The movement of gold trading to Hong Kong

 

There is a movement for the center of gold trading to be Hong Kong and not London. China has taken five clear steps to become a center for gold trading.

1. Launching the Shanghai Gold Exchange International Board (SGEI)

• Creating a Bridge for Foreign Capital: In 2014, the People's Bank of China (PBoC) established the SGE International Board within Shanghai's Free Trade Zone. 

• Yuan-Denominated Gold: By offering contracts denominated in Offshore Yuan (CNH) rather than US Dollars, China allowed international investors to trade gold directly using offshore yuan, chipping away at the dollar's monopoly in precious metal settlement.

2. Developing Cross-Border Infrastructure ("Shanghai–Hong Kong Gold Connect")

Because Mainland China enforces strict capital controls, international investors historically favored London’s free capital market. To circumvent this, China leveraged Hong Kong’s open capital borders:

• The Gold Connect Mechanism: Launched through collaboration between the Shanghai Gold Exchange (SGE) and Hong Kong’s Chinese Gold and Silver Exchange Society (CGSE), "Gold Connect" links trading liquidity between the two cities.

• "Delivery Connect" Infrastructure: Beijing and Hong Kong established direct cross-border physical delivery systems, enabling institutional traders in Hong Kong to seamlessly settle and store physical bullion vaulted across Mainland China and Hong Kong.

3. Modernizing Hong Kong’s Clearing, Storage, and Benchmarking

• Establishing Central Clearing (HKPMCC): Hong Kong launched the Hong Kong Precious Metals Central Clearing Limited (HKPMCC)—a centralized gold clearing and settlement system that mirrors institutional clearinghouses in London—backed by major international banks.

• Regional Vault Expansion: China and Hong Kong have aggressively expanded local vault capacity, scaling toward thousands of tonnes of high-security physical storage to ensure local delivery of physical metal without relying on London-based vaults.

• Asian Benchmark Pricing (HAU): To end reliance on the twice-daily "London Fix" (LBMA price discovery), Asian institutions introduced regional price benchmarks (such as the Shanghai Gold Benchmark and HAU indices) tailored to Asian trading hours.

4. Repositioning Central Bank Physical Gold Holdings

• Physical Reserve Relocation: Through the PBoC, China has systematically accumulated physical gold reserves and gradually moved portions of its bullion from Western repositories (like the Bank of England in London) to vaults in Hong Kong and Shanghai.

• De-Risking Foreign Reserve Assets: After Western sanctions froze foreign dollar assets in geopolitical disputes, China has treated physical gold stored in Hong Kong as a neutral, sanction-resistant asset outside the Western banking network.

5. Transitioning from "Paper" Speculation to Physical Delivery

• Divergence from London’s Unallocated System: London’s market relies heavily on "unallocated" paper gold—pooled claims where investors do not hold dedicated bars.

• Physical Focus: China tightened domestic retail paper-gold trading regulations and incentivized institutional contracts backed strictly by allocated, T+1 physically deliverable bullion. This attracts central banks and sovereign wealth funds seeking hard assets over paper promises.

Bond history in context

 

A recurring theme in our fixed-income view is that the current rise in yields is a return to normalcy. The excess was the low yields after the GFC. It was a form of financial repression used to boost economic growth, but it was also used as a tool to extend government programs through cheap borrowing. This was first and foremost a Fed monetary policy choice, with the fiscal side taking advantage of “free money with rates near the zero bound. 

The current rates reflect macro fundamentals. The issue will be whether the market may overshoot with higher inflation expectations and strong risk premia. 

We have not seen the impact of this higher cost of capital across all markets. Clearly, the housing market is at a standstill, but business financing will not see higher yields until debt has to be rolled over. 

The concentration problem in equities

 The book Exponential Wealth: Centuries of Stock and Bond Returns provides context on concentration in US stocks. The adjusted HHI index places us at historic levels. The smaller-cap market is being squeezed. Is this good for investors? One could argue that any index has less diversification, and that market power will be more concentrated in these larger firms. Is more vigorous antitrust action needed? The government has not used this tool, yet it may help restore balance in the markets.

