Tactical Short 1st Quarter 2025 Recap

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Decades of Inflationism Home to Roost
MWM Q1 2025 Tactical Short Conference Call
April 17, 2024

David: All right, let’s begin. Good afternoon. We are going to start the call today with performance, look at market insights, and then have Q&A as our finale. This is for first quarter 2025, conference call for Tactical Short, “Decades of Inflationism Home to Roost.”

We’re looking forward to the questions that have been reserved for the end of the call, and I’m grateful for each of them, both the level of engagement and the depth of curiosity. We’re also excited to share insights and perspectives with you today, and I would just encourage you to engage broadly. You need not agree with every point in order to benefit from the totality of insights. We are in a fast changing world, and we continue to adjust our thinking to the circumstances that emerge. [Unclear] a routine look at our thinking.

I would encourage you to always engage on a Saturday with Credit Bubble Bulletin, which Doug’s been writing for a long, long time. And it is the best chronicling of how we arrived at this point in time. It gives you a comprehensive look at credit markets and the influence that they have within the broader financial markets.

I would also encourage you to engage with a piece that we put out also on Saturdays called Hard Asset Insights, perspective on the markets from one of our colleagues, as well as my podcast on Wednesdays now and it’s 18^th year. A good way for you to keep up with our thinking on other macro issues that relate ultimately to your financial decision making. So again, thank you for participating in our first quarter 2025 recap conference call. As always, thank you to our valued account holders. We so greatly value our client relationships.

With first time listeners on today’s call, I’ll begin with some general information for those who are unfamiliar with Tactical Short, and of course you can find more detailed information available at mwealthm.com/tacticalshort.

The objective. The objective of Tactical Short is to provide a professionally managed product that reduces overall risk in a client’s total investment portfolio, while also providing downside protection in a global market backdrop with extraordinary uncertainty and extreme risk.

The strategy is designed for separately managed accounts. Separately managed accounts allow for a very investor friendly, full transparency, flexibility, reasonable fees, no lockups, it’s perfect for providing all of those things. We have the flexibility to short stocks and ETFs, and our plan has been, on occasion, to buy liquid listed put options as well. Shorting entails a unique set of risks. This is where we are set apart from our competitors, by our analytical framework and our uncompromising focus on identifying and managing risk.

Our Tactical Short strategy in the quarter with short exposure targeted at 80%. The target was boosted 200 basis points to 82% in early March, the highest in the history of the strategy. Focused on the challenging backdrop for managing short exposure, a short in the S&P 500 ETF, the SPY, remained the default position for what we regard as a very high risk environment.

Giving an update on performance, Tactical Short accounts after fees returned 4.06% during Q1. The S&P 500 returned a negative 4.28%, so for the quarter Tactical Short accounts returned 95% of the S&P 500’s negative return. As for one year performance, Tactical Short after fees returned a negative 5.14 versus the 8.23 return for the S&P 500, losing 62% of the S&P’s positive return.

We regularly track Tactical Short performance versus three actively managed short fund competitors. First, the Grizzly Short Fund, which returned 5.16% during Q1, and over the past year Grizzly has returned a negative 0.52, a half a percent. Ranger Equity Bear returned 9%, 9.06 for the quarter, with a negative 1.89 for the one-year return. And Federated Prudent Bear returned 5.631, negative 71 basis points for the one-year.

Tactical Short underperformed the active managed bear funds for the quarter on average by 256 basis points, we underperformed over the past year by 410 basis points. Tactical Short has however significantly outperformed each of the bear funds since inception, April 7th, 2017. Inception through the end of the year, Tactical Short outperformed each of the three competitors by an average of 1,932 basis points, or 19.32 percentage points.

There are also passive short products, the ProShares Short S&P 500 ETF, which returned 5.89 for the quarter, negative 87 basis points for the last year. And the Rydex Inverse S&P 500, 5.92 to the good for Q1, negative 51 basis points for the one-year number. And last but not least, the PIMCO StocksPLUS Short Fund, with a Q1 return of 7.21%, and a one-year return of 1.82. Doug, over to you.

Doug: Thanks, David. Good afternoon. I know everyone is busy, so it’s much appreciated that you would spend some of your valuable time with us. Before diving into a most remarkable environment, let’s start with performance. Remember, the market traded to all time highs mid-quarter on February 19th. On the surface, it looked hopeless on the short side. It would’ve been rational to have slashed the short exposure target, and surely reasonable to have rebalanced short exposure to target during the ongoing post-election market route. Candidly, it was just a tough period. Market topping processes are challenging for my philosophy for managing short exposure. Basically, it became a daily exercise of questioning my decision to maintain elevated short exposure, studying the market, my analytical framework, and the mosaic of indicators to best gauge the risk versus reward calculus for short exposure.

It was the type of environment that causes the most angst. I hate to lose money, and it had been such a long stretch of rising stock prices. Significantly reducing short exposure was an option, but the objective of Tactical Short is to provide a reliable market hedge, and there was no doubt that market risk was highly elevated. So the challenge: a highly speculative market was advancing in the face of deteriorating fundamentals. Tactical Short returned 95% of the inverse of the S&P 500’s return during Q1. I’m pleased we captured most of the S&P’s decline, especially considering the difficult backdrop. As I explained in previous calls, I significantly widened the band around the short exposure target, tolerating exposure to grow in a rising market environment. This wider band reduced rebalancing trades, particularly short position repurchases necessary during market advances to return short exposure back down to the target level.

This meant that at the market’s February 19th peak, instead of having reversed short exposure to get down to the 80% target, I had tolerated elevated short exposure. When the market abruptly reversed, short exposure was meaningfully above the targeted level, benefiting Tactical Short’s quarterly return.

I’ll delve a little deeper into the analysis. I widened the band around the short target because of my analysis that pointed to a market topping process that seemingly ensured instability and volatility. I also assumed a market reversal would come abruptly, making it about impossible to get positioned in a timely manner. Moreover, the markets were dismissing myriad risks, including the likelihood of market unfriendly policies from the new administration.

I’ll make brief comments on relative performance. First, Tactical Short generally runs a lower risk strategy than competitor products. That explains Tactical Short’s significant long-term outperformance. More recently, we’ve been at somewhat of a performance disadvantage as our bear fund competitors have arrangements with their prime brokerages to receive cash returns on their proceeds from short sales. This basically explains their outperformance versus Tactical Short over the past year.

While on the subjects of the short exposure band and performance, I’ll highlight an important advantage of the band that meaningfully helped relative performance last week. The S&P 500 posted a 9.5% gain last Wednesday—the largest one day advance since 2008 market instability. The Grizzly Bear Fund lost 9.25% Wednesday, and the Prudent Bear Fund lost 9.23%, with an average loss of 97% of the S&P 500’s gain. These funds typically rebalance daily, and came into Wednesday’s session with beta-adjusted exposure around a hundred percent.

Tactical Short specifically doesn’t rebalance daily. We prefer instead to have a band around the short exposure target, while employing a disciplined discretionary approach to rebalancing. I have my framework indicators and keen focus on market dynamics and policymaking that shape rebalancing decisions.

Acute market instability and crisis dynamics create challenges for managing short exposure. Think of the two funds just mentioned. If a fund is 100% short and the market surges 10%, that means at the end of the session short exposure jumped to 110%, while fund net asset value dropped 10%. That means that short exposure has surged to 122%—that’s 110 divided by 90. To return short exposure back down to 100% requires reversing about 20% of the fund’s short positions, and that’s just for a single trading section. And if the market reverses sharply lower, as it did Thursday, rebalancing will then require significant shorting to get back up to target. I’ve referred to this daily rebalancing challenge as the meat grinder. It can definitely grind away some performance in hyper-volatile markets.

Not to overly complicate this, but the example I just presented was when short exposure moved in sync with the general market, in this case a 10% surge in the S&P 500. But in a big squeeze like Wednesday’s, commonly shorted stocks tend to significantly outperform the S&P 500. They have a higher upside beta. In Wednesday’s session, the Goldman Sachs Most Short Index rallied 17% off intraday lows. Such moves can create a real nightmare on the short side. There were short strategies crushed by the intense volatility that erupted right before the 2008 market crash.

It was not necessary to rebalance Tactical Short exposure on Wednesday’s meltdown. We came into the session with short exposure considerably below target, and ended the session near target. CNBC ran an interesting article highlighting the history of the largest daily gains at NASDAQ, of which Wednesday’s 12% spike was the second-biggest back to 2001. Of the top 25, I’ve managed short exposure through 24 of them. When markets begin to dislocate, I’ve been conditioned to expect a policy response. We were fortunate this time. Tactical Short came in to the session below target, and gained some good relative performance versus our competitors. As this bear market unfolds, rebalancing will be an important factor in performance. Just as we rebalance during years of an advancing market, we will now work to maintain short exposure to more fully capture returns throughout the market’s unfolding downside. I will remain intensely focused on rebalancing decisions.

