Tactical Short Strategy – April 14, 2022

Tactical Short Strategy – April 14, 2022
MWM Posted on April 14, 2022

Disclaimer: Advisory services are offered by McAlvany Wealth Management, an investment adviser registered with the U.S. Securities and Exchange Commission. The comments made in this audio recording discuss economic and market trends and are not intended as advice for any particular investor. A short selling strategy involves a substantial degree of risk. Any decision to engage in a short selling strategy should be reviewed with your financial adviser. Past performance is no guarantee of future results.

Transcript from the call

Instability 2022: Inflation, War, and China
MWM Q1 2022 Tactical Short Conference Call

April 14, 2022

David McAlvany: All right. Good afternoon. Again, this is David McAlvany. We appreciate your participation in our first quarter 2022 recap conference call. As always, a special thank you to our valued account holders. We greatly value our client relationships. 

We will cover a good bit of ground today looking at the macro economy. As you know from the title, we have a number of things to talk about—from inflation to war to China and a number of details that you’ve asked specific insight on in the Q&A, which we will cover. Lots of questions from the Q&A that were pre-submitted. If you would like to add to those, or if there’s something that crosses your mind as we’re going through our remarks today, feel free to write them down. And if you’d like to submit them, you can, directly on our website,

That’s M as in McAlvany, wealth, M again, same M as in McAlvany or management, .com. I would also remind you that, at that website, you can weekly be reading the Credit Bubble Bulletin. If you’re not, I encourage you to do so. It’s available each Saturday and is a deep dive into what has happened in the last week, and where Doug thinks the markets are likely to be going—a look from a credit perspective with 25 plus years of writing. It’s an invaluable resource. 

Also at the same website, Hard Asset Insights available same day, Saturday. So for your curiosity and wanting to learn about what is happening in the financial markets, I hope you can feed that appetite there. So again, if you have further questions to submit. 

There are a number of first time listeners with us today, so I’ll begin with some general information for those unfamiliar with Tactical Short. And if you want more detailed information, it’s available at The objective of Tactical Short is to provide a professionally managed product that reduces the overall risk in a client’s total investment portfolio while providing downside protection in a global market backdrop that has extraordinary uncertainty and extreme risk. This strategy is designed for separately managed accounts and is very investor friendly. By that I mean you’ve got full transparency, lots of flexibility, very reasonable fees, no lockups. So you’re getting the benefit of hedge fund management without any of the restrictions and excessive relational ties. So we want to serve you. We want to add value to your overall investment strategy and overall investment portfolios. And I think we can do that very well in this format. 

We have the flexibility to short stocks and ETFs. We also plan, on occasion, to buy liquid listed put options. Shorting entails a unique set of risks, risk that has been on full display over recent quarters. And we are set apart both by our analytical framework, but also our uncompromising focus on identifying and managing risk. 

Our Tactical Short strategy began the quarter with a short exposure targeted at 72% and the target was increased incrementally to end the quarter at 77%. That’s the highest level in the history of the strategy, and that’s due to the highly elevated risk environment that we’ve seen. As it increases, that is a part of our risk management strategy. And as it recedes, so, too, you can see a shrinkage in that exposure. When you look at the highly elevated environment for shorting in this period, the S&P 500 ETF remained the only short position during the quarter.

We’re not proponents of aggressive market bets, including against the stock market. And as we stress in every call, remaining 100% short all the time—as most short products are—that’s risk indifference. And so the market rally over recent years has inflicted huge losses on the short side for those who are indifferent to risk, and we believe that a disciplined risk management is absolutely essential for long-term success. We structured Tactical Short to ensure the flexibility to navigate through even the most challenging market conditions. 

So I’ll give you an update on performance. The Tactical Short accounts, after fees, returned a +2.13% during Q1, and the S&P returned a -4.16%. As for one-year performance, Tactical Short, after fees, returned a -12% versus the 15.63% positive return for the S&P 500. Over the past year, Tactical Short accounts lost 7% of the S&P’s return.

So again, we’re an inverse of that, and we regularly track Tactical Short performance versus our three actively managed short fund competitors. So I’ll give you a view of those real quickly. First, the Grizzly Short Fund, which returned 4.86% during Q1. Over the past year, Grizzly has returned -2.91. Ranger Equity Bear Fund returned a -0.85 for the quarter and a -3.42 over four quarters. Federated Prudent Bear Fund returned a -1.75 during Q1 and a -16.9% for one year. While out-performing two of the three funds during the quarter, Tactical Short on average underperformed the competitors by 21 basis points during the period. Tactical Short has significantly outperformed each of the Bear Funds since inception, that is April 7th, 2017. Inception through the end of September, Tactical Short returned a -41.57% versus the 110% return of the S&P 500. Again, comparing it versus our competitors, an average outperformance of those three competitors of 2,540 basis points.

There are also the popular passive short index products, of which Tactical Short somewhat underperformed during the quarter, while again outperforming over the past year. The Pro Shares Short S&P 500 ETF returned +3.45 for the quarter, -15.93 over the past year. And then the Rydex Inverse S&P 500 Fund returned +3.29 during the quarter and 16.19 over four quarters. There’s also the PIMCO Fund, the PIMCO Stock Plus Short Fund, which returned 3.21 and a -15.12% for the quarter in the past year. With that introduction— This is a little bit like going to a music concert where you have the little guy who does the introduction and then the big guy takes the stage. So Doug I’ll pass the baton to you for the main event.

Doug Noland: Thanks, David. Okay, next call I go first then. Hello everyone, and many thanks for being with us this afternoon. I’ll start by— And this is my mistake, the Prudent Bear Fund actually, it was a +1.75 for the quarter, so I want to make sure and get that right. I made a mistake when I provided that number to David. 

For these calls, I focus on one area of short exposure portfolio management with the aim of having the most informed investors on the short side. We then shift to the macro as part of our overarching mission to inform and educate. I hope today to further expound an analytical framework that sheds a little light on such a complex and confounding macro backdrop.

During the last call, I referred to a quarterly string of extraordinary market environments. Well, extraordinary doesn’t do justice to what was clearly a history-changing quarter—the largest European military conflict since World War II, US annual CPI at a four-decade high, and a newfound Hawkish bent at the Federal Reserve that is now anticipating the most aggressive tightening cycle since 1994. The confluence of such a challenging fundamental backdrop and highly speculative markets made for dizzying instability. A couple headlines: “Bond Market Suffers Worst Quarter in Decades,” “Commodities Finished Best Quarter in 32 Years.” The quarter saw the greatest divergence between hard assets and financial assets in a very long time. 

But before I delve into the incredible macro backdrop, I’ll begin with some comments on performance. It was an extremely challenging quarter operating in unstable markets, both for long investors, as well as on the short side. The Rydex Inverse S&P 500 ETF that is positioned 100% short the S&P 500 returned a +3.29%. Many who own this fund would be disappointed with performance. They likely expected to capture 100% of the inverse of the S&P 500 return of -4.6%, not the actual 71% captured. 

In market parlance, this is called tracking error. It was not that this fund was mismanaged or it didn’t do what it was supposed to do. Performance—it was right in line with the Pro Share Short S&P 500 Fund. It’s just the way the math works. These index funds are managed to return 100% of the inverse of the S&P 500 on a daily basis, not quarterly and not annually. And the big quarter-end rally took a chunk of performance away from the short side, especially hurting performance versus the S&P 500 and other benchmarks.

Many of you were on the call back in October for our third quarter report. I delved in numbing detail into how managing short exposure is different on the short side—how that exposure on the short side is different than the long side, where short exposure and account value move in opposite directions. Let’s do a quick rehash. Imagine a $100,000 account 100% positioned with $100,000 of short exposure. Say the market declines 10%, creating a 10% gain on the short position, or $10,000. Here, account value rises to $110,000. At the same time, the short position declines to 90,000. The original $100,000 short shrinks by 10%, matching the 10% decline in market prices. This gets a little tricky. If there is no trading to adjust short exposure, the percentage of the account that is short declines to 90 divided by 110—the $90,000 short position divided by the $110,000 account value—as account short exposure drops to 82%.

For funds with strict exposure mandates, such as the Rydex and Pro Shares Inverse S&P 500 funds, they maintain short exposure at 100% on a daily basis. This requires daily adjustment to short exposure—what’s called rebalancing. This means that when the market declines and the value of the bear fund is increasing, short exposure will be added to ensure that the fund short positioning remains at 100% of account value. In this way, during a significant downward move in the market, short funds that rebalance will have the benefit of compounding, or generating additional gains from earlier profit. 

I went back and examined Rydex’s performance. On March 14th, near market trading lows, Rydex had returned a +12.5% versus the 12.2 negative return for the S&P 500, returning about 102% of the inverse of the S&P 500 return. But then the S&P rallied 8.2% in the final two weeks of the quarter, with Rydex losing about 8.2% during the rally.

And this offers a helpful illustration of tracking error. The S&P 500 rallied 8.2%, but this rally was from a base level of about 88—100 less the 12% market loss. Meanwhile, Rydex lost 8.2% on a base of 112—a 100 plus a 12% gain at that time. And by the end of the quarter, Rydex was up 3.29% versus the 4.6% S&P loss. In just two weeks, Rydex went from returning 102% to only 71% of the S&P’s loss. 

Tactical Short faced the same dynamic, the same math, as our quarter-to-date performance relative to the S&P 500 suffered at quarter end. But rebalancing can also be advantageous. We rebalanced regularly as the S&P advanced more than 100% from Tactical Short’s inception date, and that rebalancing mitigated losses. Rebalancing is a necessity on the short side, unless there is a willingness to put an entire investment at risk. And importantly, to recoup our losses we’ll now strive to rebalance and benefit from adding short exposure and compounding returns over an extended bear market decline. But frankly, rebalancing creates performance challenges in a hyper-volatile market environment like that experienced during the quarter.

We focus on trying to mitigate at least some of the rebalancing tracking error during periods of extreme market volatility. It’s worth noting that we outperform two of the three actively managed Bear Funds that short individual company stocks. We typically take less risk than these funds, and significantly outperform them during periods of strong market gains. Q1 outperformance can at least partially be explained by the benefit of our lower beta strategy in mitigating some of the hit from rebalancing in a high volatile market. It’s typical for short funds to rebalance on a daily basis. We specifically don’t rebalance trades daily, choosing instead to have a band around our target. I adjust the band depending on the market environment, macro considerations and the behavior of my mosaic of indicators. 

In particular, as market risk became elevated during the quarter, I tightened the band around the target when the market was declining while widening the band on rallies. Basically, I was trying to rebalance to stay near the target as the market declined and we were generating profits, while not reducing short exposure as quickly during upside market volatility. This helped mitigate volatility effects throughout the quarter, but it also proved somewhat detrimental during the 10% quarter-end rally. The bottom line: Our disciplined lower beta strategy proved advantageous for such a highly uncertain and volatile fundamental and market backdrop. I wish performance was better, but we’re dealing with an extremely challenging market backdrop.

Let’s transition to the incredible and the deeply troubling macro environment—and I’m compelled to make a declaration. I’m a diligent analyst and not a pessimist. I promised myself years ago to be a straight shooter, to call them as I see them. Unfortunately, I’m seeing the global bubble end game thesis coming to fruition. The long inevitable is now happening. Myriad global bubbles are faltering, with China leading the way. We all get caught up in the here and now. What’s the market going to do tomorrow? Bull or bear market correction? Buying opportunity or bear market rally? Growth or recession? I’m as guilty as anyone with my focus on fragility and bursting bubbles.

