Markets Fall: The Difference Between Old VS Bold Pilots

Weekly Commentary • Jul 05 2022
Markets Fall: The Difference Between Old VS Bold Pilots
David McAlvany Posted on July 5, 2022
  • Secular Bear Markets are substantially longer & deeper than cyclical bears
  • Dollar up over 11% – Gold only down 3.3% YTD
  • NFTs (Digital Rocks) lose 90% YTD


Markets Fall: The Difference Between Old vs. Bold Pilots
July 5, 2022

“You have bear markets account for up to 40% of all timeframes in terms of market trading going back to 1877, and then the last six months of pain are just the introduction following a greater than 12-year expansion. Cash and gold. Haven’t we said that before, Kevin, where— You want optionality. There’s your justification for cash, but you have to have stupidity insurance.” — David McAlvany

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

I can’t help but think back to the year 2000, the tech stock bubble. I’m thinking January, February, about the time of the Super Bowl. And the tech stock bubble, it was flying high. You had sock puppets that were representing companies that were worth more than all the airlines combined, and it was just pet food online. It was this vision, vision. I think of the commercial—this was in the year 2000 before the tech stock bubble blew up—I think of the commercial—this Super Bowl, Dave, with Matt Damon. It starts out and he says, “History is filled with almosts.” So he starts shaming people immediately for not buying what he’s talking about. “There are those, however, who embrace the moment and they committed.” Then he ends the commercial. He says, “Fortune favors the brave.” Of course, you remember the scenes. He’s walking past guys climbing mountains and Magellan and his boat, and trying to let you know that if you go to crypto.com, that’s the future. Now, here’s what I remember from that. The year 2000 changed within a very short period of time, and those who had those tech stocks that were just never going away, a lot of them did. What we’re seeing is the same type of thing right now in the crypto space, even in the speculative FAANG stock space. What are your thoughts? Is this going to be short lived, or is this going to be long and painful?

David: This weekend over the 4th of July, we stopped in a place called Pagosa Springs. It’s known for its hot springs. Right along the edge of the river, there’s a place where you can go and soak for free. We call it the hippie dip because it’s kind of a locals-only.

Kevin: It’s right in the river. These hot springs are in the river.

David: If you want to pay 40 bucks, you can go to the spa—per person, or you can just go to the hippie dip and kind of hang out with the locals. And it gets colorful. I’ll say that. On the 4th of July, we’d never seen that many people down at the hippie dip.

Kevin: Just the whole family?

David: You say fortune favors the brave, the whole family’s there. We’ve got to pull the kids aside and say, “Sometimes bravery can be confused, and it’s just flat stupid.” There’s a kid probably 16 years old. Into the rapids, he decides that it’s a great idea to dive head first straight into the rapids. You can’t see what’s underneath the waters. You have no idea what’s going to happen next. You have belief that you’re going to make it through. It looks as if the way the water curls up and out, there is no major rocks.

Kevin: At the moment you feel like fortune favors the brave.

David: And that’s how he’s feeling, is fortune favors the brave. I’m downstream in the middle of the river actually waiting to drag him out because this does just not look good. Fortunately for him, nothing bad did happen. Mary Catherine and I are comparing notes, going, “Let’s make sure the kids understand, floating is fine. Diving headfirst is not a mark of intelligence. It’s a mark of someone who hasn’t had their prefrontal cortex fully developed yet, and in that sense, this is sort of a brainless wonder.” I wonder if to some degree we don’t have that same sort of diving headlong into something you don’t fully understand in the crypto sphere.

Kevin: Dave, being a pilot, you’ve probably heard the old saying, “There are old pilots and there are bold pilots—

David: Bold pilots.

Kevin: —but there are no old, bold pilots.” My question is, because everyone is feeling pain. I mean, even gold’s down, but it’s only down 3% or 4% total for the year. But everyone’s feeling pain in the stocks. More people have stocks now than ever. Everybody’s feeling pain who got into the cryptos. I don’t think there’s any exception to that. My question is, you’ve talked about this being a secular bear market instead of a cyclical bear market. Now, the difference is the cyclical, it’s a short bear market. Secular, that’s a longer kind of pain.

David: Secular—

Kevin: What are we looking forward to?

David: Secular bear markets are just different. They extract more, emotionally. When you look at a cyclical bear market, it corrects the short-term enthusiasm, and it keeps the investor’s sentiment from staying wild for too long. It feels a little bit more like tapping the brakes. Secular bear markets, they cause lasting trauma. It’s akin to a multi-car pile up.

Kevin: Like the book Anatomy of the Bear.

David: Right. We’ve had conversations with a number of people who have not only the data to back an opinion, but Alan Newman—you might recall our conversation with Alan, whose father was a broker through the Great Depression who left his career in the wake of that experience and locked away his shares in physical certificate form in a safety deposit box.

Kevin: He never wanted to remember it again. He never wanted to see the stock market again.

