I Just Can’t wait To Be A Bull, But Not Yet

Weekly Commentary • Jul 12 2023
I Just Can’t wait To Be A Bull, But Not Yet
David McAlvany Posted on July 12, 2023
  • Semiconductor Shares Up 46% Even As Sales Are In Freefall
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  • China, Poland, Swiss, Continue To Add More Gold

I Just Can’t wait To Be A Bull, But Not Yet
July 10, 2023

“This is getting teed up to be nothing short of some version of 1929, 1973, 2000, 2008, if you put all of those major bear markets into a blender and said, okay, they’re all unique, but they have some things in common. Overextension, way too much leverage, financial enthusiasm. It’s irrational, and the end of the bears. But basically, at the end of 1929, just before the Great Depression and the collapse in the stock market starts, there were no bears, they were all dead, just before all the bulls were killed.” — David McAlvany

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

David, I’ve been around your family since I was 24 years old and I just turned 60 this year. So I’ve had a chance to almost be a member of the family as you and your siblings were growing up. When I was watching Raiders of the Lost Ark, you were watching Red Dawn and your dad was always talking about communist takeover or the unsustainability of our debt. And actually, it was a great environment to grow up in because it taught you to think, I guess, contrarian. But on the other hand, sometimes there’s this yearning to go, you know what, what if I was just a normal kid? What if I just was watching Johnny Quest and eating my Cheerios and the world was just going to get better and better? So your contrarian thinking comes naturally, but your dad was back from the Philippines last week. You guys spent some time together, and I’d love for you to expound on some of the emotional ups and downs that you’ve gone through since then.

David: Yep, because the contrarian thinking comes at an emotional cost, growing up with a high degree of negativity. There comes a certain point where you just say, I’m done with this. 

Kevin: I want to be a bull. I just want to be a bull. I want to go buy some stock.

David: I just want to be bullish.

Kevin: Yeah.

David: No, but the categories of thinking about finance and economics and monetary policy and geopolitics, and this was dinner table conversations, and it crystallized relationships, the way things work and tie together, and some of the dynamics in play you can’t ignore. I spent some time over the weekend reflecting on market dynamics, positive, negative outlooks on the future. Am I too negative? As I look back at the last 16 years of the podcast, has bearishness set in and permeated my assumptions such that I could only find the pile, I can never find the poem?

Kevin: I remember, it was like 1989, 1990, and we had been negative on the market, and one of the guys that I worked with back then, we looked at each other and said, let’s just go buy something crazy on the bullish side because we’d been bears and we’d been wrong. So we went out and we bought a junk bond fund because junk bonds were doing well at that time, and within two weeks I think we had lost 30%. It was like we got slapped right at the wrong time. So when we got tired of being negative and went out and did something, what we thought was positive, we found out that it doesn’t always work.

David: You can always contrast different kinds of information. On the one hand, the US economy has proved resilient, the labor market continues to surprise, unemployment’s at 3.6%. Last week, the service sector data was strong with many of the components in the ISM numbers improving more than expected. You had 15 of 19 industries surveyed which reported a boost in June activity. So that’s on the one hand. On the other hand, there are the leading economic indicators. You’ve got 14 months of consecutive decline. You’ve got the financial market dynamics at play, which are not sustainable as interest rates are getting dangerously high. The yield curve’s been inverted for a year, bank lending—

Kevin: That’s usually a recession, isn’t it?

David: Yeah. And bank lending conditions, they’re tightening. So equity investors, you could say are pretty enthusiastic, you’ve got bears on the run. And just as an example of that, the Goldman Sachs Index of Most Shorted Companies, it been up 16% in the last 11 sessions.

Kevin: Okay, so let’s talk about that because it’s confusing. So the most shorted companies would be companies where you would be selling short thinking that they’re going to go down, but actually, what you’re saying is, the stocks that are the worst, the ones that probably shouldn’t even be in business, are actually skyrocketing right now, up 16% because those shorts have to be covered, right?

David: That’s right. So if I’m a forensic accountant and I’m looking for problematic companies, things where there could be air pockets, performance where stock prices drop considerably in a short period of time. I’m looking for companies that maybe I could make money on the short side. And so again, fundamentals are deteriorating or they’ve already deteriorated, and they’re just waiting to do the morgue assessment of how this body died.

Kevin: So you commit to basically selling a stock short for some future period—

David: Yeah.

Kevin: —thinking you were going to be buying it at a lower price?

David: Goldman Sachs basically follows and creates an index of the companies that are most shorted. So that’s up 16% in 11 sessions, while the S&P is up 2%. So you’ve got about an eight times differential, the bears are absolutely getting slaughtered. Does it pay to be bullish? Well, in this case, it pays to be stupid, not bullish. Because you would have to say, from the standpoint of fundamentals, they’re deteriorating and you simply have to hold your nose and buy just because. 