We have an overarching message we hope listeners take from this call. Secular change is upon us. The world has reached a critical historic juncture: the transition away from an unparalleled financial and economic up cycle. Such a momentous development is usually recognized only in hindsight. We believe it’s critical to be ahead of the game on something so consequential to our lives and financial wellbeing. 

An extraordinary multi-decade cycle is drawing to a close, a process triggering great uncertainty, disorientation, insecurity, market volatility—in general, instability. And this dynamic rather conspicuously accelerated during Q1. 

For much too long, global policymakers pushed stimulus measures to precarious extremes—monetary inflation that extended the cycle, but at great cost. And some of those costs are now being revealed. I shared this analysis in the past. During the up cycle boom, the economic pie is perceived as robust and expansive. Cooperation, integration, and strong alliances are viewed as beneficial both individually and collectively. But as the cycle ages, strains mount and insecurity increasingly takes hold. Eventually the backdrop is viewed more in terms of a stagnant or shrinking pie, with a newfound zero sum game calculus. The downside of the cycle held a period of fragmentation, animus, and conflict. From this perspective, the world appears well into the transition to a perilous down-cycle dynamic. Just think of what has unfolded over recent weeks, with war, with trade relationships, financial networks, and alliances. European cities turned to rubble, reminiscent of World War II. Russia extricated from global trade and financial systems. The G20 is now in jeopardy, with even the stability of the United Nations at risk.

The relationship between the world’s two economic superpowers hangs in the balance. There’s now talk of a present day iron curtain, and even a new world order. I don’t think we can overstate the significance and far-reaching ramifications of this secular shift. The shift away from the promise and assurances advanced over a multi-decade up-cycle versus today’s ominous down-cycle uncertainties. The war has been framed as the battle between democracies and autocracies. We’re all shocked by the images we thought had been relegated to history books and black and white photos.

The subject of a new world order was top of mind last week as Russian Foreign Minister Lavrov met in China with his counterpart Wang Yi. I’ll quote from an AFP report, “Beijing and Moscow advanced a vision of a new world order.” “Lavrov painted a picture of a new world order, saying the world was ‘living through a very serious stage in the history of international relations. We, together with you and with our sympathizers, will move towards a multipolar, just democratic world order.’” Foreign minister Wang was quoted, “There is no ceiling for China-Russia cooperation, no ceiling for us to strive for peace, no ceiling for us to safeguard security, and no ceiling for us to oppose hegemony.”

And from CNN, “The top US military officer told lawmakers the world is becoming more unstable and the potential for significant international conflict is increasing. Chairman of the Joint Chiefs Mark Milley and Defense Secretary Lloyd Austin appeared before the House Armed Services Committee. Milley said that Russia’s invasion of Ukraine is the greatest threat to peace and security of Europe and perhaps the world in his 42 years serving in the US military.” Quoting Milley, “The Russian invasion of Ukraine is threatening to undermine not only European peace and stability, but global peace and stability that my parents and a generation of Americans fought so hard to defend.” Russia is now moving aggressively to settle trades in rubles while developing an alternative to the West’s SWIFT financial network.

David McAlvany: Doug, on that note, if there was ever a motivator to diversify central bank reserve assets and consider the operational vulnerability that various countries have in relation to the US Treasury, where the US dollar has essentially been weaponized, surely you have Russia and China and a dozen other countries that are determined to do so. Again, this is in the wake of official sanctions and then looking at the corporate world stepping up voluntarily to isolate Russia. 

So some have wondered what the implications are for the foreign currency markets, and even some speculation as to how it’ll impact the dollar long term. I don’t think there’s a signal here for the end of US dollar hegemony, but there is a greater urgency for central bank buying of gold as a reserve asset with a very strong reconsideration for location of that storage with a domestic focus, obviously suggesting a very significant reduction in availability of that product. So that issue of SWIFT is I think something to watch, and to see how the Chinese further develop the alternative that they already have, but which the world has yet to fully adopt.

Doug Noland: Yeah, excellent insight, David. Thank you. 

There are new cold war dynamics with serious concerns that we are witnessing conflict and hardening of alliances that could ignite into something akin to the world wars. And revelations of widespread atrocities have altered the trajectory of war. The west has become more unified and determined that Russian aggression cannot prevail. And with each passing week, Ukraine appears less a proxy war and more a direct conflict between Russia and the US-NATO coalition. And a weekend Wall Street Journal headline read, “China is accelerating its nuclear buildup over rising fears of US conflict.”

My analytical focus is more on the unfolding global economic war—the disintegration of trade and financial relationships. Even in the unlikely event of a near-term end to Russian aggression, we should not expect any relaxation of the onerous sanctions, perhaps as long as Putin remains in power. The Russian economy appears poised for economic depression, and we should expect Putin to employ about every mechanism at his disposal to retaliate. He’s an enraged, cornered animal. Putin is already threatening global energy and grain supplies while alluding to Russia’s nuclear arsenal. 

The world has fundamentally changed, with elevated geopolitical risks for years to come. Thus far, China has been careful not to assist Russia with their military or to overtly subvert Western sanctions. But the more protracted the war, the less sustainable this approach becomes. And at some point, I expect China to demand a relaxation of sanctions. When rejected by the west, China will likely adopt a more combative approach and commence Russian support. This scenario—and it’s one that today seems probable to me—would risk major escalation in the global economic war, an unfolding showdown between the world’s two dominant powers.

This developing US-China confrontation comes at a most tenuous juncture for the Chinese economy. China bubble deflation gathered momentum during the quarter. The unfolding real estate developer crisis took a turn for the worse in what was nothing short of a historic bond collapse. Major developers Evergrande, Longfor, Kaisa, Sunac, Yuzhou, to name a few, with hundreds of billions of debt, saw yield spike to 100%. Country Garden, China’s largest developer, that until recently was viewed as financially sound, saw yield spike to almost 32% after beginning the year below 7%. Indicative of a pivotal break in market confidence, China’s top 100 developers reported that sales transactions collapsed 53% in March from a year earlier.

Meanwhile, private surveys signal a broad-based tightening of financial conditions. Corporate bond yields have spiked higher, and credit is said to have tightened significantly. Economic activity has downshifted, pressured by housing [unclear], weakening exports, and Beijing’s draconian zero-tolerance Covid policies. We monitor China’s Covid situation closely, recognizing the challenge a highly transmissible omicron poses to Beijing’s Covid-zero strategy. And our fears are coming to fruition as Shanghai and other major cities face brutal lockdowns.

Nomura analysts this week estimated that 45 cities, representing 373 million people and approaching 40% of GDP, have implemented full or partial lockdowns. Some cities have been under strict lockdown for a month as the wave shows no sign of subsiding.

I contemplate China’s deflating bubble predicament and think Japan 1989. Many at the time recognized Japanese bubble excess, but who foresaw a secular inflection point in years, even decades, of economic stagnation? Yet China’s apartment bubble has been only more egregious, its structural maladjustment more epic, and it’s bloated $55 trillion banking system more vulnerable. So what explains the ongoing complacency of the analytical community and global markets when assessing China’s prospects? Well, there remains unflappable faith in the power of Beijing to once again resuscitate the irrepressible Chinese boom.

“Beijing won’t allow bubble collapse” recalls the pre-1998 crisis mantra “the West will never allow Russia to collapse.” And 2007’s “Washington will never allow a housing bust.” Beijing has responded to accelerating crisis dynamics over recent weeks by loosening some restrictions and talking stimulus measures. Market response has been unimpressive, and Beijing’s capacity to re-energize speculative excess will only diminish in the unfolding post-bubble landscape. Recall the Fed’s aggressive series of 2007 and early ’08 rate cuts. Such measures work like magic when speculative impulses remain energized, when the bubble’s inflating. Yet their potency diminishes rapidly as confidence wanes, when bubbles begin deflating, when greed is succumbing to fear. I expect fear to hold sway over greed in China for some time to come.

Importantly, there are signs of waning confidence in the great Beijing meritocracy. I believe the developer collapse marks the onset of a destabilizing apartment bust. While official prices are so far down only marginally, confidence has been badly—likely irreparably—damaged. And with housing a dominant component of overall Chinese wealth, faltering household confidence in the economy and economic management comes with major ramifications. I expect Chinese citizens to increasingly hold Beijing responsible for mismanaging apartment and economic bubbles.

David McAlvany: Well, meanwhile, you’ve got Xi Jinping who has organized a far more capable and coercive state over the last five to seven years. You’ve got technology as a tool for mass people management. You have the last year or so of Covid providing a real-time laboratory for social and political compliance and the further expansion of the Sesame credit system. 

So on the one hand you have Chinese citizens upset about economic mismanagement, and angry, and I think you’ll see more and more of that as the real price corrections occur. Doug, as you mentioned, we’ve had the volume of transactions decline by 53%, but barely a move at all in terms of a downside correction to price. What does the anger look like? And, you’re dealing with a situation where there’s less and less of an outlet for that frustration. Fascinating social dynamic.

Doug Noland: That’s right, David. The Chinese are already questioning Beijing’s Covid-zero policies and overall economic planning. Add to this Xi Jinping’s and Beijing’s partnership with Russia without limits, and one sees all the makings for a crisis of confidence in Communist Party leadership for a society that developed such inflated expectations over an enduring boom cycle. 

This root awakening comes with cycle-changing ramifications. I expect Chinese households to turn more risk averse and less willing to borrow and spend, even in the face of Beijing stimulus measures. This would hasten the transition to a post-bubble down cycle. 

I am positive that vulnerable Chinese and global bubbles help to explain why 10-year Treasury yields have remained so low in the face of surging inflation. Think of this: The last time year-over-year CPI reached 8.5%, 10-year Treasury yields were at 14%. Even after the worst quarter in decades, along with last week’s drubbing and today’s jump, bond yields are at 2.80%.

The Treasury yield curve has become a focal point. After beginning the year at 78 basis points, the 2- versus 10-year Treasury yield spread recently traded at negative eight basis points. Analysts traditionally view an inverted curve as foreshadowing recession. This beckons for some analytical nuance. When we discuss traditional analysis and market relationships, it’s important to appreciate that so much changed as QE evolved into a primary policy tool. How can 10-year yields remain so low in the face of surging inflation and the onset of what is anticipated to be the most aggressive tightening cycle in 28 years? Because the marketplace anticipates tightening measures will prove short lived. The Fed will surely be forced into additional bond purchases—yet another round of endless QE. The bond market’s disregard for inflation risk recalls the period heading into the 2008 crisis—a dynamic that worked to prolong excess and only deepen the unavoidable crisis.

I see today’s flat yield curve as indicative of dysfunctional markets distorted by years of Fed intervention and monetary inflation, with inversion not so much a predictor of recession as it is a reflection of bubble fragilities and the inevitability of additional crisis measures. And these long-term yields and expectations of Fed intervention have provided critical support for the stock market bubble. We’re witnessing today dangerous consequences of years of Federal Reserve mismanagement coming home to roost. Stock and bond markets have been unable to adjust to rapidly deteriorating fundamental backdrops. And I would contend that resulting wealth effects and loose financial conditions are working to sustain problematic inflationary dynamics. The longer bonds and stocks disregard ramifications for an aggressive tightening cycle, the greater the pressure on the Fed to talk hawkish rate hikes, to talk balance sheet liquidation. 

