EPISODES / WEEKLY COMMENTARY

Tech Stock Boom Fears Antitrust Bust

EPISODES / WEEKLY COMMENTARY
Weekly Commentary • Mar 09 2021
Tech Stock Boom Fears Antitrust Bust
David McAlvany Posted on March 9, 2021
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The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

Tech Stock Boom Fears Antitrust Bust
March 9, 2021

“The only thing that our academics within the central bank community know how to breed is every form of volatility, the stated goal to reduce volatility, introduce price stability, and it’s the exact opposite. What they’re breeding is social discontent and volatility, political volatility, economic volatility, and I think in significant ways this year, incredible market price volatility.” — David McAlvany

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

David, on Tuesday mornings I meet with a group of guys early in the morning and one of them, a friend of both of ours, he spoke this morning and I didn’t really know the detail of how he started out here in America. But he was Cuban, and his family in 1961 fled Cuba. They had been land owners there, and then of course, the great leveler came in, communism. And their land was taken away from them, their farms, they came to America with virtually nothing. And it struck a chord because we’re starting to hear about wealth redistribution right now, and top-down management of who gets what, and when.

David: Well, there’s a lot of great things that come from Cuba. But—

Kevin: I’m not talking cigars.

David: No, I think it’s a reality we quickly forget that maintaining flexibility with the resources that we have, and having some ability to move and restart. None of us wants to ever imagine that. I don’t think we have to. But in this case, we have a friend whose family was devastated by revolution. It wasn’t war, precisely, but it was just a change in ideology and there was more of an extractive nature. Well, more of, there was a completely extractive nature. For anyone who is a landowner, you were considered a part of the problem, and the new solution was going to create equality.

Kevin: It’s interesting when we look at what creates inequality. A lot of times it comes from sources that people have absolutely no idea is happening. It seems like it’s a political thing, what happened in Cuba, but really when you see what’s going on economically, Dave, you and I have talked, especially over the last eight or nine years, of the distortions that are created in wealth distribution based on the fact that you’ve got two players in this world. You’ve got those who have to earn their money and those who can print it freely. The problem is, for those who print freely, you can create an amazing amount of distortion that later turns into a political action that you may not want to see.

David: Many of our private conversations going back to the period of Occupy Wall Street included this idea that the political spectrum from far right to far left is not sort of a straight line where you have the extremes, and language kind of fits far right on the spectrum far left on a linear line. But actually bend that line and you find that the far right and far left are very close to each other. And I always wondered why the conversation never came to cause. What is the issue with inequality? What is the issue with corrupt politics and public policy? And what you find is the enabling function of central banks. When you have loose credit, you’ve got a lot of other things that get real loose as well.

Kevin: When my daughter lived in New York, I went out during the Occupy Wall Street thing, and I went down to Occupy Wall Street when it was happening. And I just talked, I walked around, and I talked to the people who were camping right there in Wall Street. And I told you the story, there was one man that he pulled a constitution out in his left pocket—

David: But out of his right pocket—

Kevin: Out of the right pocket he pulled out the Das Kapital. And so it was one of those things where it’s like communism or constitution, he didn’t understand the problem. And the problem really was where they were occupying. What they were doing was, there was privilege that was being distributed in the form of printed money.

Okay, so the distortions that that causes, let’s talk about the bond market, because really when a government can borrow unlimited amounts of money, because they can print the money to loan themselves and buy the bonds that they’re printing, how in the world can you hedge something that large? Everyone’s just sort of counting on interest rates staying near zero.

David: And I think that’s an issue with distorting values and distorting the quantity and scale of our money. What you end up with is malinvestment in markets that are unwieldy. In fact, if you look at the Treasury markets, it’s something that on a day-to-day basis is easy enough to hedge, but hedging requires someone to take the other side of the trade. 

Kevin: Right.

David: And who has the wherewithal to hedge government bonds? The likely scenario with government bonds is that they become unhedgeable at some point, and enter a major liquidation phase and require more significant monetization than we’ve seen to date. 

What that ends up doing is pressuring global currencies, sending safe haven allocation scurrying for anything that looks immune to decline. And this is, again, coming back to that Occupy Wall Street moment. You’re dealing with distortion, but it wasn’t Wall Street breaking the rules. It was operating according to a set of rules that, frankly, was not particularly fair. 

Why do I say that? Well, because it’s access to unlimited money that creates all kinds of aberrant behavior, even if you’re following the rules. The question is, what was the enabling function? What allowed Wall Street to take massive speculative bets? And we find the same thing. When we enter that significant monetization phase, you’re dealing with the same sorts of distortion and unreality. 

