Capitalism is a complex and chaotic system, composed of a great multitude of interacting processes, agents and factors. Like all previously unexplained phenomena in nature and society, the capitalist system initially confronts us as something mysterious and unfathomable; as an all-powerful force, somehow existing above society, which imposes its laws upon us regardless of our will, or efforts to control it.
The task of providing an explanation to the inner workings of capitalism was started by classical economists, like Adam Smith, Thomas Malthus and numerous others; and it is upon the work of these influential scholars that Karl Marx built his own analysis. The difficult question facing Marx was: where does one begin? After a number of false starts, he eventually decided to begin his magnus opus Das Kapital by analysing the idea of the ‘commodity’, the production and exchange of which forms one of the main bases of capitalism.
How, then, did Marx define a commodity?
He described a commodity as an external ‘object’, a thing which through its qualities satisfies human needs of whatever kind – it can also be exchanged for something else. Moreover, a commodity would typically have a ‘use-value’ for the producer and also provide utility for others across society. This ideology extended further to describe a commodity as possessing a double form (natural and value); in other words, the physical material provided by nature, and the human labour expended to create the object.
Marx made no assumptions on the features of commodities in society. They may be goods such as food, shelter and clothing that fulfil basic human needs; luxury or consumer products; services rendered; or technologies and machines developed for others to employ in production. Academics argue the development of consumerism, with a vast advertising industry that seeks to create desires and artificial needs, changes nothing about the fundamental nature of the commodities produced and exchanged in society.
Why are we reflecting on all this right now?
Earlier this quarter, global semiconductor equities had added more than US$3trn in market capitalisation over a 90-day period. As a result, the market value of this sector stood at a record US$7.5tn, or more than the total value of all the energy and materials companies in the MSCI World index.
As money-managers, we think about what this means, and one interpretation is that we are on the cusp of a paradigm shift in which the nature of global GDP moves away from spending on energy, materials and consumption towards all things digital, tech and AI-related. The next question is whether we consider this to be rational, particularly in the context of the prices now being paid to own high-tech businesses. Put more simply and returning to our reflection on the ideas presented by Marx, what is more attractive to own? Materials or innovations?
Humans have long valued things that are rare – such as gold, silver and other scarce commodities. Post the industrial revolution humans have also valued an economy’s productive capital stock – factories, machines and other means of delivering productivity gains e.g. semiconductors. Aligning with the title of this VFTD – the former ‘objects’ can be grouped as jewels, with the latter categorised as tools.
So, what should we be favouring today – tools or jewels?
This ‘tools versus jewels’ framework for assessing where value currently lies is often used by the financial research team at Gavekal, who refer to it as ‘efficiency versus scarcity’. As a proxy for scarcity, they use the price of gold; and for efficiency, they use the market value of the S&P 500. In this approach, scarcity value is finite and certain, whereas efficiency value, created using tools in the future, is potentially infinite but uncertain. Financial markets are a mechanism for arbitraging in real time between the value of gold, and the value that will be created in the future by human ingenuity using efficiency tools. When capitalism is working as it should, the profits generated by tools should be higher than the returns achieved by holding gold.
The ratio of the return series delivered by gold and the S&P 500 provides a lens through which to measure the efficiency (tools) – scarcity (jewels) relationship over time. Based on a 7-year moving average analysis of this relationship, over the last century there have only been 3 occasions when the relationship has broken through on the downside. Each of these have coincided with a period when jewels have outperformed tools. As we write, the S&P 500/gold ratio is on the cusp of another downside breakthrough.
Implication for portfolios
‘Efficiency’ stocks – best illustrated by ‘quality-growth’ companies - have been hugely in favour over the last decade and have become richly priced as a result. Consequently, headline equity indices are dominated by such equities at this stage. Meanwhile, ‘scarcity’ stocks – reflecting assets such as commodities and real estate – have been relatively out of favour over the last 10 years and the latter, in aggregate, currently trade at a historically wide discount to the former.
Source: Asset Risk Consultants
Extending this further, the returns delivered by world equities have been outsized, particularly over this last 10 years. The chart demonstrates this – but also highlights how gold has kept pace with global equities (in £) over a 20-year timeline. Equities represent GDP growth, human ingenuity and innovation – whereas gold does none of these things. An important question to be asking then, is why is gold performing so well?
Elevated geopolitical tensions are one reason and non-US central bank buying of gold, to diversify reserves away from the US dollar, is another. Further, runaway budget deficits – which post the pandemic have stayed stubbornly high in the US, UK and Europe – have investors increasingly questioning the sustainability of this fiscal largesse.
In a world of eye watering national debt levels, and policymakers with very little appetite for ‘belt tightening’, the path of least resistance is to turn a blind eye to slightly higher rates of inflation and erode the real value of these debts over time. In such a regime, paper currencies stand to be steadily debased, and real assets should gain increased recognition as an attractive store of value, as well as an investment opportunity.
To summarise, could we have reached a point where tools are relatively ‘priced for perfection’ and the time is right for jewels to shine?
Russell Waite and Jon Proudfoot
Sources:
A critical moment? – Charles Gave, Gavekal Reasearch 16 September 2024
Efficiency, scarcity and markets today – Charles Gave, Gavekal Research 8 August 2024
The Anomalies in today’s world – Louis-Vincent Gave, Gavekal Research 2 July 2024
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