- The $500 trillion Interest Rate house of cards
- Stocks rally & bonds crumble
- Consumer Pessimism highest since WWII
The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
China Stockpiles 80% of World’s Copper & 70% of the World’s Corn & Oil
March 30, 2022
“Inflation’s going to run out of gas before we run out of options. That’s got to be an assumption that Powell’s running on, not really reflecting on the phase shift from low expectations for inflation. We’re talking about human beings here, and sentiment. We’re talking about a phase shift from low expectations of inflation to stubbornly entrenched consumer expectations for much more of the same. And frankly, for as far as the eye can see.” — David McAlvany
Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany.
Last week you were traveling, Dave, and I got a chance to meet with you last night. And as we were meeting, you said, “Well, I didn’t eat lunch. I had a really busy day, and I’m trying to get a swim in before my wife gets in, and I’ve got to run. Maybe I can get that in between 11:30 and midnight.”
David: I did. I squeezed it in just before midnight.
Kevin: Yeah. And I’m thinking, “All right, so this is what training for a triathlon is. And still being a dad and still being a business owner and all the stuff you were doing last week.” So to me, that’s a form of insanity. And so I’m just going to segue to this right now because we’ve got the VIX on the stock market. Stock market right now is looking like it’s just as hot as it can be. Okay. And it’s forgotten Covid. It’s forgotten the Ukraine. The bond market— I remember when your dad one time tried to put things in perspective. He says, “Let me show you something.” He said, “Imagine a bathtub full of water.” Okay. “Now, imagine a shot glass. The stock market is the shot glass.” He says, “The bond market is the tub full of water. So you want to watch because the bond market actually is what is telling you what the economy’s doing.” Stocks—they don’t don’t necessarily rhyme or reason, do they?
David: Right. And I mean, in terms of scale and scope, actually, they’re not that different in size.
David: But in terms of importance and the messaging, that is pretty key. And so you mentioned the VIX, the volatility index, and that would suggest, as the number keeps on coming down, that all is well. That the stock market is going back to an even keel. And the equivalent index for bonds continues to move higher. So you’ve got a disturbing disconnect, where the bond market and the credit market is saying one thing and the stock market, with great enthusiasm—not a lot of careful thought, I don’t believe—but nevertheless sending a message all is well.
Kevin: And now the stock market reminds me a little bit right now of the person who was on the Titanic and never heard the hit. Okay? They never heard the iceberg hit. The guy who did, he’s the bond market right now. And that seems to be what we’re seeing; the cycle from bonds to stocks.
David: A fascinating week last week and into this week. A massive rotation from bonds to stocks. And that continues unabated, with carnage mounting for your bond investors. So this is the worst quarterly returns in the bond market since 1990.
Kevin: Hmm, wow.
David: And into this week, you’ve got stocks filling in the performance hole created by January, February, March, and the downside volatility that you had. Now, I mean, think of this: A 45% rally in Tesla shares in 10 days. And Apple moves to just over 7% of the total of the S&P 500’s capitalization. There has never been a company that has had a larger percentage capitalization of the S&P 500. If you go back to the periods of past sector excess, where technology was just, man, really flying, Microsoft and IBM filled those top slots. And Apple is making them look like small positions. Exxon-Mobil in the last period of excess for energy. Again, 7% is telling you something very, very significant.
Kevin: Maybe they should rename it the S&P Apple.
David: Steroids is one thing that comes to mind. I think this kind of rotation, again, out of bonds and into stocks is not normal. And it suggests sort of a rotation on steroids. Someone wants the quarter to finish positive for the equities markets. And if you watch the late market trades almost on a daily basis, you’ve got some interested parties jamming the futures markets and manipulating the indexes higher. And I think that’s being pulled off by interested parties. I may even smell a fake.
Kevin: I have a question for you, though, because the markets have changed since I started doing this. The markets used to be people buying stocks, sometimes selling stocks. Now it’s algorithms. Algorithms. High-frequency trading. Is that possibly part of the disconnect? An algorithm’s not going to actually be looking at news events as a whole. It’s going to be looking at shorter timeframes.
David: Yeah. I think the combination of algorithms, black box trading, and then just what happens when something gains some momentum, you increase your rate of change in a particular direction and all of a sudden, trades pile on in that direction, continuing the trend.
Kevin: So let me ask you, then, because we’ve also known that whether a market’s rising long term or falling long term, the moves the other directions are usually the sharpest. Okay.
