What Changes in Value? Gold or Everything Else?

Podcast Transcript

Ed Coyne: Hello, and welcome to Sprott Radio. I'm your host, Ed Coyne, senior managing partner at Sprott Asset Management. I'm pleased today to welcome a new guest to our podcast, Eric Biegeleisen, director and CIO and director of research at 3EDGE Asset Management. Eric, thank you for joining Sprott Radio.

Eric Biegeleisen: Yes, thanks for having me.

Ed: Being a new guest at Sprott Radio, let's start with a bit about your background. I noticed you have a degree from Trinity College in electrical engineering. I studied architecture. Neither one of us are doing that. We're in finance. Let's start with that, and then we'll go from there.

Eric: Sure. I have an undergrad and a master's degree in electrical engineering. Never had taken a finance or an investment course in my life, and naively thought in my mid-20s that I could get ahead by getting a business degree, and maybe that would get me into management quicker. That seemed attractive at the time. I went and got an MBA, found this passion for finance and investing, and thought, "Wow, I wonder if there's a way to marry the mathematics and engineering and programming that I've been doing in the engineering space. I wonder if there's a need for that in investment management."

I still don't know if there's a need for it, but there are certainly people looking for it. A lot of folks kept pointing me to this gentleman, Stephen Cucchiaro, who had founded a quantitatively driven global macro type of investing firm in the mid-90s and was building portfolios globally diversified using ETFs where they existed.

Nonetheless, as the proliferation of ETFs took off, we were able to eventually eliminate mutual funds and single stock and eventually build full portfolios of ETFs, low-cost, transparent. That brought us up to about 2010. The firm had grown significantly. This firm was called Windward Investment Management, and eventually it was acquired by Charles Schwab Corporation.

It became Windhaven, continued to grow from there. Then, being a part of a much larger asset manager, a lot of folks eventually separated from that firm and sat out some non-competes. Then the founder, again, Steve Cucchiaro, thought he maybe wants to get a lot of us back together and go at it again. That's what we're doing here at 3EDGE Asset Management now, so quantitatively driven, globally diversified portfolios across US and international equities, fixed income, and hard assets to build portfolios.

Ed: Well, that last piece is fascinating. Our CEO, Whitney, and myself kind of did the same thing. We left a small-cap value shop and came to a real asset shop. He did it, I think, a little over 11 years ago, and I did it 10 years ago. It's interesting, maybe we have more in common than I thought, than just our non-financial degrees. Well, let's stick with 3EDGE for a second. Talk to us a bit about the types of ETFs you offer and maybe walk us through why you chose those four specific themes in building out a suite of offerings.

Eric: Yes. Well, actually, we've been users of ETFs for years. It's only within the past six months that we launched our own ETFs that you're alluding to. We manage probably on the order of combined assets under management and assets under advisement through the TAMP platforms. If you're familiar with the Third-Party Asset Management Platforms, about $2-ish billion total.

Most of this is managed in SMAs, Separately Managed Accounts. We have a more conservative model, a more moderate we call total return, a more aggressive one that we call growth. These have all these parts that we mentioned: US equity, international equity, fixed income, hard assets. Rather than building just a single ETF of our solution that has all of the parts, we thought, "No, let's create the building blocks."

That way if someone says, "Hey, I don't really need your US equity, I have a US equity manager that I really like, I also don't need your tactical ability that does nothing for me, but wow, your hard asset ticker's really interesting, I want to look at that." They can be used independently, or they can be used collectively in a model.

Ed: Got it. Got it. Let's go back to what you mentioned earlier about one of the particular ETFs, the hard asset ETF. What made you focus on one of the four vehicles in hard assets? Why is that important? Why focus on that particular area?

Eric: Totally. Yes, a great question. We have this just general belief that these four major, if you've read Harry Browne's book, Why the Best-Laid Investment Plans Usually Go Wrong, there's four major asset classes, the permanent portfolio, you have equities for a growing economy that's generally where things are going up into the right and everyone's happy.

Late-cycle hard assets tend to outperform gold and commodities that can dovetail into a slowdown or credit contraction, where cash is king, and then it can cycle into deflation or depression, falling rate environment, fixed income, longer-duration, high-quality assets can do better. We believe that there should be some element of these four core asset classes in a portfolio at all times.

