EPISODES / WEEKLY COMMENTARY

China, India, & Japan Flee Currency To Gold

EPISODES / WEEKLY COMMENTARY
Weekly Commentary • Sep 20 2023
China, India, & Japan Flee Currency To Gold
David McAlvany Posted on September 20, 2023
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“Pricing pressure from the oil markets is real on the supply side, which is a hard experience for economists, with the hopes and dreams of Central Bank policy efficacy. It’s harder still for the consumer, who, at the margins, is being squeezed by any penny’s increase in goods and services. So if you’re up a little bit, penny here, penny there, a dime, a nickel, whatever, it smarts. It really hurts.” –David McAlvany

Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany. 

Last night, Dave, we’re sitting on your front porch having our Talisker. The thunderstorm rolls in and I love how you didn’t flinch and hopefully, I didn’t flinch. We sat right through a wild electric storm.

David: Oh, yeah. 30, 40 mile an hour winds.

Kevin: Yeah, and your kids were right in on it as well. They wanted to come out and see. I was telling my wife this morning, when the lightning hit and the power went out in the whole neighborhood, it popped back on, and then it was like, “Oh, that wasn’t serious enough.” Boom. Power went out for good.

David: That’s right, and it was out for a couple of hours.

Kevin: One of your kids sat down and started playing piano in the house, and everybody just— The McAlvanys are unfazed by just about everything. This is following a lunch where you’re like, “Hey, have you ever had sea urchin before?” I’m like, “Only at the McAlvanys.” So, speaking of being unfazed—

David: That was a remarkable part of Iceland to be out in one of the fjords and to harvest some sea urchins, and to serve them up fresh right there. It was a good family experience—

Kevin: I thought you were going to tell the rainbow story. But the sea urchins, tell the sea urchin story, because I would never think to do what you did, Dave. They were just a little below the water.

David: Right. Uni is exported from Iceland all over the world, and it’s a bit of a problem. It’s a little bit like the lionfish, right? It’s tough to eat that thing. The spines are helpful, and it destroys kelp forests. So, don’t feel bad for this thing that’s somewhere between the crustacean and a— I don’t know what it is actually, but it’s pretty easy to access and—

Kevin: Harvest.

David: —delicious to eat.

Kevin: Well, that’s your opinion.

David: At least, that’s my opinion.

Kevin: That’s your opinion. But you also, we saw a rainbow after the storm. That was beautiful. And you said that you could almost touch the rainbows when you were in Iceland.

David: There was a couple that were so remarkably— They looked almost fake, just painted into the sky. So vibrant, bright, stark against the background. And yeah, we had a great trip. We did survive, by the way, the RV, five-person RV, six of us for two weeks. The meals were spectacular. Horseback riding in the rain. I’d prefer it probably without the rain, but you can’t do much in Iceland without rain.

Kevin: I also love how the family actually operates. You probably have stories that you don’t want to tell as far as people not getting along, but I came in last night.

David: Do you have kids?

Kevin: Yeah. Yeah. Well, I came in last night and I heard music, and I saw both the front door and the back door open. I’m thinking, “Well, Dave’s obviously not doing his reading for the program unless,” well, I saw that you were on the ground with your three boys doing—

David: Sit-ups, pull-ups, pushups. Yeah, we’ve got a regimen a couple of times a week.

Kevin: Yeah, and your youngest son was like, “Come on, guys.” I mean, how old is your youngest son?

David: I got up, it was so funny. I got up and walked away. And I can hear in the background the nine-year-old coaching the older boys.

Kevin: And he’s like, “You’ll sleep when you die. Come on.”

David: “You can rest when you’re dead. Get this [unclear]. You’re doing a great job.”

Kevin: I’m sure they heard that from their dad at some point.

All right, well we better transition because half the population of the world, virtually half the population of the world is seeing gold hit all-time highs right now.

Now I’m the other half, I’m not seeing it, but almost, what is it three billion people are seeing, over the last week, gold hit all-time highs.

David: Yeah, we talked about the yen and the RMB in recent weeks, how serious were the levels we reached in the currency markets last week particularly. Well, in both currencies, gold reached an all-time high. What that suggests is that enough people have concluded the credibility of the central bank as an institution is cratering and that cash deposits are at jeopardy for their losses.

So the Chinese currency is at 16 year lows. In yen gold is up 16% over the last 12 months, basically the same as US dollar/gold over the same period of time. And people think, “Oh, well, gold’s not doing much this year.” Right, year to date, maybe it’s up 5%, but over 12 months we do have a 15.75% gain in the gold price.