David: He didn’t care what they were worth. The experience was so unpleasurable that he just had to leave it as a historical footnote. So his interest in the markets was broken. It’s fascinating because pleasurable experiences are never the memory makers that painful ones are. We kind of need more—

Kevin: That’s true, isn’t it.

David: —and more and more. But one really traumatic experience— Trauma lasts beyond the moment because, in some sense, it’s etched into our bodies and minds at a biochemical level. So this bear market is more than a short-term cyclical correction. It’s more than a mere tapping of the brakes. This is a big one, and it’s going to take time to unfold. It’ll leave no one undisturbed. So I would implore you, review the interviews we’ve done with Russell Napier, with Ed Easterling, for a broader perspective on secular bull and bear markets. Their books are required reading for anyone wanting to thrive through volatile and dangerous trends.

Kevin: That was an amazing book. The Anatomy of the Bear, and what Russell Napier did in writing that book, it was an amazing amount of research. He read every Wall Street Journal from— I think he started back in 1896, didn’t he, or whenever the Journal started. Anyway, he read the Journals all the way through the Depression, and then beyond to see what the news looks like, what the numbers look like. He was mainly looking at equities. But bonds, Dave, when people are running from the equities markets, they have to find somewhere to go. They’re going to go into either currency, or they’re going to go to gold, or they’re going to go to bonds for a period of time. This is a dangerous bond market because we probably are in a rising interest rate market, which is counterproductive for bonds. But people are also having to hedge against a recession, aren’t they?

David: Yeah. All markets trend directionally for a good long period of time. We’re talking about stock secular markets, bond, secular bull and bear markets, and we’re talking about things that can last years, in the case of bonds even decades. So bonds have been fascinating to watch over the last few weeks. You’ve got recession concerns that are showing up as a bid, that is, people stepping into buy Treasurys and Bunds, German 10-year treasuries as well. Yields, if you’re looking at corporate bonds, yields have not deteriorated, moving higher, expressing real stress in the corporate bond market, but notably the cost to ensure against default, both in banks and high-yield bonds, investment-grade bonds. Those credit default swaps have stayed elevated even as Treasury yields have moved lower. So in essence, you’ve got spreads widening. That’s generally not a good sign in the financial markets.

Kevin: When you’re talking insurance, what you’re talking— the acronym would be CDS, credit default swaps, CDS. When you hear these acronyms, a lot of times it’s an insurance acronym. It’s a derivative type of acronym, but credit default swaps, that’s a way of ensuring against default.

David: That’s correct. If you look at the markets today, it’s pretty interesting. You’ve got the idea that you could have a pivot to interest rate cuts because now all of a sudden there’s recessionary concerns. So people who are interested in anticipating future policy courses and their implications for the financial markets, they’re now placing a different set of bets. You think, “Oh, we’ve got inflation. Therefore, interest rates are going higher, and that’s going to be the state of affairs henceforth.” Oh, but wait. There is the Fed who will likely cut rates if we have a serious recession. However, and this is where things get really dicey in the markets, there’s no certainty that they will act. There’s no certainty that they will act.

Kevin: It’s an artificial market. How do you judge an artificial market?

David: I thought it was fascinating. Earlier this week—we’re coming off of a holiday. The markets open down considerably. Everything is down considerably. Then again, there’s this notion that maybe if things are bad enough in the stock market there will be a pivot and we’ll see rate cuts. All of a sudden, you’ve got three things that notably, on Tuesday, start to trade into the green. You’ve got the ARK Innovation Fund, Cathie Wood’s fund, and then the Coinbase, which is one of the big exchanges for cryptocurrencies. It trades into the green after being significantly down in the early part of the day. And NASDAQ trades green while the Dow and S&P are still off 1% to 2%. So it’s just interesting because risk appetite returns immediately—immediately—and that is not the sign of a mindset which has been broken down and would indicate that we’re anywhere near the end of a true secular bear market.

Kevin: If you want to be a bull, you’re going to be a bull. If you want to be a bear, you’re going to be a bear. You’re going to read things that way. It reminds me, this weekend, I was flying back from a trip that I went on. There was a baby crying very loudly before we ever took off. No big deal for me. I mean, I’ve had kids. I understand babies don’t want to be in that situation. This is even before we took off. But I heard something I had never heard before. The flight attendant called from the front and she said, “It’s okay. It’s okay. Let the baby cry. It’s better for them later. It opens up their ears before we take off.” I thought, “Well, that’s sort of a positive way to think about something that everybody in the plane was negative about.” But I think about the Federal Reserve. We’re the baby. If we cry loud enough, in a way, a dropping market like what we saw early Tuesday morning is probably encouraging to the person who’s like, “Well, see. The Fed needs to lower rates again, or they need to start QE again.”