And, again, what does an investor do? Well, some people would say, “Well, you just got to go to cryptocurrencies.” That’s going to be the time and the place. So far, however, what we have seen is that when we have risk-off events, when we have market jitters, bitcoin, ethereum, all the others, they sell off in tandem with the risk assets. And I suspect that this next significant phase, a liquidation phase in government bonds, I suspect that gold emerges as the safe haven.

Kevin: You and I talk about that a lot. It’s like, okay, where do you go? Because you do have the cryptocurrency option, you’ve got the gold option. Gold’s got a 4,000-year history, cryptocurrencies have about a 12- or 13-year history, so there is a little bit of a difference there. But small speculators are starting to go into markets they’ve never been in right now. You look at the small speculator, the latest craze is the short-term Treasury trade.

David: And that’s for the time being at least, that small speculators are jumping on that trade. They like it, it’s just another momentum trade. Interest rates are on the rise, bond prices are moving lower, and all that really means is that we’re getting closer to a rally in bonds. That’s around the corner, and the late-comers to the latest government bond debacle, will lose a bit of money. 

So the longer-term trend for rates, I believe, will be higher, but it’s not likely in a straight line. There’s volatility in all assets, and given the amount that’s been given back in the last few months, I wouldn’t be surprised to see something of a rally in bonds. 

You take TLT. TLT is a long Treasury bond ETF, marks to about the 20-year maturity, and it’s lost roughly 20% since August of last year. That trend has accelerated since November—wonder why—but rates are being pushed higher. And it actually is pretty normal to see a counter-trend move, in this case it’s a rally, and it would even be eminent. I think actually it might coincide with equity market weakness, where all of a sudden there is something of a bid or a buy for bonds as an alternative to stocks.

Kevin: Sometimes there’s these invisible forces that unless you understand what’s going on, you don’t really know why the markets doing what it’s doing. One of those invisible forces, Dave, after the global financial crisis, was our government actually paid banks to not lend money. They paid them for their reserves. There were other regulations or limitations or things that they did with the banks, like encouraging them to hold Treasury positions that they didn’t have to show on their reserves. That could change anytime.

David: Yeah, IOER is what you’re talking about a minute ago, Interest on Excess Reserves.

Kevin: Yes, amazing. “Here we’ll give you money but don’t lend it out in your bank.”

David: Well, and it appears that the emergency exemption for banks—we talked several weeks ago—which is supposed to come up due March 31, it’s expiring then. Doesn’t look like they are going to extend it. The Fed has—basically during the COVID crisis—the Fed has allowed banks to not include their Treasury positions in the SLR, which stands for Supplemental Liquidity Ratios. 

And it’s encouraged the maintenance and expansion of Treasury holdings by banks. It’s been a great stabilizer for Treasurys throughout 2020, but as we get closer to the end of March, so far the Fed has not given an indication that that exemption will continue. 

So just as SLR has increased the buying pressure for the Treasury market, it may also include an increase in selling pressure. Perhaps that’s been a part of what we’ve seen in terms of the move lower in Treasury prices. 

We know that waiting in the wings—should that pressure intensify from here, yields continuing higher, prices moving lower—is an expanded version of monthly purchases. 120 billion, combining the mortgage-backed securities and Treasurys today, but the expanded version has its own acronym too: YCC, Yield Curve Control.

Kevin: And that’s not necessarily new. That was experimented with back 50 years ago, 60 years ago.

David: Yeah, exactly. We’ve got Modern Monetary Theory, not all that modern, and the new-fangled tools from the toolbox, which are not new either. Operation Twist, we saw most recently in the global financial crisis in that era, but Yield Curve Control was used back in ’61, and essentially it just flattens the curve. Not the COVID curve, but the yield curve. If you can just flatten it out, bring long-term yields down, that’s what was intended with Operation Twist. It actually opened the door to rates getting to record low levels. 

At first it was to 200-year lows and sort of the lows that we’ve seen in US financial market history. But then all of a sudden, it was 5,000-year lows and the trend has continued globally. In essence, it was, and when they bring on YCC, or Yield Curve Control, it will be again, buying down the interest rate at the long end of the curve. It’s artificial buying, it’s with digitally generated capital, it’s to alleviate financial market tightening, and it’s to prop up prices and the Treasury markets along with other fixed income that sort of reference the Treasury market for their own rates and pricing. But it’s artificial in nature.

Kevin: And this artificial nature, what you’re talking about, it can throw everything off. Remember, if you were to think of old time investing in simple terms, you were told, “Well, if you’re in the equities, you’re taking more risk. If you want to be conservative, move over to bonds,” remember that? It was just sort of, that’s how brokers are taught, but that’s assuming that when equities rise, bonds fall, or when bonds rise, equities fall.