Kevin: Yeah, Dave, it’s really important. And this is where me actually attending this show and talking to you and what, Monday nights and our Tuesday morning meetings, these are all helpful because it gives us a larger perspective. I got a call from a well-meaning client last week, and he said, “Who’s controlling the gold price? Somebody’s obviously manipulating gold because I haven’t made any money in gold or hardly any this year.”

David: But again, I mean if you’re Japanese and you’re up 16%, it’s not that bad, right? 123 million Japanese think it’s a pretty good thing to be looking at gold today. 1.425 billion Indians look at gold and rupee and think, “Nah, it’s all right.” Another 1.425 billion Chinese also, attractive bull market, 16% gain in yen over 12 months, 19 in rupees, 19 in the yuan or the RMB, the Chinese currency.

Kevin: Yeah. So if you’re looking at technical analysis, though, in a particular currency like the dollar, you may be getting a completely different story.

David: I think that is a really fascinating thing to think about. Half the world’s population looks at the dollar price of gold and says, “Well, it’s doing this or doing that in terms of a chart formation.” How about gold and rupees? How about gold and yen? How about gold and RMB? It’s a very different chart pattern, and it suggests a very different future.

I read a technical analyst on gold here in the last few days, quite negative. It was just earlier this week. It’s like taking a cold shower, the cold shower effect. You’re like, okay. And it made me think it’s a little bit like a Rorschach test. I wonder if I see something different than the gold bear, and maybe— I wonder if there’s another three billion people that do as well. That certainly is a large enough audience to move the market.

Kevin: Well, you bring up Rorschach. And it’s interesting, we have a painting. It’s a print of a painting in our house. And it’s a beautiful painting. I’m not going to tell you what we now see in the painting because my dad walked in the door one time and he looked at it and he goes, “Hey, look at that. It looks just like…”

David: You can’t un-see it.

Kevin: You can’t un-see it. And here’s the problem. I really can’t un-see it. And so with the markets, you can do the same thing. A lot of times you can have— Rorschach is a great example because once you see a Rorschach in one way.

David: I see a bear market.

Kevin: Yeah, you’re done.

David: I see a bull market.

Kevin: And how do you get yourself out of that?

David: Well, back to the Chinese, how seriously are they taking the deteriorating currency? Here it is in their own language. This is from the authorities. “We will not hesitate on taking actions when necessary to firmly correct the one-sided and pro-cyclical market moves to resolutely address the actions which disturb market order and unswervingly avoid the overshooting risks in the exchange rate. Financial regulators have the ability, confidence, and conditions to keep the yuan’s exchange rate basically stable.”

And I thought, pretty strong language, right? Pretty strong language. We know where the pain point is, and the whole world does as well. 7.30-ish. You don’t want to see it go beyond 7.3.

Kevin: Yeah. You know what’s interesting? As you read that quote, I would’ve thought that that quote came from somebody from our own central bank when they were talking things the last few years, or going back five, 10 years ago those guys would just basically talk the markets and everybody would believe.

David: You’ve got both Bloomberg and Reuters, which covered how both banks and brokerages in China were instructed to not take trades for shorting the currency. Sounds like the US authorities 2008, 2009, taking away the market’s ability to short financial stocks. That’s still, this sort of market intervention, bullying, protecting, however you want to look at it. But basically the change of rules in the middle of the game, it doesn’t have the effect that you think it might in the end. For a short period of time it can be really impressive bluster. But if you look at the 2008, 2009 prohibition of shorting financial shares, it still didn’t prevent Citigroup from succumbing to gravity and dropping 90%.

Kevin: No. You can try to control the markets, but you can’t do it long-term.

Now, speaking of long-term versus short, though, and breaking yourself out of that forced—where I saw the Rorschach this way and I’m never going to see it any other—you look at what the traders are doing and sometimes that can tell you the short and the long as far as what the expectations are.

David: Yeah, each week Morgan does a review for us of the COT. That’s the Commitment of Traders report, and it’s an exercise to see who’s coming and going in the futures contracts. We look at gold, we look at silver, we look at the US dollar. Those are the three primary ones. Would be interesting to look at oil as well. But for our purposes, these are really critical.

The futures market brings leverage and a tremendous amount of pricing pressure to any commodity in the short run. And occasionally the physical markets operate on a different basis. There can be a distinction there.

