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Protect your portfolio with 'SWAG' assets

Returns from equities over the last decade have been low, but physical assets such as silver, wine, art and gold ('SWAG' assets) have performed very well
August 8, 2012

The period between 1980 and 2000 was a golden era for equities. Just about everything that could go right went right. Inflation moved persistently lower, labour market deregulation and outsourcing provided companies with cheap sources of global labour, and demographics were helpful. Peaking at just under $40 in 1980, oil prices typically traded below $20 for the next 20 years. Household and government borrowing were low. The Cold War ended, providing the so-called peace dividend. Equity investors saw returns over this period higher than virtually any other 20-year period in history.

Since 2000 or so, just about everything that could go wrong for equities has gone wrong. Returns over the last decade have been among the lowest on record. The major OECD (Organisation for Economic Co-operation & Development) economies have limped from one economic debacle to another. Yet, while so much has gone wrong for equities, physical assets such as silver, wine, art and gold - 'SWAG' assets - have performed very well. Since 2000, the total return on the FTSE 100 has been just over 30 per cent (the same as inflation). The ArtPrice Global Index has risen by 81 per cent, the Liv-Ex Investible Wine Index by 232 per cent, with silver and gold up well over 400 per cent. The key question for investors is whether or not the coming decade will be any different.

The answer to this question may well lie in how policy-makers choose to react to three economic 'fault lines' that are coming together to create what may prove to be a unique economic landscape.

For the first time in history, the OECD bloc as a whole stands to face a sharp inflection point on old-age dependency. In 1990, the old-age dependency ratio for developed economies stood at 19 per cent - by 2030 it is predicted to rise to 36 per cent. This will swell budget deficits and act as a headwind to economic growth. Just look at Japan.

Second, according to a study entitled 'Growth in a Time of Debt' by professors Reinhart and Rogoff, government debt/GDP ratios above 90 per cent will severely impede economic growth, lowering GDP growth by 1.5-2.0 per cent a year. In 2012, almost one-third of OECD economies will have debt burdens over 100 per cent of GDP.

Third, the growth outlook for BRIC (Brazil, Russia, India and China) economies is healthier. However, the energy intensity of these faster-growing economies is high. Supply constraints may keep commodity prices high. This may be a modest problem for emerging economies, but another nail in the growth coffin for an ageing and debt-ridden OECD.

The confluence of these economic 'fault lines' will be a game-changer for economic policy-making. Expect more money printing as economic growth fails to gain traction. Financial repression is a situation where government keeps interest rates below inflation rates. The process transfers wealth from prudent savers to bail out reckless borrowers. The biggest and most reckless borrower is the government. Savers need to address financial repression if they are to preserve their wealth.

SWAG assets have preserved wealth over the last decade. Unlike paper money, SWAG assets are finite in supply. They are physical in nature and typically have no incumbent debt attached to them. If one wanted a way to conceptualise SWAG assets, it is that they attempt to act as a pseudo money-supply index tracker. If governments are intent on bailing themselves out by printing more money, then SWAG should be a beneficiary of that process.

One criticism of SWAG is that it is seen as difficult to value. Should private investors put their money into things where returns depend on whether someone else will pay more for them in the future? In the July edition of Popular Delusions, the Extel No.1 rated analyst, Dylan Grice, dealt specifically with this issue of perceived value. Grice concluded by saying: "Are SWAG assets really so fundamentally different from a business with cash flows? I am no longer so sure. There will be differences of taste, of views of the future, in the value attached to permanence, and there is certainly an issue of expertise. But are there any investment endeavours which don't involve such differences?"

Mainstream analysts like to quantify value. Having a cash flow enables that quantification to be readily performed. Regrettably, it does not make that quantification accurate or reliable. Enron. Worldcom. Kaupthing. All these companies had readily available cash flows that proved totally useless in predicting their subsequent price action. Whenever you see a negative profit warning and a subsequent dive in share price, how useful was the prior cash flow analysis in predicting that? Predicting an expansion of the money supply seems so much simpler as an exercise in comparison.

A house has no daily liquidity. It has no daily price. It has no cash flow. It is worth only what someone else will pay for it in the future. Yet, for most people, a house represents the biggest asset that they hold. Perhaps the reason for this is that most people view property as a very long-term asset. SWAG is no different. It should be viewed as a very long-term hedge against money printing and inflation. A weighting of 10-20 per cent of total assets in SWAG seems a sensible proposal for the coming age of financial repression.

Joe Roseman worked at the US hedge fund, Moore Capital Management, from 1994 to 2010, where he was head of economics. He published SWAG - Alternative Investments for the Coming Decade in May 2012. www.swaginvestor.co.uk