Even the diehard FOMC doves have found religion, apparently coming to the realization that inflation hurts most those that can least afford it. It’s late in the game for such an epiphany. A cycle of Federal Reserve monetary mismanagement has dangerously weakened the foundations of economic, financial, social, and geopolitical stability. 

When contemplating secular change, we should think in terms of an extended period of instability. The war has caused a spike in already elevated food prices, with significant risk of future global grain and food shortfall. This is a backdrop conducive to social and political instability, with recent unrest in Peru and Sri Lanka surely just the beginning. The war also further stresses global supply chains. Russia, of course, is a major exporter of energy materials and commodities. The Bloomberg Commodities Index has already gained 32% this year. The onset of war saw dislocations in many commodity markets—most notably nickel, with its spectacular short squeeze margin calls and dislocation.

We believe the war will likely mark a secular inflection point for commodities trading, both in spot and derivatives markets. Producers will approach derivative hedging strategies more cautiously, fearing big squeezes and onerous margin calls. Derivative dealers will back away from unstable and dysfunctional markets, while bankers will tighten standards for loans and backup credit facilities. It all points to less liquidity and more price volatility. 

Russia will likely restrict the sale of key commodities to the West, leading to price spikes and shortages. There is risk that China eventually follows a similar course. I anticipate households, companies, and countries all moving to build inventories of key resources, only worsening shortages and supply chain issues. Panic buying of many things is a distinct possibility, at least until financial conditions tighten meaningfully. I’m not as pessimistic as some on near-term US economic prospects. I will turn quite negative with the onset of market crisis. For now, it’s difficult for me to focus on recession risk with a 3.6% unemployment rate and 11 million open jobs, with robust wage growth, with Walmart hiring truckers with hundred-thousand-dollar starting salaries.

David McAlvany: Doug, I agree. There are plenty of numbers to support a strong economy. The devil’s advocate might say, with unemployment under 4%, 3.6, maybe it’s in a never-better category, which could reflect an inflection point. And maybe these are the best numbers we register for a long, long time.

Doug Noland: Yeah. Makes sense. Makes sense, David. 

At this point, I think more in terms of an unhealthy and unstable inflationary boom. There will be a big national push for self-sufficiency in energy, agriculture, renewable energy, basic commodities, semiconductors, and so on. Our nation will be spending huge sums on defense, and despite higher mortgage rates, for now I expect robust home construction, at least until backlogs clear and more normal inventory dynamics materialize, but this is anything but a constructive view. 

It’s worth noting last week’s release of February consumer credit data more than doubling estimates. Households expanded non-mortgage borrowings by a record 41.8 billion. For perspective, during the decade 2010 through 2019, consumer credit growth averaged less than 14 billion monthly. This is an example of how inflation spurs self-reinforcing credit growth as we take out larger loans to purchase higher priced vehicles, appliances, home remodels, and such, while putting the higher cost of filling gas tanks and shopping carts on our credit cards. 

It’s worth adding that Q4 mortgage credit growth was the strongest since 2007, once again highlighting the dynamic of inflating prices spurring only greater credit expansion. Moreover, rising debt service and huge Federal deficits will continue to fan inflationary fires. We’re witnessing the onset of a new cycle, with inflationary dynamics reminiscent of the ’70s and ’80s. And the Fed today faces one momentous challenge as it attempts to get inflation under control. 

This will prove nothing short of a secular shift in monetary management. The previous cycle’s subdued consumer price inflation empowered a Federal Reserve policy regime focused on championing the asset markets as the key mechanism for economic advancement and prosperity. Baby step rate increases were signaled well in advance and implemented gradually—all to ensure booming security markets avoided instability. And it went without saying that any so-called tightening would be quickly reversed in the event of market anxiety.

Importantly, a powerful policymaking regime dynamic took hold. No longer was it even necessary for financial conditions to tighten during so-called tightening cycles, and security markets grew to revolve around loose conditions and the Fed put as confidence in the Fed’s willingness to do whatever it takes to bolster the markets and incentivize speculation, leverage, and risk taking more generally. Cash was made trash, with savers then plowing trillions into securities markets—most notably into perceived liquid and money-like ETF shares. 

From Fed Z.1 data, we know that household net worth ended last year at a record 626% of GDP compared to previous cycle peaks 491% in Q1, 2007, and 445% in Q1, 2000. The source of unprecedented perceived household wealth was chiefly from record holdings of financial assets at 492% of GDP, dwarfing previous cycle peaks 374 and 354%. For the new cycle of monetary management, the Fed put will surely not be completely discarded, but the FOMC will now be forced to think hard before unleashing additional inflationary fuel. Measures to support the markets—including bailouts—will not come as quickly, and I expect future QE to at least initially be doled out in moderation. 

This implies a major shift in the Fed’s willingness, capacity, and tactics for backstopping the markets. A revamped policy doctrine with less predictable and generous central bank market support will require an adjustment in securities and derivatives pricing. Financial assets become riskier, implying greater risk premiums and lower valuations. Derivative markets must also adjust to new realities. If the Fed no longer actively controls the weather, the previous cycle’s boom and cheap flood insurance is no longer viable. 

Said differently, the assumption of liquid and continuous markets that defined contemporary dynamically hedged derivative markets over the boom cycle becomes difficult to rationalize. Selling derivative insurance has become a riskier proposition. This suggests a secular shift to more expensive derivatives protection with higher-cost market insurance on the margin, providing less support for risk taking and speculative excess. I believe the popular strategy of just buying cheap hedges and sticking with risky portfolios through difficult market environments was anomalous to the previous cycle. 

The first quarter provided overwhelming support for our thesis of a new cycle of hard asset outperformance versus financial assets. The Bloomberg Commodities Index surged 26%. Sanction fears saw crude spike to $126 a barrel before ending Q1 at a hundred dollars, up 33%. Gasoline and natural gas jumped 41 and 51%. Wheat was up 34%, corn 26, and soybeans 20. Safe-haven, gold and silver rose 6.9 and 6.4%.

That big commodities’ outperformance unfolded during a period of relative dollar strength is intriguing. The dollar index is up 5% so far this year. Moreover, even the industrial commodities have been robust in the face of faltering China. Some commodities are exposed to weakening Chinese demand dynamics, but this risk is at least somewhat offset by Russian sanctions, supply constraints, and the impetus to build rainy day stockpiles. Going forward, we expect commodities markets to be underpinned by general currency market instability, along with dollar vulnerability. Dollar weakness would catch most by surprise. 

There has been, of late, insightful discussion of the potential negative impact sanctions and the bipolar iron curtain new world order might have on the dollar as the world’s reserve currency. David touched on this. 

Some of this analysis resonates. But there’s another aspect of dollar vulnerability that goes unrecognized. I believe the previous cycle of well-contained consumer price inflation that emboldened the Fed securities and derivatives market focus was instrumental in underpinning the dollar. This experimental monetary regime bolstered our currency, even in the face of massive monetary inflation, persistently huge trade deficits, and deep structural impairment. Why would the world not recycle excess dollar balances back into US security markets? Confident that the Fed was doing whatever it takes to ensure those securities rose in value. Traditional currency fundamentals, prudent monetary and fiscal policy, stable money, a favorable current account position, and sound financial and economic structures no longer mattered so long as the Federal Reserve policy focus was directed at sustaining booming asset markets.

David McAlvany: And Doug, this is part and parcel of the things that we take for granted. We’ve taken for granted that globalization has been wind in our sails for a long time. I think of the comments from the Bank of International Settlements last week that we’re on the cusp of a new inflationary era, and they went further on to comment about deglobalization reversing decades of those lower price inputs, which were somewhat of an offset to the inflationary policies that we had in play. So, we had the enablers of our massive deficits, the ’70s and ’80s petrodollar recycling. We had in the ’90s and ’00s something similar with the trade dollar recycling. Again, these are sort of keys to US dollar stability, but you begin to dismantle the globalization themes that we’ve had greater trade cooperation. And in fact challenge that now, all of a sudden you are talking about a structural support for the US dollar that may not be there—might not be business as usual going forward.

Doug Noland: Yeah. Excellent insight, David. 

The world is now experiencing momentous change, with overwhelming evidence supporting our view of a transition to a new cycle. Federal Reserve focus has begun the shift to consumer price inflation, leaving the status of the Fed’s market backstop a major open question. Going forward, we expect the dollar to be increasingly vulnerable to waning confidence in the Fed’s capacity to underpin the markets. This raises the possibility of the next serious bout of de-risking, de-leveraging being accompanied by destabilizing currency market volatility. This is a looming risk for a financial world dominated by leveraged speculation.

For the most part, currency markets have remained relatively stable as volatility dominates commodity, bond, and equity trading. If we’re correct in our secular thesis, the world could be at the cusp of acute currency and market instability, along with alarming geopolitical turmoil. With Russia’s invasion, geopolitical analysts are now focused on the possibility of China moving forward with its long-held ambitions for Taiwan. Hopefully, Chinese officials are dissuaded by the utter calamity and human carnage witnessed in Ukraine.

I have, for a while, feared a scenario where a collapsing Chinese bubble swayed Beijing into a belligerent stance with Taiwan while somehow blaming the US for its predicament. The unfolding economic iron curtain and the potential for punitive measures against China only further my concerns. 

And a final thought on the new market cycle: The unfolding crisis of confidence in monetary management and financial assets more generally has momentous ramifications. As hard assets outperform financial assets, liquidity will now gravitate to real things, working to underpin inflationary pressures even as growth weakens. This would keep pressure on the Fed, with higher cash rates reducing the appeal of risk assets. Moreover, these new inflation dynamics dramatically alter the risk versus reward profile for QE and monetary stimulus more generally. Fed bond purchases will create additional liquidity, now likely to gravitate to and to reinforce commodities in general price inflation. This implies a major cycle inflection point for the bond market. Now faced both with a secular upturn in inflation and diminished QE prospects. And a secular jump in Treasury yields would demand a long overdue downward valuation adjustment for stocks, corporate credit, and other financial assets.

If we are correct in our view of a secular shift in inflation dynamics, we would expect a new paradigm of tighter monetary policy and tighter financial conditions more generally. This will be highly disruptive to economic and financial structures that, over the previous long cycle overindulged in ultra-loose finance. In particular, there is post-bubble vulnerability for scores— and this is literally thousands of negative cash flow companies and enterprises. 

In this regard, we anticipate a difficult and protracted structural adjustment ahead. And when I look at our nation today, I dread how this adjustment will intensify social and political strife. We titled today’s call “Instability 2022: Inflation, War, and China.” Unfortunately, there is every reason to prepare for only greater instability ahead, certainly through the end of the year and beyond. Today’s macro backdrop is extraordinarily fluid. We will diligently analyze developments, careful to keep an open mind and adjust our views as circumstances unfold. 

David, back to you.

David McAlvany: Thanks, Doug. Just as a reminder for the Q and A section, if there’s something you’d like to submit a question on, feel free to go to our website, and in the bottom right hand corner you can type that in and we’ll add it to the queue of questions that we have.