Bear in mind, we have a very long-term bullish perspective on gold, long-term bearish perspective on the US dollar. But when we look at the COTs week to week, in the short term anything can happen. And it’s important for us because when we’re managing portfolios, speaking of the MAPS portfolios with the asset management company, this is one measure of risk. And for us, risk mitigation is a daily obligation. It’s not something that we can take merely a long-term view on and take a position on. We still have to manage and mitigate risk day in and day out.

Kevin: Right. And you’re also having to manage risk in dollar terms, whether you like it or not. I mean, gold may be hitting an all-time high in other currencies, but you’re having to manage in dollars.

Now, let’s talk about the dollar for a little bit because a lot of people are seeing strength in the dollar and asking the question why.

David: Well, again, short term versus long term, we think of the dollar, and we think here is, as we said last week, the kiss of death for gold. If you have a really strong dollar, doesn’t that mean, isn’t it axiomatic, that gold will trade lower? And frankly, if you have real interest rates on the rise, doesn’t that mean again, sort of the kiss of death for the gold market?

Kevin: The black box would say yes, but the problem is the black box is wrong most of the time.

David: Well, it depends on, let’s go back to a fancy word, periodicity. If you have a day, a week, a month in mind, sure, you can see a relationship between a strong dollar and a weak gold price. But you look at longer periods of time and it’s completely irrelevant. And we’ve had a significant break in terms of interest rates and gold performance this year, dollar performance and gold performance this year, as well.

Kevin: Who would’ve thought gold would’ve stayed above 1900 for, what, 25 weeks at the close of each week. I think it’s 25 weeks now.

David: That’s correct. And that’s in the face of the fastest rising interest—

Kevin: The most aggressive interest, yeah.

David: Exactly. And a strong dollar. So this is one of the reasons why we look at the COT US dollar because we do know that traders treat that relationship as verifiable and reliable even when it’s not, but we have to be aware of it.

Okay, so the dollar traded at 101 compared to the euro index back in July. Now it’s flirting with the 105 level. Price action has been positive. We have a proprietary scoring of the COTs. Our scoring of the US dollar COT has begun to fade, and that might seem like a contradiction, but it has to do with how we score the traffic through the asset class. Our measurement is meant to reflect sentiment. So the US dollar, if you go back, had a perfect score and looked more compelling at our scoring of 100, our scoring at the price.

Kevin: Yeah. Let’s back up for a sec before you go on, because I walked back in. On a Monday morning or a Wednesday if I walk back to this area of the office, I hear a very lively, sometimes, conference call going on with Doug and Morgan and Philip, and Robert’s on there. You’re on there. And what you just now talked about, when you say we have a scoring, you have a method of scoring investments that’s different than the price, right?

David: Sure. I mean, price—

Kevin: Explain that a little bit.

David: Yeah, price is important, but we’re again looking to see who owns it, who’s buying and selling it, in what quantities, how those things relate to each other, who are the strong hands, who are the weak hands, and certainly price action is a part of what we’re looking at.

Kevin: But then you apply it to a zero to 100 scale.

David: That’s correct.

Kevin: So this is one way of breaking out of the Rorschach, Dave. That’s what I was asking.

David: And so even as the price has appreciated, here from 101 to 105, the dollar price, it’s less attractive on our scoring by 11 points. So it’s off its peak of 100, our scoring, and is now scoring at 89. Still pretty high. Similarly, gold in the 2000s, higher by a $100, $150 in today’s price, it was overdone and in need of a correction. Too much enthusiasm in a short period of time. And again, we’re talking about the futures market and those who are playing futures contracts. Energy in the futures market can flip quickly and usually does, particularly in the futures market.

So at very high prices, our scoring drops, and at very low prices, our scoring increases to a level that suggests a compelling buying opportunity. So getting to 100 is not always fun, where we see, okay, this is an optimal time to be buying. But also of note in this context, it’s not just price, it’s the hands that hold the positions because there are strong hands with long-term motivations and there are weak hands that trade in a very fickle manner. So the scoring also is determined in part by who’s buying—commercials, managed money, or the other category, which includes your pensions, your insurance companies and family offices, things like that fit the other category.

Kevin: I really enjoy gold. We had a client who came in who brought some gold in, and it was sitting there on the table in front of us and he was like, “Wow, so much value and so little space.” But I said, “Isn’t it fun?” It’s really nice to have the physical gold.