David: Right. And that’s the assumption is that they will do that again. That’s the ingrained behavior within the marketplace. Things get bad. That’s good news. So you can see things trade higher because risk on is the inevitability. What’s fascinating, though, coming back to insurance, we have bank credit default swaps pretty uniformly at year-to-date highs. So even though you’ve had some positive signals in the stock market, yes, there’s negative signals in terms of the economy, we’ve had a very clear signal from bank CDS that there is concern which remains. The same is true in Europe, looking at investment grade and high-yield debt, and the indices for investment grade and high-yield debt in Europe. Yields are not moving higher at this point, but insurance prices are steadily rising.

Kevin: Is the dollar a form of insurance right now? Because it’s confusing. We know that the dollar— We’re in a high inflation environment right now, but it must be that other countries worldwide are in a more difficult situation because their currencies are falling. The dollar’s been rising. Is that an insurance play?

David: I think to some degree it’s what El-Erian described back in the global financial crisis, the US dollar being the cleanest dirty shirt. Or our friend Ian McAvity, who’s no longer alive today, used to describe it as the best looking horse in the glue factory. I don’t necessarily think the US dollar gives us a lot of information. It does, as it increases, significantly stress the emerging markets. So emerging market debt—probably the very worst in terms of credit default swaps and the pricing there—the price is moving higher. Again, it brings us back to the dollar. It’s up 11.6% for the year.

Kevin: Against other currencies, but it’s still falling in buying power. That’s confusing.

David: So we have inflation, double digit if you’re using older metrics, 8.5%, 8.6% [officially], but simultaneously, while you have inflation, you get weaker currencies elsewhere—which help the dollar show more favorably on a relative basis. That can be confusing because inflation equals devalued currency, less purchasing power, but it’s appreciating at the same time? Yep, that’s right. So a strong relative dollar—that’s what’s played out over the last five, six months. 

So we’ve got gold, which has been over that five-month period at least, it’s had positive to breakeven performance. Then here over the last 30 days, now we’ve got gold—gives up a little ground, 3.3% lower year-to-date. In other currencies— what’s fascinating is that in other currencies, that weak performance relative to the dollar shows up as gold strength, so gold is positive year-to-date in other currency terms. Not so in the dollar. 

So for the US investor down 3.3. 105 in terms of the euro/dollar index. It was the point of transition for the US dollar, tempting fate with higher numbers—maybe much higher numbers. Sure enough, now we’re at 106.72 at the present moment. That’s really meant for us as asset managers in the hard asset space with an interest in precious metals, particularly looking at some metals equities and things like that. We’ve got to be very mindful of risk, and we’ll have to take risk off to the degree that the currency continues to melt higher.

Kevin: One of the things that you can’t live with is, let’s say you’re an emerging market currency and your debt is denominated in dollars, you’re having to pay back in those higher dollars. How does that work out? Does that create a pressure that ultimately breaks?

David: Well, I think that’s why you’ve seen extraordinary pressure on the emerging market credit default swaps. As the US dollar rises, it does put extra pressure on emerging market currencies and emerging market debt with large quantities of foreign denominated debt in countries like Turkey. Going back to Russell Napier, we had a conversation with him two, three years ago where he counted up all of the euro- and dollar-denominated Turkish debt. He said, “If you want to know one country that will have to inflate or is likely to be a fly on the grill”—of the car, that is. Turkey is— We’re not moving to protein-based diets quite yet, not that kind, not—

Kevin: 4th of July is still very present and on my mind.

David: But these are obligations that would be difficult to pay back. Sure enough, the last few years for Turkey have been very, very difficult. Yeah, you’ve got the currency differentials which widen, and it puts even more fiscal stress on those countries. 

The other dynamic with super volatile foreign currency markets is that leveraged speculators, which the hedge fund community or whatnot, they get whipsawed. In the context of currency borrowing, cross-border currency borrowing, the carry trade, on a leveraged basis, this gets really tricky. Hedging is less and less economical. So you do face a certain point where volatility means you’ve just got to go to the sidelines and close out positions. That becomes an exaggeration for volatility as I just— You can’t hedge any risk, or, to the degree that you want to, you can’t. So you just start raising cash.

Kevin: So you wonder where you go. You can go to credit default swaps to try to ensure you can maybe move to the dollar if you’re trying to hedge that way. But actually all of those things are still just vapor and paper. Let’s talk about the metals for a minute because moving to the sidelines can be cash. You’ve recommended that in the past. Even in an inflationary environment, cash sometimes is appropriate. We’ve seen that in your management style. But gold, gold, that’s a hedge. I think oftentimes people think, “Oh, well, silver and platinum are the same thing,” but they’re different, aren’t they?

David: They are. There are differences. I’ll talk about that in a minute. I think one thing I want to bring up is the COT Reports, the Commitments of Traders Reports. You get kind of a backdoor look, a rearview window look at what is going on in the more speculative side of the market. You’ve got producers who are hedging future production, and you’ve got speculators who have a footprint in the market as well. Those speculators tend to be a little bit more like hot money. They’re in when they think there’s an opportunity, and, boy, are they out when they think the opportunity is gone.

