Here We Go Again: Precious Metals Edition 



The game the government and the financial markets have been playing for the past few years – in which stocks tank until the Fed capitulates and agrees to cut interest rates and/or ramp up QE, after which markets soar  – is usually measured in stock price terms.

In other words, the S&P 500 drops by 18% in two weeks and that is deemed scary enough to force the Fed to fire up the printing press.

But precious metals also tend to be swept along on these massive tides of hot money. In March of this year,  for instance, stocks tanked, but so, counterintuitively, did supposedly “non-correlated” assets like gold and silver.

The explanation for this is probably that when your stocks are plunging you have to raise money, and the easiest way to do that is to sell whatever is 1) up recently and 2) liquid enough to be easily moved. So you don’t sell your house, but you do sell some gold, silver, mining stocks or if you have them, precious metals futures contracts.

Then the Fed rides to the rescue and precious metals retrace their decline – and then some – on the prospect of huge new infusions of easy money.

Well, here we go again. The Fed promises low interest rates for years to come, but stocks read this as “no further cuts” and proceed to roll over. Gold and especially silver get slammed in the general rush into cash.

The following chart shows what happened in March and the replay that is apparently beginning now.

stocks and gold 2020 low-ball bid precious metals

What happens next? 

If the rules of this game still apply, stocks, gold, and silver will keep falling until the Fed and/or Congress provide another big cash infusion. 

That’s already coming on the fiscal side, as Congress debates the size of the next pandemic stimulus bill. If it includes another round of $1,200 checks for Millennial Robinhood traders, that alone might revive the market’s animal spirits. 

If not, the focus will shift to the Fed, which will be forced into some kind of “whatever it takes” stance that includes negative interest rates and possibly direct purchase of equities.

Either way, precious metals and related mining stocks – again, if the game continues – will suffer for a while and then resume their bull markets. In the mining stock universe there are literally hundreds of examples of a March collapse followed by parabolic recovery in subsequent months. 

Here’s one to whet your appetite: primary silver miner First Majestic fell from 12 to 5 in March before tripling in the ensuing five months.

First Majestic Silver low-ball bid precious metals

Now the rollercoaster is heading back down. 

This chart, along with most others in the precious metals space, screams “low-ball bid”

A Stable Euro Requires an Ambitious Industrial Policy

After years of falling behind in cutting-edge technologies, Europe now has a chance to transform its economy in the aftermath of the COVID-19 pandemic. The case for an EU-level industrial policy is stronger than ever, and the survival of the eurozone itself may depend on it.

Xavier Vives

vives12_Evgeny GromovGetty Images_EUeuroindustry

BARCELONA – The idea of a European industrial policy has been back on the agenda at least since the release of a Franco-German manifesto on the issue in early 2019.

But whereas that document focused primarily on global competitiveness, an equally strong argument for reviving industrial policy is that it is necessary for the survival of the euro.

Since the introduction of the single currency, the industrial share of the economy in terms of value added has remained stable in Germany while declining markedly in France, Spain, and Italy. Germany’s massive economic-policy response to the COVID-19 shock is bound to reinforce this tendency.

Industry, broadly construed to include digital services, is the key to increasing productivity, implying that the European Union’s southern members will need to embark upon an industrial revival. Otherwise, their relative lack of competitiveness will deepen imbalances within the eurozone, and raise the prospect of permanent north-to-south transfers, threatening the bloc’s political sustainability.

The bad news is that while France can perhaps afford to spend billions of euros supporting its auto industry, Italy and Spain cannot. The good news is that the recently adopted Next Generation EU recovery package offers an opportunity both to revive southern European industry and position it for a digital, sustainable future.

According to the European Council’s agreement this past July, “Member States shall prepare national recovery and resilience plans setting out the reform and investment agenda of the Member State concerned for the years 2021-23.” But EU leaders should now go further, by establishing clear goals for making European industry not just globally competitive but also more geographically balanced.

The focus should be on the same key sectors identified in the Franco-German manifesto: health, energy, climate, security, and digital technology, with specific initiatives in microelectronics, batteries, and artificial intelligence (AI).

While the United States and China each race ahead in pursuit of global dominance in AI and other cutting-edge technologies, Europe is increasingly lagging behind in the digital economy. Even in successful Germany, total stock-market capitalization is less than that of a single US tech giant like Amazon, Apple, or Microsoft.

Contrary to what some commentators have argued, Europe’s lack of technological competitiveness is not the result of EU competition policy, which has blocked such mergers as the one between Alstom and Siemens. Rather, Europe’s problem is that it has a deeply fragmented digital market, which makes it impossible for firms to profit from the dynamic economies of scale that digital platforms and Big Data would otherwise offer. This obstacle leaves few incentives to invest in the research and development that drives innovation.

