A Sneak Peak at America’s War Plans for North Korea

The Pentagon has been running war games for years, and the results aren’t pretty.

By Chetan Peddada


 
In a secret underground base, Command Post Tango, the combined headquarters of the U.S.-South Korean command, is abuzz with activity. North Korean artillery has pummeled sites around Seoul, leaving thousands of South Korean and American civilians and service members dead. A toxic combination of North Korean provocations and U.S. escalation has prompted the North to launch a last-ditch effort to seize the whole peninsula.

As the generals fill an auditorium-sized sand-table battlefield showing the disposition of friendly forces and the extent of likely follow-up attacks, hundreds of thousands of South Koreans are displaced in and around Seoul, seeking shelter and safety. Reports of North Korean insurgent strikes are streaming in as computer screens flash with alerts of cyberattacks on Seoul’s infrastructure, taking water and power off the grid and paralyzing attempts to help the civilian population.

This is a fictional scenario, but an all-too-possible one. As a U.S. Army intelligence officer in South Korea, I helped prepare for various war scenarios by testing assumptions and refining war plans in several theaterwide exercises.

Put fears of full-blown nuclear war aside for a moment. We’ve never been closer to a conventional North Korean attack on South Korea, and I can attest that the U.S. military knows how devastating the consequences would be. We can expect a massive humanitarian crisis, enormous loss of life, and economic disaster. There’s almost no doubt that the North would lose — but in going down Pyongyang could take much of the Korean Peninsula with it.

This undated photo released by North Korea's official Korean Central News Agency (KCNA) on May 30, 2017 shows a test-fire of a ballistic missile at an undisclosed location in North Korea. (STR/AFP/Getty Images)
 
                      
Pyongyang goes all in

What could provoke North Korea to start such a conflict? Kim Jong Un may eventually believe that he has no choice, given his country’s chronic humanitarian crisis, with an estimated 41 percent of the population undernourished, and additional sanctions threatening to bring back the famines of the 1990s. Kim could calculate that a surprise attack on South Korea would rally the population and remind the world of the North’s power. And the belligerent rhetoric of North Korean propaganda, with its talk of triumph and total war, could leave its own leaders mistakenly convinced that they would win such a conflict, just as the sloppy toughness coming out of the White House might leave them convinced that the United States is about to strike anyway.

Whatever the prompt, once the decision is made to attack, North Korea will move swiftly to accomplish its war objectives — either to seize all of its southern neighbor and make itself de facto master of the peninsula or to execute a limited attack to remind the world of its teeth.

From the beginning, the North will operate on a ticking clock. The logistical capabilities of the North Korean military, assuming only limited wartime assistance from China at best, will only last for a few days before the country runs out of food, ammunition, fuel, and water. Some units may be able to operate for as long as a few weeks, but maintaining supply lines across mountainous terrain will be an almost impossible task.

The North will most likely lose its major command-and-control infrastructure in the first few hours, crippling its ability to communicate across the battlefield. U.S. air power will target major brigade and division headquarters in the hope of leaving North Korean troops cut off, in confusion, and unable to launch coordinated attacks.

That will leave the North with only a brief window to entertain dreams of victory. Like the Imperial Japanese Army in World War II, the North will seek a decisive battle that, in its view, could knock out a weak-willed United States. That means a massive barrage in the first few hours of the conflict, targeting the largest U.S. military garrisons along the Demilitarized Zone (DMZ) and in the Seoul region. Other targets could include air and naval bases in the South, and possibly Japan, to prevent an allied counterattack and soften defenses for a possible entry by the North Korean military along the DMZ or via small-scale amphibious landings in the east and west. Pyongyang will fire short-range ballistic missiles and multiple rocket launchers near simultaneously to destroy these few dozen high-value defense infrastructure targets.

Although estimates vary, some figures indicate that North Korea has approximately 1,000 missiles positioned across the country and most of them within reach of Seoul. Even a small number of missiles fired into the city, targeting South Korea’s defense complex, will have a significant impact, as each warhead weighs between 500 and 1000 lbs. To put that in context, each would be enough to annihilate anything in one to two city blocks.