Let’s segue to macro analysis. I’ll begin how I ended recent calls: I so hope my analysis is wrong, and this is said with deepest sincerity. I pray my analysis and fears prove extreme.

I’ve analyzed many bubbles. In particular, I can point to the 1997 Asian tiger bubble collapse, 1998 with long-term capital management and Russia collapses, and the mortgage finance bubble collapse in 2008. In each case, my analysis pointed to quite problematic bubble excess. And in each collapse, things proved worse than what I had earlier considered a worst-case scenario. I see evidence suggesting history’s greatest bubble has been pierced. This is not the first time I’ve harbored such thoughts. I’ve intensely monitored this multi decade bubble since the early 90s.

I thought the bubble had burst with the collapse of the internet and technology stocks in 2000, 2001. I reversed course in early 2002 with my warnings of an unfolding mortgage finance bubble. I was pretty convinced the bubble had burst in Q4 2008. I reversed course in March 2009, warning of an unfolding global government finance bubble. Then, it looked like the bubble had finally burst with the pandemic crisis in March 2020, but it quickly became clear that egregious monetary and fiscal stimulus had triggered blow-off bubble excess.

To be sure, reckless monetary inflation will never resolve bubbles. It ensures they inflate to only more precarious extremes. Let me explain why I don’t expect to reverse this call for the bubble’s demise.

I’ve argued for years now that the global government finance bubble was the granddaddy of all bubbles. Bubble dynamics had finally directed subversive forces to the heart, the bedrock, of global finance, to trusted sovereign debt and central bank credit. With momentous consequences, bubble dynamics seized control of perceived safe and liquid money-like credit instruments that are subject to insatiable demand.

I’ve argued the government finance bubble is the end of the road. Previous bubbles, when they burst—that spawned bigger bubbles necessary for system reflation. Collapsing telecom debt and junk bonds were supplanted by a much bigger boom in mortgage credit. The mortgage finance bubble collapse unleashed a historic expansion of government debt and central bank liabilities. However, there is today no fledgling colossal bubble waiting in the wings to take bubble inflation to ever greater extremes. And while the inflation of government debt and central bank balance sheets is certain to continue, the trajectory of over-issuance increasingly risks a loss of confidence.

I believe markets, notably sovereign debt markets, have begun to signal an evolving crisis of confidence, one that even risks a catastrophic loss of faith in the foundation of global finance. Last week was extraordinary. A deeply systemic global deleveraging was unfolding, with instability and acute stress slamming markets worldwide. Yet the typical flight to safe haven Treasuries and the US dollar was nowhere to be seen. Indeed. Treasury yields spiked 50 basis points, the largest weekly move since October 2001. The dollar sank 2.8%.

Understandably, such confounding market development sparked anxiety and debate. Was the highly levered Treasury basis trade unwinding? Were foreigners backing away from US financial assets? Could the Chinese be selling Treasuries as part of a trade war counterattack? Did last week mark a momentous inflection point in the era of the US as the reliable anchor of global finance? Were markets perhaps even signaling the undoing of US exorbitant privilege, American exceptionalism?

It’s difficult to believe stocks hit all time highs less than two months ago. So much has changed, as if the world is being turned upside down. We live in a critical period in history. For starters, we’re witnessing the transition from a multi-decade boom cycle, to a new cycle of utmost uncertainty. Systems are in the throes of monumental transformational change, instability, turbulence, and uncertainty. I chose the title “Decades of Inflationism Home to Roost” for today’s call intending to expand on analysis I hope provides a little clarity to developments in the process of dismantling conventional wisdom.

When I took my first investment management position at a hedge fund in 1990, total US non-financial debt was 10 trillion, with outstanding Treasury securities at 2.2 trillion. The Fed’s balance sheet came in at 315 billion—about Elon Musk’s current net worth. Fast-forward to the end of 2024, Treasury securities have reached 28 trillion; total non-financial debt, 77 trillion; and the Fed’s balance sheet, 6.8 trillion.

For decades, Federal Reserve officials, the economics community, and Wall Street all trumpeted the exceptional age of price stability. They glorified an enlightened Federal Reserve that had slayed the inflation dragon and achieved price stability. But it was deeply flawed analysis. Recent decades have experienced historic credit inflation, monetary inflation with far-reaching consequences.

From my earliest Credit Bubble Bulletins back in 1999, I’ve tried to highlight all aspects of what for centuries was labeled inflationism. Since my 1990 introduction, I have had deep appreciation for Austrian economics, especially its focus on the distorting effects credit inflation has on price structures, financial and economic structural development, and society more generally. Importantly, credit expansions have myriad inflationary impacts, higher consumer prices being only one. There are effects on asset prices and speculation, along with distortions in investment decisions, resource allocation, and economic structure.

The great German economist Kurt Richebacher was prescient when he repeatedly warned that asset inflation and bubbles were much more dangerous than rising consumer prices. Credit inflation and asset bubbles fuel over-consumption, trade deficits, and currency devaluation. The deleterious effects of deranged credit and inflationism include inequality, deep structural maladjustment, and an insecure, distrustful, and resentful society.

I believe the rise of Donald Trump and the populist MAGA movement is the consequence of decades of monetary mismanagement and pernicious inflationism. President Trump is such a divisive figure. In a CBB after the election I wrote that half the country believed nation saved, the other half, nation doomed. No hyperbole there. Families, organizations, and communities are split. The country is split, along with the world.

It’s impossible to analyze the current environment without an emphasis on one of history’s most powerful individuals and his new administration. So if you disagree with my analysis, you see it as uninformed, politically ignorant, if you believe I suffer from TDS—Trump Derangement Syndrome—I understand. I get emails saying all of that and worse every week. I hope we can agree to disagree, and focus on analyzing today’s precarious environment.

Not only is the Trump phenomenon a product of inflationism, I believe the President’s policy course has pierced history’s greatest bubble. Bubble collapse was inevitable, so I won’t hold him responsible for decades of bubble excess. He’ll share blame with many for the post-bubble environment. But I certainly fear his policies will greatly exacerbate social, political, and geopolitical instability.

I’ve long feared the social and geopolitical consequences of decades of inflationism and bubble excess. Bubbles are, after all, at their core, mechanisms of wealth redistribution and destruction. Corrosive inequality has become such a critical societal and political issue, at home and abroad. For the most part, the wealth destruction nature of bubbles remains masked so long as bubbles inflate. And with the great bubble now pierced, the specter of epic waste and structural maladjustment will begin to be revealed.

Society is already insecure, fractured, and bitter. Trust in our institutions has sunk to alarming depths. This also is a global phenomenon. Little wonder this is the era of the strongman ruler, with populations gravitating to persuasive individuals championing anti-establishment populist agendas, with the promise of security, retribution, and forceful change.

Today, half the country is certain Donald Trump is the right person at the right time, the other half convinced he’s the wrong person at the wrong time. I identify with the latter. Especially as the great bubble culminated in crazy excess extending into a fourth decade, my concerns for post-bubble societal and geopolitical instability only deepened. An already deeply polarized society couldn’t be more poorly situated for the bursting bubble. It’s become a tinderbox, and it’s difficult to envisage a president with a greater capacity to inflame. I believe this unfolding bursting bubble, with dreadful effects on markets in the economy, will create a precarious backdrop for the administration’s culture war fixation.

I’ve always believed that holding society together post-bubble would present a major challenge of paramount importance. These days, I have serious worries about scenarios that previously seemed lunatic fringe. The consequences of decades of inflationism could be even more dangerous from a geopolitical perspective.

I’ll repeat a general framework I’ve shared previously, that I believe helped explain the rapidly deteriorating global environment—what is shaping up to be a breakdown of the existing world order. Bubbles are mechanisms of wealth redistribution and destruction with detrimental consequences for social and geopolitical stability, boom periods, and gender perceptions of an expanding global pie. Cooperation integration and alliances are viewed as mutually beneficial. But late in the cycle perceptions shift, many see this high stagnant or shrinking. A zero-sum game mentality dominates. Insecurity, animosity, disintegration, fraught alliances, and conflict take hold.

From a geopolitical perspective, President Trump simply could not be more polarizing. It’s like the great disrupter is taking a sledgehammer to the brittle global order. And it’s alarming to see such fracturing, animus, and conflict heading right into deflating bubbles. Certainly, an unstable and rupturing world, and faltering bubbles, are not coincidental.

Donald Trump has been lamenting trade deficits for 35 years. I haven’t been a fan myself, but I can’t imagine a more perilous juncture to experiment with the most disruptive tariff regime in a century. Markets and economies are too fragile, fraught global relationships and alliances too frail. The president will wield his phenomenal power and coerce trade concessions. But will it be a Pyrrhic victory? If my bursting bubble analysis is correct, a focus on bolstering our nation’s security and well-being would emphasize strengthening relationships with friends and broadening our alliances. We’ll need all of them.

