In the last edition of our Hype Cycle publication on 9 January 2019 we had to put ashes on our head for not having warned of the correction in the fourth quarter 2018. However, we redeemed ourselves somewhat in the last report because there we analysed the sentiment of retail and institutional investors and concluded that while retail investors were panicking about stocks and other risky assets, institutional investors were holding the course. Such a divergence in sentiment is usually followed by strong equity market returns and as it turned out, this was again the case in the first quarter of 2019. 

US stock markets have just finished the best quarter since 2009 and global stock markets rallied 13.3% in US Dollar terms (Fig. 1). Other risky assets showed strong performance as well, with high yield bonds advancing 7.4% and emerging market equities 12.0%. The best performers were, however, listed diversified private equity investments (up 17.3% over the last three months) and renewable energy stocks (up 17.9%). 

Figure 1: Asset class moves around the hype cycle

Source: Fidante Partners. Data as at 2 April 2019. Past performance is not a reliable indicator of future outcomes. 

Given this extremely strong performance, it is no surprise that the momentum signals in our hype cycle are positive for most of the asset classes we track, meaning that they appear on the right-hand side of the hype cycle in the “Recovery” or “Boom” stages (Fig. 2). 

Figure 2: Hype cycle overview

Source: Fidante Partners

Only a select few asset classes, like gold and cat bonds, currently show a negative momentum signal. In the case of gold this is important, however, since in our last report we said that the gold rally of the fourth quarter 2018 may come to an end soon. The advance in gold prices has indeed stalled for now, but investor interest in gold has not. This creates an overhyped situation in gold that we will investigate further. 

Another set of asset classes we will focus on in this report are property stocks, since REITs have shown strong performance despite their more defensive nature. This in turn has created renewed investor interest and improved sentiment. Whether this positive sentiment will translate into continued outperformance is something we will investigate in the second part of this report.

Everybody seems interested in gold… 

While institutional investors have largely shunned gold in their portfolios, it has been a perennial favourite of private investors around the world. The World Gold Council reports that in 2018 demand for gold bars and coins rose 4% and while the holdings of physical gold funds around the world grew a mere 2.9% in 2018, physical gold fund holdings have grown at an annual growth rate of 5.9% over the last five years. And this despite the fact that gold prices had an annual return of just 1.1% over the same time period. 

Fig. 3 shows how investor interest in gold is reflected in Google searches on the subject. Note that in Fig. 3 we show only searches for the term “gold” using financial websites and not the internet overall. Internet searches for gold have been trending up for the last five years with occasional short spikes, but since October 2018, we have seen an acceleration in the number of searches that has only petered out in March of this year. Since gold is held as a safe haven investment in many private investor portfolios, it is no surprise that interest in gold spikes as stock markets correct, but this spike in Google searches has now lasted longer than usual.

Figure 3: Google searches for the term "gold"

Source: Google Trends, Fidante Partners. Data as at 2 April 2019. 

But while interest in gold as an investment has accelerated, investors seem reluctant to put their money where their Google search is. The annual growth in gold ETF and fund holdings has remained stable in recent months, hovering around 3% globally, there are regional differences, though. Every region in the world has seen fund holdings decline over the last twelve months except one. In Europe, physical gold ETFs and funds have grown their gold holdings over the last twelve months by 11.7%, from 1,000 tonnes to 1,117 tonnes. The main driver of this exceptional growth in Europe was for funds domiciled in Germany (gold holdings up 21.7%) and the UK (up 13.8%). Especially in UK-domiciled funds, we have seen an uptick in gold holdings since the beginning of the year that goes against the global trend. Whether this reflects rising Brexit uncertainty amongst private investors in the UK is anyone’s guess, though. 

But no matter what the drivers behind the inflows into UK-domiciled gold funds are, they account for only about 1.3% of total annual gold demand and are hardly able to move gold prices. In terms of global gold demand, the swing factors remain demand for jewellery, gold bars and coins, all of which have remained stable or declined slightly in 2018. In order to have a material effect on gold prices from increased gold holdings in ETFs and funds, one would need to see a spike in growth like the one seen in late 2016 (see Fig. 4) and at the moment, we are nowhere near these levels.

Figure 4: Growth in physical gold fund holdings

Source: World Gold Council, Fidante Partners. Data as at 2 April 2019.

Seasonality not favourable for gold 

Another reason why we think gold is overhyped and heading for a negative quarter is the seasonality in its price pattern. Fig. 5 shows the average seasonal return pattern over the last 30 years in comparison to the path the yellow metal has taken in 2019 so far. During the first quarter 2019, the gold price followed the typical seasonal pattern relatively closely with a peak in February and a decline in gold prices since then. Gold prices typically bottom out in June before rallying into year-end. The driver for this seasonality in gold prices are well-known fluctuations in global demand. On average between 2010 and 2018, global demand for gold declined by 3.4% in the second quarter compared to the previous quarter, while it increased in every other quarter. 

Figure 5: Seasonality in gold prices

Source: Bloomberg, Fidante Partners. Data as at 2 April 2019. Past performance is not a reliable indicator of future outcomes. 

The crucial factor in this seasonal pattern is no longer demand from India, where the wedding season starts after the Monsoon season is over in late summer and continues into spring. Today, demand for jewellery, gold bars and coins from China is what determines how much global demand fluctuates. Chinese demand for gold bars and jewellery typically declines by 20% in the second quarter of the year. This effect can be explained by the festivities around Chinese New Year, during which gifts are made to loved ones and gold is presented to friends and family on special occasions, such as weddings. 