The missile attacks won’t last for long, though, as South Korean and U.S. firepower will pick up their locations quickly. But the North’s artillery ability to quickly retreat into underground complexes or deep into caves after attacking will make it very difficult to destroy the weapons immediately. With decades to prepare, the North’s artificial cave networks far exceed even al Qaeda in Afghanistan or the Vietnamese before the battle of Dien Bien Phu.

Artillery on its own will wreak havoc, but it is just one part of the North’s deadly arsenal. Since the end of the Korean War, the North has developed asymmetric capabilities in areas such as biological, chemical, and cyber. Some estimates indicate that North Korea possesses 2,500 to 5,000 metric tons of chemical weapons including nerve agents like sarin and VX. Biological weapons such as small pox and anthrax may also play a role. In the brazen assassination of Kim Jong Un’s half-brother, Kim Jong Nam, the world saw that North Korea could effectively use chemical weapons.

In the event of a war, North Korea will not hesitate to launch chemical and biological weapons at South Korean and U.S. air bases or on main supply routes. A biologically or chemically contaminated site would have to be treated with special care, requiring all forces in the area to don protective gear and severely disrupting South Korean and U.S. movements across the battlefield. Delivering these payloads would not be challenging, as North Korean missiles are capable of carrying chemical and biological weapons in place of conventional explosives.

Decentralized attacks could also be in the cards, as North Korea has reportedly recruited hundreds of spies across the world to conduct various missions. Those agents would likely be blended into the larger North Korean population and could be activated to carry out attacks using weapons of mass destruction in the South.

But the North’s cyberprogram could be even more frightening. In the past few years, North Korea has allegedly had a hand in various cyberattacks including the deployment of the WannaCry ransomware, theft of money from Bangladesh’s central bank, and leaks of confidential data from Sony Pictures.

The secretive Bureau 121 participates in offensive cyber-operations and has establishments across the world that could ensure that there will be no interruption of cyberattacks even in the event of heavy South Korean and U.S. counteroffensives on North Korean soil.

Given the country’s past attacks against financial systems, North Korea could shut down the major Korean and U.S. banks, precluding millions of transactions and denying access to credit.

The economy as a whole would grind to a halt, leaving cities in crisis as “just-in-time” delivery systems fail, businesses crumble, and stores empty in panic. Another attack could shut down the energy grid in the Seoul region. Food would turn bad, patients would struggle to survive as medical equipment failed, and personal communications would collapse. The South Korean and U.S. military and emergency services would be forced to divert resources to manage the chaos, allowing the North to push deeper into the peninsula.

Whether confined to conventional artillery or supplemented by unconventional warfare, within the first few hours of the conflict, tens of thousands of people will be dead and large swaths of Seoul in smoldering ruins. The South Korean capital is one of the most densely populated places in the world; some 43,000 people live in each square mile of the city. That’s almost four times the density of Washington, resulting in horrific scenes even from a limited strike.

The United States will quickly activate its evacuation plan to gather all U.S. civilians in Seoul and move them to nearby bases or cities to airlift them out of the war theater and to countries unaffected by the war, though many will be lost in the chaos. Millions of Seoul residents will attempt to flee their homes; however, the frequent artillery attacks, patchy gas supplies, and blocked roads will make any escape from the city challenging.

There are some other options. Seoul residents have subway stations, tunnels, and bomb shelters where they could seek cover from the artillery barrage, as they have repeatedly drilled for.

Several stations can hold thousands of people and were dug deep underground with a dual-use purpose. Some even have backup generators and water facilities. The South Korean government will attempt to establish makeshift camps, away from the intense fighting, to provide basic necessities, but the feasibility of such a system is uncertain. What is certain is that it would trigger one of the greatest humanitarian crises in recent history, leaving millions of Koreans internally displaced refugees.


US Vice President Mike Pence shakes hands with U.S. military officers during a visit to the Demilitarized Zone (DMZ) on the border between North and South Korea on April 17, 2017.
 
                      
America’s calibrated counter-attack

After the first day, a significant number of the original 28,000 U.S. service members stationed on the peninsula will be casualties — with luck, only a few hundred, but potentially far more. The remainder will form the core of the U.S. counterattack, consolidating into a single division to strike at the North.

As their counterparts in Seoul prepare for the North’s ground assault, U.S. and allied forces across the region will begin to scramble. Reinforcements and supplies from Japan, Australia, and the mainland would begin pre-deployment procedures to arrive on the peninsula in a few days.