Then your own research and modeling and what have you can help you tilt above those minimums, which is what we do. We think the majority of folks are underinvested in hard assets, particularly now as we're entering what looks like it could be a more of a stagflationary environment that is the potential for inflation via the tariffs, while you're also having a slowdown and/or recession.

Gold and TIPS (Treasury Inflation-Protected Securities) tend to outperform in those environments should the government step in to artificially cap 10-year bond yields, for example, or force certain US institutions to purchase a certain amount of bonds, so-called financial repression. Again, I think that's going to be a boon for gold, in particular. That can really help in environments where stocks and bonds are both declining, like we've seen in recent years.

Ed: You mentioned something about value, and I would assume that you guys think of yourselves more as value managers, but for someone looking at you for the first time and as you look at investments, do you have a value versus growth bent in your style, or where do you guys stand on that?

Eric: Yes, it's funny. In some ways, I would agree with you that I think of us as more of a value manager. On the other hand, if you actually look at the equities we invest in, we're generally investing in the big, major indices. It tends to be more growthy, quite frankly. What we're modeling are broad-based macro indexes. We use the S&P 500 as our proxy for US equity, obviously very growth-oriented. That said, we may be dialing down the total amount of US equity in the portfolio. The overall return profile might look a bit more value-ish, say, than growth.

Ed: Well, and speaking of that, what are some of the key factors you look at? When you're looking at an individual name, or I guess an industry or sector, what are some of the key themes you like to traditionally follow?

Eric: Yes, for us, there are three key areas, the three edges, if you will, of the research process. It depends on who you talk to in the firm to tell you what they think 3EDGE stands for. I go with this. You have these longer-term valuation factors. You have these more medium-term global macroeconomic factors, and you have these short-term investor behavioral factors.

I could go into the weeds on all of this, but at a high level, valuation is all about mean reversion.[1] The concept is that you're just mean-reverting around some reference point. We buy into that. The problem, though, we think particularly with something like P/Es (price-to-earnings ratios), or earnings broadly, is that they're often manipulated, often restated, so we don't find that to be great. We think top-line revenue or sales is less manipulatable.

We try to start with there, price-to-sales ratio. We convert that to a normalized earnings measure. We have to grow that out into perpetuity for an index at some growth rate, and we discount that back to the present at some discount rate. There's some devil in the details there, but that gives us a flavor of valuation. Are you above or below the prevailing market index? Again, it's just a starting point, not a tactical timing instrument.

Ed: Sure.

Eric: Then you move on to your macroeconomic factors. There are the types of things we're looking at. Again, we're trying to look at mostly market-driven data. We think that's the greatest leading collector of information. We're going to look at things like interest rates, in particular, both at the short end in a given economy, the 3-month T-bill, as well as the 10-year yield.

We're going to be looking at the rates of change of those interest rates. Are they going up or down, and at what speed? Are they above critical levels where the behavior of that factor might change? We're going to look at the yield curves. Now we're combining the 10-year and the 3-month, which a lot of people say, "Is there any information in there?"

We say, "Yes, it depends on how you use it." Is it positively sloped? Is it sloped enough that it should be indicative of growth in the economy? Have you accounted for central bank stimulus in your yield curve measure? What happens in a credit contraction when everybody piles into cash and it drives the short end of the curve down, that actually steepens the curve, which would say to buy equities?

That's what it told you to do in October 2008. It would've been the worst possible move to look at a steep yield curve and suggest that you should be buying equities then. We account for things like that as well. We're also looking at credit spreads, and we care less about the absolute level of credit spreads; we care more about the rate of change of credit spreads.

We're going to look at high yield spreads to treasuries, investment grade spreads to treasuries. We're going to look at the TED spread, or the difference between the interbank rate and the T-bill rate and look for concerns within the banking system there.

Ed: I was just going to say, I don't think enough investors put enough weight on rate of change or velocity of change in an asset. Some people call it momentum, but really, I think that really spells out what you should be looking at or thinking about, at least from an investment standpoint. It sounds like you guys do a fair amount of that.