David: Yeah. Counter-trend moves are always violent. So the rally is natural, in that sense. It’s only natural in the sense that a rally that is sharp and short is characteristic of a bear market rally. And I say “bear market rally” because I’m assuming that we are in the context of a broad market top. What should you do when you get a bear market rally? Sell them. There’s only one action to take with an equity sprint like this, and that is to harness the spastic energy while you can and sell into that strength. The S&P 500 is now 5% above pre-Ukraine levels. What dynamics are driving that? Is peace apparent to market operators? Are they dealing with some sort of insider information that even Biden and Putin don’t have? I mean, come on. Is this a healthy recovery, or is this a dead cat bounce? My advice, again, is sell this strength. Sell this strength.
Kevin: Well, and there are two ways that interest rates can rise. It can either be the Federal Reserve doing it and trying to stay ahead of the curve, or it can be the markets going, “You know what? We need to raise short-term interest rates.” And we talked this last week or two about the—well, last week—the yield curve inverting, where you have short-term rates actually exceeding long-term rates, which— That’s a bad signal.
David: You’ve got the US 2-year Treasury note now yielding 2.42%. The 10-year bond is flirting with 2.5. And if you look at the difference between the 2-year and then go out to the far end of the yield curve, 30-year bonds, the spread of the difference between the 2-year yield and the 30-year yield is a mere 16 basis points.
Kevin: Which is incredible because the time value of money tells you that you should be getting higher interest rates the longer you take the risk of loaning somebody money.
David: Yeah. So before you say, “Who cares?,” keep in mind that at the beginning of March, the spread between the 2 and the 30-year was over 200 basis points. That’s a 2% difference. Now, it’s 16 basis points, just a skosh over a 10th of 1%. So there are multiple issues in play, and reasons to care. Number one, you have mounting investor losses. This is a real issue. For instance, the Bloomberg Global Aggregate Bond Index, which is a benchmark for government and corporate debt, it’s fallen 11%. That’s unmatched since 1990. And it surpasses the declines during the global financial crisis in 2008.
Kevin: Wow. And bonds are held by people who really don’t want to, or can’t, lose money.
David: But this loss, I mean, this move lower for the global aggregate bond index, is suggesting a $2.6 trillion loss and counting. This is not chump change. $2.6 trillion and counting.
Kevin: And there’s leverage. And there’s leverage.
David: The second thing is, yeah, you have a leveraged bond market, which is not designed for these sorts of liquidation events and can, at a certain point, succumb to systemic pressures. We’ve noted before that bonds were traditionally a buy-and-hold asset as an income play.
Kevin: Didn’t that change, though, when interest rates were so low you really couldn’t earn any interest, so you started playing it for the move, as far as, are interest rates going to fall more and our bonds go up?
David: There’s always been speculative ways to trade fixed income. But it changed dramatically, as you suggested, over the past decade as your monetary authorities kept a lid on rates while fiscal authorities pumped debt into the system. So bonds have become a capital gain speculation rather than an income instrument, as rates went to zero and then actually went negative, taking away the income appeal and creating an opportunity for short-termism to creep into the bond market. If you know somebody’s going to come in and force the price higher, you just front run the central bank. That’s been a popular trade.
The third thing. So, I mean, we’ve got investor losses, we’ve got a leveraged bond market which isn’t geared for liquidation, and then volatility and uncertainty and the bond market. This is as unexpected and as painful as, I don’t know, playing limbo in a retirement home. Too much, too far, and things break. I’m sorry. That’s just the way it is. So because of the moves in rates, since the Fed started their modest liftoff—again, they moved them up 25 basis points—you’d think, “Okay, well, they’re playing catch-up.” No, actually, the Fed is now 32 basis points further behind the curve because the whole interest rate environment has shifted even more than what they put into play.
So their best efforts have been matched and surpassed by the market, muting any anti-inflationary effect. So small moves—and that’s what we had as a 25 basis point move, kind of a micro move—small moves by the monetary policy crowd end up being counterproductive once you are significantly behind the curve. And I think that’s probably why you’ve got folks like Loretta Mester and James Bullard from the St. Louis Fed, who are asking for more aggressive action up front. They realize you’ve got to show a little bit of muscle here to regain credibility.
Kevin: They have no muscle. I’m sorry. You know, “Bueller, Bueller?” Let’s, “Volcker, Volcker? Is Volcker in the house, right?” I don’t think— That’s real muscle.
David: Not in the house. And the house, frankly, is more fragile than when Volcker was launching his interest rate rocket. So a part of this is tied to the derivatives markets, which are a tad larger now versus in Volcker’s day. Particularly when it comes to interest rate products. Bill King, regular guest on the Commentary here, reminds us of the 500 trillion, with a T, 500 trillion of over-the-counter derivatives tied to interest rate products.