The unfolding trade war with China is alarming. Hopefully cooler heads prevail. Perhaps President Trump will make more concessions. But there is clearly potential for this war to spiral out of control during a precarious juncture for such a fight. Chinese officials have stated they’re ready to fight to the end. I don’t think they’re bluffing. They’ve been preparing for this scenario for months, if not years. The president and his team, along with most analysts, believe the US goes into this confrontation in a much stronger position than China. China is suffering from a real estate collapse, stagnation, and fragile finance, while most assume markets and the economy in the US are structurally robust.

Conventional analysis fails to recognize our system’s acute bubble fragilities. Beijing likely comprehends US vulnerabilities more adeptly than Washington. I’ve written that President Trump’s tariff policies have pushed our system to the edge, and pondered whether Xi Jinping will resist the urge to provide a nudge. There is certainly no greater priority for Xi Jinping than to see the downfall of so-called US exorbitant privilege. The competitive advantage has for decades provided incredible benefits to China’s global superpower adversary. We enjoy the extraordinary benefits of having the world’s safe haven Treasury market and the most robust financial markets generally, coupled with the globe’s dependable reserve currency.

Now, President Trump has unwittingly exposed US bubble fragility. This vulnerability, combined with reckless policymaking, puts US markets, the American economy, and the dollar at great risk. Today, our financial system and economy are too fragile for misguided and haphazard risk-taking. US and China each have a tremendous amount to lose from a trade war, but the administration and most analysts don’t appreciate that Beijing has much to gain. This trade war presents Xi Jinping with a unique opportunity in history. A global financial crisis would create challenges and risks, but blame would be directly cast on Donald Trump. The Chinese population is rallying around Xi and the Communist Party—a timely deflection of blame away from Beijing’s home policy blunders and mismanagement.

A Trump global crisis would also afford China a great opportunity to expand its close circle, its alliances, and its global influence. In the battle for global supremacy, one superpower would be expanding alliances and relationships, with the other at risk of being discredited and in retreat. Beijing might also calculate that a US in disarray would be less compelled to exert influence throughout Asia and less likely to come to Taiwan’s defense. A world with a wounded US would be a playground for China and Russia. And for Beijing and Moscow, a world without US exorbitant privilege would be a dream at long last coming true.

It’s rational for Xi Jinping to accept short-term pain for the prospect of a level playing field that ensures China’s destiny as the supreme global superpower unencumbered by US repression. Might Beijing do a cold strategic calculation and go for the jugular? The stakes couldn’t be higher. Secretary of Defense Hegseth recently traveled to meet with Asian allies, vowing to strengthen US resolve against China’s aggression. Days later, China launched major live fire military exercises that simulated a blockade around Taiwan, while issuing stern warnings directed at the US.

Last week’s market behavior was fascinating, including a remarkable one-day rally following the tariff pause. At least for a day, markets dismissed President Trump’s China trade war escalation. But as yields spiked higher through the end of the week, concerns shifted to whether China might be trimming its large Treasury holdings. The administration, especially Treasury Secretary Bessent, keeps repeating what a big mistake China is making, that they’re playing with a weak hand. A pair of twos, as described by Bessent. For an administration that has specifically stated the objective of lowering long-term market yields, to have its trade war adversaries sitting on an estimated 700 billion of Treasuries is not a weak hand.

There are big problems if these two adversaries refuse to back down. The world is in the throes of a major deleveraging, a dynamic that could easily spiral out of control. Just last week, global markets were at the cusp of seizing up. The leveraged speculators were caught on the wrong side of dislocating markets, forced to liquidate stocks, Treasuries, sovereign and corporate debt, and commodities. Acute stress developed across derivatives markets, notably in interest rate and currency swaps, markets that are integral to hedging strategies.

Deleveraging is a really big deal. Secretary Bessent last week called it normal deleveraging. And there is some justification for complacency. There were flare-ups over recent years soon forgotten. The October 2022 Liz Truss UK gilts episode, the March 2023 bank run mini-crisis, and then last August, yen carry trade instability. In all cases, quick policy responses reversed nascent deleveraging, and in no time it was right back to leveraging and speculating business as usual.

The last sustained deleveraging erupted with the March 2020 pandemic panic. Many of the indicators I closely monitor—CDS prices, credit spreads, risk premiums, derivatives pricing and such—recently posted their biggest moves since 2020. This is serious, and won’t be resolved with tariff concessions. Once deleveraging starts, the liquidation of positions and the unwind of speculative credit drive lower market prices and waning liquidity—a dynamic that spurs risk aversion and the impetus to reduce speculative leverage.

When deleveraging is quickly reversed, the impact on waning liquidity contagion and risk aversion is thwarted before momentum is gained. But deleveraging attained powerful momentum last week on a systemic basis across global markets. An ebb and flow would be typical, but it’s likely too late to get the genie back in the bottle.

A meaningful tightening of financial conditions has developed. Corporate debt issuance has slowed to a trickle. Importantly, junk bond and leverage loan prices came under significant pressure. This needs to be reversed quickly.

Our system is now years into a major subprime lending boom exemplified by the imprudent ballooning of so-called private credit. High-risk lending is always a seductively rewarding endeavor during boom times. Boundless, eager borrowers willing to pay exorbitant rates to finance all sorts of things. And so long as credit is readily available, a lot of overstretched and [unclear] borrowers will stay current on their obligations, borrowing from Peter to pay Paul, borrowing against inflated asset prices for fun and pleasure. But let there be no doubt, this is a game of musical chairs. It’s a Ponzi scheme. When finance tightens and borrowers lose access to new borrowings, the party ends abruptly and the downside of the credit cycle takes on a life of its own.

Markets are signaling tighter finance and rapidly escalating credit concerns. There was an article a couple of weeks back that highlighted the ranking of communities by the highest average household credit card balances. No surprise, California dominated the top slots. At number one, average households in Santa Clarita were carrying $22,753 on their credit cards. Chula Vista placed second at 20,567. These are wealthier communities, so I have to assume that stomaching such expensive debt was part of the strategy of plowing cash into the booming stock market.

This illustrates a fundamental vulnerability that is not well appreciated by mainstream analysts. Households have never been as exposed to stocks. A bursting equities market bubble will come with negative wealth effects and more cautious consumers. It will also expose extraordinarily problematic over-indebtedness, even for higher-income households. The marketplace has started to back away from high-risk consumer credit, which will force companies to tighten credit limits and lending more generally.

From my Austrian economics roots, I often refer to the US as a bubble economy. Bubble economies appear sound, even robust, so long as financial conditions remain loose, credit grows strong, asset prices inflated, and spending and investment elevated. However, problems fester below the surface. Vulnerability is revealed as conditions tighten. Well, conditions have tightened significantly.

It is central to my bubble thesis that uneconomic and negative cash flow enterprises proliferated throughout this most protracted period of ultra-easy money. I believe years of deranged finance have come home to roost. Unless conditions loosen quickly and debt markets get back open for risky borrowers, we’ll see a ramp-up of layoffs and business failures. There’s already been a collapse in small business confidence. When financial conditions remained extraordinarily loose, my analysis pointed to a tenuous continuation of bubble economy dynamics. Now, I believe a downturn has begun with the potential to stun conventional analysts with its depth and duration.

But don’t listen to me. Hear what the markets have to say. I’ve already mentioned last week’s extraordinary spike in Treasury yields. Benchmark mortgage-backed security yields surged 56 basis points last week to 5.91%—the largest jump since 2020. Junk bond yields were up 96 basis points in seven sessions to 8.58%, trading to the high since October 2023. Junk bond yield spreads to Treasuries widened 119 basis points in four sessions. Leverage loan prices traded to lows since July 2023. CDS prices had their biggest moves since the March 2020 crisis. And that’s investment grade, high yield, and bank CDS prices.

At Wednesday’s close, muni yields we’re up 89 basis points in three sessions before ending the week 66 basis points higher. Importantly, such dramatic yield spikes are indicative of markets seizing up. Debt markets, including leverage lending, were essentially shut down. Worse yet, acute debt market stress was a global phenomenon. Last week, 10-year yields surged 57 basis points in Colombia, 49 basis points in Turkey, 48 in the Philippines and Mexico, and 46 in Indonesia. EM currency losses, especially versus the surging Japanese yen, meant speculator pain and carry trade deleveraging. A Bloomberg headline, emerging stocks sink most since 2008 as tariff turmoil deepens. Down 13%, stocks in Hong Kong suffered their worst session since 1997. Major stock index losses included Taiwan down 9.7%; Japan down 7.8; South Korea, 5.6; and China, 7%.