What you’re talking about, and I want to talk about gold’s score on your scoring because the kind of gold that you hold in the managed portfolios is different, okay? You’re using it for different reasons than just like the base of the triangle for permanent preservation of buying power. What you’re actually doing with the left side of the triangle, which is sort of the stock and bond side, is you’re trying to figure out what it scores. Where has gold scored this year? I mean, where do you guys have it?

David: Yeah, bear in mind, what we’re interested in with the gold price, certainly we’re interested in its performance because it tells us something about risk-on and risk-off, and people moving to a safe haven asset, just like we’ve seen with the Chinese audience, with the Japanese audience, with the Indian audience, that there’s a story to tell there in terms of central bank credibility, currency concerns. So that’s very important, just the price on its own. But also because we’re interested in mining shares. That’s one of the areas that we focus on.

Yes, I mean our profit margins and the companies that we’re interested in are directly impacted by the price. Operations and effective operations management can help, but the market can hurt. So we need to be aware of both the effective management of these teams all over the world, as well as the price, which is either helping them or hurting them, tailwinds or headwinds to their performance in terms of margin growth.

It’s so exciting for us to see companies that improve performance, improve their balance sheets, and are in a position where even if gold does not improve, their margins in the next quarter to half year can go from 40% to 70%.

Kevin: Because they’re cutting their costs.

David: Because they’re effectively managing their business as well. Do we no longer care about the spot price? No, we clearly do because you might accelerate that growth in a shorter period of time, and it just drops to the bottom line for the quarter and for the year.

Kevin: Okay. So again, my Rorschach on gold is just give me some more. That’s physical gold. But what you’re basically talking about is spot. You’re going to use this on a scoring system and it changes throughout the year.

David: Yeah. So gold scored in the 30s on our metric from April to early May with the price over 2000. Again, that’s not an impressive score. Closer to 100 is an impressive score. When you’re in the 30s or even into the teens—we’ve gotten to zero, and that’s to us cautionary. Why? Because there’s too much hedge fund enthusiasm. That’s the hot money crowd. Again, it comes to who’s owning what and are they short or are they long? What are the commercials doing and why? What is managed money doing and why? What is the other category doing and why?

When we see hedge fund enthusiasm, that to us is not a positive. It’s a uh-oh because these are folks that will own anything. They will sell anything. They would sell their mothers for 10 cents. And again, so we’re in the upper 1900s as recently as July. Our scoring was still in the 30s. More recently, our scoring has climbed as high as 76, getting much more interesting. Now, we’ve dropped here recently in the last few weeks back into the 60s. All that to say, the futures market will continue to provide a US dollar gold price roadmap and suggest an entry point that is most compelling. Again, it’s also a part of the way we manage risk.

Why are we taking a position in this particular mining company or that particular mining company? Why are we waiting? Why are we on hold? Why are we favoring cash? We would look at this as one of the things that helps us look at both risk and reward, balancing out the two. Oftentimes price action and the exaggerated impact from futures trading gets us to that perfect score of 100, and for us what would be an ideal entry point. Patience for us is critical, and what we’re looking for is an alignment of the fundamentals, the technicals, and in this case, our COT scoring helps bring in line market trading dynamics.

Kevin: Yeah. And it’s really not fair, honestly, for me to say the Rorschach actually applies to the physical gold because I remember times, Dave, when physical gold’s price was very different than what you would be trading like with what you’re trading on the price of the financial markets. So the Rorschach doesn’t always work for all products.

David: It’s important to get multiple perspectives. And that negative technical piece from Elliot Wave International does suggest a scenario where financial market liquidity dries up, a shock to leverage speculators is felt, and all assets hit the auction block, as we witnessed in a 60-day period during 2008. And I say a 60-day period because it was resolved quicker than it presented itself. We had a 30% decline in the spot price of gold, and finished positive over 5 to 6% by December. So that’s October through December and a round trip of down and back again.

I’ve had many a dinner with Robert Prechter. I don’t know a couple of the other guys as well, but I’ve had many dinner with Robert—

Kevin: Elliot Wave, yeah.

David: I appreciate his work. He does go long stretches where he is wrong, but back in 2008, futures gold sold off precipitously, and so there was a deflationist vindication in part. However, physical gold hardly budged as safe haven demand from individual investors stepped in to offset hedge fund liquidations within the paper contracts.

So yes, spot gold declined and thus futures prices were very much under pressure, but you couldn’t buy for immediate delivery of physical metals at those prices. It was as if that dip in gold didn’t even happen in the physicals market because there was no physical gold available.