Kevin: Trillion. Trillion is a million million. It’s a million million times 500, is what you’re talking about, is the derivatives market right now. Tied to interest rate price.
David: Tied to interest rate price. Interest rates and prices of bonds. So the importance here is that a lift in rates, like the market is currently forcing, already has leveraged players losing gobs of money. And as they lose, guess what? You have to sell assets to meet margin calls. So they sell any asset they can. And we’ll cover this more a little bit later, but I think one of the dynamics you have with gold, it’s a liquid asset, comes into play at this stage. You’ve got financial market de-leveraging. It does create a momentary pressure for gold where you say, “No, I’m going to just keep these bets in play and make my margin call,” sell what you can to keep it in play. Add to that the opportunity to book gains against losses at month end and at quarter end, and it’s not a surprise to see the late-in-the-quarter equity manipulation to the upside, short-term carnage in the metals markets.
Kevin: So the increase in rates, especially from what the Fed did, is not why the volatility’s there right now, right?
David: You mean in the metals market? No. No, because an increase in rates, that doesn’t cause metals volatility in and of itself. We’re going to discuss real versus nominal yields in a minute. And I think that’ll shed some light on that.
Kevin: That’s been an amazing thing that I’ve had a chance to watch going all the way back to 1987. When you think metals will move up the most, oftentimes initially they’ll move down, and it’s because of the beauty of the liquidity of the asset. Most people don’t understand just how liquid gold is. It’s the most liquid asset in the world when people need money. That’s why gold drops initially in a crisis and then usually spikes.
David: Yeah. You might recall that the 2020 to 2021 easy money trade—I mean, in both senses of “easy money,” easy to make it, and they were printing it as a policy. That was to front run central bank balance sheet expansion.
Kevin: Yeah. You knew they were going to buy everything. Yeah.
David: Yeah. As interest rates went more negative, bond prices reached even higher record levels. So trillions in quantitative easing were going into bonds to subsidize interest costs and drive economic activity. At least that’s what they were doing in theory. What really happened is they were promoting more leveraged speculation and financial instruments than actually economic activity. Nevertheless, the easy money trade delivered $18 trillion in negative-yielding bonds. So $18 trillion in bonds in the global market traded at a less than zero yield. Okay? A mere 2.5 trillion in negative nominal yields is what exists today. So look at all of those trillions that were trading at negative yields; now they’re not. Read between the lines. The bond speculator, hoping for more quantitative easing, is now the bond bleeder. The bond bleeder. 7% of global government bonds are still negative, according to the Financial Times, versus 50% of all government bonds, which were trading at negative nominal yields in August of 2019.
Kevin: Yeah. And so nominal, it’s all in a name. Because if it’s below zero, that’s nominally negative. But you think about it, Dave, let’s say that we were at 2% inflation last year, or 3% inflation last year, and we were getting 1%, maybe, on our Treasurys, or a little less than that. Our real loss—that’s real, not nominal—our real loss was relatively small. At this point, we may have positive rates. Okay? So you talked about almost 2.5% right now on the two-year—
David: Yeah. But the new challenge is that even though nominal yields are rising—
Kevin: Yeah. The real—
David: The real rates are still falling.
Kevin: Huge, huge gap.
David: There’s in essence a radical amount of cheap credit still in the system. And this is one of the things that I think the gold market recognizes; that when you’re still dealing with a negative real yield, you’ve got a tremendous amount of support for the metals market. So take the 10-year Treasury at 2.5%. Okay? We were at about 0.5%, 55 basis points, in July of 2020. The average inflation rate for that entire year, 2020, was 1.2% according to the Bureau of Labor Statistics and CPI.
Kevin: Which means, okay, so my negative rate was really just about 0.5% at that point.
David: Yeah. You were negative 0.5%. If you look at the average through the year, it moved a little higher and a little lower because inflation was fluctuating. So between 0.5% and 0.75% across the various months of the year. Negative 0.5 to 0.75%. The Treasury rate is up. It’s no longer 55 basis points. It’s now 250 basis points. 2.5%, with the average CPI print year to date, take January and February, that’s what we’ve got so far, is 7.7%.
Kevin: Okay. So let me restate that. Okay. If it’s now 2.5% that you can earn on the Treasury rate, and you’ve got a year to date CPI of 7.7, now your negative rate is what? That’s five points.
David: Right? So with significantly higher rates, the real yield is negative 5.2% versus negative 0.5%. Even though interest rates are rising, inflation is rising more. So from 0.5% negative to negative 5— To be fair, the market now expects eight rate increases between now and the end of the year, or an additional 2%. Add that to the fed funds rate. Not the 10-year, just to be clear. The fed funds rate is even more negative at negative 7.2% currently. If inflation does not moderate, then the real fed funds rate increases to 2.5% from the current 0.5 and goes from a negative 5.2 versus the current negative 7.2.