Kevin: The producers are like old pilots—

David: Right.

Kevin: —and the speculators are like bold pilots is what you’re saying.

David: I think that’s very true. I think that’s very true. So you look at the COT reports, and we’re getting the most positive readings of the year, meaning that the producers would look at this and say, “We’re not going short. Absolutely not. We’re happy to be long.”

Kevin: The old pilots are holding their gold.

David: That’s right. Whereas the bold pilots are like, “We’re out. Gold’s down. I’m out. I’m out. I’m out. I’m out. I’m out.” So you’ve got the speculators who have dumped their positions. Thus, we have some volatility in the price, and the producers, which are the much bigger force in the COTs— If you’re looking at total quantity of positions, this is about as bullish a setup as you can get for gold. 

That doesn’t mean that you don’t have forced liquidations. This is the problem is, in a macro environment— go to Doug Noland’s comments from the weekend. In a macro environment, global in nature, where you’re having deterioration in the structure of the financial markets, all bets are off. Anything can happen. But you look at something like the data points from the COT, and it would imply that the strongest hands within the gold market are more confidently, more confidently long and don’t think that it’s necessary to be short. In other words, they don’t have to hedge their production because they think that these are good prices right here, right now. Take it to the bank, baby.

Kevin: But gold is different than silver. So when you’re talking about those types of things—

David: Metals are unique. Each one is unique.

Kevin: Okay.

David: Gold has been and will continue to be more stable as a safe haven play. Well, part of this is because it still is a central bank reserve asset, and it has less of an industrial profile. As an inflation play, silver has the features of a monetary metal. It also has the demand profile of an industrial commodity, which is helpful if the inflation doesn’t have slowing economic activity as a characteristic. We talk about it as stagflation. In that case, silver has downside which gold does not have. It doesn’t change its longer-term attractiveness, but it does explain even more the recent focused volatility where you’ve got silver off 15%, 16% for the year, whereas gold’s off 3%. Ultimately, the demand destruction in industrial applications from a recessionary environment can be overcome by investor demand. But the interim period is what we have now, where recession concerns exceed inflation concerns and the price suffers.

Kevin: That’s why we watch the gold/silver ratio because it’s over 90 today. Right now you can get more than 90 ounces of silver for an ounce of gold, and the average over the last 40 years is around 65. So you can get more silver for the money if you’re patient. What about platinum, though? Because we play platinum and palladium as well. We look at it and say, how much platinum can you get for an ounce of palladium or vice versa? That also has that industrial component, doesn’t it?

David: It does. I would say that the gold/silver ratio, it depends on the timeframe you’re looking at for what your base expectation is. Over a longer period of time, 100 years, 200 years, the ratio is closer to 30 to 1. Bring it into a 75-year period and it’s closer to 40 to 1, and then bring it into the last 10 years or something and then you’re talking about a closer mean of 65 to 1. You’re still in a value range. 80 to 1, silver’s a good value. 90 to 1, the closer you get to 100 to 1, it becomes sort of bargain basement-priced if you’re talking about value because you only get to 100 to 1— we have only gotten to a 100 to 1 three times in the last 100 years.

Kevin: You buy your gold for stability. You buy your silver for future gold, is what you’re saying.

David: Well, because at a low number, you come from a high number and move to a low number and get a bunch of gold ounces for free if you’re effectively playing that ratio. So—

Kevin: How about the platinum and palladium group? Palladium’s high right now—

David: Platinum groups—

Kevin: —relative to platinum.

David: Platinum groups, think of all the white metals the same, and the yellow metal is something that behaves very differently. The platinum group metals also serve as a debasement hedge, but they do share the industrial profile and the economic vulnerability of silver. Is it worth owning? Yes. Being mindful of the differences between the yellow metal and the white metals allows you to shape a portfolio mix you can live with in terms of volatility. We’re in a secular bull market. The metals? That’s as intact as ever, and it’s going to be fed more and more by the exiting masses from equities. I think once gold finds its feet, then you’ll find silver follow suit. Again, you have to have sufficient investment demand to replace what is lost from a recessionary sort of demand destruction.

Kevin: Let’s shift from the financial to the economic because you’ve often, and I’ll repeat it over and over, you’d say that we go from the financial to the economic, and then that affects the political, which ultimately affects the geostrategic or the geopolitical. GDP, which is the measure of growth in an economy, if indeed we are moving toward a recession, and that’s been stated in past Commentaries, then it’s a little bit like a wave coming in and sweeping away almost everything that really was artificially being held up. GDP, let’s talk economics now. From the financial—where everything is speculation—down to the economic, where all of a sudden it starts to affect the bottom line and maybe people’s jobs.