David: And I’m seeing a lot of chatter between Goldman Sachs, JP Morgan, half a dozen other banks, both here in the US and Europe, saying that the classic 60-40 portfolio of stocks and bonds is doomed in the years ahead. Because just like you would expect, stock market weakness equals bond market strength. Because we’ve had this artificial pricing and a buying of perfection in the bond market, there’s actually a lot of implicit risk there. And in fact, when we have significant stock market weakness, there is no longer a guarantee that you also have bond market strength to offset it. You might have the double whammy.

Kevin: Where do you go? If you’re just a stock and bond guy, and they’re both falling in tandem, what do you do?

David: And we’ve seen that on a small scale, over recent weeks, and in different episodes through 2020. We’ve seen bonds and stocks sell off in tandem recently, but with speculators loading up on a short Treasury position. 

Again, I want to distinguish between a decent short-term rally in Treasury prices and a decline in yields over the next month or so. But that’s short term, longer term we still see a significant pressure coming on the Treasury market. And the short position in Treasury is, it has actually historically been bigger, it just hasn’t been quite this large in a number of years. 

And again, it’s amongst your small speculators. So you look at a variety of factors and you think, “Well, what could turn this here? Dow is at a very high level, the leaders of 2020 in the tech, NASDAQ index, and NASDAQ 100, they’re already losing momentum. Surely an equity sell-off might, in the short run, stimulate something of a bond rally.” And all of a sudden, the chatter about the 60-40 not being a good mix, that’ll go on ice for a little while. 

But I do think by the time we get to the end of 2021, into 2022, there will be some prescient observations about just how treacherous the 60-40 mix actually is.

Kevin: I’ve been getting questions from people, quite honestly from people who haven’t owned gold for long, who came in sort of in this last wave, the COVID wave. And they’re looking at things and they’re saying, “Well, gold looks like it’s selling off right now. Does that have something to do with interest rates rising?”

David: As a part of our work on the wealth management team, we go through a variety of company quarterly reports, even ones that we don’t necessarily own. But one of the industry leaders in the gold space is Barrick, not one that we own, one that Warren Buffett has chosen to. Partially for valuation, partially for yield, I’m not sure exactly why. But listening to their CEO, it was fascinating as he reflected in the most recent quarterly report, that he kind of relished the idea of gold prices going lower in the first quarter, because he was in a very acquisitive mode. Lower prices for him meant that he got to buy assets, quality assets, cheap. And he did not want to, if he could avoid it, chase prices to the upside. So just somebody in the gold space, the CEO of one of the largest gold companies in the world, would love to see lower prices because he wants more of what he already does, he just wants it at a better price.

Kevin: And I’ve seen that with my longer-term clients. My clients that go back decades, they’re calling and buying right now. It’s only the newer ones that are like, “Well, I’ve never seen this before.”

David: Wait, it’s down $100 since— Well, you have the knock-on effect for gold going back to interest rates, the short-term trading pressure on gold from higher rates. I think that’s subsides this year, and it may even be subsiding now, and here we are at the level supporting a key Fibonacci support level in the price of gold. 

I just have to say it again, as I did last week, real rates and inflation. When we’re speaking of pressure increasing on gold, like we did last week, keep in mind that real rates— we’re still well below zero on any reasonable measure of inflation—in terms of that, the impact to real rates—and are just about breakeven if you’re talking about the CPI as a measure of inflation or the PCE relative to the 10-year Treasury. You already have the 10-year and also the five-year Treasury breakeven rate at 2008 levels, nearing two and a half percent. What that suggests is inflation over the next five and 10 years is expected by the bond market to be closer to two and a half, and that number is rising quickly. So real rates in positive territory—frankly, that still takes an imagination.

Kevin: Dave, when I was a teenager, I bought this little machine that I could put around my finger and it would make a sound. It was sort of a stress machine. And so, if I was stressed, it would make a louder sound and a higher pitched, and it’s one of those things where you can try to relax and lower the sound, but I wish there was something that we could look at, like the sentiment of the markets. Because usually, that noise is loud and hot when things are hitting their all-time highs, and a lot of times nobody wants to hear about it when a value is there, like with gold. Everybody was looking at gold when it was hitting its high, now people are starting to say, “Well, why in the world would I own it?”

David: There’s economic indicators like that, with the University of Michigan sentiment indicator, which is more about how people feel as it concerns the economy, their job stability, spending, things like that.

Kevin: It’s an indicator.