Kevin: Okay. So for the listener who doesn’t want to necessarily try to figure this out right now, they can replay this. You can rewind it, the last two minutes, or you can just know, you’re really losing money, even if you’re— If you’re in Treasury bonds, notes, bills— Yeah.
David: Yeah, yeah. Yeah. Yeah. So I had a client call yesterday and the client call was, “I just want to de-dollarize.” The whole conversation was about Vaulted, actually, and looking at our wealth management service. And I think he just wanted a cash position, but he doesn’t want to be sitting in banks. So his version of de-dollarizing was considering the Vaulted program. So these numbers may have your head spinning a bit, but appreciate the trouble the Fed is in. The gap has to be closed, and it’s not being closed fast enough. Again, so that 25 basis point move, not going to cut it.
Kevin: Yeah. And you cannot Volckerize it at this point, is what you’re saying.
David: Well, let’s look at that, okay? So if the market now expects 2% in terms of interest rate increases between now and the end of the year, that’s eight individual increases of 25 basis points each. You’re talking about—and we covered this a few weeks ago—you’re talking about over $500 billion in new interest expense from that series of interest rate increases.
David: Oh, wait a minute. Biden’s talking about a $5.8 trillion budget. So we’re just talking about adding—yeah, don’t know—an extra 10% for the big guy.
Kevin: Yeah. Yeah. Yeah.
David: I mean that in the best of ways. 10% for—
Kevin: And his son. The big guy and his son. Come on.
David: 10%, 500 billion— I mean, this is not chump change. So just for context, if our current budget proposal is $5.8 trillion, appreciate that our typical tax revenue is closer to 3.5 trillion. So we’re signing on for $2.3 trillion budget deficit, just to be clear. A leveraged financial market— This is like an X Game athlete. I mean, this is really the Catch-22 that the Fed has because they have to close the gap, but to close the gap is basically to suck the oxygen out of the room.
A leveraged financial market is like an X Games athlete; this extreme athlete, crazy, almost unimaginable feats, and yes, the athlete needs all the oxygen possible. So cheap credit, accommodative monetary policy, that’s oxygen. That’s oxygen. You can do crazy things with crazy money. And this is where the Fed has to decide, do they want crazy performance in the stock market, Tesla up 45% in 10 days? Or do they want something a little bit more modest? And this is their Catch-22. You can’t have asset prices going to the moon and also tame inflation. So I mean, the Taylor rule implies that the fed funds rate should be 9.5%. And that’s a level where the markets say, “I can’t breathe.”
Kevin: Yeah. Well, and we talk about the inverted yield curve, but you’d have to be an idiot to think that that’s the only way that you can signal a recession. The yield curve could’ve inverted— Let’s say we did have a Volcker in— He could’ve inverted the yield curve in a positive way, ultimately, because he could have said, “You know what? We are behind the curve. We’re going to get ahead of the curve. Boom. We’re going to blast interest rates.” Because the Fed owns the short rate market. They do not own the long-term rate market. The long-term rates are more market-oriented. It’s buying and selling of the buyers out there other than the Fed. But the short market, the short market they own. So does the yield curve inversion— is it that significant if the Fed gets ahead of it?
David: Well, I think the issue is, we’re not talking about something that’s causal. It’s not like the yield curve goes inverted, and that’s what determines a recession. What you’re talking about is price-signaling in the bond market; the behavior of bond investors who are saying, “We’ve got a different view about what the future holds.” And so you see yields reflect their view of what the future holds. Again, it’s not causal. You could say that the yield curve inversion is coincidental.
Yield curve inversion, is it significant? Maybe. Probably. But as David Rosenberg said a few days ago, over the past 30 years, we had recessions—1990, 2001, 2008, 2020—when the consumer cyclical sub-sectors declined 20% or more. The only head fake was 1998. So you don’t really need the yield curve. The parts of the stock market that represent 70% of GDP are telling you what’s about to happen. So yeah, the fact that consumer cyclicals are in the tank, what Rosie is saying is that recession’s in the pipeline.
Kevin: Right. And he’s not looking at interest rates.
David: No, that’s right. So again, you’ve got a coincidental indicator versus a causal factor. And so I would not be dismissive of the yield curve, but some people are being dismissive, saying, “Look, you can have an inversion and it doesn’t cause recession.” Well, that’s right. That’s right. All it is is a signal of a bunch of people in the bond market saying, “As I look to the horizon, here’s how I’m going to spend my money and how I’m going to position things.”