At the same time, the vast U.S. war machine will move into full gear. Dozens of jets will stream across the peninsula, destroying North Korean bases and troop formations along the DMZ. Hundreds of Tomahawk missiles will light up the sky destined for targets deep in North Korea. U.S. submarines lurking hundreds of feet underwater will turn North Korea’s fleet of approximately 800 vessels into sunken wrecks. Within a few hours, North Korea’s air, sea, and artillery assets will likely have been destroyed.

On the diplomatic front, the United States will frantically work with China and Russia to contain North Korea from conducting further attacks and to avoid the use of nuclear weapons. Almost all the countries in the world will condemn the conventional attack. NATO will likely begin to mobilize its forces and equipment to support the United States. The United Nations will call for an emergency meeting to work a cease-fire among all warring parties. The Global Times, a Chinese Communist Party-run nationalistic newspaper, has said China will not come to North Korea’s aid if it launches missiles threatening the United States. If that proves to be the case, this would ensure significant pressure against North Korea to stop all offensive operations. The chief diplomatic objective would be to avoid the disaster of a nuclear response.

The negotiations will be incredibly challenging. The North is almost religiously invested in its nuclear program, and North Korea’s foreign minister recently said Pyongyang will never negotiate away its strategic option (of about 30-60 nuclear weapons) to protect the country. The North’s missile capabilities appear considerably more sophisticated than believed even as late as last year, rendering the possibility of a nuclear strike on Japan or the West Coast horribly plausible.

That might restrain the United States from a full-throated assault into the North itself, wary of triggering a suicidal response from a regime about to topple — and with the generals aware of the danger of prompting a response from China. Beijing might not like Pyongyang, but U.S. troops crossing the DMZ would prompt powerful memories of the Korean War and trigger China’s fears of “encirclement.” However, the United States would move the entire world to ban almost all trade and aid with North Korea immediately to force the regime to cooperate and possibly accept an unconditional surrender.

But with South Korean and U.S. forces focused on eliminating artillery and naval and air assets, North Korean light infantry would likely begin probing attacks along the DMZ and the South Korean east and west coasts to test U.S. and South Korean readiness and conduct feints to shift focus away from those countries’ main military effort. While chaos rages around Seoul, North Korea could use submarines, as it has in the past, to slip into South Korea special forces capable of conducting guerrilla operations and disrupting U.S. and South Korean war plans.

North Korean special forces and regular troops could also enter the South through several underground tunnels across the DMZ. The North has made digging tunnels a priority, and, since 1974, South Korea has been discovering infiltration routes into its territory. Although just four tunnels are known to the public, more than 20 tunnels are estimated to have been dug, from as close to the surface as just a meter to 100 meters underground. In some of the more elaborate tunnels, mechanical fans provided ventilation, electric lines were wired throughout, and mining carts could ferry materials back and forth.

Some figures suggest that up to 8,000 troops per tunnel could move into South Korea every hour, amassing a formidable North Korean force within the space of a few hours to march south. The United States would have several options to counter the North Korean underground movements, given years of fighting experience against insurgents in Afghanistan; its main weapon would likely be bunker-buster bombs to destroy the tunnels and anything in them. The April 2017 MOAB (“Mother of All Bombs”) strike in Afghanistan was a clear example of the United States’ strength in shutting down underground systems in mountainous terrain.


This undated photo released by North Korea's official Korean Central News Agency (KCNA) on August 26, 2017 shows North Korean leader Kim Jong Un presiding over a target strike exercise conducted by the special operation forces of the Korean People's Army (KPA) at an undisclosed location. (STR/AFP/Getty Images)
 
A bloody, pyrrhic victory

But North Korean forces are already — more figuratively — underground in the South. The guerrilla tactics adopted by the North Korean forces in South Korea include assassinating key South Korean leaders, sabotaging military and paramilitary efforts, and intimidating citizens to side with North Korea. All of these have long been part of the North’s playbook. North Korea could also target South Korea’s military reservists, who are especially vulnerable.