David: It’s one indicator, you have the same kinds of things within the market. Sometimes we’ll talk about VIX as an indicator of sentiment volatility.

Kevin: Volatility Index, yeah.

David: Yes, exactly. People who are betting that the market will go down or go up or certainly not maintain it status quo. The daily sentiment index for gold, that exists, and the daily sentiment index for gold has reached a reading of 12. Again, on a 100-point scale, this is a very low reading. By contrast, last August when gold was hitting all-time highs, it was in the low 90s, some of the highest readings we’d seen in many years.

Kevin: So in other words, an easy way to look at it, it’s 10 people in the room, and nine of them are like, “Yeah, I’m buying gold at the all-time high.” Let’s ask the same 10 people right now and there’s one.

David: Exactly. And to me it’s a great contrary indicator, and I learned from my father nearly five decades ago. He used to always start his speeches with sort of 10 different principles, and one of them was, the majority is always wrong. Well, it’s helpful to see where consensus belief forms in the markets because it is typically wrong. Now we have a seven-month consolidation of price following a push to all-time highs going back to August, with gold sitting in a very lofty spot temporarily while the current consolidation has not been enjoyable. It’s actually pretty normal in the context of a long-term bull market, and to see the sentiment indicators hit these low levels, again it’s sort of like, “All right, time to turn.” Now it’s time for what they would describe as mean reversion. It can go higher now.

Kevin: One of the things that a lot of our clients don’t get a chance to see that we do is just the amount of supply of physical metal that’s there. And there’s hardly any supply. It can be gotten, but there’s a supply shortage. So you have the paper markets, you have the physical markets, those who understand value in gold that are accumulating the physical are adding to their positions right now. So do you agree with that, Dave, that they should be adding to positions?

David: I think the leverage speculator looks at an investment in gold and only wants to do that through a futures contract. And what that allows them to do is put little down but control a great number of ounces. So any small move, up or down, is magnified for their returns. That’s a very short-term trade. 

What you’re talking about in terms of tightening of supplies are the man or woman in the street saying, “I think I want to own an ounce of gold, 100 ounces of silver.” And you see all the supplies of small product disappearing, and premiums increasing. So it is interesting that even though the price of gold has come down in recent months, we’re watching premiums march a little bit higher, again, communicating something very different. 

I would add to metals positions now. You seeing strength come in around 1680 this week was incredibly constructive, and I think a notable tactical level for support. We’ve got a weekly metals podcast that’s been talking about this for several months, and it is a significant retracement to open up the next leg for gold to higher levels. And my sense of concern has been that a significant break below 1680 is obviously not constructive.

Kevin: Brings back memories of 2013, you’d go, “Ow!”

David: I have a few pain reflexes from 2013 and 2014, so it makes me want to throw out a caveat or two, or more than anything just maintain a little extra dry powder. But I would add here, I would add now, and assuming that level 1680 is a floor—

Kevin: Well let me ask you, how about mining stocks? We talked about physical metals, but if 1680 were a floor, what’s that do for the stocks?

David: Miners are cheap, some large cap names are sporting healthy dividends, you’re two and a half to 4%, as well as very reasonable valuations, well below your historic averages and relative to the rest of the market. Half again as cheap, or cheaper, nine to 12 times forward earnings puts them comparatively cheap. And at the same time, you look and how popular are they? Not very popular today, if you’re looking for trend-chasing, trend-following, the Hulbert Gold newsletter sentiment index is kind of a way of tracking the number of newsletter writers who are in short-term trading services that are recommending purchases of either gold or gold shares. And it’s now at levels seen in late 2015. If you are not remembering what that was, that was gold at 1050 where the markets had basically been bombed out. Recommendations to own or trade gold and silver are at a low ebb amongst short term speculators. All this suggests is a reversion, and a shift in trend.

Kevin: So it’s that 10 men in a room, you ask 10 of them, and if no one wants to buy gold, and you know that you’ve got 4,000 years of history, you go buy gold. But something to note, even though gold, we’re all focusing on the fact that gold has made a correction here, but you look at the gold/silver ratio, which is really what we watch. Measuring something real in something real, that’s hard to teach people. But boy, once they learn it, that’s what they watch. And gold right now is it about its average to silver 64, 65, 66 ounces of silver to one ounce of gold.

David: I think that’s a positive commentary where the gold/silver ratio has held up reasonably well in this timeframe. As we observed in last week’s hard asset insights, we published it on Friday, the precious metals miners have most recently bucked the downtrend, finishing higher last week even as bullion prices slipped. That separation in price action may have been a significant transition point, and time will tell. 

