The Real Cost of Low-Fee Funds

By John Mauldin

 TFTF Image

Today, rather than tackle some big macroeconomic issue, we’ll go back to this letter’s roots and look at market timing and portfolio construction issues. I expect this will get both enthusiastic support and at the same time, make a number of readers uncomfortable—if not annoyed.

Why? Because I am going to take on a number of shibboleths many hold sacred and dear. But after a great deal of thought over the last few years, I’ve come to realize that all too often, and this includes myself, investment advisors and investors tend to “talk their book.” We bring prejudices and biases into our portfolio construction, and then if it doesn’t work, we just call it “bad luck.” Let’s jump in.

The Real Cost of Low-Fee Funds

I wrestled with the title for this letter because I could’ve substituted the word high or true or hidden for the word “real” in the headline and just as easily have described my thesis. Low-fee funds, used the way that they are generally used, have hidden costs investment advisors don’t want to discuss and investors ignore.

Other things being equal, lower fee funds are better than higher fee funds which do the same thing. That is obvious. The total returns of lower fee funds over time are mathematically precise on this.

Yogi Berra, although he may not have been the first to say something similar, popularized the quote, “In theory, there is no difference between theory and practice. But in practice, there is.” That also applies to low-fee funds.

If you are using an investment advisor, you pay advisory fees plus fund and custodial fees. If you are an individual investor running your own account, you are paying the fund fees plus the custodian or platform fees. It makes sense to pay as little as you can for those services.

If you use those low-fee index funds (like ETFs) as trading vehicles, that is particularly good advice. But that is not the way the vast majority of low-fee funds are used.

Most low-fee funds are part of a “buy-and-hold” management strategy. Investment advisers say we are “investing for the long run,” and diversify among low-fee funds in various asset classes and indexes. They trot out studies showing that over the long run, investors will average 8% or whatever.

And those are true statements, but most investors don’t have the 40 or 50 years those studies were designed for and so have to experience the bear markets along with the bull markets. The studies can be misleading, too, depending on when they start. They generally don’t tell you that the market can be in a bear cycle for 20 years before recovering.

That is all well and good in a bull market, but in a bear market, you are simply diversifying your losses. While it may be tax efficient, in a bear market, you simply end up with tax efficient losses.

We are now in one of the longest running bull markets in history. However, it is not clear if this bull market will continue for a few more years, roll over into a much larger correction, or maybe churn sideways for an extended time. No one knows the future.

But I do know this: We are eventually going to have a recession and the accompanying bear market will be brutal, as all bear markets are during recessions. I don’t think there has been, at least that I can find, a serious bear market that doesn’t accompany a recession. You can find corrections like 1987 or 1998 that weren’t associated with recessions, but as we will see below, those should perhaps be treated differently.

I think the next recession will likely see a bear market loss of at least 40% if not 50%.

As I’ve demonstrated elsewhere, high total US debt means the recovery will be even slower this time. If you are over 55 or 60 years old, your “investing for the long run” could end up seriously impacting your retirement income. Or push your retirement off for years as you try to make up by saving what you lost in the bear market.

And the investment advisor or strategist who told you to use a buy-and-hold strategy will simply shrug it off and say something like, “I am sorry. But we can’t predict the markets. It’s just bad luck we had a recession and bear market.”

That’s because they did not disclose the true cost of your buy-and-hold strategy, and the hidden cost of your low-fee funds.

Sir John Templeton and a number of others teach us to remember that bear markets always follow bull markets and bull markets always follow bear markets. You should be anticipating the change and deciding what you’ll do in advance.

Let’s say you’re down 50% after a 10-year bull run. The actual cost of that low-fee fund was 5% a year for the risk you took. Nowhere in the disclosures you will be reading is there any indication you should be budgeting for risk as part of the fees and true cost of that strategy.

If you add in 5% total cost to your low-fee system, all of a sudden, the costs seem pretty high. You would have never bought it knowing that you would pay 6% or more. But that is essentially what you did. Whether you are paying those fees incrementally or all at one time during the bear market, the results are the same. But the investment advisor will say the markets will come back and you will be okay. That may be reasonable advice if you are 30 years old, but not if you’re 60 or 65.

Bluntly, and this is going to anger a few people, in today’s times and with our particular sophistication available to almost any investor, a buy-and-hold strategy without an appropriate hedging strategy is lazy. The next bear market is going to devastate pensions and retirement accounts for the vast majority of investors and pensioners in this country. And it can be avoided.

I argue that you should hedge by having a diversification of trading strategies. But that is just one of a half dozen different ways to hedge your portfolio. I was on a TV set with my friend David Tice (formerly of the Prudent Bear Fund), and his favorite way to hedge is simply buying put options for your portfolio. I know one manager running multiple billions of dollars that has been doing that for almost 20 years, and his total performance through a cycle simply outperforms any buy-and-hold strategy I’ve seen. He also underperforms during a bull market, as hedging costs real money. But when he makes money during a bear market, the real “cost” of his strategy is soon revealed.

