Podcast: Play in new window
- European Defense Stocks Soar Since Jan 1
- Three U.S. Goals: Minerals, No NATO Ukraine, Europe Pays Fair Share
- Gold Up 70% More Than DOW In 25 Years
“It was as if Trump and Vance were saying, “You want to raise the guarantee issue again? That was a firm no, don’t try and play the press on this issue. And you know what? If you can’t get down to business on the only yes issue we’re here to settle, then lingering on the already settled no issue brings this meeting to a close. You’re fired.” Guess how fast the tone shifts? Go back to yes on minerals, and Zelensky can stay Presidentsky indefinitely. But if you change the direction of the conversation, dead end, we’re done.” —David McAlvany
Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany.
David, welcome back. Last Friday was a really interesting day here in the United States, but Europe looked at it in a different way. And you were in, I think, France on Friday.
David: Yeah, we were celebrating our 25th anniversary. 25 years is not a short stretch, but I’m looking forward to the next 25. And glad to be back in the US.
Kevin: Well, a quarter of a century, it’s amazing when you actually talk about it like that, it’s like, wow, a quarter of a century? I still see you guys as newly marrieds.
David: I think we do too.
Kevin: Well, what occurred last Friday, it’s interesting. I called my wife, and she said, “Hey, did you just see what happened in the Oval Office?” And I think we’d better talk about that.
David: Propaganda is something that has been a fascination to me for a long time, how you message things, and what you want people to receive in the message. There’s no doubt that in warfare, messaging and communication are key. And it’s not because you want the opposition to understand you, but because you want them to understand what you want them to understand.
So propaganda is a tool for shaping perceptions and driving towards desired outcomes. And it’s a fluid communications mechanism, which sometimes expresses the truth, sometimes expresses the truth from a unique vantage point, and sometimes embraces falsehood. Most often, it’s moving unannounced from one camp to the other camp, making impressions via those staged appearances.
Kevin: I remember when you and I agreed to read Machiavelli’s The Prince together, and I felt dirty after I read it, to be quite honest with you, because there was a lot of falsehood. Do you think that sounds like the current administration?
David: No, I don’t think so. Reflecting on the events of last week with Trump, with JD Vance, and Zelensky in the Oval Office, there was no Machiavellian wizardry, no Goebbels’ manipulation machine. Trump, it seems to me, has a yes and a no.
Kevin: He seemed to know what he was going to go in there for, and it didn’t happen.
David: Two primary outcomes desired from the Zelensky talks. Number one, minerals. That is the yes. Not there to discuss, not there to ask for 50% and settle on 25%. To go forward, the yes box must be checked. Number two was the no, no NATO membership, and no backdoor equivalent. The security guarantees that Zelensky keeps circling back to are an implied membership, not literal, but the membership is for one thing, to obligate Europe and the US to directly intervene via Article 5, the collective defense article. If Zelensky can’t have membership, he wants the primary benefit of membership, the security guarantee. And Trump has been crystal clear that a stated security guarantee is off the table.
Kevin: Yeah. And did you see how Trump’s tone shifted, along with Vance, when they started to realize that Zelensky wasn’t seeing it that way at all?
David: Exactly. It was a change in posture, a change in body language. Tone shifted along with Vance’s—Trump’s, that is—when the guarantee issue was raised again. And the annoyance level was audible and visible, his tone, and volume, and body language shifted dramatically. It was as if Trump and Vance were saying, “You want to raise the guarantee issue again? That was a firm no, don’t try and play the press on this issue. And you know what? If you can’t get down to business on the only yes issue we’re here to settle, then lingering on the already settled no issue brings this meeting to a close. You’re fired.” Guess how fast the tone shifts? Go back to yes on minerals, and Zelensky can stay Presidentsky indefinitely. But if you change the direction of the conversation, dead end, we’re done.
Kevin: I think he was assuming that it was a different administration, Dave. When I was listening to it, I realized that Zelensky has a completely different view of what role Ukraine has played. What Zelensky was implying was that they were fighting a surrogate war for us, and we’d better be happy because we’d feel pressure from Russia if they weren’t doing that. And he really had been coached. Actually, we found out, just recently, he was coached about an hour before that meeting, from a Democrat side, to basically bring this up in front of the press. That doesn’t work with Trump.
David: Well, what is on the table is an implied guarantee, like Fannie Mae, Freddie Mac style guarantee. People were buying Fannie Mae and Freddie Mac paper because it had the “implicit guarantee of the government”. Nothing explicit. Implicit to the minerals deal is that the US will protect its own economic interests. Trump is clear that he will protect American interests. Zelensky is not as convinced.