David: I think last week’s revisions for Q1 GDP are important. It didn’t seem like much to go from -1.5% to -1.6%, but still, it’s worth looking at. Consumption was revised down to 1.8% from 3.1%, and the first quarter numbers would’ve been considerably worse had they not arbitrarily goosed intellectual property. That gave them 56 basis points of GDP growth, and it was an exceptionally large number. So if you’re looking through and interpreting that, last week’s GDP revisions were a reason for this week’s market volatility, to say, “Oh, well, maybe we do have a recession in the offing. Are we really ready for it?” 

Now we’ve got the GDP models from the Fed this week, downgrading growth both present and future tense. The Atlanta Fed GDPNow model has second quarter GDP at -2.1%. You couple that with the really unfortunately weak PMIs, which we discussed on the last Commentary, and you’ve got recession angst growing. So what do you do if recession angst is growing? You dump oil. You dump inflation hedges. You dump everything. Some concerns will be alleviated. 

If, in fact, things get bad enough in the stock market, that’s when, as I mentioned earlier, you end up with a major run for the roses. NASDAQ goes higher, ARK Innovation Fund goes higher, Coinbase goes higher. Because worse is better, right? I think this is where you’ll end up ultimately finding that that is wrong. The markets are first a voting machine, and then, like a scale, they weigh substance and report on real value. They go from the voting to weighing machine. So companies that lack a coherent business plan, a robust balance sheet, they’re simply going to be toast.

Kevin: Something that’s really struck me here recently is the way things are packaged with equities. A lot of people don’t know that they own stocks. They just think they own an annuity, or they think that they own a 401(k). They don’t really know the details. I was just talking to somebody this weekend in my family. She said, “No, I really don’t have stocks, but I do have this annuity that keeps going down when the stock market goes down.” So she does have stocks. It seems to me like more people have stocks now than ever, and a lot of them don’t even know they own them.

David: Yeah, US households, as of the last reading, had the highest US equity holdings as a percentage of total assets in history.

Kevin: Hmm, really?

David: So at previous market peaks, like the 1968 transitional year from bull to bear market, you remember we had a great— This goes back to Napier’s comments. We had a bull market which started in 1949 and ran to 1968. It was one of the best bull markets ever, coming out of World War II. At that point we had the equity percentage which reached 21.2%. That was exceeded in the 1999— bull market that ran from ’82 to ’99, 26.3%. Only recently, late 2021, did we reach 27.5%. This is the highest exposure to stocks of total assets that households have had in the history of the US.

Kevin: Which means households who don’t even know they have stocks are going to be affected because you’re talking about more than a quarter of their assets being in the stock market. Why is that? Is it because things have been repackaged, or is it just because it has gotten to be so popular to make money?

David: It’s sentiment. This is the reality. People take more risk at the worst time, and they take no risk at the best time. Exposure to stocks as a total percentage within a portfolio generally crests at the same time valuations reach their all-time highs or excessive levels. You’d think if the idea of buying low and selling high were operable, that more money would get put to work at cheap levels and no money would be going into stocks as they got to higher and higher prices because people would realize you don’t make money paying too high a price for any asset, but that’s not consistent with the psychological profile of speculators. Occasionally, a speculator pretends to be an investor. Now, crazy prices are normalized and rationalized at market peaks, and so the most money goes in at the tail end, not at the beginning. I want to correct something you said earlier about, without exception, nobody’s made money or is making money today in cryptocurrencies. The early adopters are. There’s folks that have a cost basis in Bitcoin of $1—

Kevin: You got to go way back. Yeah, true.

David: —$100. So there are those early adopters. The reality is the most money came in—

Kevin: At the peak.

David: —at the peak.

Kevin: November. I think it was about November of last year when they decided to put it into an ETF. Remember that?

David: You put it into an ETF, you start running advertising for the Super Bowl. Yeah, it’s kind of interesting.

Kevin: Dave, it’s counter-emotional. The very best investors are the ones who are buying when they think they should be selling, and they’re selling when they think they should be buying. So emotionally, I don’t want to say these people are emotional robots because they’re not, they go through the emotional ups and downs, but they also can look back at history. Think about even the management team that you guys have. I can imagine that when you wake up in the morning and you look at the markets, there are days when your adrenaline gets tweaked a little bit. You still have to slow down and say, “All right. Now, what does history show us?” You can’t make an emotional decision. So valuation peaks run in parallel with the interest of the public, but you have to run opposite that, don’t you? To a degree.

David: To a degree. Yeah, because valuation peaks are an indicator of people buying in, buying in, buying in positive feelings, a greed motivated gamble on higher prices, that drives the ownership percentages even higher, and it also drives those crazy valuations. What makes this bubble phase so unique is that those feelings of greed have oozed into everything. We’ve got stocks, bonds, real estate, alternative assets, like private equity and private debt. If the everything bubble, in fact, becomes the everything bust, there will be a generation that never forgets those elusive promises of a comfortable retirement and of great wealth.

Kevin: But the highest risk assets always give the highest gain when they’re going up. Remember, fortune favors the brave. How are the braves doing right now?