You’ve got the leaderboard, five to seven companies responsible for most of the market gains year to date, and they will inevitably lag in the performance game of tomorrow. It’s noteworthy that the indexes have finally said, yeah, it’s so bad, this skew towards a few names. We need to figure out how to reweight the companies, and that’s going to happen this Friday. They’ll make the decisions on Friday and then it goes into effect across indices on the 24th of July. 

So you’ve got the leaderboard, which will change, and when I’m getting at the underperformance of the leaders, that I think you can say is axiomatic. Because you have at the tail end investors overpaying for an asset, and those investors who today are buying those five to seven companies are willing to do so, may wait a long time to make any money, they may never make any money at all. 

Howard Marks is a famous investor, he observed that it doesn’t really matter what a company is, he cares less about what the asset is, he cares everything about the price. And I think that overstates the case. But it does point to this critical notion that value in cost basis is something you can’t ignore. If you’re ignoring cost basis, for better or for worse, you’re going to pay.

Kevin: Well, and I’ve watched that with you and your wife, Dave, because here in Durango, I remember what real estate was doing back in 2004, 2005. You guys were living, if I remember right, in a barn on your parents’ property, and you were waiting for prices to come down. And by about 2006, we peaked out and of course everybody knows what happened after that to real estate, but it was impressive to watch you all sacrifice until prices came down. The house that you bought ultimately, you went positive pretty quickly.

David: Yeah.

Kevin: And a lot of people went negative buying in 2006.

David: We exited California real estate after having seen the house appreciate by over a hundred thousand dollars in about six months, and we thought, this is just, it’s insane, this is stupid, this is unsustainable. And so late 2002, we exited the market. Little did we know that there was going to be about another half a million dollars in value added to that house over the next three years.

Kevin: So you left some on the table?

David: Left plenty on the table.

Kevin: Yeah.

David: But sometimes investors never make any money because of what they pay for an asset. I think of some of our neighbors today who rang the bell and paid record prices in our neighborhood, here in Colorado, back in 2006. So they waited, literally, waited till last year to make any money on their house purchase. 16 years of negative equity because momentum held sway in their decisions, they bought high.

Kevin: And you guys bought what? 2009? 2010? When did you find—

David: Two years later, 2009. And because we bought right, we had equity in the house in 90 days. We bought a house that sat on the market for two and a half years, was discounted from its original asking price by 35%. So we left California, left plenty on the table, we picked it back up on the other side. But we felt for a few years leading up to that like negativity had kept us on the sidelines for too long.

Kevin: Isn’t that always the case? You start wondering, well, how come I’m not like everybody else? Where’s the crowd?

David: It was the unsustainable nature of the asset backed securities market, the mortgage market, which ultimately came to light in the global financial crisis. Where you’ve got a tightening of financial conditions, which changed the game, it changed the game for over leveraged real estate players, it changed the game for Wall Street, who was creatively structuring the CDO market, the CLO market. They even got to the point where they had CDO squareds and CLO squareds, these really fantastical configurations in finance. Cash was king, gold was an excellent balance for our liquidity barbell, and so there in 2009 we were able to step in and do something very effectively at lower prices. A few more comments on gold in a minute.

Kevin: Well, and what you had learned being a stockbroker also had helped because remember this same thing happened with tech stocks going from 1999 to the year 2000, the cap weight on Intel, it was the largest capitalized stock in the world at that time.

David: It’s interesting because at that period of time, some of the hardest lessons you learn are the ones that have true cost. You can look and say, here are the scars. And I should say the best lessons can be the hardest ones to learn. And I remember at one point, Sun Microsystems was down over 50%, and as a young stockbroker, I thought that made a lot of sense, look at the discount. Little did I know that it had a lot farther to go, a lot, lot, lot farther. And you lack imagination for these things if all you’ve known is a bull trend, and that was 20 plus years ago. So Intel having put in a record, this is back to 2000, it was the second-highest market cap in the world.

Kevin: So it wasn’t the largest, it was the second-highest market cap?

David: Second highest market cap in the world. Up to that point, it’s putting in new record numbers and it made people a lot of money. But then, like our neighbors in real estate waiting 16 years to break even, the late entrance to tech nursed losses in Intel for an even longer stretch, 20 plus years. You’re underwater, you paid too much for it and now you’re going to pay the price in time because you couldn’t be patient, now you will be forced to be.

Kevin: So well, don’t you think people are trying to play the trend, the momentum trade? They just see things going up and so they continue to buy.

David: Yeah, and I think for most investors buying an idea, playing a trend, it’s difficult to conceive of anything other than the continuation of that trend. So they’re at the intersection of hope and greed. People rationalize a way that risk and variables— They minimize them in their thinking and a part of that is because of the way they feel. Upside momentum always feels better on the way up, and obviously, it sounds better at a dinner party too. If you’re the guy who’s curmudgeonly, yeah, the sky will fall, we will see prices lower. You want to move on in conversation.

Kevin: It’s like the guy who bets against the table in the game of craps.

David: Absolutely.

Kevin: He’s always the most unpopular guy.