Kevin: There was not a meeting of minds. But when he did bring up the threat of Russia, what he was really trying to do is play a card. Trump is basically saying, “We haven’t gotten anything out of this.” How many hundred billion? Is it 300 billion that we’ve got in this?
David: It depends on who’s counting. There’s a couple of different groups that count it closer to 150, 180. And then, of course, the White House’s projected number’s over 300. So Zelensky’s reasonable in his concerns and doubts over implicit versus explicit guarantees. If you just reflect back on the agreement between Merkel, Macron, and Putin put together back in December of 2019, his European peace partners stressed the improbability of Russian aggression if an energy deal was signed. And lo and behold, it was not respected. So from Zelensky’s perspective, his neighbor embodies the Lenin quote, “Treaties are like pie crusts, made to be broken.”
Kevin: Okay, but there’s a problem with a security guarantee because isn’t that almost like saying you’re NATO?
David: Exactly. So the problem with the guarantee is the obligation to go to war. And the Trump administration has limited their interests to matters largely within our borders. A security guarantee takes his foreign policy in the opposite direction from his domestic policy commitments. We are busy shrinking the scope of our global shared commitments. That will not be contradicted by an agreement with Ukraine.
Kevin: Well, one of the things that was interesting to me was different opinions on what occurred on Friday. A lot of people thought things fell apart and they lost control. I don’t know necessarily that Trump and JD Vance lost control at all. It seems like they stuck to their objective.
David: This is a potential interpretation which requires you to step outside the room and realize that it was taking place in a broader context. One potentially clever maneuver: If you wanted to interpret the Oval Office events as less than spontaneous, it’s basically to manufacture an offense that allows the US to step back completely from Zelensky—not forever—and in so doing create an existential threat for European nations, motivating them to step up and finally spend to defend. By scripting that sort of drama, that takes the US and reduces, if not removes, us from participating in the security umbrella in Europe. So European unity around the Ukrainian issue may be sufficient now to do two things. One, ensure pan-European debt obligations, which they’ve been able to do on a very limited basis, but the scope of the Europe project, I think, requires more. And second, it does largely displace US defense spending in NATO countries. So it may have been that this was a desired outcome, and that the first 40 minutes were mere platitudes, with the objective being waiting for the tripping of the trigger.
Kevin: Well, and what would add credence to what you’re thinking is on the desired outcome. One of the things I love about a free market, Dave, is, a lot of times, it signals truth with the investors who are putting their money where their mouth is. And you brought up to me last night, over a Talisker, just coming back from Europe, you said, “Kevin, have you seen what the European defense contractors, what those stocks have been doing this last month?”
David: Yeah, and this is one of the reasons why I’m not convinced that this was just an accident within the White House, within the Oval Office. Looking at shares of European defense contractors, I think there’s more here than meets the eye. Dassault Systemes, up 50% since January 1. Thales, up 62% since January 1. BAE Systems, up 45% since January 1. Safran, up 25% since January 1. And Airbus—the majority of revenue is still coming from commercial aircraft—also up 12.5% year to date. And just to contrast that with someone who also has some commercial exposure and defense exposure, but is trading in a different direction, Boeing, their chief competitor, is down close to 5% year to date.
Kevin: Trump has been pretty consistent on saying he wants to shift the burden that we were paying for global defense back to our national footprint. And so I would guess that that couldn’t be a surprise in the Oval Office.
David: Right. So the fiscal hatchet job is a part of the scenario we’re talking about. Shifting the fiscal burden of global defense, shrinking back our military footprint to reflect national versus global interest, that’s consistent with the Trump mandates and priorities. Was the Oval Office imbroglio really a deliberate tripwire for shifting the fiscal burden of defense, and getting European buy-in to say yes to covering future costs? If so, then the Trump administration may well have played the game effectively. And you don’t have to support that decision to understand the game or the way that it’s played.
Kevin: Well, and I think that’s so important. We have to remove our emotions. In fact, I was talking to my wife this morning at breakfast. And I said, “Let’s try to tell the story of what’s going on, not using any particular names or places. How would you tell that story?” In other words, you re-frame the story, and say, “What is exactly happening?” And investors, that is one angle from a story. Investors sometimes know quite a bit more than the policymakers or the press.
David: Yeah, sometimes when politics gets involved, and emotion is running the lens that we see things through, you’re asking, “What side are you on?” And not merely, “What’s happening?” Not accounting for the lens that you see things through. Investors do sometimes perceive more than policymakers or the news media offering a slew of affirmations or indictments consistent with their interpretation of events.