Given the current economic slowdown in China, consumers there have less money to save or invest. And since the Indian economy is slowing as well, it is unlikely that India will be able to close the gap due to lower Chinese demand. Thus, we expect the seasonal pattern for gold demand to hold in the second quarter of 2019 and, as a result, gold prices to drop.

Property hype in no way extreme 

While we are pessimistic about the outlook for gold in the next three months, we remain optimistic about REITs and listed property companies in general. As we have seen in Fig. 1 above, US and European property stocks have outperformed global equity markets over the last three months while UK property stocks have lagged only slightly.2 Normally, defensive assets such as REITs should underperform in an equity market rally like the one we have seen in Q1 2019. However, this time around, the equity market rally coincided with declining longterm interest rates which gave “long duration” stocks like REITs, infrastructure and utilities a boost. In our Quarterly Market Outlook, we explained that we expect these asset classes to outperform over the rest of 2019.3 Here, we want to focus on a more short-term analysis of current investor sentiment and the question as to whether the strong recovery of the first quarter is likely to continue in the second.

In the case of REITs, we know that the strong price momentum of the first quarter puts these assets firmly in the right half of our hype cycle, but as Fig. 6 shows, our Hype Index signals no exuberance on the part of investors. Google search volumes for US and UK property have increased since the beginning of the year, while search volumes for European property have remained stable. More importantly, ETFs, which suffered from outflows throughout most of 2018, have seen their assets under management stabilise and some even record inflows this year. While investors are putting money back to work in REITs, our Hype Indices, which are a weighted average of sentiment indicators and fund flow metrics, have only recovered from the declines of the fourth quarter 2018. Typically, the Hype Index tops out around levels of one or above, so there is still ample room for improvement in sentiment and increasing fund inflows in the coming months. This in turn means that sentiment should continue to remain supportive for now.

Figure 6: Property hype indices

Source: Bloomberg, Fidante Partners. Data as at 2 April 2019.

Property momentum should last 

With only moderate investor hype, we should expect the current price momentum to have momentum, i.e. continue in the coming months. The typical pattern of a stock market recovery after a correction or a bear market is an explosive first leg up, followed by a small countertrend movement before a longer-lasting, but less explosive, second leg up. The rally in REITs during the first quarter 2018 had all the hallmarks of such an explosive first leg up.

Fig. 7 shows the difference between trailing 3-month and trailing 12-month returns for three major REITs markets. Values above zero indicate that the return over the last three months was higher than the return over the last twelve months. In other words, it shows a situation of accelerating price momentum. As we can see in Fig. 7, REITs in the US, the UK and Europe currently all show this accelerating price momentum.

Figure 7: Difference between 3-month and 12-month return

Source: Bloomberg, Fidante Partners. Data as at 2 April 2019. 

In Fig. 8 we show the return of REITs in the US, UK and Europe over the next three months depending on the relationship of trailing 3-month and 12-month price returns at the beginning of the period. Dark blue bars show the subsequent 3-month return for REITs when trailing 3-month returns were above trailing 12-month returns at the beginning of the period (i.e. no forwardlooking information is used in calculating these returns). The light blue bars show the returns in the opposite case. We use data since the end of the Global Financial Crisis 2009 as the basis for these calculations. 

Fig. 8 shows the big difference in REIT returns in times of accelerating price momentum (i.e. when 3-month momentum is greater than 12-month momentum). The differences in average returns are not only economically significant but a t-test shows that they are statistically significant at the 1% level. Furthermore, the probability of having a negative return over the subsequent three months in the case of accelerating momentum is below 10% in all three regions but around 25% in the case of decelerating momentum. Thus, the odds are clearly in favour of continued positive returns in REITs over the next three months and, in our view, it is likely we are going to see above average returns as well.

Figure 8: Persistence of momentum in property stocks

Source: Bloomberg, Fidante Partners. Data as at 2 April 2019. Past performance is not a reliable indicator of future outcomes.

Conclusions 

The first quarter 2019 has seen strong returns for most risky assets and most asset classes we follow are currently on the righthand side of the Hype Cycle, defined by positive price momentum. In fact, since sentiment has recovered substantially in many asset classes, most assets are now in the “Boom” stage of our Hype Cycle. In our methodology paper that explains the details of our Hype Cycle approach, we have shown that returns tend to be high when asset classes are in the Boom stage and investors should be careful when assets enter the “Overhyped” stage.4 

 Given our assessment of the current sentiment and price momentum of risky assets, we expect the current market rally to continue in the second quarter 2019. As we have shown above, this is true in particular for REITs, which benefit from moderately optimistic sentiment and accelerating price momentum. These two drivers should continue to propel REIT prices higher in the next three months, so it is by no means too late to invest in these asset classes. 

The one asset we are cautious about the returns for the next three months is gold. Sentiment for gold is too optimistic, in our view, and investors are not following through on this positive sentiment by investing into physical gold ETFs and funds. Given the seasonal decline in demand for physical gold in the second quarter, we expect gold prices to decline in the coming months.



Joseph Mc Donald

Research seems consistent with the current and expected longer term economic cycle Good!