David: No, but you know, it’s the only place on the table where the odds are in your favor versus the house’s. So if you’re just doing the math, it’s the only place on the table to be, the only place.

Kevin: But nobody likes you.

David: That’s right.

Kevin: Nobody likes you.

David: So you have to deal with social pressure, right?

Kevin: Yeah.

David: To be the equivalent of the bear at the craps table. So, yeah, when markets turn, they don’t allow for what most investors assume they have. Most investors are banking on time to duck and cover, time to trim the positions.

Kevin: Oh, I’ll get out. I’ll get out.

David: An opportunity to take profits.

Kevin: Yeah, right.

David: Intel lost 50% of its value in six weeks, pretty short period of time. And the whole way down, you’re thinking, okay, it’s a better price, I should average in. And then this becomes what we now in retrospect know as a multi-decade recovery story. The L shaped, not the V-shaped, recovery that most investors count on.

Kevin: Think of that for just a second, for the listener. Stop. Okay, an L-shaped recovery is actually no recovery.

David: Yeah, it’s down and then on its keister for a long period of time.

Kevin: Exactly.

David: And it’s not the only one. You had Microsoft and Cisco Systems, which gave up their initial 30%, as Intel was as well. And Cisco ended up giving even more, right? 90% loss, on par with Sun Microsystems. So Cisco is down 90% there in 2001. 2023, where are we at? I still believe very strongly is a bear market rally, it’s been sharp, it’s been shockingly strong, but it’s been ill-founded.

Kevin: So I’m going to go back to that L. I love that phrase, the L-shaped recovery, not the V-shaped recovery. Because think about this, as a kid, if you had a basketball and it was fully inflated, you had a V-shaped recovery every time you dribbled it. That’s what it is, it’s a bounce. It’s a bounce, it’s a bounce, it’s a bounce. If that thing was flat, there’s no bounce. If you’ve ever tried to move a trailer with flat tires, which I did a couple of weeks ago, I realized, wait, wait, it’s been all winter since I pumped these things up. That is like an L-shaped recovery. But okay, so I think of companies like Apple, don’t you always win? Isn’t it always a V-shaped bounce?

David: It’s hard to imagine, it’s hard to conceive of Apple giving up a big percentage of its current market cap. It’s the most valued company ever. Back in 2000, just for frame of reference, though, Apple reached an inflection point. It actually was earlier on than some of the tech stocks which gave up the ghost in March of 2001. And so what you had with Apple was, here’s a consumer electronics company, things are not going well, and momentum turns late September of 2000, and Apple sells off 52%, not in six weeks, but in a single day.

Kevin: Wow, it lost half of its value.

David: In a day.

Kevin: In a day.

David: And that was just on a poor earnings report. So maybe it takes six weeks to decline 50% this time around. I wouldn’t be surprised. But think about that, it’s the largest market cap in the world.

Kevin: How much is it now? It’s in trillions.

David: Three trillion.

Kevin: Wow.

David: Which really categorically puts it as the most over-owned stock in financial market history, and all of the buyers today, of course, they can stay buyers and stay holders of that company, in which case maybe you’ve got stability. Is there a circumstance in which they become sellers? At least in the past we see some cycling it through of buyers turning to sellers. What’s more likely in your opinion? We’ve got a company with $3 trillion in market cap. It really doesn’t deserve it as a consumer electronics company. People think high-tech. Actually, they don’t even manufacture their own stuff. It’s really a fascinating business model. Foxconn and others are the ones who are responsible for making the stuff, they just do a really good job at design and marketing. So $3 trillion market cap. What’s more likely? To see another 2 trillion added to that? Let’s round it to 5 trillion in market cap, or are the probabilities greater that you see a 2 trillion loss of market cap back to one from the current three?

Kevin: Yeah. But it’s more fun to think about it going up. And see, that’s the thing, Dave, you are on a college foundation board, and I know oftentimes you’re the curmudgeon in the room. I don’t know, it may be like the guy who bets against the table in craps. I don’t think they even want to see you walk in the room most of the time, but it’s a college foundation. The last thing you want to see is what you saw with Apple back in 2000, where it lost half of its value in one day.

David: What I find is when I show up, there’s lots of opinions. The reason why I still have a seat at the table is because I bring lots of data. And so while I have an opinion about what the data means, the contrast is between data and the conclusion that I got—

Kevin: And a gut feeling.

David: As opposed to lots of opinions, which is kind of, well, the 60/40 mix ultimately works out, or well, stocks for the long run or well—

Kevin: The efficient market hypothesis.

David: We agree completely, we should be reducing our equity exposure from 70% to 69%, start lightening up a bit. That kind of thing is like, okay, I don’t think you heard me, let’s go through the data again.

Kevin: When’s your next meeting?

David: This week.

Kevin: Yeah.

David: Right? So I’ll once again bring some Cassandra-esque warnings with facts and figures that point to troubled financial waters ahead. The challenge, though, is, am I too negative? What we have with the Goldman Sachs’ Most Short Index up 16% in 11 sessions, bulls are on parade.