I mean, think about this. I remember having conversations with clients and I would tell them, “Look, if you want to wait until March, April, or May, then you can take delivery of gold and you can get a better price per ounce.” And they’re like, “The world could be over by then. I want my gold now.” That’s what I’m saying, immediate delivery, physical gold, you can’t have it at today’s low price because it doesn’t exist at those low prices. There is not enough supply to match demand. So what you see in the futures market, what you see represented by spot, influenced by the futures market—

Kevin: It may not be real.

David: It’s a pipe dream.

Kevin: And see, I love the fact that it caught your attention, Dave, because we went to Switzerland not long after that. You were like, “This is not going to happen to us again. We’re going to find a way to buy gold when nobody else can.” I mean, this company is now 51 years old, but it took the 2008 crisis for you to make some of the relationships that you have since then because of that fact.

David: It’s a major rethink because if I experienced it once and didn’t learn from it, the second time around it’s entirely my fault. I’m to blame. I didn’t know those circumstances could exist where we could be in the gold market in the context of the global financial crisis with demand flooding in—

Kevin: And no supply.

David: —and no supply in order to take care of the clients who wanted to purchase gold. Again, this is gold at $600, $700, $800 an ounce. And we—

Kevin: Yeah. Is that happening a little bit in China right now?

David: Well, that was last week. I failed to mention that gold off of the Shanghai Exchange was commanding significant premiums last week. Highest ever, actually, 6%. $121 at its worst. That is a good example of current pricing diverging from the paper market due to extraordinary demand dynamics. That was the unique aspect there. We don’t have weakness in paper, we actually have a limitation in supply. I’ll get to that in a minute.

But in the 20 years of watching those prices, gold in Shanghai, it has never climbed that high. It has never diverged that much from the underlying. Demand dynamics explained half to two thirds of the gold premium, we’d already gotten to $60, $65, $70 an ounce over, in China. The rest is consistent with the quote I just shared. You’ve got Chinese authorities who are actively defending the RMB. And a part of their defense of the currency is prohibiting the import of additional ounces, thus stemming the tide from RMB, the local currency, into gold as a safe haven. This is a part of their let’s-defend-the-currency dynamic. And there’s a valuable, valuable lesson. At times, the spot price, what you see, will be less relevant as arbitrary factors impact market pricing. In this case, a 6% divergence from spot and the current price—that, compliments of the Chinese authorities curtailment of imports.

Kevin: This goes back to, you can try to control markets. They try to do whatever they can. It’s like, okay, we’re not going to import any more gold because too many people are buying it. And it’s like, oh, well, how’s that going to work?

David: It just means that price resolves the supply-demand equation. If there’s not enough supply, guess what happens.

Kevin: Price goes up, I think.

David: And more gold comes out of the woodwork to meet that demand. It only does so at a certain premium. It doesn’t matter that they’re not importing more. 6% was the threshold at which new supplies were coming out of the woodwork. I may say to myself, “Look, I don’t care what the Chinese do today. Tomorrow— I’m happy collecting the 6% extra today because tomorrow I’ll be right back to my gold and I’ll own 6% more because I can get it at the going rate.”

Kevin: It goes back to that blue market rate of the dollar when we were in Argentina. To get the dollars to come out, it was really at about 14 or 15 pesos, but the government said, “No more than seven. No more than seven.”

David: Yeah. We’re at 124% annual rate in Argentina—over 12, I forget what the decimal was, on a monthly basis. Argentine inflation is going nuts. And a friend of mine requested information on what’s driving inflation. I want to provide him something substantive and academic. That’s what he expects. But the bottom line is, bad policies make for desperate measures up to and including printing money. And this is the consequence. You go back to bad policy, and that’s again why you see a discounting of bad policies in the gold market.

Kevin: Is that called Gresham’s law? Is that just another way of stating Gresham’s law? I can’t remember exactly how it’s stated, but it’s good money pushes out bad, something like that.

David: Right.

Kevin: Yeah, you have these dynamics, Dave. You talk about demand dynamics, and then there’s supply dynamics. They’re trying to control the supply side. That’s what the Chinese are trying to do to affect the demand side.

David: Yeah. I can’t help but think about the true and temporary supply and demand dynamics that hit premiums versus the false and misleading premiums that you can often find within our marketplace. Sometimes those dynamics are driven, again, by supply and demand, totally legitimate, true, and usually temporary, but there can be nefarious causes. And I’ve counted five or six major competitors, all on the airwaves, all on television. In fact, you should assume if you are viewing, listening to a major sponsorship by a celebrity, previous politician, movie actor, what have you, and you are using those companies to supply your metals needs, you are being sorely abused.