The divergences are noteworthy when you’re at or near—you don’t necessarily know you’re at until after the fact. But divergences can give you an indicator. Negative divergences and equity indices, whether that’s the NASDAQ 100, S&P 500, the Dow, or technical indicators are revealing a negative shift in the face of still-positive price action. You can also see the same at market lows where they’re positive shifts, technically, in the face of negative price action. And so, for now, we’ve got those kinds of non-confirmations where, again, silver should be pressing lower it has not, the gold/silver ratio has been fairly stable, and your miners have found footing and actually started moving higher in advance of the bullion prices. So we’ll see if those divergences, if more emerge, or if these were significant communicators from last week to this.

Kevin: Over the last year, all the talk has been tech, all the talk was tech. We would talk about Tesla. What was the profit/earning ratio on Tesla? Was it like 1200 at one point? It was something in that range.

David: And all I hear is tech-tock, tech-tock, tech-tock, and I’m waiting for things to blow up. 

Kevin: You’re thinking it’s a bomb. 

David: But the divergence between tech and the Dow is the largest it’s been since 1993. Tech was leading to the upside, now it has faded. 11% off its peak, if you’re looking at the NASDAQ 100. 

Now, set aside this week’s midweek rally. You’ve got the new leadership, which doesn’t have the same unlimited imaginative appeal. Think about technology stocks and the way they can harness sort of pro forma imagination. The new leadership in the Dow doesn’t really have that. And what that is really suggested to me is end of cycle rotation. That’s what comes to mind. The old leaders fade, new leaders lack the same energetic momentum. Volatility is thus a conversation within the marketplace representing sort of the final struggle to prove if you can bring in new buyers, if there’s new people who are willing to put money at risk, taking on risk at these elevated levels, or, in fact, are we at a top?

Kevin: Talk about elevated levels, Tesla was, what, 900? And now look at it. 

David: 550 traded for the low just a few days ago. So this is a not an unfamiliar sequence at a market top where you see the leadership rotation shift pretty dramatically, there’s not as much momentum. This is where your divergences come in, where, again, whether it’s volume or breadth or what have you, things begin to deteriorate, even though the prices are still relatively attractive. Now, throw in the Dow components motoring to new highs, the index is at an all-time high.

Kevin: Well, and what about regulation? Because you have monopoly, in a lot of these tech industries, you’ve got monopoly that looks like it might be threatened.

David: Well, this is where politics and public policy certainly can be a disincentive for growth. You’ve already got Tesla and a few high fliers well off their peaks. Tesla’s given up close to a third of its value in virtually no time. You don’t hear a lot of that on CNBC. There’s still something positive to talk about, always something positive to talk about, always. 

But with politics and public policy, you’ve got Tim Wu, who’s now on the President’s National Economic Council, he’s bringing a strong view to antitrust laws that will pressure the infinite upside proposition of big tech. And so, as that infinite upside proposition is that in question, what are the knock-on effects into the indices which have been so disproportionately helped by big tech? 

Again, the market leaders, they’ve got a few headwinds in the quarters and years ahead. Whether you’re talking about Amazon, Facebook, Google, the list is longer. But the conversation is changing in the Oval Office. And as the conversation changes in the Oval Office, so do valuations. They’re likely to change within the indices, and of course that reflects negatively in anyone’s portfolio with exposure there.

Kevin: So there’s a vulnerability there, you’ve brought up over the last three weeks or so the increase in interest rates worldwide, and how there are other countries—let’s look at the emerging market countries. For a while, it just was a complete anomaly how they could be paying so low on their rates. That’s reversing now, isn’t it?

David: In a big way. And this is one of the things that I like about working directly with Doug Noland is he’s got a number of frameworks. Very helpful in terms of explaining what is happening and how the inter-linkages within the financial world operate. One of the dynamics that he describes is periphery to core. It’s worth noting that emerging market currencies and bonds were under pressure last week, they’re at the periphery of the financial markets. Not quite as critical as the US dollar, our bond markets, and this is not me being sort of nationalistic or jingoistic. This is— You look at the scale of our US equity markets, and it’s roughly 50%-60% of total stock market capitalization in the world.

Kevin: So pay no attention to the emerging markets, we’re safe.

David: The numbers are the numbers in terms of who stacks up and what a contribution is. 

But yields were moving higher here in the US, we talked about that last weekend, the yields are also moving up in the emerging markets. And we’re talking about dollar-denominated bonds throughout the emerging markets. Dollar-denominated bonds are typically less volatile than local currency bonds. And they were moving very significantly last week. 