I suggest that European investors have been reading the Trump negotiations accurately since January, not just since Friday. US gets a mineral deal, and the Europeans pick up a larger obligation on European defense. They have not stepped up their defense spending commitments as a percentage of GDP, as they committed to over a decade ago, but that appears to be shifting. The European defense companies are the only companies they will contract with in building out their much-needed hardware. And these companies have been reflecting the trend since the beginning of the year. The only ones not committed are European politicians. And, on Friday, they were put over a barrel, on Friday, more than anyone else.
Kevin: And sometimes, this is something that’s really critical in writing music. When you write music, sometimes the spaces between the notes are far more important than the notes. And so the question would come in a meeting like this, “Who wasn’t there?”
David: Yeah, whether it’s when you’re listening to a message, what is said versus what is not said. In this case, I think who was not present in the initial peace talks, and the pressure that created on the Europeans to have a voice on the Ukraine issue, you’re dealing with a vacuum.
Europeans are now willing to fill that vacuum, not just having a vote at the table, but making hard commitments, which they would be less likely to make if the US was the willing peace financier. So Trump is betting that he gets the mineral assets and reduces the military liability attached to having a strong European presence. Yes, he did it in pure Trumpian style, which reflects a dozen episode clips from The Apprentice. It was brash, it was curt, it was definitive.
Kevin: Okay, so let’s pretend like you’re getting on an elevator, and you’re only going two floors. How would you summarize what Trump’s objective is?
David: My impression of the Oval Office meeting, for what it’s worth, was Vance and Trump had three objectives. Minerals, number one, an implicit, not explicit guarantee on security, number two, and a shift of fiscal burden to Europe, number three. So cutting off aid earlier this week keeps that first objective, the minerals objective, in the bag.
Kevin: Okay, so ding, you just got to the second floor, and I think you just told me, there are three objectives. It’s minerals, and an implicit guarantee on security, not explicit, and then, finally, letting Europe pay a little bit of their own price. But after Russia invaded, Kyiv actually tried to get into the European Union. It’s not just NATO.
David: Right. They made their formal application to join the EU four days after the Russian invasion. It was four months later that the EU declared Ukraine a candidate. They are already in the process of qualifying. And they’re going through the mechanisms of checking the necessary boxes for membership. EU membership is a close second to NATO membership if you want others to help fund and fight your wars. Of course, that would exclude the US, in terms of obligations.
Kevin: And let’s put this in perspective, one of the things I feel we’re very blessed with is, you’ve talked to some people that were critical decision-makers. Like on the euro, Otmar Issing was one of the main guys, and you interviewed him… What was that, 15 years ago, Dave? 15 or 16 years ago. And one of the critical things that he brought up was, first, we’re going to create the euro, and then they’ll have to work out all the political things. So I’m going to ask you, does the EU have the capacity to even absorb Ukraine? It’s going to be a very expensive project, even if they were just rebuilding after war.
David: Well, they continue to expand, and there is a whole host of nations that are already on that candidate list. And a number of them, last year and the year before, were being approved as members. But it’s not clear that the EU has the budget capacity to absorb Ukraine and fund its rebuilding after the war ends. The budget is designed to disperse funds across all member states. Percentage of funds available from the EU be paid out to member states, according to the Brookings Institute, estimates put Ukraine needing nearly 42% of currently budgeted funds.
Kevin: Wow. Wow. Almost half.
David: So the risk, according to Brookings, is a centrifugal force going into effect, where the Eastern European countries receive so much support it comes at the expense of Western European countries. And that Western European countries question whether the benefits of membership outweigh the costs. To quote from a paper they wrote about a year ago, “For the European Union, there is a risk of activating centrifugal forces that have been working under the surface for at least a decade. It is since the euro crisis, after 2010, that relations between member states have become less cooperative. Conceptually, the management of that crisis made the principle of national responsibility prevail over that of European solidarity.”
Kevin: So what would the Europeans say? Do they have the capacity? Can they afford this?
David: Well, the current multi-annual framework, which covers the expected outlays for the EU through 2027, does not have the capacity to bring Ukraine into the European Union with the required resources for rebuilding, alongside integration. Unless, of course, you were to expand the fiscal capacity of the EU. That would be necessary. That implies integrated taxation schemes to more adequately address collective debt obligations, and obviously an increase in those collective debt obligations.
So if you remember the power ratchet, which Robert Higgs described, there is a crisis which stimulates an expansion of governmental interventionism. And it appears that we are at an inflection point where either the EU crumbles—we talked about this with Bill King last week—or it redoubles its efforts, redoubles its commitments. And what is the justification for that redoubling, that strengthening of the super state?