Kevin: Granted, bears are getting spanked.

David: Yes. So is it worth throwing in the towel and playing momentum, becoming a bull? It’s tough because being concerned with valuations and being informed by a certain version of contrarianism, it’s tedious, it’s unpopular, yet the numbers speak.

Kevin: Well, and the market sometimes goes up when the earnings and the overall structure of the companies that are being purchased is plummeting.

David: Yeah. If you look at the market on a broad basis, not individual companies, price to sales ratio of two and a half times, it’s excessive. That’s too much. The Buffett ratio we’ve talked about pretty regularly. Buffett back in 2001 was in an interview and they said, what’s the best measure of knowing if something’s too expensive or too cheap? He said, well, you just compare the economy itself, so GDP compared to in the Z.1 report gives the number for this, the current value of all US equities. So it’s GDP compared to the value of stocks. 

We got to 210% of GDP, that was the peak, the everything bubble craziness. We’ve backed off to 165% of market cap to GPD. This is the Buffet ratio. And it’s put us smack dab on where the 2000 levels—if you go back 23 years ago, the year 2000, those crazy peaks in valuation were trading just above the tech era peaks now, 165% of market capitalization to GDP. And again, we’re well below the post-pandemic everything bubble, but the question is, where do we go from here? When you’ve reached excessive valuation, typically, the market swings from over to under, it’s never finding sort of the midpoint or perfect valuation. It goes from overvaluation to undervaluation. What we should expect to see in the context of a bear market, at the conclusion of a bear market, is where equities trade at a value of 30 to 50% of GDP.

Kevin: Wow.

David: A fraction of current value.

Kevin: Yeah. I was reading last night, we’re both reading a book on energy right now, and one of the guys who was very successful in the development of fracking, he also was a macroeconomic thinker and he would see supply and demand, and he started to see that the fracking of natural gas, it was wonderful, but it was going to produce over supply. And so he said, let’s go do that with oil. Let’s shift from natural gas to oil. While everybody’s thinking it’s always going to go up with natural gas, he saw the supply and demand. 

We see the same thing with semiconductors. Last couple of years, everybody’s been talking about, gosh, there’s a shortage of semiconductors, we’re never going to get enough. It really was, we even talked about it on the Commentary as being possibly a geopolitical concern.

David: Yeah. Well, that flipped to surplus in a hurry. The interesting thing is, we’ve had tech leading stock performance, those five to seven companies which have defined the upper bound of equity performance this year.

Kevin: And some of those are semiconductor companies.

David: Yeah. But stock performance is not the same thing as operational performance. Company fundamentals are deteriorating rapidly. Semiconductors in particular, up in price, 46%. If you’re looking at the semiconductor index, the SOX, semiconductor index. Stock performance, 46%. Even as year over year sales for that segment, free fall. For April down 22%, at a rate not seen since the 2009 recession.

Kevin: So a 22% drop in one month?

David: Yeah. You also have Taiwan semiconductors on a broader basis. Again, Taiwanese exports—not just the semiconductors, but Taiwanese exports, which are heavily focused in tech, again, and the parts that go into tech—fell 23.4% last month at the fastest pace since 2009.

Kevin: Wow.

David: Global demand for electronics is something of a signal for consumer strength, or on the flip side, weakness.

Kevin: So for the crowd that’s out there buying tech right now, they probably ought to look at actually what the sales are.

David: Yeah, who’s buying what?

Kevin: Yeah.

David: So this notion that prices are sky-high and going higher, that an Apple is going from 3 trillion to 6 trillion. You might look at the probabilities of a return to 1 trillion before 6 trillion. Micron, another example. Further illustration again in the chip sector, and Fred Hickey’s great on this stuff. They’ve seen a revenue collapse of 57% compared to last year at this same time. So year over year, 57% decline in revenue.

Kevin: But their stock is still going up?

David: Yeah, they’ve lost a net $1.9 billion. They’ve flipped into gross margins which are now in negative territory. Gross margins, not positive, negative territory.

Kevin: Yeah, but their shares—

David: Share prices up 26%, year to date. So you’ve got fundamentals which are—they’re not circling the drain, they’re somewhere six, 12 inches below the drain. This is a cataclysm for Micron, and yet the shares are up 26%. There’s these mixed currents of, we should be bullish, look at price action. We should be bearish, look at fundamentals. Where do you settle out? 

This week, we have small business optimism numbers coming out. We’ll have a survey of folks running shops, everything from 7-Elevens to small clothing retailers, you name it. I wonder how that will compare with Dell’s most recent quarterly results. Largest hardware/software provider, two businesses, enterprise software, hardware. Last month’s revenues were off 19.9%. Earnings per share, down 29%. Management expects very cautious IT spending through the next quarter and through the rest of the year. 