David: Well, you mentioned the year 2000 and the volatility that we had in that market environment. Up to that point, I didn’t have a lot of live experience in the marketplace. I studied philosophy in college, but working at Morgan Stanley through that particular knockdown, drag-out fight in the markets was interesting because I got to hear the commentary of professionals who’d been there for years, but they had only been there during the context of a bull market. They had been raised, they had been raised on bull market dynamics, and none of them knew what a bear market looked like. So you get Cisco or Sun Microsystems down, Palm down at 30%, and it’s a buy. You got to buy. It’s down 50% to 60%. All of them, it’s a buy. It gets down to 80% to 95%, and it’s a sell. Sentiment changes at the market lows, and people walk away. So you tend to see more volatility and the riskiest assets. Those are the most popular assets in the markets that proceed because that’s where the most money has been made.

Kevin: Last November, cryptocurrencies were the hottest thing.

David: Thus far, we’ve seen the most pain in the highest risk assets. Cryptocurrencies in the tradition of speculative assets move both directions, with force, from a cumulative value of $3 trillion now to $900 billion and shrinking. We have a real mess for those who were the late adopters. The early adopters are still sitting on gains. The late adopters— Look, I guess more on cryptocurrencies in a moment.

Kevin: Do you remember the digital rock that sold, what was it, for one point something million? And it really didn’t exist. It was just a digital rock. That’s called a non-fungible token. I wonder how those are getting along right now.

David: Well, I had a number of people contact me. They said, “What do you think about NFTs? I’d really like to get in on what’s going on here.” It was like a license to print money in the private sector, and now it appears that that license has expired. At least it appears so. Non-fungible tokens, again, this is another digital apparition of the 21st century and a clear opportunity for just rank speculation. It’s done a complete round trip. 90% down is an index for NFTs.

Kevin: Wow.

David: That index has lost 90% of its value, and it’s returned to the pre-2021 launch levels, which did see an eightfold increase in half as many months. How do you see something go up eight times in four months? Well, it’s given it all back. It’s given it all back. Meme stocks, on average, are down 65%. The New York Stock Exchange FANG+ index, this is your Facebook, Amazon, Netflix, Google, that index finishes the quarter and the first half of the year down 43%. NASDAQ stocks suffer a one-third decline. Again, if you’re looking at sort of the degree to which there is a real business or a real investment, there’s less and less of a decline. Where there is rank speculation and risk and not much of a business plan, just hope and a prayer and lots of leveraged money in the system, then all of a sudden, again, it’s 90%. It’s 65%. It’s 43%. The NASDAQ’s down a third. The S&P 500 registers its worst first half in over 50 years, off only 21%, only, only.

Kevin: Well, only, only. So we don’t know the bottom of a market, but there are indicators where you can say, what is the valuation of stocks relative to GDP? People talk about the Buffett Ratio. Do we have further to fall, and how will we know?

David: Well, that’s, I think— One of the things that I like about the Buffett Ratio is— We started some of our comments on ownership levels because the vast majority of households are still equity— We should translate this, not holders, but hodlers, just like the cryptocurrency speculators. Now you’ve got equity owners who are hodling, and they’re just trying to maintain some sanity in the context of a market decline. So like their digital asset cousins, the equity hodlers of mid-year 2022 are still neglecting the overvaluation status that remains. Looking at the Buffett Ratio, still north of 200% is the most recent read. Jill Mislinski puts these numbers together on a monthly basis. We’ll get some fresh numbers mid July. But the correction we’ve seen year-to-date took the number from 214 to 205. This is as a percentage of GDP, stock market capitalization as a percentage of GDP. The correction year-to-date has barely taken a bite. The bear will be back, and this next time for a full-fledged feeding.

Kevin: So the question is inflation concern with growth, or recession concern, and maybe a third, recession concern with inflation. That’s the worst of all outcomes. So government bonds, are they going to be a safe haven, or are they going to be a disaster?

David: Great question. The adjustment phase in the financial markets is still, too, whether or not central banks will provide some protection, downside protection in the market where we won’t see the low valuation levels of yesteryear because the central banks will intervene—or will they? So this is the battle royale. Inflation on the one hand argues that they can’t, or they will eviscerate the global middle class, allowing inflation to run its course and squeeze households into oblivion, or recession. To a degree, recession is an acceptable outcome if you’re fighting inflation because it will reduce demand, and there will be a reduction of money flowing into products and services, which should alleviate some inflationary pressures. 

So as we head into the second half of 2022, it’ll be interesting to see if government bonds reflect less inflation concerns and more recession-oriented concerns. This is the tug of war in fixed income markets between central bank excesses and the potential for a global economic malaise, translate that as recession, and will that concern become acute? So inflation has not gone away, but a new threat has already cast its shadow across the industrial metals complex and to a degree into the crude oil markets, certainly with volatility this week, demonstrating real concerns about recession. Again, each commodity has its own profile. You look at supplies and you look at demand. The volatility in oil this week had everything to do with the potential for demand destruction triggered by recession.