As South Korea summons its reserve forces, it will have to establish new bases and camps to train and organize them. The actual makeshift war bases are unknown, but the massive Olympic Stadium could be selected as one of the bases due to its cultural significance and vast facilities. This would offer the opportunity for the North Korean forces to carry out a massive attack, perhaps with an improvised explosive device, from inside the stadium. Amid the confusion of mustering, it would be easy for North Korean special forces to blend into the reservists and place military-grade, or ammonium nitrate, explosives under the bleachers, where excited soccer fans once enthusiastically cheered “Daehan minguk!” in an otherwise normal world. The North Koreans would be aided by their shared ethnic and linguistic heritage with their southern neighbors. Although the North’s dialects have now diverged from the South’s — with Russian and Korean terms substituted for English ones and a distinctly different accent — it doesn’t take a particularly proficient actor to sound like a South Korean.

At an opportune time, North Korean special forces in the stadium could detonate explosives and quickly follow up with an attack to target fleeing reservists and first responders. Snipers positioned a few hundred yards away would have a great vantage point across the parking lot and into the stadium.

The ensuing commotion would be played on loop in North Korea, showing how the heroic North Korean forces were winning the war and would soon return home victorious.

But the clock will eventually run out for the North’s assault. South Korean and U.S. commitment is likely only to be deepened by the use of unconventional weapons and the terrible casualties. As with Pearl Harbor, the North’s attack would be perceived as both treacherous and sadistic. The deaths of thousands of U.S. forces would commit the United States to avenging them. Even the most successful possible attack will fizzle as the North’s logistics fail and the jaws of American power close.

After all the North Korean strikes and allied counterstrikes, South Korea and the United States will eventually prevail in toppling the Kim regime after a bloody, pyrrhic war. Even a couple of weeks of fighting will leave behind sights more suited to Stalingrad than Seoul, a ruined city marked by small-arms fire, annihilating missiles, and unexploded ordnance. Sites such as the Blue House and the U.S. Embassy will be destroyed, neighborhoods will be razed, and thousands of military and paramilitary forces will blanket the South. Corpses will litter the streets, and many people will lose their entire families.

The Kim dynasty will be expunged, leaving North Koreans to face a far more difficult situation than the famine in the 1990s. China will face a humanitarian crisis on its border as North Koreans migrate north in search of food and water. The United States, Japan, and other developed countries will be under significant pressure to adopt tens of thousands of refugees from both sides. The death toll due to the hostilities could total in the hundreds of thousands, but the humanitarian crisis on the peninsula will result in far more through disease and malnutrition and could take decades to heal.


Top image credit: JUNG YEON-JE/AFP/Getty Images


Miners Risk Falling Down Same Old Hole

Rebounding investment in copper and iron mines could spell trouble next year

By Nathaniel Taplin

The Oyu Tolgoi copper-gold mine in Khanbogd, the South Gobi desert, Mongolia. Photo: Taylor Weidman/Bloomberg News


Commodity powerhouse Australia has always been lucky, but the last few months have been particularly kind. Copper, coal and aluminum prices are all at or near multiyear highs—with iron ore not far behind—and big miners’ profits and share prices are riding high too.

That is a welcome change after years of disappointment for mining investors. The cloud looming over recent stellar results from the likes of Rio Tinto, Anglo American NGLOY 1.97%▲ and BHP is that they are falling into a familiar trap: namely, using high commodity prices as an excuse to spend more just at the wrong time in the cycle. Aggregate capital expenditures from the Big Five miners—which also include Glencore GLNCY 1.16%▲ and Brazil’s Vale—are set to rise sharply for the first time since the commodity crash.

That renewed investment push comes as the biggest source of demand for industrial metals, the Chinese real-estate sector, is showing signs of weakness following big growth over the last 18 months. Sure, mining investment is rising from very low levels following years of belt-tightening, which means metals markets remain in balance for now. But if miners keep ramping up at current levels next year, there is a real danger of another tumble in prices in the next couple of years.

There is some logic to the price gains for metals so far this year, with demand strong and investment in new supply low. Chinese property investment was galloping along at growth rates of over 10% by late 2016, levels not seen since before the commodity crash. Total capital expenditure by the Big Five global miners meanwhile languished at around $8 billion in the first half of 2017—about one quarter of the boom-time levels of 2011 and 2012.