If you are a smaller investor and can’t get an investment advisor who can hedge for you, then simply use the 200-day moving average. When your funds drop below their 200-day moving average, exit to cash. If it’s a real bear market, you will be in cash for the rest of the drop and then you will be able to buy back in closer to the bottom, and as their recovery begins (and there is always a recovery), you will be closer to your original capital position and able to continue to grow your portfolio.

But the important thing to do is to plan your hedging strategy in advance. It must be automatic and quantifiable. I know some people who only want to use the 200-day moving average after market close on the weekends because they don’t want to be looking at their portfolio every day. I can’t argue with that. Just do something to avoid the worst ravages of a bear market.

And recognize that you must have a risk budget. Risks and the losses that accompany them are part of the total cost of investing and managing money. I have my own preferred strategy that I use for client money, and regulators don’t allow me to use the word “guarantee” very often, but I can guarantee you that my system will lose money at a minimum during the early stages of a true bear market. You can’t participate in the market to whatever extent and not expect to take some losses. But we have quantifiable systems that know what to do and when to exit. Hopefully, we will avoid the worst ravages of a true bear market. Our philosophy is more of a “participate and protect” strategy.

But again, there are lots of ways to hedge a portfolio. If your investment advisor is not hedging you in some way, if you don’t have a quantifiable strategy to protect against a serious downside move that is accompanied by recessions, then you need to get a new investment advisor. If you are managing your own money, you need to either get an investment advisor who can hedge your portfolio, or you need to have your own strategy. If you don’t, then I predict you will not be happy with the results.

Risk is a cost to your portfolio that is not disclosed in the documents you get talking about the total fees you pay. The regulatory authorities are properly focused on having advisors and brokers disclose the total costs of their management to their clients. But nobody calculates the cost of risk. First off, it is unknowable. Will a bull market last for four years or eight years or 10 years or 12 years? No one knows. How deep will the bear market be? No one knows. So, it’s very difficult to actually estimate a cost upon future facts that no one knows today.

That being said, I can tell you there is going to be a recession a bear market in the future. And it is going to exact tremendous cost upon your equity portfolios. Telling you exactly what that cost will be? I don’t have a true clue except looking back in history, and that tells me losses of 40–50% (or more) are quite possible. Ugh.

This weekend, if you don’t have one, at least begin to figure out what your hedging strategy for the future will be. There will come a day when you will be happy you did.

Where Is the Market Going?

I’m getting more questions at my speeches and in my inbox about whether I think we are entering into a bear market? The honest answer is I don’t know. My particular management system doesn’t really care as we have triggers that will move us out of the market or back into a market based upon various indicators that my underlying managers use. I trust their systems and I sleep at night, not worried about what my portfolio or the portfolio of my clients are doing.

But the question is still reasonable. And it allows a teaching moment. First, looking back in history, there are essentially two types of bear markets: those that happen in a recession and those that don’t. Bear markets that happen accompanied by a recession generally are deeper and the recovery is much longer. Those that happen simply because the market had gone “too far, too fast” and seemingly needed a correction tend to be “V” shaped recoveries. Think 1987 or 1998.

Looking at the economy today, and absent a trigger from Italy/Europe or China (or worse, shooting ourselves in the foot with our China tariff policy) or some Black Swan, there is no true reason for a long-term bear market. The economy is in relatively good shape, and I don’t see a reason for a recession to begin anytime soon, absent some trigger event.

That means if we did have a bear market correction, I would actually expect it to be “V” shaped and a very tradable exercise.

The market itself is showing signs of weakness. My friend Dave Wright points out that even during the large upward movement on Monday, the stocks on the NYSE made more new lows than it made new highs. That is not a healthy market. Dennis Gartman gives us this following graph:

Source: Dennis Gartman

Again, this is not the sign of a healthy market. All that being said, much of the correction came in the tech sector, especially the S&P. I’m not going to show a chart here, but if you had taken the technology stocks out of the S&P 500, we would’ve been in a downward market for quite some time. Technology clearly led the way in recent times.

It is very possible that we get into a “sector rotation” market and that we churn sideways for quite some time. It is just as possible that we see what normally bearish David Tice thinks will happen: That we are actually in danger of a market melt-up, which can happen for all manner of reasons. Let me give you a potential. Right now, the market and most commentators believe that Democrats will take the House in the midterm elections a few weeks from now. What happens if they don’t? Could we see the same type of bullishness in the markets and sentiment that developed after Trump was elected?

I know my Democratic friends want to ignore it, but so many sentiment indicators are at all-time highs, and they’ve been getting that way since Trump was elected. Don’t ask me to tell you the reason or discuss politics with you, I’m simply looking at the facts. And I think we all agree that sentiment does drive markets. But we need to remember that sentiment can turn on a dime.

Mastering the Market Cycle

Now let me give you some really good advice, one that I am confident will make you a better investor. One of the greatest investors of our times is Howard Marks of Oaktree Capital. He manages $122 billion and his quarterly letters are must-read. They are full of wisdom and insight. He is one of my investment and thought heroes. (He has graciously agreed to come to my conference in May next year.)