Kevin: Doesn’t it always go back to liquidity, though? Doesn’t everything, when it comes to a crash, go down to liquidity? If the liquidity is easy and it’s flowing, it seems that people could be buying. The problem is, when you make liquidity flow, you create inflation, or destruction of the buying power of the currency that you’re creating. So liquidity right now, you’ve talked about, we don’t know what the central banks are going to do, but they really are between a rock and a hard place because they can’t do much without creating higher inflation—or can they, if the recession is severe enough?

David: I think liquidity allows you to look onto a distant horizon, and whatever your near-term reality is, you can just ignore it. So liquidity gives you a different vision of the future. When liquidity dissipates, then all of a sudden you have to deal with the here and now, and that’s where liquidity crisis becomes solvency crisis very quickly. So if speculation depends on a continual free flow of capital to drive prices higher and even higher, are we surprised to see the prospects of limited capital flows, what we’re now referring to as QT, quantitative tightening? Are we surprised to see that spoil the entertainment? 

Last week, Three Arrows Capital, this is a hedge fund out of Singapore, they defaulted on $675 million in loans, facing margin calls they could not meet. Who did they borrow the money from? Enter Voyager Digital. It was the exchange handling the collateral for that crypto-only hedge fund, and they are, of course, under pressure as well. Why are they under pressure? Because collateral that they held, which had some value, now is trading for pennies on the dollar, if not completely evaporated.

Kevin: So how do they meet their commitments? This reminds us, Lehman. Remember that?

David: Sure.

Kevin: Back in 2008, that was a surprise.

David: Like Lehman, in a moment going from solvent and liquid to illiquid and insolvent. The crypto space is dealing with its own unwind of leveraged bets. The Financial Times runs an article last week: “Crypto feels the shockwaves from its own ‘credit crisis.’ Crypto fund Grayscale launches lawsuit after SEC rejects the ETF plan.” There’s not a lot of liquidity coming into the space, and it’s separating out the solvent from the insolvent. Crypto space is dealing with its own line of leverage bets. You’ve got Babel Finance and Celsius Network, two lenders into the digital asset space that are not returning money to depositors. They’ve frozen accounts.

Kevin: That’s a perfect name, Babel. Babel Finance, the unfinished tower and the scattered languages. Babel Finance.

David: What’s the number Celsius which represents cold death? Because—

Kevin: That’s right.

David: —we’re getting there pretty fast.

Kevin: I think you can get down to about two degrees above absolute zero on Celsius.

David: Steve Hochberg pointed out that Celsius went from pricing shares for an IPO on June 9th— Again, I love this quote because it just points out how fast liquidity dynamics can shift, and you go from liquidity to solvency dynamics. Pricing shares for an IPO on June 9th to hiring attorneys to provide advice on a potential bankruptcy filing on June 24th.

Kevin: That’s like planning your anniversary, and then going and getting a lawyer for a divorce all in the same month.

David: Yes.

Kevin: Did you say that was— how long ago?

David: June 9th—

Kevin: June 9th.

David: —to June 24th. That’s how fast liquidity can impact a leveraged player in any market.

Kevin: Wow.

David: So Voyager Digital prices at 30 cents today versus $21 at its 52-week high earlier in this 12-month cycle.

Kevin: 30 cents? 30 cents today, and it was $21.

David: Well, if you’re looking at a long-term time frame for this group, $26.

Kevin: Wow.

David: So from $26—

Kevin: To 30 cents now.

David: —to 30 cents. 99% losses were unimaginable in the crypto space six to nine months ago. A short-term cyclical correction was in play, buying the asset down 30% to 45%. That’s what you saw as huge enthusiasm in the crypto space. “Buy now. It’s cheap. This is the opportunity of a lifetime.” Well, you buy it at [unclear]. It’s down 30%. You just assume that you’re smart enough to step in. Again, luck favors the bold. That was the tagline for the Coinbase Super Bowl ad last year, right?

Kevin: Yeah. It was crypto.com.

David: Oh, was it crypto?

Kevin: Yeah. Crypto.com, fortune favors the brave.

David: So hiring—

Kevin: Are you brave? Are you brave, Dave?

David: For Coinbase, hiring has turned to firing. They IPOed at $250 a share. They traded to as high as $429. Today, they’re at 45 bucks. Actually—

Kevin: Wow.

David: —as I mentioned, they traded higher from $45 all the way up to $50 because we think there might be a Fed pivot, and maybe they’ll cut rates instead of raising rates and maybe we’ll get—

Kevin: It’s the baby crying.

David: —QE instead of QT. Okay, great. So Coinbase, you realize, just to look at how they traded at $429 a share in a valuation of over $100 billion, and speculators were assigning them a valuation which at that point exceeded the valuation of both NASDAQ as an exchange and the parent company of the New York Stock Exchange, the Intercontinental Exchange, from $429 down to 45 bucks. You’re talking about an 89% move lower from peak to trough.