Kevin: Okay. So is it the central bank or is it the market right now that’s inverting the yield curve?
David: It’s the market. It’s the market. So the late first quarter equity manipulation, you’ve got this as just sort of lipstick on the pig. Our friend Bill King is keen to point out here that the yield curve inversions driven by market dynamics where the central bank is behind the curve, that’s very different than inversions driven by the Fed driving up short rates and leading the curve.
Kevin: Volckerization. Yeah. Right.
David: That’s right. And that’s not what we have. We’ve got the market leading and the Fed following. And as I said earlier, they’re still 32 basis points behind the curve, even from when they raised interest rates a quarter of a point just recently.
Kevin: So you’ve talked about the bond cycle: The bond cycle, going back hundreds of years, we can go back and say, “All right, what is that?” What do you normally call it, Dave? 30, 35 years, max?
David: What I normally call it is, Dave’s been wrong for a long time. That’s what I normally call it.
Kevin: Well, we have talked about it for a long time, thinking it was going to reverse. Has it reversed?
David: I know. Well, it’s because you look at 200 years of interest rate history in the US, and up to this cycle, the longest stretch of interest rates either moving up or down was 36 years. So history sometimes limits the imagination as to what is possible in the future.
Kevin: And what have we been now? 40?
David: Yeah. I mean, 1982— Yeah. 40 years. So and the average is a lot smaller than that. Again, when interest rates begin to shift in one direction or the other, they move in that direction for a long period of time. So it’s likely— Well, what’s likely is that I’ll be wrong again— But it’s likely that the 40-year bond bull market is over. If that turns out to be the case, and a financing supercycle is over, you can expect to see a massive recalibration in the corporate sector. Expect a decade of underperformance in US equities, perhaps more. Look, you got three to four decades of outperformance in US stocks as bond yields collapsed. To see one to two decades of subpar returns in equities should come as no surprise.
So inflation is the catalyst for the end of the bond bull. But perhaps inflation will prove itself to be transitory. Time will tell. The inflation monster, if it is a monster, must be proven dead before bond buyers are out of the woods. So that’s where you could say, if we actually are in the middle of, or partway through, a bear market in bonds, then it’s going to continue as long as inflation remains elevated.
Kevin: Okay. So let’s look at this. Let’s look at this, then. We’ve been talking about short rates being higher than long rates. Why are the long rates down right now? Why do the long rates stay down? What is that signaling?
David: Yeah, I mean, the long bond at low yields says either inflation’s not a long-term concern or it could also say the bond market recognizes that central bank tightening is a short term affair, and that rates are likely to come down again after the hype of tightening passes and the constraints to raising rates very much at all reveal themselves. So again, you begin to see an equity sell-off. And I think, all of a sudden, you’re back to people looking at bonds as a safe haven. Now you’ve got traffic going the other way. So you could argue that the long bond says, “We’ve got trouble ahead. It’s recessionary trouble, it’s economic trouble, and it may even be financial market trouble. And we’re just going to stay pat. We’re not interested in leaving our safe haven just yet.”
Kevin: Well, and see, if Powell were sitting here right now, if Powell were sitting here, I’m just wondering if he would continue with the running assumption, which is that [inflation is] transitory. And his reasoning for the transitory argument was supply chain. Is it transitory? What would Powell say right now? Is that still his running assumption, or is it his hope beyond all hope?
David: Well, inflation is driven by multiple factors. And certainly there’s aspects that are transitory. So if you resolve supply chain concerns, then one of the contributing factors goes away. I think that’s fair to say. But I think the running assumption of the Fed must be that market-driven inflation dynamics will moderate, supply chains normalize, energy costs average out over time. We’re not dealing with a constant spike. And so the deeply negative real yields we were talking about earlier are going to be alleviated naturally. So there’s no need to raise rates too aggressively and then be blamed for triggering an asset meltdown or an economic recession.
So this 25 basis points was the opening salvo in the war against inflation. Inflation’s going to run out of gas. Again, this would be the Fed view. Inflation’s going to run out of gas before we run out of options. That’s got to be an assumption that Powell’s running on. Not really reflecting on the phase shift from low expectations for inflation. And we’re talking about human beings here and sentiment. We’re talking about a phase shift from low expectations of inflation to stubbornly entrenched consumer expectations for much more of the same. And frankly, for as far as the eye can see.
Kevin: Right. Because people have to raise rates if they expect inflation. And so let’s say that you’re running a company and you’re selling Campbell’s Soup. Well, Campbell’s Soup is going to be raised if you think that inflation’s going to continue. At that point, Powell doesn’t have control at all.