Kevin: You got a 30% celebrity— yeah.

David: 30%, 40%, 50%. What’s fascinating is you can go to any of their websites and get into their disclosure documents, and you find that they will tell you just how much they’re abusing you; 30%, 40%, 50%, 60%, even 100% markups. Which, again, read their disclosure documents. The fact that they even have disclosure documents tells you everything you need to know. They are covering those companies from lawsuits because they know they will exist. I mention it because there’s a distinction between market dynamics that drive premiums in a legitimate way and premiums driven by greed in an abusive fashion. Please don’t confuse the two.

Kevin: Yeah. One of the things you see in the market sometimes is people will raise prices because they see something is popular. And that’s not necessarily abusive, but if they do that in an abusive way, Dave, you’re just the opposite. I remember when we ran out of supply back in 2008. And it was like we could have just been writing business with people all day long with gold. All day long, they were just calling, and we couldn’t get it. And you were like, “We’re not going to have this again, but we’re going to find a way to still get it in a way, even when that’s happening, that’s affordable.”

David: Let’s walk down memory lane. We launched our first overseas gold storage project after that. Again, when we found in the US wholesale market we had zero product available for clients. We were actually restricted through only one provider stateside to one kilo bar per day.

Kevin: Yeah. For the whole office, one kilo bar per day for the whole office.

David: And that was the only US source that had any gold available for immediate delivery. At that point, we decided it was mission critical to have direct access to the mints on multiple continents.

Kevin: Go straight to the source.

David: Right, so we could reliably supply gold under any circumstances. No one really sees these kinds of things, but this is what goes on behind the scenes. Just to brag a bit on the Vaulted program, because these are dynamics that aren’t just 2008, 2009. When demand skyrocketed at critical points over the last few years, March 2020 (Covid), the Russian invasion of Ukraine, wholesale premiums here in the United States were pressured significantly higher even beyond what we saw the Chinese circumstances of last week.

Kevin: But not at all in Vaulted.

David: Not in Vaulted at all. In both those scenarios, we were able to continue to provide superior pricing with virtually no shift higher in premiums. As a savings tool, offering gold in partnership with the Royal Canadian Mint, offering silver in partnership with HSBC London, our technology and product is second to none in the market. Pricing stability under pressure was and is a critical distinctive. Again, nobody really knows that because it was us managing that. No one in the US avoided paying those premiums except in the Vaulted program, where our retail price structure was below— At one point, we were below the wholesale market’s offer. Retail pricing below what you could buy on a wholesale basis. That’s truly remarkable in terms of the integrity of the product.

Kevin: And this is why I think we have to look back at these moments like 2008 and say, “Okay, what is a dynamic that hardly ever happens, but it does when you need it the most?” Or when you need the product the most. I’m thinking no-bid markets, Dave. There are times when you can’t sell a stock, you can’t sell a bond. I don’t know of any time you can’t sell gold. Maybe I’m a little bit jaded, but I do know there are times when you can’t get what you want when you need it and you can’t sometimes sell what you want to sell when you need to sell.

David: Doug highlighted one of the precipitating events of the 2008, 2009 global financial crisis over the weekend. Lehman failed September 15th, 2008.

Kevin: That was 15 years ago. Gosh, remember that? Brown boxes. We all remember brown boxes.

David: Now we’re just past the 15th anniversary. March 2008 was when we started the podcast. Again, March versus September. What we wanted to do was better educate and more broadly communicate with all of our clients on a routine, on a direct, basis. We saw the subprime collapse coming, and we regularly spoke in client conferences about the financial market. Frankensteins. These were monsters which would come back to haunt their creators. The podcast was a better way for us to be in touch with clients weekly rather than on an annual basis through seminars. Doug was also pointing out that 10 years prior to that, so 25 years ago this week, September 23rd, 1998, LTCM, Long Term Capital Management, went under, nearly collapsing the financial system. And so this was Nobel Prize winners, this was MIT and Harvard mathematicians and physicists who had figured out a way to leverage a portfolio, and in theory take virtually no risk, but be able to make 20%, 30%, 40% a year.

Kevin: Yeah. It worked for a little while. What was the time period thing you were talking about? What was the word?

David: Periodicity.