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Change from a year earlier(rmb)



The bad news is that miners’ guidance implies a roughly 30% rise in capital expenditure in the second half of 2017—the sharpest on-year rise since 2012—just as Chinese real estate is starting to look wobbly. Property investment in China grew at its slowest pace in over a year in July.

Hot weather may have played a role, but if August data show investment weakening again, demand for iron ore and copper will inevitably start to follow. China trade data released Friday painted a mixed picture: Copper ore and coal imports dropped on the year, while iron-ore imports grew, albeit weakly.

Industrial metals have not yet lost their shine, but the mining sector has a history of misreading China to catastrophic effect. If capital expenditures keep rising at the same rate next year, it might be time for investors to sell those shares while they’re still glittering.


Bitcoin And Ethereum Continue A Journey That Shocks

by: Andrew Hecht

 

- The digital currencies experience unprecedented gains in 2017.

- Digital currencies in a digital world.

- An electronic failure could be the biggest risk for the cryptocurrencies.

- A commentary on traditional markets.

- Will governments embrace or reject a trend that is significant?

 
I get myself into trouble with many readers when I mention the "B-word" when referring to the move in the cryptocurrencies in 2017. Those devotees of the new asset class that includes Bitcoin and Ethereum are happy to accept the term "bull market" when describing the price action in these assets. However, when I have used the word bubble, the hair stands up on the back of their necks, and I get lots of nasty and passionate comments. On the other side of the coin, those who reject the idea of the cryptocurrency world have been providing scores of reasons why the market in the digital currencies will disappear in a flash. However, this year that flash has been nothing short of a fire, a bullish and bubblicious inferno of buying and that is a lot of Bs that will likely bother and badger or even bug almost everyone who reads this piece.
 
The truth is that I was a doubter in the early days of Bitcoin and other cryptocurrencies, which I wrongly looked at as economic science fiction rather than financial fact. Meanwhile, I was 100% wrong and have admitted so much in many articles over the past two years. The price appreciation in Bitcoin and Ethereum have humbled me as the two markets are moving on what I learned early in my career is the most significant reason for price appreciation. The bottom line is that there are more buyers than sellers in these markets. In 2017, buying has amounted to nothing short of a stampede to an extent seen in few markets through history.

The digital currencies experience unprecedented gains in 2017

My training is as a commodities trader, so I am accustomed to volatility. I am used to the price of a raw material doubling, tripling or quadrupling and then halving or worse over short time frames. I watched as the price of sugar traded to 2.29 cents per pound in 1985 after it traded to over 45 cents in 1980 and over 60 cents in 1974. I watched as silver rallied from under $2 per ounce to $50 and then back to under $6. Most recently, the price of cotton rallied from under 60 cents per pound in 2009 to $2.27 in 2011.
There are so many more examples of markets I have watched explode and implode over the years, too many to mention. I am not afraid nor am I intimidated by price variance; in fact, I embrace it because I believe that volatility creates a trader's paradise. Meanwhile, I have never witnessed anything like the price volatility in the world of digital currencies. Bitcoin is only a baby at seven years old. However, this baby has appreciated from 6 cents to almost $5000 over the span of its lifetime.

Source: Bitcoin Price Index - Real-time Bitcoin Price Charts


The chart shows the moon shot that has been the price history for Bitcoin. At $4630, a $1000 investment in 2010 is worth over $77 million today. I cannot think of one other investment vehicle in my lifetime that was available on the open market that offered the kind of reward that Bitcoin has. This year alone, the cryptocurrency has more than quadrupled in value appreciating from $956 at the end of 2016.

Source: Ethereum Price - CoinDesk


Ethereum is even younger than Bitcoin, as it began trading in September 2016 at a price of $1.20. Today, just one year later, it has appreciated by over 279-fold and is trading at over $335. A $1000 investment in Ethereum last year at this time would be worth more than a quarter of a million dollars today.
 
Some call it a bubble, while others say it is just the beginning for these digital assets. I say "wow" - I have never seen anything quite like the price action in these vehicles.

Digital currencies in a digital world

We live in a digital world. I just moved into a new house, and my iPhone controls almost everything. I can open the doors, set the alarm, turn the lights on and off, and control the heat and air-conditioning through my digital device. I pay my bills via my computer or iPhone and never need to carry cash around. Email has replaced the need for stamps, and my correspondence arrives at its destination in the blink of an eye. The phone I carry in my pocket is a computer, camera, recording device, compass and much more.
 