David: Yeah. Yeah. The Hard Asset Insights this last week— If you’re not reading that over the weekend, I would encourage you to. Our team puts that together. It’s a great resource— University of Michigan consumer surveys show 32% of all consumers expect their overall financial position to worsen in the year ahead. And that’s the highest level since the survey started in the mid-1940s. Over half of all households expect a decline in their inflation-adjusted income. So again, they may be getting a pay raise, but it’s not buying them more stuff. They’re not having a direct benefit from that. And they expect that to be a negative impact over the next 12 months.
David: So the consumer is saying, “We got a problem here, and it’s not going away.” The Fed is saying, “Look, we’re not getting too concerned about inflation because we expect it to moderate 3 to 4% by year end. We’re going to raise interest rates a little bit between here and there, but we’re going to be a lot closer to no real gap between fed funds and the inflation rate.”
Kevin: You know where the gap is? The gap—
David: Between their ears? Oh—
Kevin: Okay. So let’s say we had Powell in here, and we had the people who were answering the question on the University of Michigan consumer survey. Okay. There’s a huge gap right now. His expectations and what he’s trying to convince them of are not their expectations. Because you said it’s the lowest— I mean, it’s the worst that the— How do you say this? The highest level. Okay. How does that work?
David: Yeah. The greatest number of people who are saying, “Oh, crap, I’m not happy here.”
Kevin: Since the mid-’40s. Dave, I’ve showed you last night—
David: Right. Since World War II. That’s the end of World War II.
Kevin: I’m reading a book right now on D-Day. There were more reasons at that time to probably say, “Oh, crap,” is that what you said was—?
David: Well, and again, we’re not in a recession yet. So we’ve got these deteriorating consumer feelings about their financial position and inflation, and we have yet to be in a recession yet. What does it look like if we do go into recession, going back to Rosie’s comments again, David Rosenberg? Parts of the stock market that represent 70% of GDP are telling you what’s about to happen, full stop.
Kevin: Yeah. Without the yield curve even coming into the picture.
Kevin: Okay. So let’s do a what-if. Okay. Again, Powell’s here in the room and he goes, “Well, all of this was working until Ukraine.”
David: Well, in some sense, it was. But at every turn inflation finds a fresh reason to remain elevated. So supply chains post-Covid have normalized, but only to a degree. Fuel costs, look, they moderate daily, depending on whether Germany and the EU remain captive to Putin fuel supplies. Or this week, what is it? Oh, Shanghai shutting down. Okay. So fuel demand’s going to be lower. The oil markets are sensitive to demand all over the world, including in Shanghai. And if you’re going to shut the whole city down—say that five times in a row—you’re going to find that there’s an oscillation in price. And I think when you go back to Germany and the EU, what you have is oscillation around political calculus. Europe is not at this point banning Russian crude imports. They may, they may not. And they’re reading the tea leaves. They’re reading the audience. They’re getting a feel for how people will vote in light of the consequences of this choice. And so depending on what comes out in the news cycle, oil is up 10%, oil is down 10%.
Kevin: It is interesting, though, Dave; they know they’re so dependent on Russian oil. And so standing on ideology— This isn’t taking sides with Putin or Ukraine or whatever, but just looking at what their rhetoric is versus what they’re actually doing— I think they realize it’s going to be pretty hard to stop taking in Russian oil.
David: Sure. So cancel culture has found its limits in self-interest.
David: So I mean, Putin, the costs are too great for now. And again, crude’s up 10% one day, down 10% the next. And I think it’s fair to keep in mind, not only do the commodities themselves have interesting supply and demand dynamics, but they also are driven by derivatives. And not only are the derivatives tied specifically to oil futures, precious metals futures, what have you, but then there is, as we mentioned earlier, a $500 trillion OTC, over-the-counter, derivatives market that’s bleeding. So you can expect to see wild and inexplicable moves in all assets. And that’s part and parcel to the craziness of these end-of-cycle dynamics. I would mention, April 14th, we’ll talk a little bit about this in the Tactical Short call with Doug Noland. You’re not going to want to miss that.
David: April 14th, save that date. And Doug will explore not only the credit markets in China, but some of the sub-structural issues, which would say, yeah, you can have stocks move higher, but that doesn’t mean they move higher forever. In fact, we’ve seen moves like this; 40% move higher in the middle of a wipe-out circa 2000, 2001. We had a 40% rally in NASDAQ on its way to a— What was that? A 60, 80% decline. Some individual shares, you were down 90 or more percent.
Kevin: So don’t be fooled by bear market rallies.