There is also the issue of how EU members vote on various initiatives. Changing the institutional framework to allow for less unanimity would be necessary. Just if you think about this, to illustrate, does Viktor Orban want to share his EU funds with Zelensky? I doubt it.
How this is accomplished then, changing the institutional frameworks in the context of increased national priorities amongst member countries, is not entirely clear. But it may be, it may be that Russia, as a perceived existential threat to the EU, is sufficient to create buy-in.
Kevin: Which takes us to Crisis and Leviathan. You brought up Robert Higgs, and his books are basically how a government grows and grows and grows. And I remember, I went back to the notes from when you interviewed him back when Obama was in, and he said, “The growth of state is not a smooth, gradual process. The state 100 years ago was very small compared to now.” And, Dave, you asked him, “How did we get from A to B? How did we go from such a small government to get to B?” And he said, “It’s a number of discrete lurches, and it’s usually crisis and war.” And that’s what you’re saying. We have leviathan here, and we’re paying the leviathan money over to the Europeans. The Europeans, at this point, are going to have to figure out whether they grow the leviathan while we shrink, or face the consequences.
David: If you think about the EU, they’re dealing with domestic political issues. One of the big ones is immigration. Very much a domestic issue. It may take something like the Russian threat to recreate “European solidarity”. So the centrifugal forces described by Brookings, they are a reminder that the euro, as a political structure, is already under pressure. How do you create a European super state when the members are eyeing the exit? Maybe that overstates it because it’s not the politicians that would consider that. It’s the people who are the source of discontent. Coming back to those domestic political issues, crisis, crisis is the answer. Is this a positive inflection point for Europe, or is it an accelerant towards its ultimate demise?
Kevin: Well, and if you recall, Robert Higgs said there is some limit to the growth. He said, “It’s like a predator, at some point, he’ll overwhelm his prey, and it’ll reach critical mass.” And, right now, that may be what’s occurring between Europe and, well, America. We’re stepping aside, and they’re having to make some big decisions.
David: Yeah, I think the more interesting aspects of the White House chaos on Friday, they’re macro in nature. Europe is being forced into a position which may make for the end of NATO, and a European security cooperative that extracts the US from our formal obligations. These are things that are incredibly interesting to me.
Kevin: Well, and the stock market, tell us about the stock market right now? Because we’re not just talking about international politics here.
David: Yeah, meanwhile, meanwhile, an equities top has been put in. The NVIDIA quarterly numbers were not sufficient to reverse pressure in the AI trade, the tech trade, therefore the S&P trade. These are all tied together. We’ve had crypto, which is cracked, and that’s despite an announcement of a US crypto reserve. We have reversed the entire rally since the announcement of that reserve earlier this week, and moved lower. Talk about negative activity or behavior within a market. The tide is on its way out.
So within the equities markets here in the US, risk-off is becoming noteworthy. And as we’ve argued, liquidity in excess has driven risk assets absolutely bonkers.
The reverse is equally powerful. If liquidity dynamics are shifting, so too will asset prices to much lower levels. We look at the risk indicators, and they’re still relatively calm, even as air is coming out of the equity bubble. Notable moves, which have seen some action this week, high yield credit default swaps, this week, are on the move. The VIX Index, obviously with the equity markets being down, that’s on the move. The MOVE Index, which is a measure of bond market volatility, also showing concern, but not at panic levels.
Kevin: So maybe investors should not be betting long on the stock market right now.
David: No. In fact, we’ve increased our short exposure in recent days, reflective of a super fragile environment. Gold has performed well as a safe haven, relative to other markets, which is absolutely remarkable.
Kevin: Well, and that brings us to an interesting subject, Dave. Because, yes, gold’s been doing fine but, actually, if you weigh it against real things, when you start weighing gold against how much acreage costs, or the Dow Jones Industrial Average, the Dow/gold Ratio, gold’s been stellar relative to the Dow.
David: One of my favorite—and I think one of the most important—macro indicators if you’re managing money across generations is this ratio, the Dow/gold Ratio. The fact that, this week, we’re breaking below 15, 15 to one, for the first time since the COVID 2020 stock market collapse, I think is absolutely worth pointing out.
This is a trend we expect to accelerate towards a five to one ratio in the coming years. At this point, you should consider what your portfolio looks like under extreme duress, as we noted in last week’s Commentary. As asset managers, when we’re wearing that hat, we’ve increased our cash position in the direction nearly to 50%, limiting exposures only to those areas we see as maintaining compelling rewards relative to the market risks.