The questions that were submitted ahead of time—the first was an inquiry about variable annuities, and it’s a general question. I’ll take that. And Doug, we can go back and forth on a couple of these. 

“Wondering what to do with a variable annuity,” is that first question. First, I would ask how critical is the future income generation from the product to your entire retirement strategy? And if it’s critical, then consider how it sits there and whether or not it continues to. Second, I would explore if the insurance company allows you to be in a cash position as opposed to a stock index. A variable annuity is essentially an exposure to the S&P 500 or something generic like that. You don’t want blind market exposure, and that’s what you have. Not carefully selected equity positions, but just a broad market exposure. There are some insurance companies that let you opt for money market or some sort of a cash alternative. And I think that would be wise over the next 12 up to 24 months. 

The third consideration is to explore your options on an exit from the product. Again, if you’ve answered the first question about how important that income generation may be, I would look at what the costs are involved. After a period of time has passed, the penalty to exit is reduced, and then all together eliminated. So, figuring out what the cost is will probably tell you if that’s an option in your decision-making. There can still be reasons to hold an annuity, but coming back to that issue of the variable part, that’s what I’m not too keen on. Essentially a stock index exposure is where I think you have to look and weigh the benefits against the cost over the next few years. And the cost in terms of market volatility may weigh against the benefits.

Doug, a late submitted question, but I think an interesting one relating to fixed income. Let me throw this one at you. “In my advisory account, my portfolio manager has laddered short term corporate bonds. With interest rates rising, he indicated that he’ll no longer be buying corporate bonds, but has invested in municipal bonds, which average around a seven-year maturity. Given the rapid rise in interest rates, I can see that there are already losses on the principle, plus, with yields averaging 5%, I’m realizing a negative return. What would you do if these municipal bonds were in your portfolio?”

Doug Noland: Yeah, I’ll begin with a caveat. I’m not familiar with the questioner’s overall investment holdings, his risk profile, tax planning considerations, or his particular muni bond portfolio. So, these are just generalized comments. The question was for if they were in my portfolio, so that’s how I’ll approach it. 

My own preference would be for a shorter average maturity than seven years today. I could see an allocation to longer-dated fixed-income securities because of the high degree of uncertainty with today’s forecasts for monetary policy of the economy and bond yields. But for my portfolio, I would today have a significantly shorter average portfolio maturity than seven years, and I mean significantly less than seven years. And I’m not an analyst of municipal debt, but I do believe this is an area with a lot of vulnerability if we’re correct in our macro thesis.

In a financial crisis and recessionary environment, some municipalities, perhaps many, will surely face some degree of financial hardship, especially coming out of such a long boom period where spending has been lavish and lots of probably uneconomic projects. Some states—California comes to mind—they could experience a radical decline in revenues. Generally, credit markets today are not priced for the type of credit stress I expect to materialize. So, a heavy amount of monitoring and analysis will be required on a muni portfolio, from my perspective. 

I’m also concerned about the proliferation of municipal bond insurance. I would want to know how much in my portfolio— how exposed I am to muni bond insurance. I’ve long been skeptical of credit insurance. And in recent years, the marketplace has completely erased the post-2008 crisis environment from memory. So, I would approach municipal debt today with a healthy dose of caution. And I would give careful thought to the size of that allocation within a well diversified, cash-heavy, and generally risk-averse investment portfolio. And thank you for the question.

David McAlvany: I think that summarizes it pretty well. The difference between revenue bonds and geo bonds—as you mentioned, California having, potentially, revenue issues, you’ve got specific sources of funding for particular pieces of paper. And so, there’s ways that you could improve the security of a muni portfolio. But I think the big risk factor is what you’ve addressed in your comments today, Doug, which is, if this is a cyclical shift within the credit markets, then perhaps there’s very little to be concerned about in something like a muni portfolio, particularly if you’re talking about an insured bond or a general obligation bond, but if this is a secular shift, we really don’t know what the consequences will be, and tightening maturities and taking less risk is a matter of prudence.

The next question is about gold mining equities as a defensive position. It says, “Gold mining equities as a defensive position of portfolio, what do you think about that relative to a weak dollar and considering the rise of bitcoin and with out-of-control inflation?” 

I would say— well, I would ask a question: Are they defensive gold mining equities? And the answer is no. Gold bullion is a defensive position in the portfolio. With bullion, you’ve got complexity which is dramatically reduced. That is secure savings, where the only consideration you have is the price movement of the commodity. That’s the key. When you’re talking about precious metals equities, they’re an effective offense. And they may coincide with moving alongside the metals price as a good defense, but, just to be clear, the character of them is different. They’re an effective offense. They do introduce a variety of complexities in order for them to actually work.

So, these are the complexities that we manage in our hard asset strategies, but looking at, what is the quality of the asset in ground? Does management have the resources to develop that asset? How safe is the jurisdiction? What is the appropriate scale of exposure to that company amongst others and why? And how does the commodity price movement affect that company? So, I guess, just to contrast, you’ve got a simple defensive position within a portfolio, and then you’ve got a more complex offensive position. So, I think that’s a real key thing to distinguish. What are you trying to get within the portfolio structure? Is it defense or is it offense? They may both be appropriate, but I think the character of each needs to be clarified on the front end. 

I like the line of thinking. It’s right. What assets make sense relative to weak dollar? And there are a variety of answers. For our money, it’s a combination of real assets that include infrastructure and specialty real estate and global natural resources and precious metals minors. I do think you need a broader diversification than just gold mining equities, particularly if you’re looking at a total return proposition where income might also be a healthy component and de-risker within the portfolio. 

The mention of bitcoin, I just want to comment on that because I think the inconvenient truth for bitcoin, if you look at the context of the last year, risk assets have come under pressure over the past year. Gold’s up 13.3% year over year, Bitcoin is down 34.78% year over year. It’s a risk asset. You can own it, you can trade it, but don’t mistake it for a safe haven. I think that would be the key takeaway. It appears to have more in common in terms of that kind of volatility profile with SPACs and NFTs and meme stocks. And so the real appeal is more about the riches that it can create. And it’s been sort of legitimized and cloaked in a gold wrapping, if you will, digital gold or what have you, but it’s not a safe-haven asset. It’s a risk asset. 

So Doug, the next question for you, “Could you give us an update on your China outlook?”

Doug Noland: Sure. Adding to my earlier comments, it would be difficult for me to be any more negative on China’s prospects. We still don’t know to what extent Beijing will be willing to use monetary stimulus to counter its downturn. They’ve criticized others for employing quantitative easing, but I’m assuming they will resort to similar stimulus measures. 

I’ll be watching very carefully how the unfolding economic war impacts Chinese exports, and that’s to the US and Europe in particular. In her speech yesterday, Treasury secretary Yellen warned that it’ll be increasingly difficult to separate economic issues from broader considerations of national interest, including national security. It’s a little shot across the bow to China. As I mentioned earlier, I would not be surprised if the US and the West respond to China’s Russian support with sanctions—a tit for tat trade-war dynamic. It’s not a low probability scenario. I expect a deep and protracted downturn.

I presume social and political stability will be an issue. And as I mentioned earlier, I fear Beijing will lash out against the US and the West. And let’s all pray that the confrontation remains economic/financial and not military. A big unknown is how long market confidence holds for what I believe is an acutely vulnerable banking system. Of course, Beijing has ample resources to recapitalize China’s banks, but the bigger issue is for how long and at what consequence can Chinese banks continue their historic lending boom—a boom that holds credit collapse at bay while raising the likelihood of an inevitable crisis of confidence. And that’s a crisis of confidence not only in China’s financial system, but also likely its currency. And thank you for the question.

David McAlvany: The next question: “Is the euro-dollar link to oil broken? Will the Russians succeed in acquiring payment in gold or rubles for their oil, natural gas, and other commodities? Will the Saudis sell their oil to China for RMB?” 

I’ll take a shot at a couple of those. And Doug, if you want to backfill all the gaps, that’d be great. It certainly looks like the correlation between oil and the euro has broken down, at least over the last several quarters. As for the rubles-for-resources, I do think that’s likely. We’re talking about terms of trade. We’ll probably reflect a new trend in multi-polarity in the years ahead. If you get contract settlement in a preferred currency, whether that’s the RMB or the ruble, that requires greater cross-border holdings of that currency and provides a more stable basis for a country going forward. You can see how the ruble stabilized once it was announced that they would be interested in receiving rubles for oil and gas.

We traded from an 80:1 US dollar exchange rate down to about 140 (the ruble to the US dollar), then back to the pre-invasion levels. So frankly, a lot of the sting from the sanctions was removed with this idea that they could trade in their own currency. Tell me there’s not observers all around the world who say, well, it looks like if we’ve got more of our currency floating in other people’s bank accounts around the world, and we force them to pay in our currency, it creates something of a stable factor for us. So I think that multicurrency preference is likely to become the norm. The US Treasury may have very effectively flexed its muscle on Russia, but the unintended consequence is for goods producers, whether that’s natural resources or other tradable goods, to adjust their terms of trade and solidify their currency stature and safety.

So, there is that unintended consequence we will now have to deal with in the marketplace. When we create threats, others then must figure out how they insulate themselves from those threats. So our primary audience was Russia, but there were secondary or tertiary audiences who were noticing what we did, what they’ve had to do in response, and so that’s an issue. 

There’s also, going to Saudi Arabia for a second and selling oil to China. When we don’t buttress relationships, we see relational drift occur, and it’s important to invest in the relationships that we have. I say that directly, we know this from our own personal lives, but in terms of international relations, it’s no different. When we don’t buttress relationships, there’s relational drift that occurs. And we’re watching that with the Saudis at present. We took the Houthis off the terror list. That was not positive for our relationship with Saudi Arabia.

This is the terror group out of Yemen who Saudis have had to deal with now for some time. We’re seeking a refreshed nuclear deal with Iran. Again, this is not something that the Saudis would say is a sign of friendship. It allows for a little relational drift, and we’re not all that diplomatic in what we say directly to, or about Mohamed Bin Solomon. And so there’s no surprise that relationship with the Saudi kingdom is drifting. Why wouldn’t the Saudis sell crude for RMB? Are we still providing a sufficient quid pro quo to keep a US dollar trade monopoly? I think the fair answer is, not really. So when the Saudis are consulting with other Arab states, when the Saudis are consulting with Israel to discuss what improved Middle East security looks like, something has broken down in the US-Saudi relationship.

And I think you can assume that, going forward, that’s one of the things that’s on the table. Do we trade crude with the number two, number three producer of crude in the world in the currency of choice? So again, I’ll shut up now. Multi-polarity is a trend that’s being revived at the level of institutional organizations with sort of the re-engineering of the foreign currency plumbing to facilitate trade more easily around the US dollar. I think that’s an inevitability going forward.

Doug Noland: And David I’ll just throw out— I can’t really add much to— That was excellent. I think we need to think in terms, a little bit, of a barter-type trade relationship where the actual currency matters less than it has for a while. For example, where China ships manufactured goods and electronics to Russia and Russia sends back energy and natural resources. So I think we’ll see more of those types of arrangements. And certainly everything’s not going to be denominated in dollars going forward.