Kevin: Okay. So you talked about things don’t have to make sense. Okay. Because things don’t have to make sense right now. But what really doesn’t make sense, going back to the Russian thing— Isn’t it strange that while we’re doing these negotiations with Iran, that Russia is so critical to helping us out? How do we have the rhetoric of Biden saying that Putin can no longer be the leader in Russia— Okay.
David: Putin’s a butcher, in fact, but he’s also our chief negotiator.
David: Well, his team is. Not him personally.
Kevin: Yeah, right.
David: But their team is the chief negotiator in the deal with Iran.
David: That is odd that we are still engaged with Russia as a negotiating partner in Iran.
Kevin: And calling Putin a butcher at the same time. Yeah.
David: Is it a surprise that crude oil supplies have been limited from the one place that has the power to pump more now?
Kevin: Yeah. Where is Saudi Arabia? Where’d they go? Why aren’t they helping?
David: They don’t like us. Because, one, we took the Houthis off the terror watch list. Two, we’ve turned a blind eye to the Iranian funding of the Yemeni Houthi rebels that are currently blowing up Saudi Aramco infrastructure. So they don’t really like us. And we’re still in the habit of name-calling with Mohammed bin Salman—MBS, affectionately known as. And number four, we’re seeking a nuclear deal with Iran. How does that strike—? I mean, you go back to the age-old conflict between Sunni and Shiite. I mean, come on.
If Chris Rock is looking for entertainment material, I think the Biden administration offers a lot of low-hanging fruit. Look, no common sense, no clear rationale, which are paths that the administration has chosen. That seems a little bit more appropriate as a laugh line than no hair, which is a health concern out of Jada’s control. And I know this is a sidebar, very much a sidebar, but NBC, and this is— I don’t know when I lost respect for the mainstream media in terms of what they report and how they report it. But NBC really thinks that Chris Rock’s bad taste is rooted in racism and patriarchy.
Kevin: Hmm. Isn’t that amazing? Wow.
David: Really? I mean, this is the same news media that can cover over every truly insulting gaffe that Biden makes, from referencing the Secretary of Defense as the Secretary of State to confusing the Polish president as an ambassador.
Kevin: He did that.
David: Or implying that US troops are going to be on the ground in Ukraine.
Kevin: He did that.
David: Yes, it’s a little lacking in decorum to say Putin’s a butcher and is a leader who cannot remain in power.
Kevin: He did that too.
David: But I think Rock is offensive and he knows it. Biden is offensive and is unaware of it.
David: Which is more dangerous?
Kevin: Yeah. Maybe it’s not even mainstream media. You’ve probably read every one of Niall Ferguson’s books. He’s an interesting commentator, and he was also really worried about what Biden now is saying. And the trip to Europe really was a disaster.
David: Right. Right. Poland was not a roaring success. Now, there’s two books that I haven’t read of Ferguson’s, but he said in the Financial Times, “The Biden administration has apparently decided to instrumentalize the war in Ukraine to bring about regime change in Russia rather than trying to end the war in Ukraine as soon as possible. Biden just said it out loud. This is a highly risky strategy.” Yeah. Yeah. So again, I mean, you want to be offensive and you’re unaware of it— A good friend of mine—actually, the guy who married Mary-Catherine and I—used to say, “There’s two kinds of people in the world. The goofy who know they’re goofy and the goofy who don’t, and they’re the ones that are dangerous.” And that’s the way I feel. It’s like, yeah. Being offensive, if you don’t know you’re being offensive, that’s the problem.
David: That’s the problem.
Kevin: So speaking of goofiness now, most people grew up hearing the story of Joseph. And Joseph knew that there would be seven years of plenty and seven years of famine, and he acted accordingly. That’s what the Bible tells us. Okay? I didn’t know Joseph was Chinese. I’m starting to look at what was going on over the last few years. Did China see this coming, Dave, and prepare by just accumulating all the stockpiles of commodities ahead of time?
David: Well, I can tell you, Joseph would not have been very popular as he was increasing taxes. There was roughly a 20% increase in taxes.
Kevin: That’s true. For seven years.
David: To be able to warehouse and store— Right?
Kevin: That’s right.
David: “I’m increasing taxes. I promise this won’t be forever.” But he actually didn’t keep it in place forever.
Kevin: But China has been stockpiling commodities now, especially for the last two or three years, big time.
David: It was JP Morgan’s observation that while the world is short on commodities, China is not, given that they’ve started stockpiling commodities since 2019 and currently hold 80% of global copper inventories.
Kevin: That’s amazing. 80% of the copper.
David: 70% of corn, 51% of wheat, 46% of soybeans, 70% of crude oil, and over 20% of global aluminum inventories.