Making matters worse, Europe also has deeply fragmented public procurement policies, owing largely to the fact that it lacks a joint defense policy. It is this fragmentation, not competition within the single market, that explains the absence of European “champions.”

In the past, European industrial policy decayed after the strategy of picking winners failed in the 1980s and 1990s. Policymakers shifted their focus to fostering innovation, training the workforce, and providing an attractive business environment. Then, the 2008 global financial crisis renewed interest in industrial policy, and now the COVID-19 pandemic has underscored its potential advantages as a means of driving competition, advancing sustainability objectives, securing supply chains, and increasing economic resilience.

The pandemic has made technological sovereignty and value-chain stability leading priorities, not just in Europe but everywhere. Both imperatives feature prominently in US Democratic presidential contender Joe Biden’s economic-policy platform, and there is every reason to believe that the operations of foreign state-controlled firms – particularly Chinese companies – will be closely monitored both in the US and in Europe in the years ahead.

Moreover, industrial policy has a crucial role to play in moving resources from declining and obsolete sectors to emerging, viable ones. Without a strategic approach, state aid to the private sector will merely create more zombie firms that should have failed.

This danger is particularly acute in the current circumstances, given the scale of emergency spending by governments. In pursuing a post-pandemic recovery, the goal of Next Generation EU and other programs should be not just to restore growth but also to transform the economy. 

To that end, industrial policies should be used to help coordinate investments. Key industries like electric vehicles depend not just on the automotive sector but also on domains ranging from AI and 5G to battery manufacturing and infrastructure (charging stations).

Achieving global competitiveness in this industry thus requires wide-ranging complementary investments, not to mention a properly trained and educated workforce. In Europe’s case, a traditional laissez-faire approach will have little to recommend it. Public-private cooperation will be necessary.  

The success of the EU recovery fund depends on coordination at the European level, following a process of careful selection and monitoring of public spending. To prevent pork barrel politics from limiting the transformational potential of the recovery, candidate projects should be evaluated and shaped by independent national agencies staffed by recognized professionals.

The eurozone needs an industrial policy that preserves internal competition while also bolstering southern European industry and upholding the EU’s commitment to open markets internationally. Otherwise, the euro itself will remain at risk.

Xavier Vives, Professor of Economics and Finance at IESE Business School, is co-author (with Elena Carletti, Stijn Claessens, and Antonio Fatás) of the report The Bank Business Model in the Post-Covid-19 World.

The House Of Cards Is Ready To Collapse

Bert Dohmen


- Bullish enthusiasm has gone on a parabolic trajectory in the month of August, guaranteeing a volatile election season for the stock market.

- Economic indicators no longer paint an optimistic picture - now, they are showing a deceleration in the recovery, coinciding with a deterioration in sentiment.

- Investors relying on the Fed to "stimulate" the markets with loose policy are being roped into a trap.

Note to readers: We published this article on September 1st, prior to the selloffs on the 3rd and 4th.

Despite new signs that the U.S.'s economic growth will be slow and painful, the euphoria we've seen take hold of markets over the past few months has now started to accelerate. Investors who are already overexposed to the stock market are loading themselves up with even more risky assets, even as we closely approach a volatile election season.

Bearish Divergences

The Put/Call ratio, which measures the ratio of bearish versus bullish options bets on the stock market, has fallen to record 2-year lows repeatedly over the past several months. This reflects the fact that speculative activity is the highest it has ever been over this period as SPY (orange line) has climbed to new record highs:

This confirms everything we've written over the past several weeks. It is increasingly important that investors consider the psychology and behavior currently driving the markets higher, and why it is unsustainable.

This week, one analyst on TV said, "We have to be comfortable in being uncomfortable. You have to stay fully invested." A major CEO of an investment firm said that he has "no doubt that by next year, the economy will be as strong as last year."

Attitudes like the ones above tempt fate and will ultimately lead investors to ruin if they increase their exposure in this market. The major indices continue to depict a distorted image of what's really going on for the vast majority of companies.

The divergences in market breadth we've previously highlighted have grown substantially larger during the month of August. Below, we have an hourly chart of the S&P 500 (red line) compared to its "equal-weighted" counterpart (candlesticks):

The two have veered off in different directions, with the "equal-weighted" version making a clear top and holding in a steady downtrend since August 12th.

Divergences of this sort typically signal that the markets are currently in a period of distribution. Large Wall Street firms have slowly and carefully unloaded their positions over the last 2 and a half months onto retail investors, who are walking into a trap.

A similar "distribution" trap was set earlier this year, just before the February plunge. A warning sign emerged when the S&P 500 began to diverge from its equal-weighted counterpart only a few weeks ahead of the crash.