And if you look at the last several weeks, as the Credit Bubble Bulletin noted, where you see even more action is in the local currency denominated bonds. Two-year yield spikes, 68 basis points in Turkey, 62 basis points in Ukraine, 56 basis points in Brazil, 56 basis points in Peru. Those are actually the dollar yield. In a two-week period, the local currency bond yields 173 basis points, 1.73%—almost 2%, in Lebanon; 79 basis points in Turkey; 70 in Colombia; 47 In Thailand; 41 basis points higher in South Africa. That is a significant tightening of financial conditions. That is a significant risk off in those geographies. And again, following that periphery to core model, that’s typically where weakness shows up first. Weakest hands fold fastest. You can’t forget that.

Kevin: Well, that’s one of the things that fascinates me about Doug Noland because that theory, that’s his working model, that periphery to core. And his warning comes, it’s a little bit like when the Tsunami hit Banda Aceh, they say that the water goes out before a tsunami to where you see an extra third of a mile or half a mile of beach. Well, and then, that tsunami comes in. And the way Doug talks about periphery to core is, “You better look at the periphery, even though you may not be interested in Lebanese bonds.”

David: I think that’s right. If you watch the edge of liquidity, whether it’s the tsunami, what’s happening at the edge of liquidity. If it’s receding, you’ve got a very important interpretation that needs to occur, and an action to follow. And if you’re not paying attention, or if you’re chasing the fish that are now flopping in the sand.

Kevin: Picking up seashells you’ve never seen before.

David: It’s amazing. The perfect record migration, what it shows is weakness at the edges of the global financial system, with the migration inward over time. So when peripheral strains are on display, you can actually have the core appear even healthier than it actually is. So the dollar traded higher last week by almost one and a quarter percent. That’s no surprise. Again with last week’s weakness in the emerging markets, in fact the dollar was strong, there’s a relationship there. 

But the migrations are important, and most important will be the transference of stress into the corporate credit markets where you begin to see tightening of financial conditions in US corporate credit, I think that’s going to be very telling. If that happens in the weeks ahead, then you’re closer, you’re a lot closer to the Fed changing their tune, getting far more concerned, both verbally and in terms of the actions they take. And of course, that’s when you’ve got Yield Curve Control closer to reality.

Kevin: Well, let’s talk about the yield curve for a moment, because maybe that’s unfamiliar to some of our listeners. But typically, interest rates should be higher the further you go out in bonds. It just makes more sense to say, “Well, there’s more uncertainty as you look further out in time.”

David: Well, there’s a couple of things. Number one, you’ve got the uncertainty of outcomes as it relates to the entity, and that might be more of a concern with a corporation. Are they still around in 10 years? I don’t think you’re asking that question about the US, are we still around 10 years or 20 years from now. But there’s different kinds of concern, like inflation concern, the longer you’re in that fixed income instrument, the longer you’re subject to public policy and desperate measures which might drive the unintended consequence side, drive inflation even higher.

Kevin: So the free market should allow that yield to move to whatever that risk level is, but what you’re talking about is Yield Curve Control, which is something the Federal Reserve feels that they can step in and do.

David: The yield curve is measuring time and the value of money through time. So the longer you get out, whether it’s one year moving out to three, three years moving out to five, five years moving out to 20 or 30, you should see an increase in interest rates the farther out you go to compensate for the added risks, including inflation risk, in that particular asset.

Kevin: So what’s the probability that the Federal Reserve is going to come in and actually manipulate that?

David: Well, and that’s where a flattening of the curve where you’re not being compensated to cover any of your risk is a consequence of the Fed stepping in and buying that price down. I think the outcome, again, Yield Curve Control in my mind, that’s a 90% probability. Then you have the costs associated with that kind of intervention.

Kevin: Inflation.

David: Well, basically put, yes. And I think that’ll drive investor interest in gold and silver like we haven’t seen in our lifetime. And that says a lot, seeing that we’ve seen just in the last 20 years from 250 to 2,050. That seems like a big move.

Kevin: And when this company started, it was 35. We’re going into our 50th year, coming soon.

David: And the move from 35 to 875 was an interesting one, particularly since the last half of the move from 400 to 875 took place over a six-week period of time. And this is what I’m getting at, if you think the journey to $2,000 an ounce was interesting, consider what it looks like when there is seemingly no place to hide. Because again, we’re talking about the problems having migrated to the heart of money and credit, the Treasury market, the bund market, the government bond market globally. With no place to hide, with dollar concerns, with bond market concerns, with potentially equity market concerns at the same time—

Kevin: And it’s no longer on the periphery only, it’s now at the core, is what you’re looking forward to.