The periods of pain in equities

 This chart from Exponential Wealth: Centuries of Stock and Bond Returns shows significant, long periods of pain for US stocks. There has been a long drought since our last pain period. Should you be worried about this? We may not be at an inflection point, but history suggests the current path won't last forever. 

The historical great divide in the bond market

I like the following graphic from Exponential Wealth: Centuries of Stock and Bond Returns. It makes clear that we were in two great bond environments: pre-1981 and post-1981. The high-inflation period reversed between 1981 and 2020. The real question is whether we are now in a new third regime. The big fixed-income bet is on what this new regime will be. 

 

Asset management business - all about scale

McKinsey & Company has issued its report "Asset Management 2026: Plenty for the Few," which shows that the asset management business is about scale and increasing concentration. It is about gathering assets to improve operating margins in a world of falling fees. 

The families of quantitative signals

 

The paper, "A Taxonomy of Quantitative Signals: One Normalization, Many Mechanisms" by SQV3 is an interesting way to place the type of quant signals used into some type of context. It is not yet posted on ssrn, but it is worthy of a discussion.

The multiple years of double-digit returns

We still have two and a half months before year-end, yet we might see another year of double-digit equity returns. It is important to look at the before and after surrounding these periods. The before is usually a strong equity sell-off. The double-digit returns are a catch-up, and the after sees a strong decline to reverse the excess. Call this a revision to the mean. 

We often get big stories wrong - be a skeptic?

 

Big stories that media and analysts got wrong from a number of sources. Here are some highlights, yet we have to ask the question - should you be a skeptic? What is the cost of being a skeptic? 

Enron (2001)

Global Crossing (2002) 
WorldCom (2002)
New Century Financial (2007)
Bear Stearns (2008) 
Lehman Brothers (2008)
Luckin Coffee (2020)
Wirecard (2020)
Silicon Valley Bank (2023)
First Republic Bank (2023)

| 1 | Lehman Brothers | ~$691 billion | September 2008 | Investment Banking |
| 2 | Washington Mutual | ~$328 billion | September 2008 | Banking / Savings |
| 3 | WorldCom | ~$104 billion | July 2002 | Telecommunications |
| 4 | General Motors | ~$91 billion | June 2009 | Automotive |
| 5 | CIT Group | ~$80 billion | November 2009 | Commercial Lending |
| 6 | Enron | ~$65.5 billion | December 2001 | Energy / Trading |
| 7 | Conseco | ~$61 billion | December 2002 | Insurance / Finance |
| 8 | MF Global | ~$41 billion | October 2011 | Brokerage / Derivatives |
| 9 | Chrysler | ~$39 billion | April 2009 | Automotive |
| 10 | Thornburg Mortgage | ~$36.5 billion | May 2009 | Mortgage Lending |
| 11 | Pacific Gas and Electric | ~$36 billion | January 2019 | Utilities |
| 12 | Texaco | ~$35.9 billion | April 1987 | Oil and Gas |
| 13 | FGIC | ~$26 billion | August 2010 | Bond Insurance |
| 14 | Refco | ~$33 billion | October 2005 | Brokerage / Futures |
| 15 | Bed Bath and Beyond | ~$4.4 billion | April 2023 | Retail |

Dislodging the dollar - Not likely

 

There has been significant talk about the dollar’s fall, but it often ignores how important the dollar is to global trade and finance on a number of metrics.  

As US global hegemony declines, dollar dominance will deteriorate, but we are still a long way from the rise of an alternative. The EU needs a safe asset, and China must be willing to allow open capital flows. 

After seeing a decline earlier in the year, it is now near year highs. It is certainly off the 2022 highs, but it is still higher than five years ago.

Perry Mehrling - We will miss you

 

Perry Mehrling suddenly died this week, and the monetary economics world will be diminished. He was a monetary theorist and an important economic historian, though his work in history was largely accidental. 