Eric: Totally. I think it helps with those turning points, and then you combine these valuation and economic factors together, and that helps us provide our initial projected return for this broad-based asset class. As we know, investors can act with this herd mentality either in a virtuous up or a vicious down kind of way. We introduced these, what we call these investor behavioral factors, and there's two stages there.

The first part is like taking a canary into a coal mine. If the canary dies, you say, "I guess we should get out. Things are problematic." We're looking at shorter-term measures. They could be credit spread measures. They can be currency measures, inflation measures, if any of these are relevant, and that's only about 10% of the time. That's going to take any incoming positive projection and either zero it out or make it negative, just to get you out of that asset class short term. It's not a guarantee that there's a drawdown coming, but there's certainly a heightened risk. If that's not present, then you move on to what we call trying to examine that stage of investor psychology.

What we do is we start on a very simple construct, where we're looking at effectively a 200-day moving average for a given index, and then we're breaking 5 ranges around that. If you're in or around your 200-day moving average, we might say you're neutral, directionless. If you're up and above that, you're in this rally mode, that's where assets tend to perform well, and they keep doing well up until you've risen too far in too compressed a timeframe, we might say you're overbought, now you're ripe for a correction.

The same thing on the downside. Things that are down and below the 200-day moving average, like where we are now, are considered to continue to go down until they fall too hard, too fast in an oversold condition, and they're ripe for a rebound. The real trick there, that none of that's rocket science, is that we take the incoming valuation data and the incoming economic data to assess how to treat that output from that behavioral filter. It's very context-dependent.

Ed: Well, it's interesting that you invest in gold then because so often people say, "Well, what's the yield on gold?" I'm like, "Well, that's the whole point." The fact that gold's outperformed the S&P for, actually, with the most recent returns, almost three decades now, and there's no intellectual capital. There's no earnings. There's no nothing.

Eric: It's a hunk of metal gathering dust.

Ed: Why do you guys like it? All that sophisticated modeling you do, why do you like a rock on a shelf then?

Eric: One could argue that gold's price is not changing at all, and it's the rest of the world that's changing around it.

Ed: Ooh, I've never heard that, and I actually like that. I'm keeping that one. [laughter] It's the hub. It's the hub of the economy.

Eric: Kind of is. A lot of people like to look at Bitcoin and say, "Hey, is this a digital gold?" Maybe it will be, but gold's got a few thousand years' headstart here as this trusted go-to asset that's relatively finite and is that stable anchor around which, in many ways, you could price the real return of all assets.

Ed: Yes, that is a great way to think about it. It's amazing. I thought I've heard every explanation to gold, and here we are with a new one, that everything's changing around it. I think that's spot on. I really like it. I thought I was super smart when I said gold's the original alternative investment. When you think about what alts do, gold's been doing it forever.

I was really proud of that, but I think this is actually better. I like that a lot. Gold doesn't change; things change around it. I think that's fascinating. Well, let's talk about education for just a moment. I spent a little bit of time prepping for today's podcast, and I know you have a whole suite of educational pieces. Someone new to 3EDGE or just new to investing in general, what would you recommend they look for on your particular website? What pieces do you like as far as helping educate an investor on ways to think about the world the way you do?

Eric: Great, yes. There's two websites. There's the broad asset management website, which is the number 3, the word edge, E-D-G-E-A-M for asset management, so 3edgeam.com. That's going to have a lot of access to literature, white papers that we write, particularly one on gold that you alluded to, the nearly 30-year outperformance versus the S&P. We just did something on that.

In terms of education beyond just the occasional white paper or so that we throw up there, our CIO, Steve Cucchiaro, founder of the firm, and our chief investment strategist, Fritz Folts, the two of them do a weekly video that's about 10 minutes, a weekly podcast video kind of thing.

Ed: Well, that's awesome. I really appreciate you taking the time. I enjoyed getting to know you a little more today. Thank you for joining me today on Sprott Radio.

Eric: Excellent. Thank you for having me.

Ed: Once again, my name's Ed Coyne. Thank you all for listening to Sprott Radio.

[1] Mean reversion is a financial theory that suggests asset prices will eventually return to their long-term mean or average.