David McAlvany: Yeah. I mean, One Belt, One Road is China’s opportunity to open up trade to a huge part of the world. And why the US dollar would be a centerpiece to One Belt, One Road I don’t know. Obviously it would benefit us. I’m not saying it’s a bad idea. It’s a great idea for us. I just don’t know that it’s a great idea for the Chinese. And so all these machinations with Russia bringing this front and center. How do we engineer the payment plumbing?

And you’re right barter is a— Particularly when SWIFT comes into question, if it’s a question of monetary transactions, and we hold sort of a bottleneck. We can shut that off in terms of movement of money. Maybe we just move stuff. You’re right. Barter’s a very interesting way to solve that problem. 

Question to you, Doug, “How high can the Fed raise interest rates and run off the balance sheet before the economy goes into recession?”

Doug Noland: Yeah. Excellent question. I can’t see how Fed tightening goes smoothly. There’s been too many years of excess and resulting structural impairment. In particular I see balance sheet runoff, the removal of liquidity from the system as particularly problematic for highly levered and speculative financial markets. And it’ll be fascinating to see how the Fed responds to the next serious bout of de-risking de-leveraging, but there is today some excess liquidity that’s built up after five trillion dollars of injections. There’s some excess liquidity that can’t be removed—that is, so long as markets remain stable. I just don’t expect market stability to be the norm for the months ahead. I guess my focus would be more on the markets and financial conditions when it comes to a potential breaking point, as opposed to a primary focus on the economy and recession.

My analytical framework sees financial developments leading economic activity, not vice versa. I turn very negative on economic prospects as soon as market instability leads to a significant tightening of corporate credit conditions and tight financial conditions more generally. Our system just doesn’t function well—it doesn’t function well at all when fear overwhelms greed, because we have so much market-based credit, market-based finance and that fragility. That’s a hallmark of a bubble economy, structural fragility. To more directly answer the question, I’ll be surprised if the fed funds rate gets much above two percent without much market and economic instability.

David McAlvany: So fed funds two percent. The second part of the question is actually, “If the economy does go into recession, how long before the Fed pivots to QE again?” ‘Cause I remember from your comments earlier, your thought was that there may be a little bit more of a delay. We’ve seen such a quick response with even a little bit of a sniffle or sneeze from the financial markets, and boy, Dr. Powell was there to fix everything. So from your comments earlier to this question here, the economy goes into recession. How long before the Fed pivots to QE?

Doug Noland: Right. And that’s the key question, the individual’s right. I touched on this earlier, but I wouldn’t be surprised if the Fed resorts to additional QE even before the US economy is officially in recession, with the FOMC initially responding to market instability and resulting tightening of financial conditions. But I do not expect the Fed to— well, let me phrase it differently. I expect the Fed to be slower to restart bond purchases with inflation risks now top of mind. I see the most important issue down the road being the size of future QE programs.

Recall back in March of 2020, when markets kept selling off, they dislocated, even as the Fed announced plans for large QE bond purchases. It took the Fed a few attempts and the prospect of truly massive QE to reverse de-risking de-leveraging to avoid bubble collapse. The approaching challenge for the Fed, it’s going to be multifaceted: Whether or not to fall back and rely on QE. How much market instability will they be willing to tolerate before a QE re-launch, at what size, and perhaps most importantly, how do they respond when markets throw a fit and demand additional, massive open-ended bond purchases like they have in the past? That’s when things get really interesting, and perhaps that will be a scary juncture for the markets. We’ll have to wait and see, and thank you for the question.

David McAlvany: Doug, a question of my own, just because we’ve seen the ECB step one beyond us, we’ve done the mortgage bank securities and Treasurys. The ECB’s done that and more, including some select corporate bonds, and the bank of Japan has then sort of blown things wide open, buying everything in the kitchen sink. So now it’s government debt and mortgage paper and corporate bonds and equities and ETFs. What are the probabilities of the Fed’s stretching beyond mortgage backed securities and Treasurys and everything in the kitchen sink?

Doug Noland: Sure. And they did as much in 2020. They didn’t buy stocks, but they started buying corporate credit, and even some ETFs that held high yield junk bonds. Yeah. I expect them to do that. I expect them to broaden their purchases, but think in terms of, okay, they can add liquidity in different segments of the marketplace, but does that liquidity then circle back for commodities and only make the inflation issue worse? That is their new reality that they’re going to confront. They can buy whatever they want, but if they add liquidity, where does that liquidity want to go? Where does it want to go? I think it’ll be less financial assets and more real hard assets.

David McAlvany: Thanks. The next question. “What role will the midterm elections play in the Fed policies?” I’ll take a stab at this, and hopefully I don’t put my foot in my mouth. 

Obviously Fed policies are still very accommodative. We’ve talked about the 10-year Treasury, we’ve talked about the fed funds rate and adjusting for inflation. When QT begins in earnest and asset prices deflate to a critical pain threshold, that’s when politicians will howl and political pressure on the Fed will mount, and we will have to see how the Fed responds at that point. So the interaction between political anxiety and the Fed’s ability to relieve some pain for the general public— It’ll be interesting to see how they navigate that. 

A lot can happen between now and November, including QT, then the reversal back to QE, even between now and then. We have to wait and see. If you go back to the third and fourth quarter of 2019, the tightening was minimal. The Fed balance sheet was a fraction of its current size. The market started to panic, and the Fed reversed course. Maybe it was accidental, convenient acquiescence to help prior to an election. Maybe it was nothing to do with that, and really just Powell’s sense that things were going to come unglued very quickly. 

The disturbing difference between then and now is, Fed credibility is already severely damaged, and Powell was starting out on a very different footing. And if Powell doesn’t follow through on QT, he already has an institutional problem, which is that his credibility is already damaged. Inflation was a bigger deal than they thought. It wasn’t transitory. If he does follow through, the markets are in big trouble because, along with politicians facing the ire of frustrated and financially impaired voters, you’ve got inflation hitting the monthly budget.

You also have asset deflation, which can then hit your future hopes and dreams. So your investors at this point— or consumers. Damned if you, damned if you don’t. So given the fact that the consumer is already under pressure, a hit to net worth in the financial markets is likely to drive consumers apoplectic. Again, coming into the midterms. Who knows what gets squeezed in between now and November, but there’s a lot in play and there’s no doubt that Fed policies— You can expect the phone lines to be very active if there is much volatility in the financial markets between now and the elections, with the Fed under a tremendous amount of pressure.

Doug Noland: Yeah. David, just to add on that, I’m amazed to watch the FOMC officials, those that lean left and right. Both feeling compelled to talk hawkish. Both sides trying to present their inflation fighting credentials. I mean, what a change in the backdrop there.

David McAlvany: Yeah. I mean, and maybe it’s just a sequencing issue because this issue is live and they’re getting the feedback from constituents now that the inflation’s intolerable, and they’ll just have to deal with the ramifications of tightening down the line and however they have to, but right now it’s almost like inflation triage for the lower-income families that are coming to the polls in November. 

Next question. “Why does silver remain so flat given our financial world of inflation, crisis in confidence, questionable credibility of the Fed, surging commodity prices, surging demand in gold and silver coins, and limited above ground silver supplies and the war?”

I think inflation is one thing and stagflation is another altogether. Stagnation, or the anticipation of economic slowing, keeps silver and platinum held in check. If you look at the white metals, they’re behaving on a different basis than gold. And at this point only an overwhelming investor stampede will take silver out of the relative doldrums. And I say, relatively, it’s 80:1, is the gold silver ratio. If by contrast, if you were only looking at inflation and not the stag part of that, then I think both white metals would be higher. There’s simply more in the backdrop right now. And a part of what Doug was saying— While recession may not be front and center, financial market impairment and the implications of that variable could be. And there’s just more complexity to the white metals. They’re more sensitive.

I would just end it with this, and Doug, if you want to say anything, feel free, but it is common for silver to lag gold. And when it moves, imagine the engine and the caboose. The engine goes first, that’s the gold market. And waiting for confirmation, waiting that all of a sudden the caboose comes around the corner. Maybe the last, there’s actually a little sort of whip action at the end of the line. When it happens, it tends to happen fast. It closed the gap fast, that ratio of 80:1 dropping to 60, and then to 40. It can happen very quickly. Just because it hasn’t happened thus far doesn’t mean it won’t, but I think that’s a part of the explanation, is there’s a lot of wondering if stagflation isn’t a part of this unfolding saga. 

You want to add anything on that? Or should I move to the next question?

Doug Noland: The quick comment would be the Chinese economy has decelerated dramatically. So I would just assume that’s had some impact on some of the more industrial commodities.

David McAlvany: Yep. With the exceptional standouts being those that are more supply constrained. Tied to Russia and the Ukraine, where you can still see some dramatic volatility on the upside, with a palladium, where 40% of the world’s supply is coming from Russia, or from nickel, where they’re almost a 9% global producer. So things where supply is in question, dramatic moves, and your thought on China has more to do with the demand side, I presume. 

But next question for you, “What probability percentage do you assign to a further equity melt up from here, leading to a final manic top?”

Doug Noland: Yeah, I believe the top has been put in, but I love the question because we always have to think in terms of scenario probabilities. If I look at the deterioration and fundamental factors, surge in inflation, the hawkish Fed, the war ramifications, geopolitical risk, and waning growth and corporate earnings prospects, I would say the probability of another melt-up scenario would be 20% or less. But from a different perspective, looking at, say, market structure, the derivatives backdrop, resilient greed, and speculative excess. From that angle, the probability would be higher. I’ll venture, let’s say, throw out 50/50. So looking more comprehensively at the backdrop, I’ll put the probability of another manic blow off top at less than 30%. And even that seems high to me. As I said, I believe we’ve already, back in 2021, experienced the final crazy speculative mania that put in a historic top. But I can’t rule out a kind of echo-type speculative run to new highs. That’s not beyond probabilities. Thank you for the question.

David McAlvany: The next question I’ll admit is a little tough. One, it’s lengthy, and there’s some commentary in it, but I want to honor the question and just start by saying that my response is with all respect to the person who asked it, as well as to my father, who’s a part of the question. So I’m going to ask and answer as we go through it, because it is a little long and there’s embedded questions. 

“I’ve heard many people, even people who with financial podcasts, say that we owe the national debt to ourselves. Of course that’s patently false. We owe it to the holders of federal Treasury bonds. So what is the collateral that backs up those bonds? It’s the real hard physical assets of this country.” I just want to interject a few things there before I move on.

Actually it’s partly true. Six and a half trillion dollars is loaned—out of 30 trillion—is loaned on an inter-governmental basis, so theoretically it could be canceled. But you’re correct on the 23.5 trillion. That is a real obligation to real people and real institutions. As to, is it the real hard physical assets of this country? Again, that’s partially true. What backs those bonds really is the taxing power of the government, by law and by force. So you can say that all the land and the resources in the United States is a part of the equation, but what a creditor wants to know about when you’re looking at debt is, are you able to make these ongoing payments? And that assurance comes from the taxes, which theoretically is up to 100% of your assets, my assets, your income, my income, as a worst-case scenario. So that’s kind of the backdrop for all this debt. 

So, just to clarify on a couple points. 