Mehrling’s defining intellectual contribution is his "money view", an alternative analytical framework designed to make sense of the modern, highly integrated global monetary and financial system. Rather than relying on traditional macroeconomic equilibrium models, the money view approaches the economy through the lens of monetary reality (using balance sheets, ledger accounts, and cash flows).  His view focused on the link between short-term funding and long-term capital markets, the hierarchy of money, and the importance of liquidity over solvency. 

He often expressed his ideas through intellectual biographies and histories of economic thought, bridging abstract financial theory with the real-world evolution of central banking and capital markets. Two examples, Fischer Black and the Revolutionary Idea of Finance (2005), an influential intellectual biography of Fischer Black (of Black-Scholes fame), exploring how modern quantitative finance transformed Wall Street and academic economics, and The Money and the Empire: Charles Kindleberger and the Dollar System (2022), a definitive intellectual biography of economist Charles Kindleberger (author of Manias, Panics, and Crashes), tracing the historical mechanics of how the U.S. dollar displaced the British pound to become the world’s dominant reserve currency.

His writing is not easy and requires strong focus, but i think it resonates with anyone who works in finance and wants to get a good feel on how the financial system works. 

Hall and Woodford - great choices for Nobel Prize

                                  

Robert Hall and Michael Woodford are excellent choices for the Nobel Prize in Economics. They have influenced generations of macroeconomic scholars. They were at the forefront of New Keynesian economics through their work on the microfoundations of macroeconomics, grounding macroeconomic policy and economic models in how individual households and businesses actually make decisions over time.

Robert E. Hall: Consumer Expectations and Consumption Theory

Forward-Looking Behavior: In his landmark 1978 research, Hall fundamentally changed how economists view household consumption. He demonstrated that if consumers are forward-looking and base their spending on expected future income, changes in consumption should be largely unpredictable (following a "random walk") because consumers only adjust their spending when they receive entirely unexpected news.

Additionally, Hall was an important contributor to business cycle analysis through his work as chairman of the NBER dating committee. 

Michael Woodford: Monetary Policy and the New Keynesian Framework

Unified Policy Models: Woodford integrated forward-looking microeconomic behavior into cohesive, quantitative macroeconomic frameworks that could actually be used by policymakers.

Interest and Prices book (2003): In his foundational book, Woodford analyzed how individual firms set prices and how monetary policy affects the broader economy through expectations. He was influencual at focusing monetary policy thinking on the natural rate of interest. Central banks should focus on rate management.

The Power of Central Bank Communication: Woodford highlighted that the success of monetary policy depends heavily on how the public and financial markets perceive future interest rates and policy intentions. Clear, credible central bank communication is vital for controlling inflation and managing economic shocks, heavily influencing how central banks worldwide handle crises today.

Credit to GDP ratios - Telling the fiscal story

The BIS uses the credit-to-GDP ratio as an early warning indicator of financial excess. It clearly showed extremes before the GFC. You can also see the explosion of credit after the Great Pandemic, which was a man-made surprise. Currently, the private credit-to-GDP ratio looks tame, although there is a clear movement to higher levels. 

The story looks very different when we look at public credit-to-GDP. The public debt usually spikes after a market peak as fiscal policy kicks in to support the economy. The public debt is increasing but not at levels that seem excessive, yet there has never been a reversal of the Pandemic extremes. 

What is most interesting is when we difference the private and public change as a percentage of GDP. There is a large secular change in the composition of debt from private to public. The issue with this switch is whether the government can afford its spending. Get ready to pay through more taxes or through a debasement of the debt. 

 

Convenience yield is falling for Treasuries

Interest rates have been rising with what some may call the "Great Bond Sell-off" of 2026, yet there are other underlying problems that will have much longer-term implications for US debt markets. There has traditionally been a convenience yield associated with US Treasuries because it has been viewed as a safe asset. The safe asset problem is arising because the supply of Treasuries has been increasing relative to demand, thereby reducing the convenience yield. Additionally, other policies affect Treasuries as a safe asset. If the reserve currency is also perceived as less safe, global investors will be less inclined to hold US Treasuries.