The world has changed dramatically over the course of my lifetime, and I guess digital currencies like Bitcoin and Ethereum are just a natural extension of today's world. The digital world has simplified daily tasks. However, many of us who have accepted and embraced the current times and innovations wonder what could happen if there is a significant failure.

An electronic failure could be the biggest risk for the cryptocurrencies

As I read about the current conflict with North Korea, I learned all about the risks of EMP or electromagnetic pulse as a strategic weapon. Whether it is North Korea, Iran, or a terrorist attack, an EMP would fry the power grid of the United States. By burning out a portion of the three hundred or so high voltage transformers that link the United States together as an industrial age economy, everything would stop functioning. We could not use our phones, computers, and the necessities of life would disappear in a flash. While digital currencies could vanish in a blink of an eye, legal tender like dollars, euros, yen, and other exchange instruments would likely become worthless paper. Most importantly, many people would perish and those who survived would be thrust back in time to a world that existed centuries ago.
 
The U.S. is one of the, if not the most, advanced nations on earth. However, our power grid and infrastructure are old-school and in need of an upgrade to meet the risks of modern day technology and warfare. Aside from electronic failure, the massive leap in value in cryptocurrencies surely makes them a target for hackers and others who operate in the electronic world with nefarious goals.
 
Many people around the world are coming around to understanding and accepting currencies like Bitcoin, Ethereum, and other digital currency instruments.

The fact that they are global and fly below the radar of governments and regulators makes them the perfect means of exchange for drug and arms dealers, as well as other criminal enterprises and activities. It is wonderful that one can buy a cup of coffee with a Bitcoin debit card in cities in Europe or Japan these days, but that is not the essence of why the market has grown to a market capitalization of over $100 billion between the two digital currencies.

A commentary on traditional markets

The digital age comes with benefits and risks. Bitcoin and other cryptocurrencies are a rejection of central banks and governments that control the money supply. In the world of digital money, it is buying and selling alone that determines the value of the asset against other currencies around the world. The value of the digital money has been rising, but it may just be that the traditional forms of currency are declining precipitously. Economists view inflation as a major risk that eats away at the value of money.
 
However, the world of digital money has complicated the risk of monetary debasement, and central bankers and regulators have no control over this segment of the market. In the wake of the global financial crisis of 2008, the world's monetary authorities dug deep into their tool boxes to avoid a depression. They injected unprecedented levels of liquidity into markets, slashing interest rates and instituting programs of quantitative easing to inhibit saving and encourage borrowing and spending. However, there are no tools when it comes to the world of digital currencies, although there is a myriad of applications aside from the world of crime.
 
Since these instruments can move wealth around the world with the click of a mouse, they can be employed to shelter assets from spouses, tax collectors, or unfriendly governments. Today, one of the primary goals for technological advancement is in the area of AI or artificial intelligence. Elon Musk, a modern day Thomas Edison, has said that AI presents the greatest risk for the world. Vladimir Putin has stated the country that controls AI will rule the world in coming years.

I believe the biggest argument in favor of digital currencies surrounds us on a daily basis. Technology has changed the world and banking, and currency markets have become fossils of the past. If I can heat or cool my home on the other side of the world, controlling my savings through a tool that only I can see, and control makes complete sense. The rise of Bitcoin, Ethereum, and other digital currencies are a natural extension of the world we live in today, and they are a commentary on traditional markets that will slowly become extinct. The dollar may be destined to be like the Betamax and the euro like the VCR.
 
Will governments embrace or reject a trend that is significant?
 
Governments have little choice but to accept the inevitability of digital currencies now that the cat is out of the bag. The price trend this year alone has been more than important and a harbinger of the future of all markets. Blockchain technology, the brainchild of Bitcoin, will revolutionize bookkeeping and accounting as it quickly and efficiently tracks ownership. The CFTC in the United States and other regulatory agencies around the world have validated blockchain, and they will eventually do the same for digital currencies.
 