If it seems like we’ve been imploring for too long for you to raise cash and increase the metals’ exposure, we remind you of Rudiger Dornbusch’s favorite quote. “In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could.” We’re now in that period of time compression. A lot will happen in a short period of time.
Kevin: I got on the phone with one of my client’s stockbrokers because he had told his client that, obviously, stocks have very much outperformed gold. Why in the world does he still own gold? And I just shared with him, “Back in the year 2000, the Dow would buy 42 ounces of gold.” And at the time I had this conversation, it was about 17 to one. And I said, “Now, the Dow only buys 17 ounces.” How is it that the Dow actually has outperformed gold?
David: The break below 15 on the Dow/gold Ratio is a macro indicator that suggests the hard asset thesis has its best days ahead of it. The flip side of that is that financial assets are at a distinct disadvantage. Hard assets are the relative winner. The real Dow, that is the Dow priced in gold ounces, priced in gold terms, is now down nearly 70% from its all-time highs in July of 1999.
King’s comments last week—and this is so critical—King’s comments last week that value investors are absent from the market, having been converted over the last decade to indexing, is very important to keep in mind. You don’t have a lot of institutional capital waiting to step in and buoy stocks, and be the buyer of last resort. There’s two data points. Mutual fund cash positions compared to their assets reached a recent low in December of 1.6%.
Kevin: Wow. You’re 50% in cash. They’re 1.6% in cash.
David: Pension fund assets are at 2.1% cash versus assets. In March of 2000, pensions retained 6.4% in cash, leading into the market sell-off. What I’m getting at is that no one’s prepared. No one is hedged. No one is liquid enough to step in.
Kevin: And so, if you’ve got your go-bag, you’ve seen how much snow we’ve gotten this year, Dave, which is virtually none. And what that means is we’re going to have forest fires this summer, unfortunately. We have to have a lot of snow to not have forest fires. We were just talking the other night, saying, “We need to get our go-bag back together because this is going to be a tough summer.” So you’re saying, no one is prepared for the dry summer, no one’s prepared liquidity wise for what we’re probably going to see in the financial markets.
David: My snowblower is still in the shed, at the back of the shed. I haven’t had to take it out once this year.
Kevin: It’s a terrible thing.
David: But our response to that is, we’ve already had folks out to start trimming trees and start mitigating.
Kevin: You’re preparing.
David: And we know that, by the time spring comes, there’s going to be a mad rush to do the same, and you’re not going to be able to get on anyone’s schedule.
Kevin: That’s the equivalent of increasing cash in these portfolios.
David: Yeah. Well, today, we’ve got the KBW Bank Index, which cut through its 100-day moving average like a hot knife through butter. And it’s important to remember that financials will often lead in the market decline. And that was a very significant move lower this week.
Kevin: I was talking to a client yesterday, and he was talking about polar bears. I didn’t know this. He did a study on polar bears because his daughter’s going to do a canoe trip, a long one, where there may be polar bears. And he said, “Do you know that they’re such an alpha predator?” He says, “Most bears will bluff if they’re not at the top of the food chain. But the polar bear is at the absolute top of the food chain. There’s no bluffing with a polar bear. If he’s charging you, he has one intention, and he’s going to fulfill it.” So I’m going to ask you this about Trump. We already talked about the three things that Trump wanted out of that meeting on Friday. How about the tariffs, these tariffs going forward? Is it a bluff, or is it real?
David: He might have an orange tint more than a white hue, but, yeah, I think that you could make the case he has some polar bear tendencies. You got the tariffs on Mexico and Canada. They go into effect this week. And the markets are surprised. We’re seeing pressure in the equities markets, in some part related to this surprise. The cry-wolf syndrome has set in. Very few expected Trump to stick to his guns.
And just, again, replay this. Friday, he made clear that the US negotiates from a position of strength. And I think that’s the message that’s being reiterated this week with the tariffs. Chinese tariffs go into effect later this week. He’s not bluffing. He’s simply breaking things. And I know that he wants to rebuild something better. That’s his build-back-better theme. But he’s not bluffing.
Now, the global economy is going to feel the impact, for sure. But even if you look at the US domestic economy, and this is a volatile indicator, but it’s worth looking at, consider the Atlanta Fed’s GDPNow. Most recent numbers for February, they had flipped from positive 3% to negative 1.5% in January. Now, for February, they’ve gone to negative 2.8% GDP growth. That’s nearly a six percentage swing since December.
Kevin: So no bluffing.
David: No. Trump administration may not be messaging in subtle ways, but the messages his administration are sending are unequivocal. Right or wrong, he’s not waffling on his priorities.
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You’ve been listening to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany. You can find us at mcalvany.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.