Illusions of a Strong Stock Market and Economy

The narrative of a strong stock market rests upon a handful of the largest companies. The largest 10 constituents of the S&P 500 by market cap now make up over 29% of the index.

What's less known is that the largest 10 companies in the NASDAQ 100 make up over 50% of the QQQ's holdings.

While an upcoming bear market is likely to be triggered by technical weaknesses like the one discussed above, it will be prolonged by the real outlook for the U.S. economy.

Economic indicators no longer paint an optimistic picture - now they are showing a deceleration in the recovery, coinciding with a deterioration in sentiment.

The most concerning factor of all, however, is a reduction in stimulus. The Peterson Institute for International Economics estimated that fiscal aid to U.S. households will plummet by $500 billion if Congress is unable to craft a new rescue package. The result? A further 4-5% decrease in GDP.

With the last government stimulus payments being exhausted after July, the decline we're already seeing in the economic indicators will become even more severe. The effect will be felt throughout the entire stock market, although some will be hit harder than others.

In our latest Wellington Letter, we discuss various sectors of the economy which have seen the largest demand declines due to COVID-19. Many pessimistic forecasts at the outset of the pandemic predicted that airlines, commercial real estate, resorts and other hard-hit sectors would not recover until the end of the year.

Now, more than 5 months after the plunge, we know for certain the recovery will be much longer and worse than even the most pessimistic forecasts in March. Already, the number of large corporate bankruptcies has put 2020 on pace for the highest annual count on record, as shown below:

Chart showing that Covid-19 has triggered a record wave of corporate bankruptcies

The Fed's Impact

Monetary policy has grabbed everyone's attention since Chairman Powell announced the adoption of "average inflation targeting." The yield curve has steepened, money is flowing back into gold after several weeks of consolidation, and now everyone is discussing the prospects of big inflation down the road.

Is this really viable? One important factor to consider is the money velocity. This is the rate at which dollars exchange hands in the economy and is a critical factor driving inflation. The Fed, however, has very limited control over it.

The velocity of the money supply not only witnessed a steady decline over the past two decades, but saw a massive drop of over 20% in the second quarter of 2020, as shown on the chart below:

Trends like this are indicative that inflation won't be going significantly higher anytime soon.

Bulls continue to hope that the economy will recover in the same way the stock market did, which is nearly impossible. Central banks can exert their powerful influence, but that only works until investors realize that artificial credit is not a substitute for genuine economic growth.

In the meantime, we will closely watch markets for when this inevitable turning point emerges.

China’s Middle East strategy comes at a cost to the US

Beijing gains in oil and influence as successive presidents in Washington withdraw

Jamil Anderlini

Ingram Pinn illustration of Jamil Anderlini column ‘China’s Middle East strategy comes at a cost to the US’
© Ingram Pinn/Financial Times

Critics of the 2003 US invasion of Iraq have always believed the real motivation was taking control of the world’s second-largest proven oil reserves.

Even the architects of Operation Iraqi Freedom were convinced Iraqi oil revenues would quickly fund reconstruction of a US client state that would help redraw the contours of the Middle East in America’s favour. But if oil and influence were the prizes, then it seems China, not America, has ultimately won the Iraq war and its aftermath — without ever firing a shot.

Today China, the world’s largest importer of crude oil, is Iraq’s biggest trading partner. Only Russia sells more oil to Beijing. In the first half of this year, Iraqi oil shipments to China increased almost 30 per cent from a year earlier and accounted for more than a third of Iraq’s total exports. During a visit to Beijing last year, Adel Abdul Mahdi, then Iraq’s prime minister, described Sino-Iraqi relations as poised for a “quantum leap” and his electricity minister wrote “China is our primary option as a strategic partner in the long run.”

Meanwhile, Iraqi oil exports to the US nearly halved in the first half of the year and the Pentagon plans to reduce its remaining troops in Iraq by a third in the coming months.

A similar dynamic is playing out in Afghanistan, as America’s longest war finally draws to a close. Afghan and Pakistani officials tell the Financial Times that Beijing is effectively in control of the peace process and is promising the Taliban lavish energy and infrastructure investment once the US has left for good.

China’s influence is rapidly growing across the Middle East at a time when American commitment is being questioned by regional allies and US politicians alike. Beijing is the biggest foreign investor in the region and has sealed strategic partnerships with all Gulf states apart from Bahrain. Most investment has gone to traditional US allies, many of them also eager customers of Chinese military technology.

China’s first ever overseas military base was established in Djibouti three years ago. But Beijing is also investing heavily in commercial ports that could easily be converted to naval use in other strategic locations, including Pakistan’s Gwadar and Oman’s Duqm port on either side of the Gulf of Oman.

Along with the Strait of Malacca between Malaysia and Indonesia’s island of Sumatra, China considers the Strait of Hormuz and the Bab al-Mandab Strait as critical to its economic and military survival since the bulk of its energy imports are shipped through these strategic chokepoints.