Are small business businesses going to feel better? Are they generating more cash flow? What’s the basis of them feeling better? Samsung— When I think about the global economy, you’ve got these indications of problems. The US economy is not in a bad place, but you look at South Korea, you look at Japan, you look at Europe, a number of these places—in the case of Europe and Germany, you’re already in recession, formally in a recession. And so these things are relevant. Samsung electronics, they reported their worst decline in quarterly revenue since 2009.

Kevin: But their share price, their share price.

David: Worst decline in quarterly revenue since 2009. Operating profits fell 96% in the quarter ending in June.

Kevin: Wow. But who cares?

David: Share price is up 28% here today.

Kevin: 28%.

David: Forget the fundamentals, the bulls are on parade.

Kevin: So when I was a kid, Mom and Dad took me to Acapulco, and I saw a real bullfight. I’ll never forget it. It was everything a bullfight is supposed to be. I don’t even know if they still do them, but the way you kill a bull in a bullfight, unfortunately, it’s slowly. 

But I’m thinking about this, you were talking in the very beginning of the program, down deep inside, you just want to be a bull. Just for a little while, let me be a bull. Even though all this stuff is bad, but in a way, that bull has entered the ring. Everyone knows, when the bull enters the ring, every time, without exception, the bull is what leaves the ring dead. And so interest rates, I have to figure. With interest rates staying high and inflation still not being tamed, is that what kills the bull?

David: Yeah, and interest rates are the real story in recent days. And if you’ve ever wondered how that contest with a bull ends, that’s the ticket. Just let interest rates rise, bloodier than a bullfight in Pamplona.

Kevin: Yeah.

David: Right? A further rise in rates is the delivery of spears to the bull’s neck, it’s the capitulation, it’s bloody, and the financial markets are ill prepared to stomach it. You’ve got an investor class which has moved back to a bullish setting. I looked at the Greed-Fear Index on Monday morning, and sure enough, it’s in the very greed category, not the minorly greed category or the middle. We’re back in greed mode.

Kevin: So it reminds me of when the Economist magazine, the front cover said the “Everything Bubble.” Are we in the everything bubble with absolutely no fundamental basis?

David: No, no, no. There’s pockets of weakness, they just don’t show up because of the weightings we’ve talked about. You don’t have an equal weighting in the indices which are most popular.

Kevin: So you’re saying five to seven stocks may be pulling everything up, but we don’t have an everything bubble?

David: It’s window dressing though. Take for instance, commercial real estate. Commercial real estate in some geographies is already down 20 to 40%. Morgan Stanley says, universally it’ll be down 40% if not more. This is chaos in the real estate markets. Oh, but not residential real estate, just commercial today. Flirting with the level of rates we see, if you’re looking at the two-year, if you’re looking at the 10-year Treasury market, we’re bordering on a breakout to the upside.

Kevin: So the interest rate is bordering on a breakout? Not the value of the bonds, but the interest rate?

David: Yeah. So if bond yields go higher, if they break out, there will be chaos in every tradable asset, from stocks to real estate to fixed income with any duration. The bull market in everything will solidly express itself as the bear market in everything. 

So where are we at today? We’re already revisiting the recent highs. March took the two-year above 5%, very briefly. 10-year was over four, very briefly. They quickly reversed to lower levels by the end of that month, back in March. We’re back to those same levels again. Back to testing financial market tolerances, and time will tell who’s affected by the moves. But rates are, as we speak, at 15½-year highs. Governments and marginal borrowers are not prepared for any more pain. The bull, go back to the bull in the ring. The bull is strong, but stamina gives way when you’ve got pain and suffering. 

And so we’re talking about the precursors, an increase in rates, the precursors to outright capitulation. Higher rates for longer will re-price existing fixed income portfolios, they will stress marginal borrowers, it will constrain economic growth. So the Fed may win on its inflation fight, but it will take breaking things for the victory to be counted.

Kevin: About three months ago, we saw something breaking with these higher interest rates because people started making the decision, just like you have, to start moving cash out of the banking system. If you can get 5% on a Treasury, why in the world would you sit around in a bank at 1½ or 2%? So we’re not just talking about killing a bull in the ring on the financial markets, what happens to the banks?

David: Banking sector is just as vulnerable. Just to replay the banking sector drama, that’s a clear possibility over the next few months. Last week, we mentioned BofA’s 100 billion in portfolio losses. Of course, they’re not marking those to market, but higher rates for longer is a killer for banks. It’s a killer for bond portfolios. It’s a killer for leveraged loans. It’s a killer for CLOs, collateralized loan obligations. It’s a killer for private equity deal flow and financing and refinancing of private equity. Last week’s global bond moves carry with them extreme financial market consequences. Things will break. 

So back to the banks, consider the S&P global, we subscribe to them, and in one of the reports they put out this morning was on the cost of deposits rising in Q1, first quarter, cost of deposits. The other way of looking at that is if you’re the depositor, this is the income you’re receiving on your deposit. Does that make sense?

Kevin: Okay, so it’s the interest the bank pays to the depositor?

David: Yeah. So the bank categorizes it as the cost to have the deposit. Well, if the cost of deposits for a bank is rising, maybe there’s no need for deposit migration, what we call the bank walk.