David: Fear is more powerful than greed. It takes time to take hold, but when it is operative, it’s very difficult to shake. And frankly it’s why the rehearsal of a reduction strategy is so important. How can we talk about prices of gold moving higher and also be talking about selling gold? But what did I say earlier, now’s a good time to buy? Well, it’s because I have a sequence in mind, and so following that sequence, it’s very consistent. 

To reduce a gold or silver holding as the ratios to equities and other assets reach an optimal exchange, I’ll tell you, that does not happen easily. Action is not always easy, even when circumstances are unpressured. And action under pressure only happens with practice, only happens with mental training, only happens with a rehearsal.

Kevin: It’s interesting that you brought up what happened in the 1970s with gold, because what also happened in the 1970s was a— one of the worst bear markets in stock market history, yet no one really saw it. They didn’t feel it because, like John Maynard Keynes said, “Inflation is a tax that only one in a million understands.” And so, since the stock market wasn’t rising and the buying power of the dollar was falling so dramatically, we actually were having a pretty severe bear market that wasn’t really recognized until about 1980.

David: The deflationary camp likes to argue that the quantity of debt is going to slow our ability to continue to pay and grind us into oblivion. And there is some truth in the quantities of debt. What we’ve seen is the Fed tipping their hat in favor of inflationary tools. In this respect, bear markets take many forms. Since the Fed is tipping their hat in favor of inflation and a higher number initially to get the average to 2%, I think the most likely scenario in my mind is a stealth bear market in equities, moving slightly down, mostly sideways, even as inflation rates creep higher. Gives us a very similar scenario to the 1968 to 1982 bear market. Gave us one of the best buying opportunities in a generation, there in 1982.

Kevin: So you start in 1968, some start in 1966 but you start at ’68.

David: If you adjust for inflation at ’66, if you’re looking at nominal prices, ’68 is pretty much the end. And I prefer ’68 in this respect because it ties in with a commentary which I think is important to keep in mind. It’s been since the late ’60s that we’ve had the kinds of disruptive social issues that we have today. There is a similar social tension, there’s racial concerns, there’s wealth and equity and a broad public conversation, and that was very alive and well at the end of a bull market which stretched from 1949 to 1968. It was a big one.

Kevin: We’ve talked about the late, not-so-great, 1968. It was a turning point.

David: That’s right. And so no real concern emerged initially, but there was a sideways jump in price. And you’d see equities drop 10, 15, 20, even 30%, and then they’d recover the losses, and then they repeat that pattern. Again, this is all through the late ’60s, early ’70s, you had these cyclical bull bear markets. 

But what it meant when you started factoring in inflation, what it meant is that real returns as inflation mounted, those real returns were sinking into deeply negative territory, but they were not as easy to identify as say the 1930s deflationary collapse. 

What you could identify was the fraying of the social fabric. And that was one coincident indicator that a lot of people were not happy, were very much under pressure. And in fact, I think it’s very important to keep that in mind now because it may be even more important than equity prices. Because the majority of Americans then were un-invested at that time. Tell you about income pressure, that’s where it really was. The Dow top, going back to ’68, you didn’t see it exceeded for 20 years. It stayed under that cap for 20 years. This time is a little different, there’s a greater public interest in stocks. We’ve seen the changes between defined contribution plans and defined benefit plans. We’ve seen IRAs, which have become ubiquitous. Now we have the Robin Hood investor, kind of bringing in the last few un-invested Americans into a speculative environment at peak valuation.

Kevin: It remind me of the old stories back from the ’30s, when the shoeshine boy starts giving you stock advice, we’ve talked about that. You’ve— Robin Hood and these types of things that have happened just over the last few months even.

David: Well, and there are other social ramifications as a bear market sort of gets ugly in terms of real returns. The scope of investment demoralization is likely to be equally spread out. There’s more people investing in stocks today than any other time in US history.

Kevin: And then there’s politics, wealth is becoming a target.

David: Cap gains are changing, that will change in the next year. So wealth is becoming a target. You’re right. Today the conversation is around the 10% of 1%, the ultra-high net worth, tomorrow I think it’s going to be the 1%. Eventually, it’s the top 10% of income earners taking the target to— If you did that today, top 10%— if you’re in the top 10% of US income earners, you’re making about $115,000, $120,000. And you’re talking about a wealth tax, right? Well, that’s 2%, 3%, an annual tax on the assets that you have in addition to income taxes on the rise. 