I view the past couple weeks in the context of an expected, arduous, and protracted deleveraging period. Deleveraging last week went to the precipice, and recoiled after the 90-day tariff pause. This episode provided important thesis confirmation. Highly over-leveraged systems at home and abroad exposed their fragility. From experience, such market dynamics tend to be unpredictable. But I am confident that the leveraged speculating community and market systems more generally have suffered impairment. Leveraged speculation over years ballooned to become the key marginal source of liquidity throughout global markets. And this key source of liquidity is now unsteady and weakening.

Confidence has been shaken—confidence in policymaking, market structure, and in the future. While timing is always uncertain, mounting fragility raises the odds that the next phase of deleveraging turns highly destabilizing. Last week, we also learned that the Treasury market and dollar face serious issues. In past crises, so-called US exorbitant privilege provided critical system ballast. Now, important new market dynamics are afoot. In particular, the Treasury market now seemingly creates a key source of potential instability. Concerns including Chinese selling and even a replay of a Liz Truss-style crisis of confidence have the potential to destabilize the most important market in the world.

Count me skeptical that Congress will rein in deficit spending. It will be difficult, if not impossible, to offset anticipated tax cuts with a combination of spending reductions and tariff revenues. I expect tariff receipts to come in much below the numbers bandied about by administration officials. I also fear that dynamics associated with deflating bubbles will see a problematic increase in countercyclical federal spending coupled with weak receipts from personal income, corporate, and capital gains taxes.

Prospects for inflation are both troubling and highly uncertain. Global market instability and deleveraging have put pressure on crude oil and some of the more industrial commodities. A seizing up of global markets has the potential to unleash the forces of economic depression and deflation. But beyond the shorter run, inflation prospects are troubling.

Globalization has been a powerful force for lower goods prices. I’m all for rebuilding our industrial base, but for many things, the US would be a high-cost producer. And at the minimum, the unfolding trade war with China will accelerate decoupling between the world’s great consumer and producer economies, a dynamic conducive to supply chain problems and ongoing inflationary pressures.

As crisis dynamics gain momentum, I see no alternative for the Fed and global central bank community than to aggressively expand their balance sheets to accommodate speculative deleveraging and counteract acute systemic stress. The administration’s new tariff regime will be an inflationary shock, though the intensity and duration are unclear. There is the clear possibility that the Fed is forced into another aggressive round of QE despite elevated inflation risk.

A future scenario that has for years occupied my thinking could now turn into reality. How might the Treasury market react in an environment of massive issuance, elevated inflation risk, and aggressive Federal Reserve money printing? I never contemplated that such a scenario would also include pursuit of the most extreme tariff regime, fraught relations with our allies, a potentially perilous trade war with China, and a trillion dollar plus highly levered basis trade.

For years, I’ve expounded my analytical framework and bubble thesis warning of dire consequences. I appreciate that this has often seemed like stubbornly pessimistic analytical musings, especially with markets rising inexorably higher. Well, my overarching message is that bursting bubble risk is reality today. I purposely titled today’s call, “Decades of Inflation Home to Roost,” not “Coming Home.” It’s here now—knocking on the door, if you will. Reckless monetary inflation and lose financial conditions were never a solution. From my perspective, our goal is to look back at this period and feel that we did our best to prepare for unexpected and unprecedented uncertainty and turmoil.

Thank you for your time. David, back to you.

David: Thank you, Doug. I want to thank you all for being with us today. We’ll transition to the Q&A. And as we do, I just want you to write down an email address. Those of you on the call today are stewards of wealth. Some for your family. Some have institutional responsibilities as allocators of capital. And I would encourage you to set up a time to visit with myself, to visit with Doug, in the coming days and weeks. Send us an email at Te*@******ny.com. Ted@McAlvany.

Love to visit with you and see how this fits into your overarching responsibilities to steward wealth through a generation. And we think we’ve got a solution for you that complements creating a hedge for existing positions, and even considering opportunistically what is there on the downside in the financial markets.

For questions, I’ll start with Ed’s question to this. “Would you recommend rebalancing cash, precious metals, and stocks and bonds more often than once a year in this volatile environment?” It’s a great question, Ed. And I would consider doing this consistent with what I would describe as ratio triggers, not based on market prices.

So I’ll give you a couple of examples. For instance, a heavy gold portfolio or gold-heavy portfolio could shift mildly towards silver, with the ratio being over 100 to one. Again, the ratio being more important than the prices. Is it concerned stocks and bonds? I think it’s too early to make any major shifts in the direction of the S&P and the Dow. I think there’s a relationship to watch and a ratio which is helpful there, the Dow/gold ratio. The extremes in relative value set up for a once-in-a-generation rebalancing, and that’s something to watch. The current ratio between gold and the Dow is about 12 to one.

And we have consistently seen through the last 120 years, that ratio will decline to three to one on the basis of economic factors. And if there are geopolitical considerations in the mix as well, it can even reach a one to one ratio. That may seem extreme, that may seem unthinkable, but it’s what happens when you’re dealing with fear in the marketplace and people trying to figure out what the bottom is in financial assets.

The extremes in relative value set up for, again, I think an interesting opportunity. I’ll give you another example, Ed. The ratio of physical metals to miners is just in the process of breaking out, and it’s breaking out to the upside. Where bullion values have moved up, and moved up and to the right, miners have, until 2025, been moribund. And that’s changing. Just kind of a word of caution there. Not all miners are dealing with the same opportunities, and weighing the merits of management team, the quality of assets, jurisdictional risk, all of those are super important.

That is one of several areas our team maintains a focus and an expertise in. So talk to us in-house if you’re interested in our MAPS strategy, the hard asset strategy, wherein we have a healthy exposure to precious metals miners. If you are still very long traditional financial assets, you are on the disadvantaged side of the trade. And if that describes you, you should be short to hedge. You should be increasing cash. Thus here we are today discussing the dynamic supportive of our Tactical Short product.

As it relates to bonds, bond rebalancing and doing that on a more routine basis, bond rebalancing to the short end of the curve is something that I think is a priority. It’s most of what I have to say. Avoid unnecessary credit risk, avoid duration. Risk in credit has been papered over. Risk in credit has been normalized, even to the point where the industry no longer even talks about junk. We think of it and we talk about it as a high-yield product instead. And after all, who doesn’t want a higher yield?

So there are in the world too many unknowns that could press rates higher, leaving both duration plays and lower credit quality very much in the cross hairs. So with massive bear market inequities, you could certainly see yield compression out of a rotation. You could certainly see yield compression followed by direct Fed intervention and emergency rate cuts. But that may not be sufficient to bail out your longer-dated paper and lower-quality borrowers.

The next question is on gold, so I’ll take that and then hand the next one to you, Doug. Art asks, “Is gold going to take a break from here?” It should. And investors have been assuming that it would since the breakout over $2,200 an ounce. The correction was going to be off of 2,500, or was it then going to be off of 2,650 or 2,850 or 3,000 or 3,350? I think you can see the trend. Yes, it should. But what we’ve seen with each correction thus far, which has been very sharp and very short, is that those corrections have been bought by investors that are very under-allocated to the space.

If this is a real regime change in terms of how the dollar and US Treasury markets are regarded globally, you can’t take this move for granted. The gold move is signaling something bigger and far more structural and systemic than we’ve seen in past cycles. If you’re not already invested in precious metals, you should be dollar cost averaging in over the next six to nine months. You won’t be the only investor buying on weakness. That is part of this secular trend. A case to be made for a cyclical breather is completely legitimate. And so anticipating that kind of a correction I think is reasonable.

The reason you dollar cost average in even at these prices is that the secular trend can take, is likely to take, the price to between 5- and $8,000 an ounce. And we have no idea the time frame for that move. It’s driven by circumstances. If there are external circumstances, those prices can be achieved in a very short time frame. If you’ll just recall the last structural bull market in gold, the price doubled from 400 to $875 in six weeks. That’s in six weeks.

So a part of my thinking on the duration of the gold move ties to silver. Silver is very much an expression of investor participation in the metals bull market, and that has yet to begin in earnest. Metals markets typically end with a blow-off top, and silver would be sort of the final nail on that coffin. Today, the ratio between silver and gold, it’s 100 ounces of silver to one ounce of gold. That’s the ratio.

I would be worried about both metals if the ratio was under 30 to one. At this point, I think we have a long way to go in terms of the extent and the duration of this metals market. So, no easy answers here. These are unprecedented times with massive global shifts underway. Capital allocators are only just waking up to these structural shifts, and have little— In fact, I think, at this point, they’re very cautious to do anything at this point, climbing the proverbial wall of worry.

So, insofar as dollar cost averaging is concerned, a correction to 3150, buy it. 2975, buy it. 2875, 2800, all buy points. Financial markets narrative obviously will drive volatility in gold. And so in the weeks and the quarters ahead, either a buoyant, bullish narrative will negatively impact gold if that narrative can be revived, or a bearish narrative—in which case market stresses are more likely to drive safe haven allocating.