Kevin: Periodicity.

David: Yeah. It worked for a while. What about the next time slice? Well, the Asian financial crisis and the Russian bond defaults, we’re talking about 1997 and 1998, contributed to the destabilization of the environment of the financial markets. And that had an impact on these highly leveraged trades. Digressing a little bit, but not really because it is the leverage in the financial system, which when unwound provides the risk of assets collapsing in price, going to what you described as a no-bid market for anything. No-bid market for everything.

Kevin: Yeah. And that’s a terrible feeling. You’re kidding. You don’t want to buy my Beanie Babies. I’m sorry, I’m going back to my old toy store days. But there was a time when you had Cabbage Patch Dolls that were selling at a ridiculous premium. I happened to be a toy store manager when that happened. Women were actually physically hitting each other to get those cabbage patch dolls. You can’t give them away today. That’s a different kind of no-bid market.

But let’s go back to inflation because the managers, remember the gods of the financial market, the little “G” gods of the financial market are these central banks. And I think this week they’re going to tell us how they’re going to manage the current disease, which is inflation.

David: This is a super active week from Wednesday of this week through the close of Friday. Eleven central banks will communicate their next steps on the path to managing inflation—

Kevin: Drum roll, drum roll.

David: —to target. Right. So 36-hour marathon starting midweek, and while the disease is of one kind, globally, inflation that is, there are various degrees of intensity for treating it. So the central bank community will have the opportunity for differentiation this week. What’s interesting, though, is that bonds are not suggesting much of a difference in approach.

Kevin: So the bond market doesn’t care that there’s a drum roll. The bond market’s doing its thing.

David: In the last couple of weeks, it’s just been, wow. The bond market is not so differentiated. Global yields are pressing higher across Europe, across Asia. The benchmark for return-free risk— No, I’ve said that backwards.

Kevin: Return-free risk.

David: I said that backwards. I mean risk-free returns. It is trading higher. That’s the US Treasury, is trading higher in part because supplies keep it coming. But that’s been the case with lots of central banks around the world. We have this interesting uniform rise of rates all over the place.

Kevin: So what’s the Fed going to do?

David: Not expected to do much between now and year-end. One hike before the year comes to a close. There’s kind of a difference of opinion here. You’ve got economists of one opinion. You’ve got market analysts of one opinion. You’ve got central banks of another. So the uniform market judgment—talking about sort of the asset managers, if you will—the uniform market judgment, financial market judgment, is that this rate hiking cycle, whether it’s the UK or the EU or the US, it doesn’t matter. It’s peaked. It’s peaked, and we can therefore expect smooth sailing in asset markets through year-end and well into 2024.

Kevin: When I drive past the gas station, I think our gas right now is at about $4.20. Are they saying that inflation’s been beaten, yet I’m still having to put $4 gas in my tank?

David: Well, that’s a challenging, call it flaw in the thinking. Does the 30 to 40% rise in oil just since May, June, say otherwise? That inflation is not in fact behind us, but there’s more that’s going to be here. Energy costs increase, and guess what? Inflation has a hard time not staying sticky. Not only sticky, but it’s like an annoying piece of gum on your shoe.

Kevin: You can’t get rid of it.

David: But more of it, not less of an issue from June to the present. Remember June, we had the 3% CPI number, consumer price index number. That was the low ebb, and the tide has been creeping back since then, now to 3.7 as of last week. And PPI, the wholesale version of CPI, had its sticky and substantive surprise last week as well. So OPEC has said that first we might have 1.2 million barrel deficits in terms of the oil supplies built into the current market, and other groups expect as much as three million barrels of a daily deficit as we get from now into the last a hundred days of the year.

So pricing pressure from the oil markets is real on the supply side, which is a hard experience for economists with sort of the hopes and dreams of central bank policy efficacy. It’s harder still for the consumer who at the margins is being squeezed by any penny’s increase in goods and services. So if you’re up a little bit, penny here, penny there, a dime, a nickel, whatever, it’s smarts. It really hurts. And keep in mind, OPEC’s not likely to play ball. What would they have to have as a quid pro quo to go ahead and increase production? You’ve got OPEC+, which includes Russia, and you get Saudi Arabia who is essentially flipping the Biden administration the middle finger.

Kevin: They used to be our friend.