David: Consider the possibilities of what would inspire the Chinese to start stockpiling commodities three years ago.
David: I don’t think it was like the US consumer buying extra cans of Campbell’s Soup for the pantry to save a few bucks down the road. I don’t think so. Could they have been planning an event in Taiwan and have been building a strategic buffer ahead of time? I mean, what Russia has proven, to them and to anyone else looking, is that the need for protection, being at the receiving end of sanctions— This is a modern economic weapon. This is something that the Chinese would’ve anticipated, and may have justified building in these huge commodity stockpiles.
Kevin: So you think they’re thinking Taiwan? Do you build the stockpiles ahead of time, knowing that you may be cut off from SWIFT or other types of things?
David: I don’t know. Now the Chinese know there is a global attitude of intolerance for extraterritorial affairs, if you want to call it that. This is not affairs of the heart; not particularly romantic. If you’re thinking of Mariupol, there’s a number of cities in Europe which are no more.
David: And Mariupol is now amongst those, completely devastated. So I think they recognize the global attitude has shifted, and maybe that reaffirms their decision to own more commodities, if they are enticed to any sort of extraterritorial adventurism.
Kevin: You brought up Mariupol. And last night, the chapter that I read was on the Coventry back in World War II, when Churchill knew, and the intelligence community knew because they had translated the Enigma codes, they understood that the Germans were going to bomb the Coventry to the ground. Now, there was a lot of arms manufacturing in that area, but also it was the jewel of Britain, as far as the— I think it was St. Matthew’s Cathedral. St. Mark’s? St. Matthew’s? I don’t remember. But it was bombed to the ground.
And I remember visiting Dresden, Germany, which was the retaliation for that. And those are cities that just ceased to exist because of carpet-bombing. Mariupol, the same type of thing. What we’re seeing— I mean, even to the degree of watching someone— Let’s take the personalities out of it for a second. Watching the Oscars on Sunday night, if I were to explain that a man— Let’s take his name out of it— A man got up on stage and slugged, slapped, slugged, whatever, the comedian who was on stage, you would say, “I really have a hard time believing that.” But it seems to be a characterization of our age. Violence.
And this is why it’s important, Dave, that we talk to the author of the book that you met a few weeks ago on why we fight. What is it that causes us to fight? What is it that causes us—? There’s a lot of reasons that— This book that I’m reading, that you had me read, it has to do with game theory. And I don’t know that those are all the reasons that you fight. Sometimes you just fight because you’re mad. But when countries fight, more often than not, it has to do with gaining a piece of the pie. You’ve got China possibly going into Taiwan. You’ve got Russia already in Ukraine, but— I don’t know how this thing will negotiate out, but they’re not going to be probably leaving with less than they came with.
David: Yeah. When you think about misperception and insecurity and why people move into conflict when they could remain in some form of peace, even if it’s a low-level form of conflict and you’re able to avoid outright war. Thinking about China this last week was fascinating. One evening last week, I sat with a retired British MP. Three decades in politics. And he described Xi as very vulnerable, with a fragile hold on power.
Kevin: Hmm. Really?
David: And I thought that was fascinating. When someone who is 30 to 40 years older than me has an insight, I listen. And I know that there’s more behind it than just the word spoken. But I thought it was very intriguing. One point that we discussed was the 11,000 Communist Party members that have opposed Xi and have been removed or disappeared.
Kevin: Hmm. 11,000. Wow.
David: Now, if you count seven degrees of separation, that suggests that Xi exists in a pit of vipers, all with bared fangs. I don’t generally consider Xi to be between a rock and a hard place in a power structure. It looks like he’s fairly well cleaned things out and is ready for a breeze coming into a third election. Unprecedented, but a third election. But you layer in the count of adversaries that he has, and then count the economic pressures growing for the average Chinese consumer— Because remember, inflation is not our domestic problem, but it’s a global issue. And then count the tick, tick, tick of the time bomb in the Chinese debt markets. You can reasonably wonder whether the Chinese act preemptively to better shape a narrative for the Chinese people around nationalist themes of unification and undivided national interest in support of a deteriorating financial and political picture in China.
Bloomberg had this to say: “You get capital flow data suggesting some level of concern amongst global investors about the security of investments in China, given its diplomatic friendship with the much-sanctioned Russia.” I’ll just say this: When money starts to move, someone knows something. And wouldn’t you like to know why the money is moving?
Kevin: You’ve been listening to the McAlvany weekly commentary. Now, I’m Kevin Orrick, along with David McAlvany. You can find us at mcalvany.com. M-C-A-L-V-A-N-Y.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.