“I think every person with a financial talk—,” this is back to the question. “I think every person with a financial talk show should disclose this at the beginning of every program, along with the fact that Congress’s treasonous act of giving the Federal Reserve the authority to control our money supply and manipulate the interest rate for money that we have to repay, that they create out of thin air, is what has created the booms and busts since 1913. Many, many people do know this background. I think it would make a difference in getting people to understand the real source of our problems, and hopefully decide to help in the true fight. We’re losing this game, and it will be permanent. We will not recover in 50 years or a hundred years or ever.”

“You have the audience. Tell the whole story. Don McAlvany knows this whole story. I suspect that David does too. Does Don think we’ve gone too far to fix it?”

So, just to fully engage with this, again, I just want to preface it with my respect for the question, the comment, as well as my dad. We’ve spent a lot of time with the likes of G. Edward Griffin, talking about the original creation of the Federal Reserve, our third iteration of a central bank, and beyond The Creature from Jekyll Island. I’ve spent even more time trying to understand the current PhD monetary standard. Certainly the commentary here is correct. Booms and busts on the scale we have, and the drive toward speculation and away from long-term investment—these are consequences of an unsound monetary system. And yes, the dollar’s lost 98% of its value since the Fed’s creation in 1913. And no, that’s not a good record when your chief mandate is price stability. 

So the system is worthy of critique, but to come back around to sort of where the common question ends, I wouldn’t despair. If the system fails, that’s not the end of the story. Recovery, if we can imagine beyond a financial market, an economic market or currency collapse, you’re really talking about a matter of confidence. There’s no doubt that as credibility in our monetary system is challenged, confidence can disappear. That hasn’t happened yet, but looking at even a case of monetary extinction, where you had a complete collapse in confidence, take the Weimar currency, all that was necessary was a fresh set of policies to be implemented that restored confidence. And obviously there’s a change of the guard. You’re not going to find the creators of the problems as the best ones for being the new problem solvers.

So in Germany they tried to restore confidence, first with land being the reference point, the Rentenmark used the land of the nation as the backstop for the currency. That worked for a matter of months. And ultimately the only thing that restored confidence in the German currency was gold. So it was game over, and then a new game was on. And I think people forget about the end of an exponential curve. It doesn’t go to infinity. Covid is maybe the most recent example. Rates increase exponentially, and then fall. When they’ve increased exponentially, anxieties obviously increase with them. And this is where I think we can lose ourselves too many times. If we’re looking at charts, you see the exponential curve. But what we often fail to do is look at what happens next. That growth rate on the exponential curve is not permanent.

So my opinion, I disagree that the challenges we have ahead lead to an inevitable or irreversible terminus. Now I’ll be honest, to some degree that’s the conclusion of my father, and I’m not on the same camp with him. I disagree. And I think too often, it’s the conclusion. And again, I say this with all— Please don’t take it the wrong way, but it’s often the conclusion of an older generation that the problems we face are irreversible. Does Don think that we’ve gone too far to fix it? I can be candid. At 81, his fight is done. For him, it’s gone too far. For me, it’s not. That’s not how the facts stack up, in part because there’s a resource that I’m looking at that he doesn’t have. That’s time. And so I don’t want to underestimate the resilience in the system, in people.

When we look at problems within the system, there are people who may not be present as policy creators who may have their day in the sun, and have not been there yet. There’s creativity which is born out of stress and necessity. As we know, the old phrase, necessity is the mother of invention. I think being at the end of a credit cycle or in an advanced age as a reserve currency, that doesn’t imply an end of the world. It does suggest that pain of various sorts is highly probable. 

Doug, your comments earlier, it is very disturbing to consider the social and political implications of what we have to deal with. We’re not in a healthy place from a political standpoint. People aren’t really feeling generous, right? We’ve adopted cancel culture. But as a student of history, difficult transitions have always provided compelling opportunities for those that remain flexible in their thinking and hopeful in their outlook.

I remember reading the book The Battle For Investment Survival as a younger man. It was written by an old man after the 1929 crash. There’s no doubt that in the 1929 crash, many fortunes were destroyed and the world was undone, but it’s been remade in a thousand ways from then till now. We are at the end of a cycle. I don’t think we’re at the end of a rope. So if we face another battle for investment survival—and I think that’s what we have prepared for, with Tactical Short being a very useful tool in that respect—if we face another battle for investment survival in the years ahead, there is also a good chance that the story gets better from there. So as Doug spoke earlier, I mentioned the turning point for the employment numbers, maybe 3.6%. It’s a good number. We have evidence that the economy’s not all that rotten.

It might be as good as it gets. Let’s not forget that inflection points emerge at both ends of the spectrum, and they set the stage for what’s next. 

Doug, let me give you another question here. “Is cash still a worthy alternate among equity, bond, and real estate investments?”

Doug Noland: Well, most still consider cash as trash today, but if the Fed moves forward with aggressive rate hikes, it’s not going to be too long before cash is an even more attractive alternative to a lot of risk assets. The market is today pricing in a 2.47% fed funds rate at the FOMC’s December 14th meeting. If it plays out that way, that would provide an appealing return to many investors, especially if they’re experiencing mounting losses on their security holdings. 

I’ve made it clear, I believe this is a high-risk backdrop where outsized cash holdings certainly seems like a prudent allocation. From my perspective, it’s been a long time since cash was as appealing as it is today. I also suspect that a lot of those so-called cash proxies in the marketplace, anywhere from the high dividend-yielding stocks to corporate bond ETFs have, over this long cycle, become real crowd favorites. So that makes them vulnerable to a run of heavy outflows. So I see cash today as especially appealing versus the proxies, and appreciate the question.

David McAlvany: I remember my conversation with Andrew Smithers. He wrote the book Valuing Wall Street, which I think is a must read, on the Q ratio. And this is many years ago, so obviously his timing was not perfect. But at his advanced age—he was just retired from being a journalist for the Financial Times—he said “I would happily take a multi 0.23% inflation hit each year, then extend myself in the equities market today, knowing what I know about how to value stocks. The downside potential in terms of volatility far exceeds the slow bleed of inflation.” So when you think about cash, do think about it in contrast with the alternative, which is significant market downside. Now, again, I’m not saying that Smithers was perfect as a trader, but his insight is worth thinking about.

The next question, “Given the likely changeover to a digital currency in the near future, if one is sitting on stocks, cash, 5% to 7% gold/silver coins, one’s total assets, what is an ideal percent of various assets someone should hold, wanting to get out of 70% cash? Thoughts on bitcoin?” Again, this contrasts with what we just talked about. Is cash trash? And we’d say no. Do you want to get out of it completely? No. In fact, you may want to increase it relative to what you have invested in equities today.

Let me start by this comment on digital currencies because I think Ken Rogoff more than anyone has made this perfectly clear. From a policy perspective, from a governmental perspective, he said, “What the private sector innovates, the public sector regulates and then appropriates.” And there, in a nutshell, you have a life cycle of digital currencies. What the private sector innovates, the public sector regulates and then appropriates. The central bank digital currency, yes, it’s the wave of the future because it helps optimize financial repression and the tools desired by policymakers to utilize inflation as a means of paying off debt at a cheaper price. It gives them much greater control of economic activity. So bitcoin and the promises of easy wealth, that’s not the wave of the future. It is central bank digital currencies serving the purpose of fiscal and monetary policy implementation and economic management, top-down management.

Bitcoin in that sense is more of a tradable speculation. Yes, it has enough volatility to provide opportunity if you’re nimble, if you’re bold. But like any speculation, you limit your risk by limiting the size of the position. The thing that’s often said about these digital currencies is, look at the adoption rate. There’s going to be so many more people that adopt it. And frankly, like any speculation, that’s true. The continued success requires increased adoption. And I would note historically, tulips were reliant on the same dynamic. After a dozen years, I don’t see the use cases for these cryptocurrencies, but I do see the digital currencies and the central bank variety continuing to be developed. Again, I would think of them more as digital dystopian central bank currencies, but that’s my personal view.

In terms of the ideal percentage of various assets, it’s a difficult question mainly because everyone is faced with different life circumstances. What kind of income needs to be generated at this particular point in your life from the assets that you have? Some people have a very high requirement, some have zero requirements. So to say precisely what your allocation should be, it’s impossible not looking at the details of your particular circumstances. What I can say is that having a healthy percentage in gold, having a healthy percentage in cash, having a modest percentage in stocks and bonds still makes sense. We don’t exactly know the future and a well-positioned portfolio can still do well.

The emphasis, if there’s a big takeaway from what I heard from Doug’s commentary today, is that the big transition is away from financial assets and towards real things. And so, yes, there’s equities that are attached to real things, but be aware that everything that’s done well in the cycle of money getting cheaper and cheaper, interest rates getting smaller and smaller, tends to work in reverse. So if it worked well in the last cycle, it’s probably not going to work well in the next cycle.

Diversifying a portfolio thus requires that you look at things differently. Yes, allocate to cash. Yes, allocate to metals. Yes, allocate to equities—but selectively chosen. Make sure that real estate is a component as a real asset within your portfolio. Most people don’t think about international diversification, that there is a case to be made for other countries and other geographies as a place to invest. Doug, what would you say to the ideal percentage of various assets, that allocation model? 

Doug Noland: It’s individualistic, right? It just depends on someone’s risk profile, their outlook. So it’s hard for me to venture into that one.

David McAlvany: Well, let me launch you on another. “How accurate”—this is back to the yield curve—“how accurate are the inverted yield curve and the transportation indexes as a forecasting tool for an upcoming recession, and how far out?”

Doug Noland: Yeah, that’s a more manageable question for me. Yeah, excellent question. This isn’t a discussion, David, we have regularly at our team meetings, at least for now. I hesitate to put too much weight on any one or two factors. For me, it’s always a mosaic of indicators that need to be weighed and deciphered. I’m not too comfortable with the yield curve as a recession indicator right now. Treasury trading, it’s dominated by leveraged speculation, interest rate hedging, and just derivatives activity more generally.

And this ensures volatility and some wild moves, and a big move a couple weeks back where the yield curve inverted. It spurred a lot of talk about recession. Two weeks later, the yield curve has steepened markedly with the 2-10 yield spread back to 37 basis points today from negative eight just a couple weeks ago. So such gyrations are more about the market and speculative dynamics than traditional market discounting of economic growth prospects.

And as for the transports, the weakness, it’s certainly something to keep in mind, something we watch, but I tend to think of the transports these days as being less reflective of kind of this services-dominated economy than in the past. So I’ve deemphasized that sector as far as a general indicator of the market. And I’m also mindful of a marketplace where disruptive rotations in and out of sectors, that’s just part of the current landscape. Once again, speculative dynamics somewhat diminish traditional market price signals, which create a lot more work for us because we got to watch a lot of things and try to put them together and make sense out of them. But thank you for the question.

David McAlvany: Next question. “Is there a way to avoid high percentage taxes when selling silver or gold? Income taxes were painful. Thank you.”

Yeah, I would defer to your IRS Treasury auditor for the best answer. But beyond that, I would suggest that a tool for someone who wants to own silver or gold and manage the cap gains side of things more effectively, tax-deferred accounts are a useful way to position in metals and not have to worry about the cap gains aspect. A Roth conversion from a traditional IRA is also something that is worth considering because there you’re talking about a metals position that can essentially become tax-free. Doing a Roth conversion, owning the metals, and being able to keep the proceeds because you’ve already settled up on the taxes on the front end.