Thanks for that question. This next question comes from Leslie. Actually, not a question. “I don’t have a question, but I do want you to know that I truly appreciate your research and your commentary each week. You help keep us informed.” Doug, I don’t know if you want to comment on Leslie’s comment, but I will say that, for the decades that I’ve been reading the Credit Bubble Bulletin, it has remained a source of insight into what’s going on underneath the veneer of the financial markets, bringing adaptive understanding. And the work that you do each week is greatly appreciated. For those of you who do not take advantage of the Credit Bubble Daily, I would encourage you to do so. If you want to save yourself three hours a day in research, Doug has done a masterful job of curating a news feed with the most important articles for you to read from a variety of sources, whether it’s the New York Times, Bloomberg, Reuters, you name it, he’s got it covered. And for that tireless effort, I, too, thank you.”

Doug: Thank you.

David: Well, then, I’ll take the next one. “The eventual impact and probable amount of time for Trump’s trade and money refresh—when is it 80% or more completed? Thanks for hosting the conference.” Mike, you’ve asked a challenging question. I think it’s impossible to know in terms of a time frame. The Trump trade money reshuffle is not one event but a span of time and a series of shocks that is likely to encompass all of his first two years.

Now, the implications are not only for that two-year time frame, but I think may stretch out for years or even decades. There’s a chance that none of these policies being implemented work, and this is an utter disaster. The last time we had significant reform and reorientation of the economy, reconfiguration of the tax code, was under Reagan. Before that, FDR, again, a reorganization of the state apparatus, reconfiguration of the tax code to fund it. And the impact was felt for decades.

So, I wish I had a better answer, but the ability to say when we are 80% past this—I think we’re in the first inning. The temptation here for investors will be to look at the financial markets and buy what they think is value—cheaper prices would certainly be a better value—only to find out later that they were too soon, catching the falling knife, so to say.

So, I would just encourage you, Mike, be careful, be patient. If you are overcommitted, this will be an emotional time for you. If you commit too soon, this will be an emotional time for you. If you’re adequately liquid, if you are adequately hedged, your blood pressure should be manageable. So, those are questions that I would ask you in return. Are you adequately liquid? Are you adequately hedged? And if you can’t easily answer that, then let me help you. The answer is no. What you do next matters. I’d like to see you open a Tactical Short account and be able to answer those questions very much in the affirmative.

Doug, the next one from Nathan, “What are your thoughts on the direction of interest rates? For several decades, they’ve been declining, but the trend seems to have reversed back in 2020. Trump wants a weak dollar, which is usually achieved by lower interest rates. And hard economic times are often accompanied by a drop in interest rates by the Fed. However, tariffs are inflationary, which usually calls for higher interest rates and a reduced demand for U.S. debt due to trade war would require increased interest rates to entice lenders to lend. But then you have our ballooning federal debt, which requires lower interest rates to keep the interest payments manageable. With so many factors, it’s hard to know what to expect.” So, Doug, what are your thoughts on the direction of interest rates?

Doug: Yeah, thanks for the question, Nathan. Seems that “hard to know what to expect” could be an understatement there. Let’s start by separating short-term interest rates that are determined by the Federal Reserve from market yields determined in the bond market. Unprecedented pandemic, monetary, and fiscal stimulus, they were fundamental to that inflationary spike that we suffered through. Instead of leaning against supply side and fiscal inflationary pressures, the Fed opened the monetary floodgates. And then the Fed stayed way too loose for too long. And then, despite a major increase in the Fed’s policy rate, financial conditions remained loose and inflation stayed meaningfully above target. Simply put, momentum throughout the credit system and leveraged speculation, they had become too powerful. Basically, the Fed had lost control of finance.

There is now great uncertainty as to how the administration’s tariff regime policies will impact inflation. It’s already above the Fed’s target. And Chair Powell made cautious comments just yesterday in his presentation in Chicago. At the same time, you have the impact of tariff policies that they’re having on this the highly levered global financial system, with unprecedented leverage speculation, in particular.

I discussed this. The system is fragile. And the risk of a major deleveraging eruption is high. Market behavior over recent weeks, it supported this thesis. So, to try to answer your question, inflation has moved fundamentally higher since the pandemic. And the prospect of another inflationary shock suggests that short-term policy rates will remain higher than they would have traditionally been—in the case of an environment of unstable markets and waning economic growth. Fundamentally, short-term interest rates now are higher.

I’ll add, though, that all bets are off in the event of a major deleveraging where the Fed would likely be forced to slash rates and restart QE. We saw the market price some of this early last week, where quickly the market was pricing at least four rate cuts by the end of the year. There are various scenarios, but with my view of market fragility, I lean towards the Fed being forced to slash rates this year.

The discussion of future market yields is even more challenging. With inflation expected to remain elevated, this points to market yields that will be less sensitive to Fed rate cuts and economic issues than we’ve seen in the past. We’ve already witnessed— This is extraordinary. Think of this. Beginning in September, the Fed cut interest rates 100 basis points, one full percentage point, yet 10-year Treasury yields surged over 100 basis points. And then we saw last week, 50 basis point spike in Treasury yields in the face of global market instability. Now, this is all quite extraordinary.

So, evidence seems to suggest that the bond market has or is in the process of transitioning to a new paradigm. As I mentioned earlier, market scenario analysis must now— We’ve got to contemplate that the bond market might not respond to Fed rate cuts and liquidity injections as it did predictably over recent decades. And there are other critical issues weighing on bond market confidence, including these unending massive deficits, the now-weak dollar, trade war, and possibly Chinese selling. There could be a crisis over Fed independence. The president this afternoon is making_ He just said that he can fire— He is not happy with Powell, and if he asked him to go, he has to go. So, we could easily see a crisis there. One today cannot rule out a crisis of confidence and highly destabilizing spike in Treasury market yields. That’s something we haven’t seen before.

Over the years, I’ve repeatedly made the point that my job is not to predict but to react. I come in every day focused. I have my analytical framework, my mosaic of indicators. I intensely monitor developments because it’s imperative to be able to react effectively. The current environment, in particular, demands intense focus on rapidly changing developments, including policy developments.

And I’ll be keenly focused on how the administration and Federal Reserve, how they react to market developments. When it comes to interest rates, the market’s in, really, about everything else. I’m in the mindset to expect the expected, really. Anything could happen. So, not a very clear answer for you there, but thank you for your excellent question.

David: Doug, let me add to that, the market has assumed the Fed put for a long time, that there would be an intervention in the case of destabilization, deleveraging—that you could assume a policy response. What are the implications of a delayed response?

Doug: Thank you, David. That’s something that I should have probably hit on. It’s a very, very important issue because the markets—it’s the so-called Fed put—the markets have been trained, if there’s any instability, the Fed immediately comes with a policy to response. We certainly saw that with the March ’23 mini banking crisis, quick liquidity injection. That stops deleveraging from gaining momentum. And if it doesn’t gain momentum, it’s pretty easy to reverse. The hedge funds haven’t done much. They’ll get right back, as I had mentioned earlier, business as usual.

A delayed policy response ensures that instability deleveraging has gained important momentum. And when it gains important momentum, it takes a lot more Fed firepower to reverse the dynamics. Back in March of 2023, it took three big rounds of QE announcements to halt deleveraging. Three of them. I think it was 1.6 trillion QE in a month, basically, for the markets. I think the amount of speculative leverage is so much larger today than it was going into the pandemic. And now we have the Fed—because of inflation, because of the new tariffs, they are going to sit and watch. And they will respond because they’ll have to respond, but they’ll respond late. And by the time they respond, their task is going to be extremely challenging. And thanks for having me clarify that.

David: Well, one more thing just to build on that. Last week, you were describing the dynamics within the credit markets and true global deleveraging unfolding. Powell was quiet. There was no response. Trump reversed course, put his tariff initiative on ice for 90 days. Does that not implicitly communicate to the leveraged community, the hedge fund community, that it’s different this time, that Powell does, in fact, have a reason to wait? What you just described, whether it’s inflationary concerns, tariff concerns, the implications, we don’t know what those are yet to don’t act too early? Wasn’t last week’s silence and the forced move on Trump’s part something of a shot across the bow for the levered speculative community?

Doug: Absolutely. And the market has to question how the Fed will respond going forward, and if the Fed specifically will wait for the administration to respond first before they have to. So, the old days of market instability and the Fed right there ready to do what everyone expects it to do, there’s no clear path here for how the Fed’s going to respond to market instability because you’ve got this dynamic between the administration in this tariff regime and the Fed and inflation dynamics. So, this is, as they say, uncharted territory.