Kevin: If they could compete with the Treasurys?

David: Yes.

Kevin: Yeah.

David: That kind of migration would be over if they’re actually going to pay a market rate. But the details, the average cost of deposits for US banks, and these are fairly sizable banks, but not huge ones, anything under 10 billion in assets. Cost of deposit’s 0.85 of 1%, 85 basis points. Now, that’s up from 54 basis points, about half a percent, fourth quarter, 2022. Up from a quarter of a point, fourth quarter of 2021.

Kevin: So still less than 1%, yet three month T-bill pays what?

David: 5.4%?

Kevin: Yes. So why? Why would you even sit in the bank?

David: No, do the math. The difference between 85 basis points and five and a half or 5.4%, 4.55%. The that’s what it costs a depositor to keep money at a bank, 4.55%. That’s the interest a bank is willing to pay a depositor, again, 85 basis points, or you can move and for virtually a risk-free position, 90-day Treasury obligation. I wouldn’t walk, I’d run.

Kevin: Yeah. Running from the bank. But the thing is, we’re talking right now just about the United States, but rates are rising worldwide.

David: Well, and that was fascinating because last week, they were higher all over the world. Notable shifts higher in Italy and Greece. Notable shifts higher in Germany. The UK is an absolute disaster, but they’re higher everywhere. 

So the fixed income investor has begun to come to terms with economic data last week, which implies rates will remain higher for longer. And that’s what the central bank community has been communicating: We will have to raise rates. Powell and team with the Fed have been very clear. We’ve got one or two more rates. We’re going to pause, but we have more work to be done. They’ve said it over and over again. 

Here’s the reality, higher for longer tests financial market tolerances and investor pain thresholds—which, frankly, have been overwhelmed by market positivity. Investors have basically said, we can ignore it. It doesn’t matter. We think rates are going to be significantly lower by the end of the year. Engineers in the audience will appreciate the word tolerance because you’re talking about a threshold, you’re talking about a permissible limit beyond which normal functioning ceases or failure occurs.

Kevin: And I think about these central bankers, and they still talk about a soft landing. I was learning to glide in Boulder, and the instructor allowed me to have a very, very hard landing in a Schweizer glider. And you sit right on top of the wheel in these gliders, it’s got one wheel and you’re right on top of it. And I remember coming in and not flaring. Flaring as you know, is when you pull back on the stick right before you touch down. 

Well, I didn’t flare, and I still feel in my jaw and in my teeth the pain of that slam to the runway. And so my question would be this: are we going to have what I had—a hard landing? You were talking about engineers, can they engineer this thing for a soft landing? No bank failures, no market crash, easy—virtually no—recession? Are we going to have a hard or soft landing?

David: I seem to remember the worst landing I ever made was the second bounce where I flared too much. Came down and touched-

Kevin: I understand.

David: And I don’t know what I thought, but I pulled back.

Kevin: It’s called ballooning. Yeah, yeah.

David: I ballooned, and boy did I—ooh, I felt that one.

Kevin: But you got it down safe, and that’s what I’m asking, are they going to get it down safe?

David: Hey, we’re all going to walk away.

Kevin: Well, that’s a good landing.

David: Yeah. And so whether it’s soft or hard, we’re going to walk away.

Kevin: Okay.

David: And so maybe this is the bull in me speaking, we’re going to survive this. Whether it’s a hard landing for the economy or pressure in your more vulnerable tiers of credit, high yield and the more risky, bond investors are having to reconsider this higher for longer, the length of the inflation fight, and the cost to tame it. Great interview in Financial Times with PIMCO Chief Investment Officer Daniel Ivascyn. PIMCO is battening down the hatches; largest single bond fund manager in the world, about two point—maybe 1.7 trillion in assets, if I remember correctly. He says the market’s too optimistic about central banks and their ability to dodge recession even as they’re battling inflation, both here in the US and Europe. He says, “a great trade will be to take advantage of the violent repricing of the public markets and then wait for private markets to adjust over the next few years and then rotate into what should be a really attractive opportunity. Hold some cash because we think the next two or three years is going to be target rich for opportunities in the higher yielding space.”

Kevin: Okay, so that’s the quote. But are they talking about equities or are they talking about bonds here? When he talks about a radical repricing or very quick—violent is the word, right? Violent repricing. Is he talking about interest rates?

David: The difference between publicly traded assets and privately held is just the market that they’re trading in. So publicly traded would be if it has a ticker symbol attached to it, and that could be a bond fund, that could be a collection of bonds that’s been put into an ETF instead of a mutual fund, or it could be stocks. There’s almost 11,000 ETFs today. 

Think about this, there’s almost more derivative products relating to underlying stocks than there are actual stocks, it’s a fascinating thing. So what he’s saying is that you see the first round of pain in the publicly traded markets. This is where people can get liquid the fastest. Then you wait, then you wait because it’ll trickle down to your privately held assets. And when you’ve seen the evidence of decline in the privately held market, then you know it’s time to enter the market.