David: But when you take someone for granted long enough and still hold demands over them, you eventually say, look, you told us in not so many words that you did not need us. You got your shale production, you’re at 13 million barrels a day. Good for you. Happy, happy, happy. What happens when your decline rates set in? What happens when you need Saudi oil? What happens when the president makes the call to MBS, Mohammed bin Salman, and says, “Why don’t you play ball? We need a little help here.”

Kevin: And Mohammed is basically saying, “Oh, are you out of your strategic reserves? Did you sell all your strategic reserves to keep the price low?”

David: I don’t know why my wife sent this to me. I was probably on a group text. I’m going to pretend it was on a group text, but there’s this picture of this famous actor and it looks like she’s taking the top off of a lipstick to put it on her lips, but it’s actually her middle finger, and then she just puts it on her lip and puts the top pack on and puts it away. That’s essentially what MBS has done. He’s taken out his middle finger lipstick, taken off the top, he’s putting it on, and now he can put it back in his purse.

Kevin: And the price is still over $4 a gallon.

David: Higher prices of oil pass through to almost everything, whether it’s CPI, PPI. They’re now a very inconvenient truth in this climate of higher for longer. The logical view—

Kevin: A little bit of a word play there.

David: Why not?

Kevin: Inconvenient truth in this climate. Yeah, there we go.

David: Of higher for longer.

Kevin: Subconscious, you’re just trying to manipulate it.

David: Rates and inflation. The logical view to take is higher oil prices equal higher CPI. Higher CPI equals higher rates for longer, and that equals lower asset prices. But the judgments have been made already by market practitioners that rates will not go higher because inflation is already behind us. Rates will come down, and they will come down soon, which, I mean, it seems less logical, it seems more hopeful.

Kevin: But that’s how they see the Rorschach.

David: That’s how the financial markets are priced today, as if we don’t have higher for longer. And as John Authors—he’s got a great column for Bloomberg—he recently wrote, “there’s been a strategist short squeeze of late.” And what he means by that is that analysts who’d expected softer results in the equity markets are now clamoring to raise their year-end targets. It’s like, oh, well, it didn’t go down. So now it’s not only going up, it’s going up much higher. What he calls it, a strategist short squeeze. Trying to cover their mistakes and say, oh, no, no, no, no. We expect much higher prices.

Kevin: Blowing with the wind. Blowing with the wind. Remember this song?

David: Yeah. And it’s funny how one’s thinking tends to move with the market. I mean, 2022, the markets were off. People lower their expectations for 2023. Markets move higher, you adjust your expectations. No one is actually trying to anticipate what happens next. They just don’t want to be embarrassed or stand out from the crowd. It’s ironic that analysts are getting more uniformly bullish, this sort of strategist short squeeze. Analysts are getting more uniformly bullish even as folks like Manish Kabra at Société Générale describes the S&P 500 as overvalued on any sensible basis. Overvalued on any sensible basis. He says US equity valuations are still expensive on 10 out of 10 metrics we track. Value investors would buy the S&P at $3,100.

Kevin: And put that in context. What he’s saying is value investors would buy the S&P at $3,100. Where are we now?

David: Quick math off of today’s basis, $4,430. $4,430 and $3,100 suggests a target 30% below current prices.

Kevin: That’s just the metrics speaking.

David: That’s to bring in value-oriented investors. Savita Subramanian of BofA echoes that finding. The S&P’s overvalued for BofA on 19 of 20 measures. So, last few weeks, you and I have mentioned this, we’ve got price to sales. We’ve got the CAPE—cyclically adjusted price earnings ratio. That’s a 10-year rolling average of the PE. You’ve got the Q ratio, the Buffet ratio. Just bear in mind, other measures are uniformly confirming that this is a don’t-touch market. Don’t touch it.

Kevin: And there’s your wordplay again, Dave. I hate to point this out. You may be subconsciously doing this, but you said bear in mind, and I think that’s what you have.

David: Of course. Well, one should conclude that a move higher is connected to Wall Street’s analysts flipping into a very positive script. And I think this is going to ultimately prove to have been a very poor timeframe for flipping the script from being modestly bearish to being very bullish. No doubt, new highs are an outside possibility, but significantly, significantly lower lows—well below the 2022 levels—are very much in the making.

*     *     *

You’ve been listening to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany. You can find us mcalvany.com. And you can call us at (800) 525-9556.

This has been the McAlvany Weekly commentary. The views expressed should not be considered to be a solicitation or a recommendation for your investment portfolio. You should consult a professional financial advisor to assess your suitability for risk and investment. Join us again next week for a new edition of the McAlvany Weekly Commentary.

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