration risk.

 

The nightmare that all banks fear is a bank run. Think of "It's a Wonderful Life" and George Bailey's Building and Loan, a small community bank in Bedford Falls. Depression-era depositors, fearing for their financial lives, rushed to take their money out of Bailey's bank. Few depositors understood how credit and loans work. They thought their money was simply sitting in the safe. George tried to explain the concept but ended up making good for his customers by giving them his honeymoon money.

 

In the case of SVB, the same thing occurred, although, unlike George Bailey, the management of the bank could not make their depositors whole. For most depositors, there was no need to stand in line. A simple electronic transfer via computer transferred millions out of the bank in seconds. As a result, SVB was forced to sell bonds at a loss to satisfy depositor demands until it couldn't. The rest is history.

 

What may some readers have in common with SVB? In today's market, there has been a mad rush to capture higher interest returns after years of an interest rate famine. The U.S. Treasury markets, especially on the short end, have seen yields of 5 percent or above for six-month, one-year, and two-year notes and bills.

 

Putting excess cash into these high-yielding instruments and intending to hold them to maturity is a reasonable financial strategy. However, if you need to sell them to raise cash for an emergency may leave you open to losses. Remember that a bond's yield is not the same as the interest rate coupon promised at maturity on that instrument.

 

A six-month note may have been issued with a fixed 1.75 percent coupon, however, because of the Fed's recent interest rate hikes, the price of the note has declined. As it does the yield has climbed. 

 

You are in effect, buying that note at a discount to the original purchase price. If you hold the instrument to maturity, you will receive the full-face value of the note when it was issued, plus the coupon. That is ideal. But remember, yields will go up and down over time in an inverse relationship with the instrument's price depending on market conditions. If things change and you need to sell early, you may face the same issues as SVB. That is the risk you are taking when you buy Treasuries.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

Stocks fell this week as investors turned more bearish. You can blame Fed Chairman Jerome Powell for that as well as troubles in the banking sector.

 

"Higher for Longer" may be finally sinking in. Powell's two-day testimony in front of the House and the Senate this week was decidedly hawkish. In retrospect, there was nothing new in his statements, but for some reason the financial markets were willing to listen. Congress heard his message as well: inflation is still a problem, the jobs market needs to weaken, and if higher interest rates mean a recession, then so be it.

 

Those who had been confident that the Fed would raise the Fed funds rate by only 25 basis points at the March FOMC meeting are having to rethink that stance. Chairman Powell would not commit to a specific increase. He insisted the Fed would remain data dependent in determining the next rate move. Over in the bond market, indications are that a 50-basis point hike is just as likely now as a 25-basis point hike.

 

However, the Fed is not the only concern of the markets. Two regional banks, one a noted small crypto bank, Silvergate Capital Corp., announced that they would be "winding down" operations. On Thursday, a second bank, SVB Financial Group, which owns Silicon Valley Bank and focuses on lending money to start-up companies, announced they are being forced to sell assets and raise $1.75 billion in a stock offering. This is the 16th largest U.S. bank. Management admitted that higher interest rates are hurting their bond holdings, which is weighing on the company's flow of cash. On Friday, banking regulators closed the bank and the FDIC has taken over.

 

These announcements triggered a wholesale round of selling in the banking sector. Silvergate's stock price was down almost 42 percent, while Silicon Valley Bank's shares lost more than 60 percent of their value and another 40 percent in after-hours trading. The global mega-banks fell along with the rest of the sector. Those big banks suffered 5 percent-plus losses, while the regional bank's exchange-traded fund also fell by over 8 percent.

 

On Friday, the much-awaited U.S. jobs report for February came in stronger than expected with the nation gaining 311,000 new jobs, versus an expected gain of 225,000. However, the unemployment rate ticked higher to 3.6 percent on a rise in labor force participation. Average hourly earnings ticked down to plus-0.2 percent from plus-0.3 percent, which was a small positive on the disinflation front. 

 

As you might expect, the troubles in the banking sector spilled over into the overall markets. The three main averages — the S&P 500, the Dow, and NASDAQ — lost 1.5 percent-2 percent on Thursday and continued down on Friday. It seems to me that the market's direction is going to be dependent on what happens on Tuesday. That is when we will receive the next all-important Consumer Price Index release for February. Investors, like the Fed, remain data dependent.

 

A cooler CPI number would be an excuse for markets to rally and climb out of this hole we have dug for ourselves. A hotter number would mean the rate of inflation remains stubbornly higher than the Fed would like. That would almost certainly mean we decline with the S&P 500 Index testing 3,800 or lower as a result. 

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

Coats to protect your pets from severe weather, or orange safety vests during hunting season are fairly common but today, the fashion industry has embraced the concept and taken pet clothing to new heights.

 

Canine couture is a big business. The pet clothing business market is growing by 4.5-5 percent per year, and by 2030 should exceed $9.15 billion annually, according to Brainy Insights, a research firm that tracks sales in the pet industry. The U.S. accounts for 30 percent of global sales and hit almost $2 billion in 2022.

 

I divide the pet clothing market into two segments: clothes that are practical, and clothes that are indulgent. Practical items have a surprisingly long history. Ancient Greek armies, for example, would fasten leather boots on their horses to protect them from the snow. Greyhound and whippet owners have long-used coats to keep their pets warm in cold weather. Police horses and dogs are often dressed in fluorescent coverings.

 

Certain kinds of animals benefit from wearing coats, boots, and rain gear. Dogs that are old, thin, tiny, elderly, have thin coats, or are ill often need protection from severe temperatures, rain, and snow. Therapy jackets and those that are used for medical conditions such as hip dysplasia, and canine arthritis or to protect an incision from the aftermath of surgery are useful protective clothing. 

 

Our dog, Atreyu (a poodle), has an insulated coat, which came in handy this winter in sub-zero temperatures. He also wears an orange vest during hunting seasons. Boots, on the other hand, while useful, (due to the heavy use of salt in our area during snow season), are a no-go. As it is, this dog is such a drama queen that he balks and runs when he sees his coat come out of the closet.

 

Canine couture, however, is an entirely different world. It is here that I believe that our tendency to anthropomorphize our pets has run rampant. Anthropomorphism is the tendency to map human traits and emotions onto animals. For many, assigning human characteristics to our pets helps them to make sense of the world around them.

 

For others seeing our pets as human-like fulfills a social need. They believe that dressing dogs, cats, and other animals in trendy, high-fashion clothing allows the pet and the owner to stand out and gain social status among certain groups. In short, you are dressing your pet for success. Doing so today, however, may cost you more than dressing yourself.

 

A deluge of high-end fashion houses has jumped into the pet clothing business with specially designed pet collections. Dior, Prada, Versace, and Fendi, among many others, offer everything from designer purses to matching people/pet outfits for all occasions.

 

Their success has spawned all sorts of marketing efforts. Tika, an Italian greyhound model, has over a million Instagram followers and has been a big celebrity at New York City's Fashion Week. Boobie Billie, an Italian sighthound/Chihuahua, another Instagram favorite, has launched a luxury clothing line. Dozens of lesser-known pet celebrities are modeling for various brands and establishing followings on social media. Dog agencies are springing up and signing these four-legged stars to contracts. The rates vary per dog, but these new influencers have millions of followers.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.