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April 27, 2021

Central bank economy forces investors to be reactive with their portfolio planning

By Antti Saarnio

A year ago I made thorough analyses of where the world is going as a consequence of the Covid-19 pandemic. I spent 300 hours analysing the impact of COVID on people, society, economy, and technology. Some things I got right are that we will have two years of covid causing social distancing ahead impacting our societies and economies and that remote work and remote work enhancing technologies would boom. 

However, there are so many things I was not able to foresee. I did not understand how massive actions the central banks would take to keep the economy running. Because of this, I was not able to see that we will be heading to historically high stock market prices.   As a spillover effect of the massive stimulus, the crypto market would accelerate five to six times within a year since Covid hit us. 

I also thought that gold would be a good investment, and it certainly was for the mid part of the year, until crypto and increasing government bond yields, which started attracting funds away from gold. 

Predicting gold and its implications

Gold is a perfect example of how predicting asset prices based on fundamentals is hard, especially when it is affected by the following factors:

Central bank policies affect gold prices so much. In the long term, we know from history that there is a strong connection between the value of gold and total balance sheet growth of central banks. The more money central banks print, the more investors seek protection against potential inflation from gold. 

Gold is still the rock which you can trust in long term. But in the short term, government bond yields tend to push down gold prices, as is happening right now. Same thing happened by the way in 2007 just before gold started its big price run. 

So where will the price of gold go from where we are today? We are close to an all-time high for gold, but trend analyses for gold value vs central bank balance sheets show that gold has potential to double its current price. In the medium-term, gold’s price will depend on the yield of long government bonds, which started increasing at the end of last year. This yield increase, however, affects the recovery of the economy as the price of loans becomes more expensive, so could expect that central banks start buying the government bonds at lower yield, which would push the yields down and thus gold price up. 

Another factor affecting gold price and the whole economy is increasing inflation. So far, central banks have commented that they are not going to try to slow down inflation, but I think the real question is that are they able to? When the economy is  in a vulnerable state and heavily indebted, central banks would need to put a break on  the lending policy which would potentially crash the economy. If inflation starts growing above 3% figures, we should see gold and potentially crypto also benefiting, but again, this is only a guess as central banks actions affect so much on asset prices. 

America banknote on automatic counting machine

Switching to dynamically reactive investments strategy

Let’s take an example: After summer 2020, gold prices started going down and crypto prices started accelerating. I had invested heavily in gold and not very heavily on crypto. Why did I not react? Because it takes time from humans to first  form an opinion about the market situation and then make decisions about the allocation change. Especially if you are an investor who has another day job, your decision time could take months. As an example, Crypto went 5x and gold -10% in the last 5 months. 

So, we would first of all create tools to be able to quickly change our investment portfolio allocation, but more importantly I would recommend all investors to dynamically react to price changes and re-allocate their portfolio at least on a monthly basis. One possibility is to consider  a user algorithm to do the portfolio allocation work on behalf of you. The algorithms don’t have the human psychological bias, and they can be designed so that they just simply react to price changes. If crypto price starts growing faster than gold, the algorithm can adjust the portfolio allocation from gold weighted portfolio to crypto weighted portfolio within hours. Also, if crypto prices start crashing, the algo can again allocate your portfolio towards gold.

Lohko’s trading algorithm performance 14.4-27.4.2021 during very turbulent crypto market

For example, Lohko uses its own in-house developed algorithm that manages our own investment portfolio. The algorithm is designed to perform well in the long term and especially protect investments during price crashes. Recently Bitcoin price dropped from 62 000 to below 50 000 in a week. While the first sudden drop was too fast even for algorithms, it still managed to protect the investments and outperformed the market by 5%. Similarly, algorithms can be used to automatically switch between different assets within a portfolio in case one asset’s price starts decreasing. 

Whatever tools you decide to use, my recommendation is to develop a dynamically reactive investment strategy. 

Lohko is developing an investment platform for investors to manage their alternative asset portfolio (like gold, silver, crypto) reactively and assisted by algorithms. 

Note: this example is for informational and entertainment purposes only and should not be relied upon for any other use.

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