As Sino-US relations deteriorate, Beijing’s goal of increasing control of these waterways and reducing America’s ability to cut them off in a conflict has taken on greater urgency. It is the main reason why China has built a navy that is now bigger, if not more advanced, than that of the US.

Until recently, Beijing had followed a hands-off policy in the Middle East of being a friend to everyone but allies with none. The success of this has been on display as it negotiates a $400bn investment and security pact with Iran while assisting Iran’s enemy Saudi Arabia with its nuclear programme. And it fully supports the Palestinian cause while charming Israel into sharing state of the art technology and leasing key strategic ports to Chinese state enterprises.

But perhaps the most powerful sign of China’s rising influence in the region is the fact that almost every Muslim-majority country has supported the incarceration of as many as 2m Muslims in re-education camps in western China. In public statements and joint letters to the UN, countries including Saudi Arabia, Egypt, Kuwait, Iraq and the UAE have all praised the camps and suppression of Islam in the region of Xinjiang as necessary “counterterror and deradicalisation” efforts that have brought “happiness, fulfilment and security”.

In the US, two successive presidents have been elected on promises to extricate the country from Middle Eastern entanglements. In the wake of the shale oil revolution, with America now virtually self-sufficient in energy, the rationale for pouring more blood and treasure into the sand looks thin.

Washington’s resistance to playing regional policeman while other countries, particularly China, reap all the benefits has been evident for a while. It was Barack Obama’s administration that first proposed the “pivot to Asia” to refocus American diplomatic and military might on the Asia-Pacific and counter China’s rise as a regional hegemon. President Donald Trump has accelerated that strategy.

But what seems like a compelling case for American retreat from the Middle East is now complicated by China’s rapid advances there. If the US goal is to contain China’s ambitions in Asia and shore up close allies Japan, South Korea and Taiwan, pulling out of the Middle East is the last thing it should do.

Most Asian countries are even more dependent on ship-borne oil than China. Ceding control of the key waterways around the Arabian Peninsula to Beijing would force all countries in Asia to rethink their strategic alliances and make them far more susceptible to the kind of coercive diplomacy China is using all over the world.

Whoever wins the US presidential election in November will face the uncomfortable reality that competition with and containment of China now runs through the Middle East.

China Exports Are Booming and Trade Surplus Is Widening—Why Is the Yuan So Weak?

Many factors are at work to push the yuan higher, but its climb has been sluggish

By Mike Bird


China’s August exports were up 9.5% from a year earlier, beating expectations, while import numbers declined. That prompts a nagging question in currency markets: With a widening trade surplus, why isn’t the Chinese yuan rising more?

It’s true that at 6.83 to the dollar the currency is at its strongest level in over a year, but that mostly reflects a weaker greenback, not a stronger yuan. The ICE Dollar Index, which tracks the dollar’s value against a basket of currencies, is down more steeply this year and this quarter than the dollar is against the yuan specifically.

The yields on China’s 10-year government bonds exceed those on their U.S. equivalents by 2.4 percentage points, a larger gap than in the aftermath of the global financial crisis, making the yuan-denominated debt an attractive investment opportunity.

The gap speaks to the relative austerity of Beijing’s response to the pandemic: The year on-year-growth in China’s money supply lags behind those of the U.S., the U.K., the eurozone and Japan.

The inability of the vast majority of would-be Chinese tourists to leave the country is an advantage too, since China is a net importer of tourism services: Its residents spend more abroad than visitors spend in China.

Though the reliability of official Chinese data is partial, there is little sign the government is intervening in the currency market to suppress the yuan’s value. Foreign-exchange reserve figures ticked up slightly in July, but have been largely quiescent. Alternative measures of intervention haven’t indicated any major activity, though it can’t be entirely ruled out.

So why isn’t the yuan stronger? Goldman Sachs analysts offer at least one good reason: Currency settlement data suggests that only 32% of the net proceeds of July’s goods trade was repatriated, meaning less impact on currency markets.

Though foreign holdings of Chinese government bonds have risen, the increase this year is minor and tentative in the grand scheme of global capital flows: a little more than $40 billion, equivalent to roughly two thirds of August’s trade surplus in goods.

Other news on Monday offered an insight into one less quantifiable factor that may be holding the yuan back. The U.S. is weighing import controls against China’s largest chip maker, Semiconductor Manufacturing International —a fresh symbol of trans-Pacific turmoil, heaping additional risk on the ownership of Chinese assets.

Even with a trade surplus, fewer tourists exchanging yuan to travel overseas, and an advantage in yields, the now-constant threat of commercial Cold War will hang over Chinese assets. And with that in place, the currency will likely continue to be weaker than other fundamentals might warrant.