Kevin: What you said earlier still bothers me, that when you look at the Buffett Ratio, when you look at these other things, we have a long ways to go before we return to actual current price discovery that was lost during this artificial market.

David: Yeah, because that’s— We’re talking about high risk/high reward. Many of these things have gone and will go to zero. But when we talk about the Buffett Ratio, we’re really talking about the core of the markets, something much more solid. Go back to the more commonly held assets, stocks, run of the mill stocks, S&P 500, probably the most commonly held index. Stocks are in a secular bear market. When stocks are in a bear market, a secular bear market, they typically decline by greater than 50%, particularly when those returns are adjusted for inflation. Adjust them for inflation, and you go back to 1906 and 1921, that period of time, massive correction. We end with what Jim Grant describes as the forgotten depression of 1921. So that’s the end of the line. Stocks were down between 1906 and 1921 by 69%.

Kevin: You’re talking long. That was 15 years. That’s a long time. They were down 69%. Wow.

David: Between 1929 and 1949, down by 54%. That includes a powerful counter-trend rally between 1932 and 1937.

Kevin: So when people say, “Just hold for the long term,” it could be a very, very, very long term.

David: Yeah. Hodlers of 1932, that was a tough vintage, well, 1929 in particular. Go to the next one, 1968 to 1982, the secular bear was a 63% decline when you count in the inflation factor. The move from 2000 to 2009 was a move lower by 59%. So I am not exaggerating when I say the typical secular bear market takes away more than 50%; 69%, 54%, 63%, 59%. The move from 2000 to 2009 was a move lower by 59%. These are numbers specifically for the S&P 500. We’re not talking about the high risk/high reward NASDAQ, meme stocks, cryptocurrencies. This is a run of the mill exposure. So our 21% year-to-date declines are really just the beginning, less than half of the journey from overvaluation to undervaluation.

Kevin: Pretend for a minute. You’re Rip Van Winkle, and you see this stuff happening. You’ve been told you’re going to go to sleep now for years. Let’s say you’re going to sleep for the next five years. You’ve got to make a decision, because once you go to sleep, you’re not doing any more trading. I just wonder if you just go to cash and gold and go to sleep. Then when you wake up, I hate to say this, but it would be a dream come true because we’ve been begging, Dave, all through this Commentary the last 14 years, we’re on our—

David: Almost 15.

Kevin: —we’ve been begging for a return to the actual market where you have true price discovery. So is this in a way like allowing the baby to cry because it’s going to open up the baby’s ears? Is it okay to let these markets—? I mean, not that you’re going to change it anyway. But if you had your choice, as Rip Van Winkle, and go, “Okay, well, they could either control these markets while I’m asleep or just let them fall. Let’s go back to the real world and not the artificial Federal Reserve world.” What’s your thought?

David: I’m just not sure we can go back to the artificial world of the Federal Reserve setting prices because you’ve got something that holds their activity in check which has not existed for 40 years. It’s—

Kevin: Mr. Market?

David: It’s inflation.

Kevin: Oh, inflation.

David: Yeah. Mohamed El-Erian says this in a Bloomberg op-ed piece this week, “For long-term investors, it’ll prove beneficial over time that markets are exiting an artificial regime that was maintained for far too long by the Fed, and that resulted in frothy valuations, relative price distortions, resource misallocations and investors losing sight of corporate and sovereign fundamentals. The promise now is one of a more sustainable destination. Unfortunately, it comes with an uncomfortably bumpy and unsettling journey.”

Kevin: It’s a little like getting a limb removed that’s going to kill you anyway. You remember when Gus, he got shot in Lonesome Dove with the arrow and they said, “We’ll take the leg.” He says, “Don’t take the leg.” Well, he ended up dying because they didn’t take the leg. He got gangrene and he died. But what’s being said here is this may be healthy to let the leg get chopped off.

David: The unsettling journey, the uncomfortably bumpy ride that El-Erian describes is that process of moving to undervaluation from overvaluation. So the journey from overvaluation to undervaluation is a healthy one, but fraught and frazzled is the speculator that fails to recognize the tide as it turns. We’re in a bear market of epic proportion in stocks and bonds with the normal pain you’d expect being dished out in oncoming waves and teasing out an investor’s desire for better days and for better performance. The end of the bear market is notable for registering the death of desire and the birth of indifference. Indifference is that state where the speculator just gives up. They capitulate. They walk away. We’re not there. In fact, we’re a long way off from a secular bear market low. If bear markets account for up to 40% of all time frames in terms of market trading going back to 1877, then the last six months of pain are just the introduction, following a greater than 12-year expansion from 2009 to 2022. Cash and gold. Haven’t we said that before, Kevin, where— You want optionality. There’s your justification for cash, but you have to have stupidity insurance. You need them both.

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 dot 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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