I think what you’ll likely see as rates go higher is that wealth will want to get quiet. Yes, I think cryptocurrencies are certainly a part of that mix, but there’s a whole slew of regulations which we don’t know about yet, and they will be specifically targeted at something that is mobile and secret. But I think you’ll also see stocks like Sotheby’s or Christie’s do well. Why? Art, gold, anything with a slower mark to market would be of interest in a time of inflation. And if you start combining the ’60s to the ’80s, that bear market and those dynamics with modern day sort of a lack of privacy, I think you’ll begin to see a premium on things that are quieter, in terms of assets. You might even see a shoebox sell at a premium, if you know what I mean.

Kevin: It reminds me a little of what our friend was talking about this morning, when their family got out of Cuba, “When you start to see the handwriting on the wall, that there’s going to be wealth redistribution.” I’m not saying necessarily that America is falling completely into communism right now, but there is a different attitude at this point of private property ownership.

David: One of my favorite little coin collections that I have is gold coins from Cuba in the early teens. 1914, ’15, ’16 ’17, I think ’18 is the last year. But there was significant wealth created in Cuba. There was gold in the system, in the period of time where wealth was in the country.

Kevin: The sugarcane fields were producing, and was turning into gold, and there was more of a free market feel?

David: Sure. And a part of the reason I like those coins is it’s a part of a larger narrative, which is, what was is not necessarily guaranteed to be what is. And so the stability that you had in Cuba was but a moment in time, and there is a longer history that both predates it and of course what we’ve had since. And our friend, you’re talking about a restart, you’re talking about having to begin again. With what resources?

Kevin: Well, and you look at pictures of Cuba, and it’s amazing, Dave, back during the time of those gold coins, Cuba was booming. And now when you listen to Buena Vista Social Club and watch the videos, they go back to Cuba and there’s a reason why all those cars that are in Cuba are still from the ’40s to the early ’60s. Everything stopped when the wealth was redistributed.

David: I love fixing food with my wife and family, listening to Buena Vista Social Club. Probably my two favorite things to listen to while we’re fixing meals are Keith Jarrett’s Cologne concert and Buena Vista Social Club. So those things in the background, have a special place in my heart.

Kevin: By the way, they like trumpets in Cuba. So I felt a calling.

David: Well, when I read Elizabeth Warren’s and Bernie Sanders’ wealth tax proposal, again it depends on how much you have. But between 2% and 3% annual tax for high net worths and ultra-high net worths. The argument runs that the powerful have rigged the rules in their favor. Somehow, they’ve managed to pay less in taxes for years, and now wealth, even if you’re looking at post COVID wealth, is the greatest it’s ever been. This disparity in the amount that they have as the us versus them conversation, not particularly a conversation that is about uniting or finding a clear national identity. What they’re arguing is we need a leveler.

Kevin: Can you hear the whisper, “We need a leveler.”

David: But I never hear a proper diagnosis of the wealth disparity. Modern day central bank policies, if you’re talking about harnessing the power of low levels of inflation for economic growth, that’s what you have with central banks today. Accommodating credit markets with plenty of supply, on easy terms, very low rates, inflating asset prices like nothing else on the planet ever has, no one seems to want to take aim at root causes of malinvestment and economic inequality. You can try to make it political, but it’s actually monetary. You can try to make it us versus them, the rich versus the poor—

Kevin: You’re not in favor of redistribution, that’s what you’re saying. You believe in private property.

David: And I do believe in proper attribution if there is a problem. Look, I’m not saying that there aren’t people who have a tremendous amount of wealth and those who have none. That exists. The wealth disparity exists. I’m in favor of a sound basis for capital accumulation and investment.

Kevin: Which means sound money.

David: It’s always rested on a sound currency. And without sound money, excess will exist. Excess privilege, excess benefit to the politically connected, excess at the expense of others. To me, forced redistribution does not resolve what continues to be the problem, which is central bank largess and runaway bubbles enabled by academics in search of a perfect world.

Kevin: Utopia.

David: This is where this mis-connection of people wanting a world free of volatility, when in fact the theories that have been put in place, monetary theories which have been put in place— the only thing that our academics within the central bank community know how to breed is every form of volatility. The stated goal is to reduce volatility, introduce price stability, and it’s the exact opposite. What they’re breeding is social discontent and volatility, political volatility, economic volatility. And I think, in significant ways this year, incredible market price volatility.

Kevin: You’ve been listening to the McAlvany Weekly Commentary. I’m Kevin Orrick a long with David McAlvany and you can find us at mcalvany.com. M-C-A-L-V-A-N-Y.com. And you can call us at 800-525-9556.

This has been the McAlvany Weekly Commentary, the views expressed should not be considered to be a solicitation or a recommendation for your investment portfolio. You should consult a professional financial advisor to assess your suitability for risk and investment. Join us again next week for a new edition of the McAlvany Weekly Commentary._

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