So if you were interested in having a metals position that had some tax advantage, I think you work within the sphere of the knowns and the approved, and never really test creativity beyond that, lest you be answering a lot of other questions from your favorite local IRS Treasury auditor. But as it relates to the tax-deferred accounts, Roth conversions, things of that nature, our sister company now in its 50th year, we’ve been doing that for decades and decades and decades.

Another question. “With the big changes in banking, Canada seizing private citizens’ accounts because of an emergency, Russia is accepting payment for its oil in rubles and gold, what impacts do you see resulting on the metals exchanges, especially COMEX and the LBMA? What impacts us, the average citizens who hold metals as wealth preservation assets?”

Three impacts come to mind. One is an increased scarcity of the physical metal. For the time being, you’ve got gold production from Russia which is no longer acceptable on global exchanges. So if you’re looking at COMEX and LBMA stocks, and them being replenished with investor demand and central bank demand, Russia is a decent-size gold producer, and their bars are not going to be coming to the market. So you’re dealing with a greater scarcity issue in the form of physical metals.

Of note is the Russian central bank generously—I say with tongue in cheek—offering to buy Russian-produced gold at $1,600 an ounce. So they’re going to solve the supply issue that the producers in Russia have by picking it up at 1,600 bucks an ounce. As long as the international markets have shut them out, it will go comfortably in the central bank. So increased scarcity of the physical metals is the first impact.

The second impact is reduced hedging viability. And I think Doug’s comments have gotten to this. When you look at financial market deterioration, we see hedging as less reliable. And certainly, if you’re looking at what just happened with nickel, you reduce hedging viability altogether. What happens there? Obviously price volatility is a part of it. Maybe it’s on the upside, maybe it’s on the downside, but when the London Metals Exchange canceled $4 billion worth of trades on nickel, these were profitable trades on nickel because someone was on the right side of the trade versus the wrong side. Somebody’s always on one side or the other. It calls into question the viability of the organization, LME, but it also suggests that anyone who’s engaged in commodity production and hedging does not have a sure bet, and they’re not exactly sure what to do going forward. So it does suggest that there’s a significant impact for volatility.

The third impact, I would say, is that, as your exchanges restructure, with greater volatility comes increased margin requirements, reduces leverage within that. As you reduce leverage within the commodity space, you’re going to force an identity shift. People are going to have to say, am I an investor in a commodity or am I a speculator in a commodity price? I think you’re going to be reducing the number of speculators because they don’t have the same leverage in that market.

And as it becomes clear that the market and the available product on those exchanges will not accommodate 10 or 50 or 100 bets on a single underlying ounce, again, it’s sort of a truing up of the marketplace and an awareness of just how thin these markets actually are, which, I would suggest for the average person, holding the metals ultimately is a driver of price to the upside. Speculators are out, investors take more control. So I think these there some net positive impacts, if I can offer that. 

Anything you’d add to that, Doug?

Doug Noland: No, that was very complete. Thank you.

David McAlvany: “Potential impact of interest rate hikes, continued war issues in Europe, and uncontrolled migration on the tactical short portfolio.”

Doug Noland: Okay. From the Tactical Short perspective, I’m pretty excited about higher rates. Our accounts are positioned with short exposure and cash collateral, and we’re going to be receiving a nice positive return on our large cash holdings. So that’s really good news. And as I mentioned earlier, I believe rising rates will invariably lead to a tightening of financial conditions, and a backdrop of tighter lending and market liquidity have traditionally been advantageous for shorting. That’s kind of the way the cycles work.

As for war in Europe, it’s an important aspect of significantly heightened geopolitical risk, and certainly economic risks such as inflation and supply chain issues. In general, a marketplace with less speculative excess is also advantageous for managing short exposure. So that will be helpful. And in the unfolding environment, the new cycle that I spoke of, I believe it will be a lot less hospitable environment for corporate America and for the markets generally. I don’t really see the migration issue impacting our portfolio composition, but you never know. But thank you for your question.

David McAlvany: Yeah. Another question, just on Tactical Short: minimum investments for the tactical short strategy, which is for an IRA, $50,000; for a non-retirement account, $100,000. 

And to follow up on your conversation, Doug, this is many years ago, you and I had a conversation about low interest rates and how that was, for a short position, almost an additional tax. You have to work that much harder for that much less. But when interest rates begin to rise, because as you mentioned the cash collateral is now an interest-bearing component within the total return proposition of a short portfolio. When interest rates are zero, you’re not getting that benefit. Now as they start to rise, let them be 5% and 6% and 7%. That’s straight to the bottom line

Doug Noland: Cash rates were at 8% when I started in shorting back in 1990. That was helpful.

David McAlvany: Yeah. “What impacts do you foresee for the US dollar?” I’ll just say two things quickly. Higher prices under the scenario of global dislocation. We still get some benefit from a flight to quality, flight to safety, safe haven status relative to the rest of the world. And the second thing I would say, lower prices going forward as soon as you get the Fed’s savior complex kick in and QE challenges sort of the viability, just creating too much supply in one form or another. Anything else you want to say on impacts on the US dollar?

Doug Noland: No, no, I think I’ve said enough on that. Thank you.

David McAlvany: Yep. “Why do they say that the recession is 12 to 18 months away? If you stay in and if you time your sale, you can then still grab another 18% to 19%.” I’m trying to understand this question a little bit.

Doug Noland: And I think the question, if I’m reading it correctly, is that a lot of bullish analysts say that the recession— we don’t have to worry about it today. It still could be year and a half away. So the market could go up another 20% by the time the recession comes. So I’ll just look at it that way. Hopefully I’m reading that correctly.

It’s been a long bull market. And as they say, bull markets create genius. So those that have just stayed bullish, bought every dip, they perform very well. They’ve attracted the assets, the inflows, and now they control the big portfolios. That’s the nature of market cycles. And most have been conditioned. You just remain fully invested, believing stocks will always go higher. And I often think back to history and to Irving Fisher’s— At the time he was America’s preeminent economist. His infamous stocks have reached what looks like a permanently high plateau only weeks before the 1929 stock market crash. People can’t see when trouble’s coming. It doesn’t work that way.

From my analytical perspective, I see an unfavorable risk versus reward calculus for staying fully invested until recession hits. From my view, it doesn’t make any sense. But I believe markets are in store for a historic bear market, one that could last years and see declines investors today would regard as impossible. I would be more focused today on not losing money than trying to play for more gains and trying to time when the market might respond to inflation or to recession dynamics. But thank you.

David McAlvany: “Do you see both energy and food inflation continuing for the rest of 2022?” That’s part one of the question. “And is GLD and SLV a reasonably safe tool for betting on the price of the metals?”

I would say that inflation driven by supply constraints will be with us for as long as the Russia-Ukraine conflict remains. And you can see some of the commodities that are most affected, whether that’s wheat or corn or a number of your commodity-specific oils, rapeseed oil, these are things that are very much tied to the conflict, and the price has spiked. And so supply is constrained. That inflation remains on the food side, and could dissipate. That doesn’t mean that there’s not other factors that can drive the price of commodities higher over a longer period of time, but this is really something that can be resolved to some degree with that conflict.

In terms of oil, again, we’re talking about, let’s call it $75 to $80 a barrel sans the Russian conflict. So yeah, there’s a good $20, $30 of conflict premium built in. Sitting right at $75 or $80 is still a level that represents a reasonably high tax on the consumer, and is continuing to drive inflation higher. Note that we had 12 months of rising—each month—rising inflation numbers preceding the Russian invasion of Ukraine. So Putin’s not responsible for inflation pricing. Inflation is in the pipeline. And certainly the move up to $80, $85 a barrel was influencing that before things became acute. So in all likelihood, energy and food inflation continues for the rest of 2022, probably not at the same pace that we’ve had it. We’re now, for PPI and CPI, these are big numbers, these are big numbers, nearing double digit on CPI and already surpassing double digit on PPI.

Does it moderate? Perhaps. I would expect it would moderate somewhat and then just maintain a level of five to seven versus eight and a half for a good long period. GLD and SLV, I think they’re reliable. And I think they’re reasonably safe tools for betting on price. And part of what is to like about them is the high liquidity. And so, yes, I would consider them a very reasonable way of betting on the price for the metals. We use them in our hard asset strategies for that particular reason. Are they the basis of your own monetary reserve? I’d say no. I think having physical metals in your possession has some benefits that you don’t get from an ETF. So there is still a distinction, but the question specifically was betting on the price of the metals. You bet. GLD and SLV are an adequate tool for betting.

I’ll just throw in this last question because it does relate to gold, on this next question. “Is a Vaulted program at more risk now since Trudeau went rogue than before?” 

I’d say, no, we don’t have any exposure. First of all, it’s a US-based account. Nothing like that has come under pressure. This is a relationship directly with the Royal Canadian Mint. Again, the singular places you can count on a hand. This is not a big number of cases where people who were involved in protests— This is like the Sesame credit scores being applied in Canada. If you didn’t do as you were supposed to do, there was a penalty raised. And so you had no access to your bank account. We had zero issues with anything like that, in part because this is a storage agreement with the Royal Canadian Mint.

If things change, obviously we’ll consider storage of metals in other jurisdictions. We have other programs that allow for gold to be stored in other parts of the world, but I do think the product that we have from and through the Royal Canadian Mint is second to none. The relationship and the pricing cannot be duplicated elsewhere. So those are certainly factors and considerations for us.

“Do you believe the dollar is going to zero? If so, how soon? Short of going all in with gold and silver, what’s the best alternative for safe investing?” 

I’d say no, I don’t think the dollar’s going to zero. I think a diversified portfolio does make sense, and our emphasis has been on real things. Some of that’s publicly traded and some of it’s not. You could include in that farmland, cattle, art. Oftentimes Doug and I will talk about just resilience in general, whether it’s relating to health or communication or transportation. I think there’s ways of managing your wealth that aren’t just for gains, but make a tremendous amount of sense in terms of wellbeing and value that is of a non-financial nature. And would I diversify my portfolio into more real things? Yes. And consider not only the publicly traded variety, but the personally held variety as well. But no, I don’t think the dollar’s going to zero.

The Schwab Reset question is one that I actually get asked quite frequently. Will it happen? And what are the implications? Simply put, there’s too many unknowns. There have been, through the history of time, countless utopians and idealists who have made grand plans, and they’ve come to naught. I look at the current Russia-Ukraine conflict as a major setback for the World Economic Forum globalist agenda. There’s actually some really big questions about supply chain redundancies and a move towards more national resilience, as opposed to internationalism. I think that ends up hurting the world in terms of inflation and helping it in other respects. But the utopian ideal of a Klaus Schwab, I think it’s actually had its own great setback in terms of global conflict because you realize that there’s some things that you have to do on your own. You can’t rely on your neighbor completely for. And so there’s a huge rethinking.

You even think about what has changed in terms of some of your Scandinavian countries wanting to join NATO. The kinds of shifts in thinking as a result of this conflict could not have been imagined prior to, and I don’t think it’s particularly helpful to Schwab’s Reset. 

So a question for you, Doug, from Michael, would like to know if in the Tactical Short program you would ever introduce long positions and not just short positions; looking at the cash position and wanting to sort of manage the downside exposure to cash.