The reserve currency status and safe asset status are not the same thing, yet they are closely connected. In the paper, "Tariff war shock and the convenience yield of US Treasuries - A hedging perspective", the authors document the erosion of the convenience yield for long bonds because of the rising stock-bond covariance. They find that the rise in long-bond yields is associated with a deterioration in the convenience yield, driven by the withdrawal of safe-asset investors worldwide and a shift toward shorter-term Treasuries, which still serve as a safe asset. 

The data surrounding last year's tariff wars show a shift in perceptions of safety. Policy choices matter and will impact US credibility and reputation. Markets will look for other safe havens such as gold or shorter-duration Treasuries relative to traditional safe assets.

 

 

Investment management - like catching butterflies

The power to synthesize  "a vast amalgam of constantly changing, multicolored, evanescent, perpetually overlapping data, too many, too swift, too intermingled to be caught and pinned down and labeled like so many individual butterflies"... requires a "direct, almost sensuous contact with the relevant data, an acute sense of what fits with what, what springs from what, what leads to what"...This skill combines reason, emotion, judgment, and analysis  "so many individual butterflies".

- Quote from The Sense of Reality - Isaiah Berlin; from Sensemaking by Christian Madsbjerg 

The problem with investment management is that there is just too much data. It is coming fast and constantly changing. It is hard to keep up. That is the challenge, and we use data analysis to condense the information. The power of machine learning lies in its ability to process large amounts of data quickly and frame or provide context. We want to impose structure on this data, yet it defies control and requires models and thinking that constantly adapt.

The work of investment management - no glamour

 

"I am sojourning among the termites." - TS Eliot  commenting on his work as an employee of Lloyds Bank  

Yes, T. S. Eliot was a banker who took the train into the city every day and walked to his job. The work in investment management often involves sojourning among termites as we search for alpha, manage risk, build portfolios, develop models, and attempt to generate excess returns. There is no glamour, just a task that is reset every day.

AI returns and risk in a nutshell

Stock returns moderated this year across many key AI industry sectors. Hyperscaler and software returns have moderated sharply. Semiconductors, hardware, and power still show strong performance but have also moderated to some degree. Earnings remain strong, except in the power sector. Sustained earnings have required more capex which has cut into free cash flow for the hyperscalers. If they cannot scale as fast as expected, it will spill over to the other AI sectors. The best returns may have passed in this industry, yet that does not mean we are in for a reversal; nevertheless, moderation is not what many investors expect. 

 

The why for higher yields.

Don’t act surprised that yields are moving higher. Inflation is not being tamed. Real rates are rising alongside stronger economic growth. The term premium is rising because of risk and bonds' lower diversification value. And we haven’t even mentioned the huge increase in Treasury supply that the Fed isn’t buying. 

What would you expect to happen? Nevertheless, this shall pass. Rates are not going back to the days of financial repression and the Fed flooding the market with liquidity. Bonds will reflect the underlying drivers of yield, and if those are controlled, yields will moderate.  

 

Economics as art - ML does not solve the problem

Economics is not an exact science, it's a combination of an art and elements of science. And that’s almost the first and last lesson to be learned about economics: that, in my judgment, we are not converging toward exactitude, but we're improving our databases and our ways of reasoning about them.   

- Paul Samuelson 

Every time we try to make a forecast, we run into the problem that economics isn’t an exact science. There is an art to looking for and weighting different factors. These factor weights also change as economic agents' behavior changes. 

We are improving our data or at least have more it, yet data needs analysis and data science without theory can only sort or rephrase the data but not always providing useful insights. Machine learing has pushed the boundaries of data analysis but that does not mean we are better interpreters at understanding the causal links within the economy. 

Is it time for rotation into bonds?

One of the key drivers of portfolio return is the allocation between stocks and bonds. If you can get this right, you will achieve stronger overall portfolio performance, but it is not easy. Timing will not be perfect, so you have to play the odds when evidence suggests a tilt toward bond relative value. We may be at a point where equities are overvalued versus bonds.  Can stocks get more expensive? Yes, the overvalued market can last for another year, yet a high current coupon suggests that you are being paid to take risk off the table.