Kevin: It’s like you and your wife with the house. 2006 was not the time to enter, but 2009 turned out to be excellent timing.

David: Yeah. So the mortgage backed securities market, you had publicly traded assets which suffered through the global financial crisis, 2008 and into 2009. Then we went to the private markets, we bought our house in November of 2009 in the private markets. It had washed out, we basically bought the low in Colorado real estate. And that’s what the PIMCO CIO is arguing. Now, what he does suggest, something that’s really fascinating, because I think this has implications for the private equity market as well, not just private markets, but private equity markets where you have to see things wash out there as well. So he still has these concerns that this cycle might see central bank interventions less aggressive than we’ve seen in the past. In fact, he says this could be more like an old-fashioned cycle that lingers for a few years with inflation high, but policymakers not coming to the rescue.

Kevin: Well, when we talk about these soft and hard landings, but the United States, we’re still trying to figure out whether we’re going to go into a hard landing or a soft landing. Some of these countries worldwide, they’re already clearly in recession.

David: Europe’s in recession. Germany’s in a bad place, recession. China’s not far behind. South Korean export figures suggest that they are suffering from a significant lack of consumer demand. We talked about Samsung earlier, and I mentioned Taiwanese exports earlier as well. Scandinavian countries under both economic and monetary pressure as they have fiscal blowouts and they’re devaluing at the same time. It’s just a disaster. So perhaps the US will fare better. Maybe we avoid recession. I doubt it, perhaps not. 

I would agree with the PIMCO CIO, the public market domino is an early one to fall, private markets will feel things on a delayed basis. Private equity is a part of that. Vulnerable, and it’s a 24 to 36 month time to clear from the point you see major hemorrhaging in the publicly traded markets. Because you basically have inventory that’s held privately that can’t be held indefinitely because as interest rates continue to rise, you’re talking about leveraged players who will have to refinance their paper, and they can’t afford to do it at higher numbers. As they are forced to do it at higher numbers, all of a sudden, the economics fall to pieces. And what made sense in a zero rate environment makes no sense at all in a normalized rate environment.

Kevin: Well, it reminds me of the dangers of the carry trade, too, because not only are we looking and trying to figure out interest rates, but if you’re working in multiple currencies, that can wash you out. The currency markets play a huge role in this.

David: Yeah, you’ve got a compounding of complexity with carry trade dynamics. We’ve been talking a lot recently about the yen and the RNB and the pressure that they’ve been under—staging a small rally in the last couple of days. You step back from a two-week rally, if you will, for the RNB and yen. The Chinese in fact intervened, so they’re trying to verbally boost it. It reached a level, it was critical, and they’re doing what they can to talk it through. But you look at their fiscal policies and that the RNB is going to trade considerably lower. You’re seeing it with capital flight, you’re seeing Chinese people moving as much money as they can to Hong Kong and to insurance products to get away from direct exposure to the RNB. And like rats running off of the lines, jumping ship, something’s wrong with the boat. You may not be able to see it, but the traffic of rats is telling you there’s a problem here. 

And I think that there was a guy back in ’97 to ’99 who worked in the Japanese government, I think he was ex-vice finance chair, and he was known as Mr. Yen because whatever he said would drive the yen either up or down. He was the guy who understood the currency markets. Just in the last day or two, even as the Japanese yen is rallying along with the RNB, he’s warning of the yen collapsing another 10% through its recent 30-year lows. And why? Because of loose monetary policy, because Ueda is continuing to do what he inherited, a holdover policy of reckless design. 

So both of these currencies, the yen and the RNB, incredibly vulnerable. If you want to review Hard Asset Insights on our website, McAlvany.com. Go to the wealth management section, look for Hard Asset Insights under the information and resources part of the site. Hard Asset Insights this past week, you’ll see a clear step sequence to the same thing for the US dollar. Weakness tied to debt, deficits which are bigger and bigger by the day. Why do we say that? It’s a bigger deal in a higher for longer environment. There is a negative compounding effect as you increase interest rates. The obligations which you signed on for, which are not just one year, but 10 and 20 and 30 year obligations, are more expensive. And it turns the fiscal math inside out, upside down, it’s wrong sided. It’s untenable, strictly untenable.

Kevin: Well, and that’s why, honestly, Dave, and I know managing money is something you enjoy, but I enjoy sleeping at night and I buy gold. And I’m not saying people shouldn’t be doing anything else with managed money, but a lot of complexity is eliminated. We just had our weekly staff meeting right before we came in here and recorded, and it reminded me of a story because, okay, the Chinese right now are buying gold. They are buying physical gold, and a lot of other central banks are buying gold. You’ve been outlining that now for the last few weeks. But the ETFs, like GLD, the ETFs are seeing an outflow of gold. The typical investor’s going, I don’t think— I think we’re in a bull market, let’s just go ahead and sell our gold. 