The means of exchange that lives in the cyber world is the next step in the globalization of the world. Many governments are against the digital currencies because they exist in a borderless world; for them, the issue is control. Globalization or nationalism has become a hot-button issue in political contests around the free world. Brexit was a rejection of globalism. The rejection of immigration policies and slogans like "America First" during the U.S. presidential contest are anti-global rhetoric that is an effective message for those who fear a new and different world order.
 
The problem facing the world is that we exist in a world where various political systems, ideologies, and belief systems coexist because of borders. That symbiosis is easy when there are borders separating people, but when the walls come down, the differences become apparent. In my opinion, governments will attempt to shut down the digital currency world sooner rather than later as Bitcoin and other digital means of exchange threaten their very existence. China has already moved in this direction, and so has Russia. The centrally planned governments have no patience for individual will.

However, even in democracies in the U.S. and Europe, full acceptance of the digital currency world works counter to revenue collection and economic control, free will only goes so far in modern democracy. The latest news that the president and Senate Minority Leader Chuck Schumer seem to be negotiating to get rid of the debt ceiling could mean that the government has no intention of reducing the level of national debt, and that provides justification that government officials prefer to spend at their discretion with the printing press as the only instrument to bail them out. Out of control government debt is another reason why digital currency makes sense, but government will do everything to stand in the way of success of the pan-global means of exchange.
 
Meanwhile, the ascent of these instruments is not only shocking from a value perspective; it is a journey that transcends money and wealth and a trend that started with the technological age.

The destination of this trip is not clear, but is likely one that will create great concern and resistance by the status quo governments. After spending lots of time thinking about the appreciation in Bitcoin and Ethereum this year, the one thing I am sure of is that they are not bubble markets rather they are making a statement. Cryptocurrency-mania may look like a bubble if the governments of the world get together and shut them down which is in their self-interest and would make them worth zero in a flash. The record-breaking ascent of value in digital currencies is a byproduct of the age of technology that has made the world a smaller place with each new product that hits the market.
 
Meanwhile, those cryptocurrency bulls continue to charge higher and nothing breeds acceptance like a good old-fashioned bull market that today is combining old world greed with the new order.


Will The Rise Of ETFs Be The Market’s Downfall?

By Kenton Toews



The rise of exchange traded funds (ETFs) is one of the more interesting topics in light of the ongoing general equity bull market. For the first time in history there are more indexes than stocks! Hence, the rising popularity of ETFs (which track indexed strategies) comes as no surprise.


fig1.jpg

Source: Bloomberg

Bloomberg: There are now more indexes than stocks

Investors are piling more and more money into passive investment strategies and it is causing huge misallocations of capital. This has resulted in many people calling for a crash in the stock market to correct the imbalance.  The following presentations by Steven Bregman explain the situation well.

 
The gist of the interviews is investors are simply buying stocks without any regard to valuations. Bregman points out that, in aggregate, all the major active investors are underperforming the indexes’ for the last few years (the first time in history). This unusual outcome makes one take notice. Is the poor performance of active investors anomalous or is it the outperformance of the market? 
 
Active investors tend to buy undervalued stocks and short overvalued ones.

However, if the majority of money inflows go to passive investment strategies, where there is no valuation analysis, the constant buying will drive up the prices of the underlying stocks. As people chase the momentum, buying begets more buying.

Furthermore, a rising share price could force any shorts to cover and drive that stock up even further.
 
Meanwhile if a genuinely undervalued stock is not held within an index/ETF, then no one buys it and it stays perpetually undervalued.  This all leads to the underperformance of the active investors.
 
What’s true for the general equities is also true for resource stocks. Last year we saw many resource stocks explode higher because of all the money pouring into the GDX and GDXJ.
 
When the resource market turned up, investors piled money into the passive investment strategies, not the active ones. If a stock was held between both indexes, then it received twice as much buying pressure. Then when the market cooled off late last year, and money pulled out of the ETFs, we saw the reverse. Meanwhile, stocks not held within the GDX and GDXJ were much more stable in their price swings.
 
I have clients, with speculative investment objectives, whose accounts held up much better than the GDX and GDXJ, despite being in more risky stocks. Since none of their stocks were held in the ETFs, they weren’t subject to arbitrary selling pressure.
 
This could prove to be a nice feature of the speculative stocks we buy. Because they are too small to be held within an ETF, they should be better protected from arbitrary outflows of capital. They don’t benefit from arbitrary inflows either, but that’s okay. In the long run, the investment community will see the inherent value of these companies and bid them appropriately.
 