And the point I’ve been making now for a bit, for weeks now, is there’s too much uncertainty to be leveraged, to be highly leveraged here. There’s just too much uncertainty. And it’s going to take quite a while for the big leveraged players to reduce their leverage. There’s not enough liquidity for them to come out quickly. They can go out and hedge and they can do things in a swaps market and some of these things, but to actually deleverage positions, that’s going to take a while. But I think they know they need to do it because of this change to backdrop.

David: Stephen’s question, I think this is for me. “First, thanks for all you do. Love your weekly commentary. Like you, I see hard assets being the best investment, perhaps, for the next decade. If the stock market drops in the neighborhood of 50% from the top to low 3,000s, would you be an aggressive buyer of stocks at that point? What would your allocation be in metals, stocks, and Treasuries at that point? At what level on the S&P would you be a buyer and not be shorting?”

It’s tough to say. Managing money requires a fresh set of eyes on a daily basis. And as Doug mentioned a moment ago, that’s what we do, come in every day and look at what the conditions are then. So, to pick a price on the S&P assumes we know more than we do about a lot of things, about the credit markets, about the financial conditions, and are those financial conditions such that they might lead to a 30% correction, a 50% correction, or an 80% correction?

Liquidity is a huge dynamic. As Doug often mentions, liquidity is critical for solvency. And as long as liquidity is available or provided on time under duress, then solvency concerns will remain negligible. And so, these are the things that we just don’t know. We can’t know. Is there an intellectual justification for the central bank community acting too slow? Is there a political reason for them to be slow in the intervention process? If the promise or the provision of liquidity is uncertain, then prices don’t have a bottom.

So, 50% off the all-time highs, is that the time to step into the market? Again, it’s difficult to say. There will be financial market conditions which we have to look at at the time, on a day-in, day-out basis. I thought that Liz Ann Sonders at Charles Schwab had some interesting things to note, just a disturbing trend here in recent weeks, which is foreign holders of U.S. assets are, from what she sees in terms of capital flows, as the chief there at Charles Schwab, they’re reconsidering their allocations and beginning to head for the exits. That is a new factor for market participants.

So, again, as we look and try to pick a point to reenter to either cover shorts or re-enter on the long side, we haven’t seen market volatility married to what could be a generational abandonment of U.S. dollar assets. So, our positioning is, it must be determined on a day-by-day basis without trying to predict the future.

Having said that, yes, we have a thesis which suggests where, in terms of hockey, if I can borrow from the sport, where the puck is going next. And we’re actively skating to where we think it will be, but we must course-correct with new data and daily price action. It’s the only way to mitigate risk.

Stephen, I often come back to Richard Rainwater’s influential guidance provided to the Bass Brothers. He spent a couple of years with Goldman Sachs and then was hired by the Bass Brothers. He had been a classmate with one of the Bass Brothers. At the time, their fortune was about $50 million and he helped guide that well over 10 times then. He was allowing the trends to play out. He exited hard assets in the late ’70s. He entered equities by 1982, and with patience allowed for the transitions to occur slowly, again, to the next trend.

I think some of the best opportunities in the next trend, they don’t exist today. And others are there already. And under the right market conditions, it should be owned. I think I would encourage you, Stephen, to think about the team that you partner with, the process that they employ. Those are critical elements to navigating structural change and emergent opportunities.

Doug, the next question for you from Jeff. “Gentlemen, thank you for your painstaking and insightful work on our behalf in these volatile markets. With the prospect of increased volatility ahead, are you planning any changes in the portfolio to capture maximum gains while still mitigating risk?”

Doug: Thanks, Jeff. As for Tactical Short here, my focus, and I’ve talked about this so much, my focus has been on a very disciplined risk approach, risk management approach, for our short exposure, managing the volatility or the beta of short exposure. Especially in hyper-volatile markets, I will keep a very tight rein on exposure. I don’t want to risk allowing expected wild volatility to too negatively impact performance. I strive— It’s just very important to me to avoid negative surprises.

For now, I’m content to stick with the S&P 500 short through what I expect will continue to be highly, just incredibly once-in-a-lifetime type unstable markets. I don’t want to have days like our competitors had last week where they lost over 9%. I don’t want days like that. We’re in this strange environment where Truth Social posts will trigger historic rallies. And they’re probably going to come when it looks like the market’s in the most serious trouble—when the analysis says, okay, the market’s in serious trouble; okay, get ready because we’re going to see some posts.

So, I have to factor this into short exposure and short composition decisions. I’ve always planned on broadening our short exposure. And I will consider adjusting the composition of short exposure when the market has proven to me that it is less unstable and more predictable. I don’t want to sit around and say I’m expecting the unexpected and then have a volatile short portfolio. Those two don’t work. I don’t see much shift in the composition of short exposure here in the near term. Again, right now, the focus, I just want to get through this incredibly unstable market period with Tactical Short providing an effective and reliable market hedge. We’re not trying, we’re not out swinging, trying to hit home runs here. We’re trying to get through this period and perform as advertised, do exactly what people expect us to do. So, very good question and plenty to think about as things progress over time. Thank you.

David: Bob asks, “If the U.S. dollar was to be devalued, would there be long-term effects on gold, different from short-term effects?” Maybe this is taking the question in a slightly different direction, but Bob, I think one long-term effect could be a generational shift in perceptions from seeing gold as a commodity speculation to seeing it as an anchor asset in a broadly diversified portfolio. A younger generation coming of age in the context of dollar devaluation would emerge with an ingrained experience of managing currency and stability, either through opportunistic purchases, the accelerated consumption as a response to inflation, or, if you’re talking about allocating capital, how do you preserve purchasing power? Is that in the form of gold? Is it in the form of silver? Is it in cryptocurrencies, some or any dollar alternative?

So, I think there is that generational shift in perceptions. Short-term, and again, this may be taking it in a different direction than you’re asking, but the short-term implication for dollar devaluation and its effect on gold, I think you’d have greater investment manager cynicism. They’re already looking at an asset class that they’ve been under-allocated to for years. And they’re dealing with more and more phone calls from clients saying, “Why don’t we own this? Last year’s performance numbers were interesting. Year-to-date, their performance numbers are interesting. What is it telling us? Should we be allocating?” And I think, for many of them, they feel it’s too late to allocate. There will come a point where they are finally forced to allocate. And typically, that comes right on the edge of a cyclical correction, just in time for a corrective process that leaves them even more cynical than they were before. So, being as late as they are, dragging their feet as they have, I think it sets at least the financial advisory community into even a more staunch position that this is just not something you want to own.

Next question, “is the present financial environment favorable for precious metals?” I can answer that very quickly, and Doug, if you want to add to this, I just say, very favorable. It has been and will continue to be so long as uncertainty remains. It’s there as a reliable hedge. Frankly, a lot of what’s driven the market to date has not been investor interest. They’re not looking at it. The buyers of metals are not looking at it from the standpoint of potential gains. It’s the central banks that have gotten us to 3,000 an ounce. And I think their motivations are not particularly price-sensitive. It is a trend, de-dollarization and diversifying reserve assets, which is set to continue for many years to come. Doug, what do you think? Present financial conditions favorable for metals?

Doug: Highly favorable. I’m expecting wild volatility, but certainly no interest in selling any of the gold holdings here.

David: The next question is from Mike, “what is the best way to invest $200,000 just sitting in the bank?”

I would start with clarifying what your mandate is. The mandate needs to be clear. If it’s a liquidity mandate, you already have it in the bank, it’s supposed to be liquid, then your choices are fairly straightforward, in my view. Bank deposits are higher risk for less reward than what you can get in short-term T-bills. And note a huge difference, when we talk about owning Treasuries, it’s always short-term Treasuries. It’s not 5, 10, 20-year Treasuries. We’re not playing with long-dated maturities.

So, if the mandate is liquidity, then you’ve got a higher rate of return with a lot less risk. That makes sense. If your mandate is not liquidity, if your mandate is growth, you first need to clarify where you are on the spectrum of volatility tolerance. Because the word “best,” best for someone may be a solid growth rate at 7% on an annual basis. Someone else, “best” may be defined by a higher rate of return into the double digits. To me, and for me, I need to be able to measure downside risk versus upside rewards. And when the risks are manageable or measured and the rewards are reasonably projected to be multiples of that downside risk, that’s how I would put it into a best category—again, if we’re talking about that mandate of growth.

The last mandate that we talk about is insurance. Gold bullion is a great macro and geopolitical risk hedge. And also in that category is Tactical Short. Tactical Short has the advantage of lower costs. And so, I think, again, it just depends on the mandate that you are wanting to fulfill. So, clarifying that question, that’s where I would start in terms of the best way to invest $200,000 and the means of accomplishing that.