Doug Noland: Yes, we would definitely consider having some long positions. In the past I’ve generally run portfolios dominated by the short exposure as a market hedge, but with some long exposure also. So that’s something that we continue to think about, discuss. That will be communicated well in advance. I wouldn’t want to do something like that without making sure everyone was aware of what was going on. The focus would most likely be in some of the more hard asset areas. I don’t want to get into a situation, though, where I’m taking much risk with the long exposure that would offset our mandate, offset our ability to be a reliable hedge in a down market. So kind of a long/short strategy is much more complex than it would seem in theory. So it’s something that we would work on a lot before we implemented it.

David McAlvany: And just to add to that, Doug, if it was more of a long/short strategy, is it less complex if that long holding is sort of metal-centric? You mentioned hard asset. Might that be the solution?

Doug Noland: Yeah. Traditionally, I’ve run a short portfolio with a resource-long component. Not huge, but a resource-long component. So that’s where my interest would be. There’s just work to do to get there. I would feel more comfortable doing something like that when we’ve started to perform well and we have a few risk calories to play with. Right now I’m just focused on the downside of the market and doing the best we can in a difficult market environment.

David McAlvany: Well, that exhausts the questions that have come in, as well as the questions that were pre-submitted. And what an amazing time to be partnered with you as our clients. And for those of you who are interested in taking that next step, you can see there’s more complexity in the market and in the significant amount of downside risk. If there’s anything that we can do to partner with you in reducing your total risk exposure, that’s what we’re here for. And to connect with myself or to connect with Doug in the next few weeks would be time well worth the spending. So be in touch with us. We’ll be as responsive and welcoming as you can imagine. We are looking at this as one of the rare opportunities in the financial markets, being at a significant inflection point and seeing a new era in front of us, where it’s not just months, but years and perhaps even decades of adjustment.

And so figuring out who’s on your team in that respect— I can tell you who I want on my team. And Doug’s at the top of the list. I would encourage you to consider who is at the top of your team in terms of portfolio management, asset allocation, risk mitigation. If you feel like, to this point, what you’ve had is good portfolio management, but not very good risk mitigation, then you’ve just found your team. And I would encourage you to engage with Doug in the coming weeks and figure out how to integrate it into your larger allocation strategies. 

We thank you for your time today. We thank you for your interest. We thank you for the questions that have come in, and we look forward to an exhilarating 2022.

Doug Noland: And thanks very much everyone, and good luck out there. See you next quarter.


What is the purpose of the Tactical Short Strategy?
The McAlvany Wealth Management (MWM) Tactical Short is designed to generate positive returns from downside volatility within the equities market.  The strategy is not intended to necessarily hedge an equity portfolio dollar for dollar, but will instead strive to opportunistically capture gains as particular stocks and/or sectors decline in value. The objective of our short offering is to provide a mechanism for reducing a client’s overall investment portfolio risk profile while providing downside protection during periods of market instability.

The Tactical Short is described as non-correlated instead of consistently negatively correlated.  Can you explain?
A constant negative correlation would imply always being positioned fully short, thereby reflecting the direct inverse returns of the asset mirrored.  Such approaches are indifferent to risk.  It is fundamental to our strategy to be selective and willing to wait for more favorable market conditions and compelling opportunities.  Our focus on risk versus reward metrics dictates that there will be periods when we will be minimally short.  Our decision-making process is driven by intensive analysis of a mosaic of indicators, from both “top down” and “bottom up” perspectives.  Depending on our analysis of the backdrop, we will have the flexibility to position either opportunistically or defensively – to expand short exposures in favorable backdrops or significantly reduce exposure to mitigate losses during highly unfavorable environments for shorting.  Positioning the strategy as “non-correlated” is consistent with the objective of avoiding the type of heavy losses suffered by negatively correlated funds during bullish periods.

Is this a fund with pooled assets, or will investors have separately managed accounts (SMA)?
We have chosen to structure the Tactical Short offering in separately managed accounts to allow for advantageous investor transparency, liquidity and, on occasion, some tailoring to better suit the needs of an institutional or individual investment mandate.

What kind of accounts can be opened?
While the Tactical Short offering was developed with the discerning institutional investor in mind, it may be appropriate for individual, trusts or corporate accounts.

Can I transfer a retirement account?
That’s not possible.  The nature of shorting requires that securities be borrowed prior to consummating a short sale.  Regulations mandate a margin account for such strategies, and margin accounts are prohibited for qualified plans (IRA’s and other retirement vehicles).

Is positioning a portfolio to benefit from declines and volatility the only investment style MWM offers?
Definitely not.  While MWM specializes in alternative asset investment management, we do offer traditional portfolio management along with our natural resource and long/short strategies. Tactical Short is a unique offering intended to compliment other risk asset allocations held with MWM or elsewhere.

What do you see as an appropriate percentage allocation to something like the Tactical Short from an overall portfolio mix perspective?
An allocation to our non-correlated Tactical Short adds value by reducing overall investment portfolio downside risk. We would suggest exposure to the Tactical Short in the range of between 5 and 20% of risk assets to help reduce overall portfolio volatility, enhance liquidity and provide meaningful downside protection.  For example: $2,000,000 in total equities and risk asset exposure would typically benefit from a $100,000 to $400,000 Tactical Short allocation.  With an allocation above 20%, we would assume that an investor has chosen our product to place a directional bet on a declining market.

Are there Minimum account sizes?
Institutional investors would generally have a minimum account size of $1,000,000 while, where appropriate, qualified individual investors would be considered with minimum account sizes at inception as low as $100,000.

What are management fees for Tactical Short?
1.0% per year paid quarterly in advance (25 bps per quarter).

If I am utilizing margin in the Tactical Short, will my account be charged for margin borrowing expenses? Are there other expenses I should be aware of?
While the portfolio manager seeks to minimize such costs, there are typically expenses associated with borrowing securities.  Borrowing costs are generally small, with the exception of hard-to-borrow securities. Traditionally, borrowing costs were offset by the return on an account’s cash collateral.

Why would I choose a MWM Tactical non-correlated account instead of a short ETF or options strategy?
We believe our strategy is superior to competing “bear” products and instruments.  Being fully short all the time simply doesn’t work.  Options strategies are risky and tough to execute successfully.  In our eyes, risk management is paramount.  The key to success on the short-side is having the flexibility to navigate through various market environments.  To do so successfully demands a disciplined investment process coupled with a sound analytical framework.  Importantly, there’s no substitute for experienced active-management on the short-side.  In our view, our new offering incorporates the most seasoned portfolio manager with the most compelling analytical perspective, investment process and philosophy available in the marketplace.

Does MWM custody assets? If not, who is the custodian?
We do not custody assets.  Our preference is to retain the services of a preeminent third-party custodian, an arrangement that facilitates online access to account holdings and myriad amenities common to a brokerage account.  Tactical Short client assets are held at Interactive Brokers.

Can I send additional funds to my account in the future?
Sure.  Additional funds can be added in any quantity.  Because Tactical Short accounts can be rebalanced daily, there should be minimal delay in adjusting positions sizes to incorporate flows into (or out of) your account.

Will this offering be closed at some point to new money?
We do not at this time anticipate capacity issues that would cause us to close the Tactical Short to new investors or restrict inflows.

Do I need to reserve a place?
That’s not necessary.  We would, however, highly recommend funding an account and then to allow us to determine the appropriate time to allocate assets. This is much preferred to beginning the process in the middle of unstable market conditions.

Are assets always invested on the short side?
No, there will likely be periods when we choose not to hold short exposure.  Our analytical framework and proprietary indicators assist us in gauging both when conditions are more favorable for shorting along with the most attractive composition of short exposures (i.e. stocks, sectors, the market, etc.) from a risk versus reward perspective. When conditions are expected to be unfavorable, the Tactical Short is content to watch from the sidelines (sitting in cash and avoiding short exposures).  Such a tactical pivot from being opportunistically short to defensively positioned creates the flexibility necessary to capture gains and then safeguard them from major market advances.

If Tactical Short operates with hedge fund-like versatility, why not charge the standard “2/20” (2% management fee and 20% of profits)?For one, we do not share the typical hedge fund mindset.  By keeping fees to a minimum, we endeavor to develop long-term partner relationships with our investors as we together navigate through the vagaries of market cycles. We did not develop our new product with the intention of getting rich from the next market downturn or financial crisis.  We were motivated by what we saw as a glaring lack of quality flexible short-side products – the type of strategy that savvy investors could live with comfortably during these uncertain and unsettling times.

When you are not short how are funds allocated?
It’s a little confusing.  Unlike long investing, cash is not used up in the process of borrowing and selling securities short.  Whether fully short or not short at all, account assets remain mostly in Treasuries and/or cash-equivalents.  Some of the cash holdings are used as collateral against short positions, but this cash remains in the account.  So even in periods of market stress, Tactical Short assets should remain safe and highly liquid.

How liquid are the funds in my account?
Funds are generally available same day. One of the benefits of a separately managed account is that requests for same-day liquidity can be accommodated.  Short positions will also be highly liquid.  In the event an account is liquidated, it will be possible to unwind (“cover”) short positions upon request and return cash collateral on a standard T+3 settlement basis.  No “gates” here.

Can I add money to an account in the future?
Yes.  There is a minimum to open an account but should you desire to increase your allocation to the tactical non-correlated theme you may do so at any time.

If future gains boost the size of my account, would you recommend allowing my short allocation to increase over time or instead employing a total portfolio re-balancing approach?
Having access to liquidity at market bottoms can be highly advantageous to value-conscious investors.   We’re going into our new venture with the assumption that Tactical Short’s ability to create liquidity in down markets creates an enticing long term value proposition for astute investors.  While tactical decision-making will be a primary management focus of our short offering, we fully expect our long-term investors to engage in cyclical allocation decisions consistent with their individual goals and circumstances.  As partners, we’re committed to doing our very best in offering valuable insight as well as attractive investment alternatives to best serve our investors as they strive to generate and preserve wealth.

  • Don’t be risk indifferent – unwise to maintain 100% short exposure all the time
  • Don’t disregard the macro backdrop
  • Don’t ignore the market
  • Don’t disregard portfolio beta
  • Don’t pretend long/short strategy mitigates risk
  • Don’t only short stocks
  • Don’t maintain concentrated short positions
  • Don’t only short a market index
  • Don’t have illiquid positions
  • Don’t rely on potentially problematic third-party derivatives
  • Don’t invest short collateral in potentially risky and illiquid instruments
  • Don’t be a “one-trick pony” – (i.e. company research, index or quantitative focus)


  • Daily intensive, disciplined risk-management focus
  • Wisely adjust exposures based on market risk vs. reward backdrop
  • Be flexible and opportunistic with individual short positions and overall exposure
  • Incorporate experienced top-down macro research and analysis
  • Search for opportunities rather than fight the market
  • Intensive beta management: 
    • Protect against short squeezes and “upside beta” issues 
    • Guard against high market correlations
  • Have as many tools in the toolbox as possible: 
    • Short stocks, sectors, indices, various asset-classes, global perspective,
    • Liquid put options
  •  Incorporate a technical analysis overlay with risk management focus
  • Protect against potential systemic risks: 
    • Avoid third-party derivatives 
    • Liquid put options
    • Vigilant cash and liquidity management
  • Incorporate the best of micro, macro and technical analysis

    For more information or to inquire about opening an account for the Tactical Short Strategy, please contact us: co*****@mw******.com 

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