I am, however, deliberately holding select names that are held in both the GDX and GDXJ. When investors come back into the sector they will buy the ETFs again and should give those stocks double the buying pressure.
 
But what will happen to resource stocks if the general stock market crashes?  Many believe the next crash will be like the last one in 2008 where every asset class suffered except the USD. I tend to disagree. True, many of the problems that existed then still exist today, and are worse. However the crash in 2008 was precipitated by a wave of defaults on subprime debt because of rapidly rising interest rates.

Borrowers couldn’t afford the payments and defaulted on the loans. Those loans were packaged and repackaged throughout the industry and wreaked havoc on many balance sheets, especially those of banks. Since no one knew how bad the defaults would be or the true contents of those “packages,” collateral was quickly priced at zero forcing a wave of selling as entities needed to shore up their balance sheets.

This is what led to quantitative easing and the push to make the financial system liquid again. 
 
Today’s market conditions are more reminiscent of the 2000 period. Asset prices were way overvalued, particularly the tech stocks, and eventually they came back down to earth. That is where we’re at today with the current market. Interest rates are not escalating like they were from 2005-2007 and those concerned about a crash are not basing the call on debt defaults. Pundits are pointing out the extreme overvaluation of general equities and how those valuations are unsustainable. Therefore, they conclude, the next crash should bring current valuations back down to earth à la 2000.  
 
The crash in 2000 did not really register on the price of gold or resource stocks. They were already at extreme lows and didn’t have much room to go down further. The situation is similar today. Despite the multi-year rally in general equities, resource stocks are still at lows last seen in the early 2000s. The price of gold in real terms (using Shadow Stats alternate inflation rate) is near what it was in 2000. So resource stocks, and possibly gold, don’t have much room to go down from here, especially compared to 2008 when the resource sector had already been in a multi-year bull market with lots of room to go down.
 
The chart below highlights the relative price of gold stocks compared to the S&P 500.

Note the difference between now, 2008, and 2000.
 

fig2.jpg
Source: StockCharts.com


Also, note the price of gold relative to the S&P 500 during the crashes of 2000 and 2008. In 2000 gold held its value pretty well. In 2008, despite a volatile couple months, gold ended up doing very well compared to the S&P 500 as you can see from the spike.


fig3.jpg 
Source: StockCharts.com


The picture I’m painting for you is that holding gold should benefit you during the next market meltdown. Take a look at the last 6 months of the S&P 500, VIX, and gold price. In three of the four spikes in volatility, gold has gone up. And despite the rising S&P 500, the price of gold is holding up. Is this foreshadowing what’s to come? 

Maybe gold will finally start acting like the safe haven we expect it to be?

fig4.jpg
Source: Stockcharts.com


If the gold price does well, gold stocks should hold up. Should. After all, gold stocks are stocks too and could get swept into the selling, especially if margin calls force investors to sell anything they can. 

To be safe, I have been buying puts on the S&P 500 to hedge my portfolios. If the S&P 500 crashes, my clients will be pleasantly surprised.

A critical part of this hedge is buying the puts (insurance) as cheaply as possible so that the cost is a mere fraction of the account value. That way if a crash doesn’t occur, the cost is small and can be made up elsewhere.  With volatility so low right now, the cost of this insurance is low too.

When I go through this hedging strategy with some people, they want to bet big on it because they are convinced the market will crash.  That is a mistake.  The key to this hedge is being able to keep it going as long as possible which means not being greedy and spreading out your cash out over a longer time frame. 

There is one fly in the ointment of the argument for the market being on the edge of a collapse.  As I said in the beginning, many people, too many, are talking about the overvaluation of the market and the likelihood of a pullback. That means many people are short and could be forced to cover if their timing is wrong. This would cause a huge short squeeze taking stocks even higher. Even so, this should be temporary and set the stage for an even bigger decline.

In summary, I believe the general stock market is due for a pullback in the months and years to come. If or when this happens, I expect gold to hold up well. Resource stocks being stocks may not hold up as well. Purchasing protective puts on the S&P 500 is one way to benefit from market turbulence and potentially offset losses associated with a general equity sell off.