David: Doug, the next question is from Brian. He says, “Hello, I’ve been reading the Credit Bubble Bulletin since 2021 after I noticed Ed Steer over at SilverSeek via Casey Research started referencing your commentary regularly. Mr. Noland, I find your perspective helpful and the fact that the CBB includes mainstream news articles in one place has made it a must each week. You’re one of the most important voices to me over the past few years, along with Torsten Slok, Zoltan Pozsar, Luke Gromen. I was born in the ’80s, work in application support, IT, for one of the largest financial firms in the U.S., based in Tampa, very much like a chance to be a listener on the call.” So, I think this is not a question, but just an attaboy.

Doug: Well, thank you, Brian, if you’re on the call. Actually, I deeply appreciate feedback like that. The goal from day one was always to do my best to—if I could help inform and educate, that’s all I’m trying to do. So, appreciate it. I’ll keep grinding away at it.

David: I’ve got a couple of questions here. William asks, “What are the chances of a failure to deliver physical silver on COMEX, silver contracts?” It’s a good question, just know that they can always settle contracts not in kind, but in cash, and so there’s always an out for them. Settlement does not require the physical metal, they can always settle in cash. So, that’s probably the out.

There is I think an interesting question relating to tariffs. They have not yet applied to the physical precious metals, but if they ever did apply to the physical precious metals, the movement between the London markets and the New York markets—very fluid. Lots of metals moved back and forth this year, in the last three to six months, lots of metals have moved from London to New York.

If that was at a 10% or 15% or 25% tariff, it would shut down the movement of metals. And now, the question is what’s the demand side or how many people are taking delivery of contracts? You could get into a situation where COMEX is bone dry. Long way away from that. There’s ample ounces available in the form of thousand-ounce silver bars and there’s a lot of other product as well which can go straight to the hot pot for melting and then conform to your contract satisfaction in the form of kilos, kilo silver, hundred-ounce silver, thousand-ounce silver, what have you.

So, next question, “thinking about the current situation with regard to trade, I have two questions. How likely do you think it is that the US and other nations will extend the trade friction into currency devaluations?” You want a shot at that Doug?

Doug: David, it seems like that’s your question.

David: I think it’s a given. I think it’s a given. I think the unknown is to what degree. And reading through Steven Miran’s paper from October makes it pretty clear that the re-engineering of the trade system towards greater industrial capacity in the United States and an increased flow of exports and less dependency on imports, I think the implied conclusion from that paper is what you would expect from any mercantilist regime. You’re going to devalue. It’s one of the things that facilitates the trade advantage is having a lower currency value. And does that translate into a competitive devaluation? Yep, I think it does. So, I think it’s a given. I think the unknown is to what degree and what countries decide to try to remain or keep a competitive edge.

Doug: David, I’ll add something briefly. We’ve been running huge current account deficits for over 30 years. Usually when you do that, you have a weaker currency. You’re flooding the system with your currency, and you have a weaker currency. We haven’t had that because of these issues, the exorbitant privilege and all of these things. Right now, the market’s re-evaluating this issue, but all of these dollar balances are out there, right? So, I think just revaluing the balances out there could cause one significant dollar decline, and these kinds of things feed on themselves.

And to me, the trade frictions are just one aspect of what’s going on, right? It’s the deleveraging, the trade, all of these things I think are leading to a re-evaluation of, is the dollar always going to be this currency that’s immune to— you can have as large deficits, current account, fiscal, you can print up money, you can do whatever you want. It doesn’t matter, the dollar’s going to be strong. I think that’s all being re-evaluated now and the dollar started to make that adjustment.

David: The next question is also from Alan. “Can you talk about the Roosevelt currency devaluation in the ‘30s? I believe we were on the gold standard when we devalued.” He asks, “How do you think a drastic 20% to 60% devaluation would look this time since we’re not on the gold standard?” So, just a little background, the dollar was priced in gold terms at $20.67 to the ounce. The law shifted in 1933 to create a two-tier monetary system where US ownership was illegal, allowing for the domestic devaluation you’re talking about. And that was from $20.67 to $35 an ounce. So, in percentage terms, the difference of $14.33 divided by the original $20.67, 69% devaluation.

It also going to a two-tier monetary system, it allowed for settlement of foreign debts in gold, which preserved our reputation. We were not pulling a fast one on our foreign creditors in order to pay them off with devalued dollars. The effort was different, the motive was different, the effort was to re-liquefy the domestic banking system through disconnecting the domestic dollar’s relationship to gold and allowing for a relief of liquidity pressures. Today, with an extreme dependency on imports, 20% to 60% devaluation would hit the consumer hard. Less goods for the same dollar, definitely hit to a lifestyle—or more dollars for the same goods, however you want to phrase that. Inflationary for sure.

The Trump transition—this is the proposal anyways—the Trump transition towards domestic production—again, this is in theory—over a long enough time frame would increase exports. Theoretically it invigorates income growth and to a degree would offset inflationary impacts from imports. But you’re talking about time and you’re talking about sequences, and we don’t know how much time. So, it’s the time and sequencing that are not clear to me. These kinds of major macroeconomic re-engineering programs, they don’t take place very often, and you don’t know if they’re going to work and you don’t know how much time it’s going to take.

Consumers are going to have to deal with today’s bills and obligations, with less ability to weigh the long-term benefits of structural change—again, assuming that they work. My concern is that devaluation might improve our ability to export goods 10 years from now. But again, this is a time and sequencing issue, you’re talking about from plants that don’t exist today. But to the degree that inflation is a near-term effect for consumers coming from a currency devaluation, I think there’s a high political cost. And so, it’ll be interesting to see how theory and practice work themselves out with the current administration.

There’s another question here that relates to gold, I’ll just take it real quick. Let’s see, “how do you think the current economic environment will influence gold and silver, the ratio, over the next six months?” So, I mentioned earlier, central bank demand for gold has been strong, and it continues to be, I think it predictably will remain strong. They’ve got non-price priorities, diversification, control of assets, things that are not held on deposit with the US Treasury Department. They view that as a lack of control, which is no longer desirable. They don’t want to see what happened in 2022 with the Russians and the disappearance of $300 billion in reserve assets overnight.

So, the demand for gold is not really, “Hey, I think the price is going higher, we should own some.” It’s very much “we like the control that that provides, and yes, it diversifies us away from paper and financial assets.” That I say is important to keep in mind because it’s driven gold higher, but central banks don’t buy silver. So, the ratio is stretched. The 100 to 1, I think we got to a high of 107 to 1 in the last 10 days. And that is historically like the high-water marks. We saw during Covid 125—it’s the highest we’ve ever seen it. Typically, a 100 to 110 is the max you’ll see.

Now, that investors are beginning to second guess their equity positions and are looking for portfolio diversifiers, we are seeing a shift in demand for the metals via the ETF proxies, GLD and SLV. We are seeing an uptick in demand for the metals—or the miners. And whereas, the last few years, even though the price has gone higher, you look at shares of GDX, they’ve actually shrunk dramatically because there’s been no investor demand for them. So, I see silver participating in the same way, benefiting from investor flows, where that ratio is likely to go from 100 to 1 initially to 80, 70, 60, and it’s anyone’s guess as to where it goes from there.

But so, I think over the next six months you do begin to see investor traffic into the metals, investor traffic into the miners. And as a part of that metals complex, silver benefits, particularly when you have small investors who stare $3,300 an ounce in the face and don’t know how to— It’s too big. It’s too much. They can’t wrap their minds around paying an all-time high price when silver’s trading still at 40% below its previous highs. There seems to be value and affordability and a number of factors that I think will drive investor demand there.

Doug, another question, and this just relates to not so much the nature of Tactical Short, but when you think about hedging of risk in a portfolio, what are the limits to hedging market downside?

Doug: What are the limits for hedging market downside? David, do you think that’s in the context of an effective hedge? I’m not quite sure the—

David: Yeah. So, take that to mean you’ve got hedge funds that assume that in a moment’s notice if they’re long they can go short.

Doug: Oh, I see.

David: I guess this hearkens back to ’87 and the dynamic hedging strategies which were supposed to be a cure for protecting against market downside and in fact just increased the downside volatility. So, the assumption is, by hedge funds and market operators, that they can hedge. So yeah, what are the limits to the actual ability to hedge?

Doug: Sure, sure. And let’s start from kind of a systemic review of it.

So, let’s think you have this huge run higher in stock prices. You have this specular melt up, and then stock prices really elevated and a lot of the markets says, “I just want to lock in. I want to hedge my risk, lock in my gains up here at high levels.” So, a large part of the market just goes out and buys put options that protect themselves, and everything works fine—except all of a sudden if the market goes down, whoever wrote all those put options, they don’t have the wherewithal to pay on market insurance if a big chunk of the market bought it. They have to go out and sell something, they have to short something. They have positions to generate cash flows to pay basically on those hedges, on that insurance that they sold.