So there’s this interesting pattern, and I remembered a story. There were three guys here, I was one of them, that it was a Friday. It was April 12th, 2013, and the markets were quiet. It felt a little bit like now. And so we went fishing. We went to Lake Powell, out of cell phone range. We all went fishing and left the office to be tended by a couple of other people. And sure enough, that day, gold fell a hundred bucks, and then that next Monday on April 15th, it fell another hundred bucks. And so the ETF, the GLD ETF, 700 tons of physical gold left, you know what the average investor’s going to buy, it left that GLD ETF fund, but it ended up in the hands of the Chinese. They got a $200 discount. And in a way, we’re seeing this pattern repeated right now. Maybe not to the same extreme.

David: Yeah, only I don’t see the weakness in gold. I think what you’re illustrating very well is that there’s a difference in audience, there is an eastern and global audience, which sees gold, likes it, and is buying it aggressively. There’s a western audience that sees Samsung up 28% and says, I’d buy that. Even though you’re talking about a 96% in operating profit decline. It doesn’t matter, the price is going up, I want some of that. Give me some of that.

Kevin: Well, you make a great point though too, because the price of gold did drop when that happened. We’ve been seeing very strong gold based on some of the flows.

David: That’s exactly right. That’s exactly right. Now, I called my colleague Doug Noland this morning, and I said, Doug, I’d like to be 300% short, how we’re going to do that?

Kevin: I want to be a bull, but I’d rather be 300% short.

David: Yeah. At this particular point in history, I think owning a lot of gold and staying very hedged makes a lot of sense. China added to its holdings of gold for the eighth consecutive month. Not a huge number, 23 more tons. I guess that’s real, it is real money and those are real ounces, 680,000 ounces.

Kevin: Yeah. Wow.

David: So that’s 183 tons more since November for the Chinese. The official total is now at 2330, that’s a couple of tons. You look at the context, and it’s Chinese social and political instability on the rise. There’s a risk of the economy, in this context of failing to recover, becoming really problematic from a social and political standpoint.

Kevin: And how about the real estate?

David: Real estate developer sector moving into a second wave of decline. If you look at the yields on Chinese developers, they’re not up 50 basis points this week. Some of them are up 10 percentage points this week, and up 30 or 40 percentage points over the last four weeks. So we’re in a second wave of freefall within the Chinese developer sector, and they can’t stimulate growth. They’ve tried. It’s not working. But the Chinese, they’re not the only ones buying gold.

Kevin: No.

David: Polish added 34 tons in recent months. You talked about the Swiss. Well, actually, you didn’t, but that was the Nexus. When GLD liquidated, gold went to Switzerland, was converted to kilo bars, and then you saw the exports out of Switzerland to China skyrocket. So how do we know the 700 tons went from GLD to China? You just follow the footprint through Switzerland to kilo bars, onto both Shanghai and Hong Kong.

Kevin: Huh. That’s how they knew. Yeah, I wondered. I’m glad you did, I’m learning stuff every time we do a Commentary.

David: And part of the reason is because the Swiss are major refiner, they’ve got a couple of different refiners there. 54 tons to China here in the last month, and that includes China and Hong Kong. 31 tons to India, 18 tons to the United Arab Emirates, 12 to Saudi Arabia, nine to Turkey. This is tons, by the way. And this is even as Western investors are dumping gold. If you look at May and June, you’ve got an exit from the ETF. You’ve got less interest in gold. And if you go back to when we put in the high, we’ve retested the highs. But we put in the high of August, they’re in August, 2020, that was the price peak. GLD has shed 342 tons. That’s 342 tons of outflows, 27% of the holdings in the fund since—

Kevin: And that’s the western investor? That’s the western investor.

David: Right, so your point earlier about this audience is different, Western investors see through a particular lens, and the rest of the world is seeing the world from a different vantage point. And who’s right, who’s wrong? Time will tell. But I do know that by the end of July, it will be out of a seasonally weak period back into the love trade. They call it the love trade because of the Indian wedding season. Always, you see a big influx of physical demand for gold. And I can’t say it strongly enough, add on any weakness, 2100 is a ceiling, but not for long. So if I’d like to be 300% short the stock market, I know I’m just speaking more emotionally here, but I’d like to be 300% long gold.

Kevin: I understand.

David: This is getting teed up to be nothing short of some version of 1929, 1973, 2000, 2008. If you put all of those major bear markets into a blender and said, okay, they’re all unique, but they have some things in common. Overextension, way too much leverage, financial enthusiasm. It’s irrational, and the end of the bears. But basically, at the end of 1929, just before the Great Depression starts and the collapse in the stock market starts, there were no bears. There were no bears, they were all dead just before all the bulls were killed. So what do we have? 1929, 1973, 2000, 2008, I’m not sure. But 2100 is the ceiling for gold—not for long.

Kevin: You’ve been listening to the McAlvany Weekly Commentary. 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.

Our listeners should be advised that McAlvany Wealth Management maintains positions in GLD ETFs for our client accounts. 

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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