Well, if you have a significant decline in the market, and back in 1987 it was called, it was a portfolio insurance issue, all of a sudden, the sellers of that insurance, they start to sell and the market starts to drop, which means more selling and more selling. Buyers back away, and you have a crash. The point being, the market can’t hedge itself. Someone has to have the wherewithal to pay on the insurance that people buy. And today that insurance is bought from people that use computers and models that are going to sell things if necessary to hedge the insurance they sold. So, there’s a big problem, and I’m sure that’s part of the dynamic we’ve seen over the last couple of weeks.

All of a sudden, if the market starts to go down, these sell programs just kick in, sell, sell, sell, the market’s, lower, lower, lower, the buyer’s back away and you’ve got a problem. So, there’s a big flaw in— I used to talk about writing flood insurance during a drought. It’s great as long as there’s a drought, but when the inevitable flood comes, you got a wipeout because everybody was buying cheap insurance and building on the river. Not only do these derivatives and this insurance lead to systemic vulnerability for illiquidity and market dislocation, they also change market behavior because when stocks are going up, if you could buy cheap insurance, why not aggressively speculate, thinking, “Okay, I’ll take a lot of risk, and if I have to, I just make a phone call or get on the market terminal and buy some quick put options”?

And it’s just a dangerous dynamic that’s going to come back. We’ve had plenty of examples of this over the years, and I fear now it’s an even bigger problem because the markets went up so much. There’s so much speculation, so many strategies depend on different types of derivative insurance and such. So, it’s right at the heart of this systemic vulnerability that I talk a lot about.

David: This next question is, I’m going to take a shot at it, but I’m going to tie it to something that I think relates to this theme of limited liquidity, or that liquidity is limited. John asks, “Is there a source that ties together the interrelationships between the Fed, ECB, Bank of International Settlements, International Monetary Fund, hedge funds, private equity, dark pools, other entities that are invisible to the public?” I could read that a couple of different ways. Where you have an overlap— All of these entities have a keen interest on normal market functioning and there being limited to no constraints for liquidity for those markets to function on a normal basis. And so, certainly, you can break them into two groups—the larger institutions, the Fed, the ECB, Bank of International Settlements, IMF, and they have “public good” that they’re supposed to be guiding.

It’s different than the siloed profit interests of the hedge funds, private equity, and dark pools. But where they overlap is that they are all interested. The interdependency is that liquidity is required, they all prioritize liquidity for proper market functioning. You could argue that the hedge funds, private equity groups, maybe even the dark pools are taking advantage, privatized risks and socialized losses. That was a lot of the talk back in 2008, 2009 during the global financial crisis.

But Doug, to direct a part of this to you, we are in a really unique period of time. If you look at the Trump impact on institutional cooperation, every time we’ve had a liquidity issue where all of these groups’ interests are tied together—and whether or not the Fed, ECB, IMF sanctioned the risk taking of the hedge funds in private equity, they recognize that for saving the system they’re willing to intervene. Now, we’re in a different place in time. Do you imagine that these organizations are going to operate on the same basis, coordinated policy responses? Or could you see a compromise of swap lines being extended and things like that, where, again, the interdependency is liquidity, but what if liquidity is inadequate because we have a new constraint to coordinated policy responses?

Doug: Lots of constraints to policy responses right now domestically and internationally. I’m going to try to see if I can have any success here in mentioning a very important concept that’s complicated. It’s complex, I’m going to try to simplify it. We talk about the basis trade and leveraged speculation. When a hedge fund goes in and does a basis trade, they borrow in the repo market, they take that and they use that borrowing to buy a Treasury bond. That increased leverage creates liquidity. As long as there’s an increase in speculative leverage, that adds liquidity. And my analysis, I focused a lot— If you go back to early 2023, money market fund assets have increased $2.2 trillion since early ’23. They’re like $1 trillion last year.

It is part of the liquidity created in this speculative leveraging, That’s $2 trillion of new liquidity just out there in the marketplace. Everybody is just loving liquidity—all the different parties, right? The problem is, with de-risking and deleveraging, all of a sudden you have an unwind of that same speculative leverage, so, you have a contraction of liquidity.

I just got a data point, I just checked it here on my Bloomberg. So last week, money market fund assets we’re down $126 billion. I would have to go back, but I think that’s the biggest weekly decline we’ve had in quite a while. Is it a coincidence that that comes in a period of deleveraging? No, it’s not a coincidence.

So, when I look at that chart, I’ve got the chart over here. Watching money market funds go from $4.5 trillion to $7 trillion going back late 2022. I just see a huge problem because I think that’s associated with leverage that now there’ll be pressure to unwind some of it. And we see today that it’s making an end to money market fund assets. I won’t belabor the point, but liquidity is everything to everybody in the marketplace. And it’s the system’s weak link because of this unprecedented expansion of speculative leverage we’ve had over the last few years.

David: Well, Doug, thanks for sharing your insights with us today. Again, for those of you who are interested in pursuing next steps and exploring how Tactical Short is a fit in your portfolio mix, in the stewardship mandate that you have, whether that’s institutional capital or private family capital, do reach out to te*@******ny.com. And I think I might’ve missed one question, bear with me just a moment. Doug, help me with–

Doug: Yeah, let me go ahead David. There was one question and it’s kind of topical, sorry to interrupt. It’s kind of topical, so I thought maybe we’d hit it. It’s from Michael Wilson, he says, “Is the basis trade unwinding still a high risk, are bonds still a safe haven? If no, at what point does the yield on a 10-year become too much and for whom?”

David: Yep.

Doug: So, those are topical questions, Michael, thank you. And there’s some market intrigue here. Lots of market chatter the last week about the great basis trade blow up, but as of last week there had been little reduction in Treasury short futures positions in CFTC data. And that’s one place where people look for clues as far as this basis trade. So, this strongly suggests that there has been yet not much movement there on a basis trade unwind. And for those of you not as familiar, the basis trade is a highly levered hedge fund strategy of borrowing in the repo market—just what I was discussing—to finance an often 50 to 75 times levered purchase of cash—Treasury bonds—which are matched against short positions and Treasury futures. It’s kind of complex.

The key point is that 50 to 75 times leveraged borrowing in the repo market. This trade is estimated to have surpassed a trillion, I think it could be a lot bigger than the trillion. And even that estimate is about double the size of the basis trade heading into the pandemic. And the unwind of the basis trade was an important aspect of that highly destabilizing March 2020 deleveraging that required these massive Fed liquidity responses. And over the past few weeks, there has been some deleveraging across various leverage trades in global markets, including Treasuries. There’s been some deleveraging, no doubt about it, but I do doubt that significant basis trade unwinding has occurred yet.

Much of this basis trade is held by a few dominant players. These are massive positions, these are hundreds of billions of dollars of positions by a single group. I don’t believe they would be able to unwind this leverage in the marketplace without major upheaval. The Fed would likely have to be involved to accommodate such deleveraging. We’re not there yet. That I think’s unfolding, but we’re not there yet.

So, this massive basis trade will likely overhang the Treasury marketplace so long as the market remains under pressure, and I expect the status of Treasuries as safe haven—which became a serious market concern last week—I expect that to be part of this ongoing market discussion. And as I mentioned earlier, I see the Treasury market is having shifted from a primary source of market stability to a key source of potential market vulnerability. And this is quite a consequential sea change.

Going forward, Treasuries could, they could definitely still benefit from safe haven buying during periods of acute market stress, but Treasuries and other dollar—and we’ll just say the dollar—they’ve become, they’ve suffered a hit to confidence in the markets. It’s a stretch today to talk of Treasuries in the traditional terms of a risk-free asset. And for a number of reasons, the risk of a crisis of confidence is now elevated. And you also, Michael, you ask about a level. As for what level would be problematic, this is arbitrary, but I would see a 5% 10-year Treasury yield, that’s an important psychological level for the markets. This would put further pressure on the levered players.

It would also exacerbate market concerns for this scenario of rising debt service costs becoming increasingly unmanageable, which we’re on the cusp of that. And if we have rising market yields coupled with a weak post-bubble economic environment, that would be quite problematic for housing and asset markets, corporate America, and for our over-indebted system generally. And thank you for your question.

David: Thank you, Doug, for catching that. I missed it.

Well, again, thank you all for joining us on today’s call. We look forward to engaging with you. The resources that I’ve mentioned before, you’re probably well familiar with the Credit Bubble Bulletin, the weekly and the daily. Hard Asset Insights, our Weekly Commentary, the podcast, and we’d love to begin a conversation with you.

If we’ve not had the opportunity to get to know you, we’d love to. And with any questions on Tactical Short and next steps, please send an email to te*@******ny.com and we’ll get something on the schedule to explore what it looks like as an integration into your overall planning.

Thank you so much for your time. Doug, any last words?

Doug: Yeah, thanks everyone. Good luck out there. And David, thank you for doing such a great job with these calls, much appreciated.

David: Absolutely. That’s a wrap. Thank you, gentlemen—and ladies.