He has written a brilliant and extremely readable book called Mastering the Market Cycle: Getting the Odds on Your Side.

In interviews and other places, he basically says he thinks that 2018 is much like 2006. As he says, “Where we are in the market cycle shapes the probability distribution of returns that you face, and so it’s worth trying to figure out where we are.” This is from a man who wrote his famous memo, “Race to the Bottom” in 2007.

Whether you are a professional investment advisor or an individual investor, you really should get the book. It may very well be the most important thing you do for your investment portfolios this year. I can’t say it any stronger than that. Other than to say, I wish I had written the book.

What Should You Do Now?

Okay, after you buy Howard’s book and begin to create your own hedging system if you don’t already have one, what should you do? Let me offer a brief personal advertisement.

Quickly, I advise on money for a variety of investors and professional investment advisors. The strategies I prefer are available in both a mutual fund and in managed accounts. Full disclosure, I have recently closed my own personal investment advisory firm down and moved my registration to my longtime friend Steve Blumenthal of CMG. As a personal strategy, he has all the infrastructure and team to support me, and it really does allow me to spend more time researching and reading and writing.

We have done a report called “Investing During the Great Reset,” which explains our strategy and rationale. If nothing else, it will show you how I want to deal with the risk of a coming potential bear market and give you ideas for doing it yourself or in your own firm. Of course, I hope that some of you will become clients. But I am perfectly willing to help you whether you do or not. I want as many people as possible to get from where we are today to the other side of The Great Reset.

I should note, for investors who have a net worth of more than $1 million, there are additional opportunities to diversify your portfolio that we can talk about. I will be talking more about those in the future, but whether you are worth $25,000 or $250 million, I think this report will give you something to think about.

Shane and I will go to Puerto Rico next week, then come back to Dallas for a few days before I catch a plane to Frankfurt where I will speak to a large group of institutional investors. I know I have a few other trips that aren’t scheduled as yet, but they are clearly going to be in my future. And sometime in late December, Shane and I will end up in Cleveland for a long overdue full-day medical checkup. I understand Cleveland is wonderful to visit in December. I may be ready to go back to Puerto Rico after that trip just to warm up.

Winter and rain showed up in Texas beginning last Sunday. We had a norther come down bringing an enormous amount of rain along with it and drop temperatures into the uncomfortable area. Shane was complaining about it being cold before Halloween, which is not normally the case. David Tice and I were talking about how perfect the weather normally is prior to Halloween, and he remembers particularly in the last two years because he had to pay for two weddings which were outdoors.

I will be writing from Puerto Rico next week, or at least finishing up the letter. And with that, I will hit the send button. You have a great week. And think about how your portfolio is positioned for an uncertain future.

Your wanting to help you get to the other side of The Great Reset analyst,

John Mauldin
Chairman, Mauldin Economics

Donald Trump is wrong: China is not Mexico

It would not be hard for Beijing to offset a loss of demand in a trade war with the US

Martin Wolf

“When a country (USA) is losing many billions of dollars on trade with virtually every country it does business with, trade wars are good, and easy to win.” This tweet of March 2 set out the aims and means of Donald Trump’s trade policy. The apparent victory over Canada and Mexico and the signing of a new trade deal will convince him he is right. But China is not Mexico.

The US president believes if a country sells more goods to a trade partner than it buys, it has “won”. He also thinks that if it buys more goods from a trading partner than it sells, it can “win” a protectionist war, because the other side has more to lose. These two convictions — bilateral mercantilism and asymmetric balance of pain — are his guides. His policy is to use the way in which the US “loses” to secure victory. Since the US is also the most powerful country in any bilateral relationship, it has to win.

Serious economists, back to Adam Smith, would insist that seeking a surplus with every trading partner is not “winning”. It is absurd. This is not even intelligent mercantilism, which would focus on the overall balance. Yet, particularly with free capital flows, overall balance is a foolish goal and one that trade policy cannot achieve. It is incredible that such primitive ideas rule the most sophisticated country on earth.

Put the sense of this to one side. Are trade wars easy for a superpower to win against countries with large bilateral trade surpluses? The answer is “yes and no”. Mexico’s exports to the US were 28 per cent of gross domestic product in 2017, while Canada’s were 19 per cent. US exports to Mexico were only 1.3 per cent of GDP, while its exports to Canada were 1.5 per cent. When countries are as asymmetrically dependent as Canada and Mexico, some sort of victory is likely. In a bilateral negotiation, the US was likely to get much of what it wanted (though it seems not to have got it all).

China is a different story. Its exports to the US are a substantially larger share of its GDP than vice versa, at 4.1 per cent, against 0.7 per cent, in 2017. China’s bilateral surplus was about 3.1 per cent of its GDP, which is far down from the 10.2 per cent in 2006. Imagine that the US imposed prohibitive tariffs on all its exports. One might think the effect would be to lower China’s GDP by 4.1 per cent. One would be wrong. US exports to China would also fall, as Chinese retaliation bites. Furthermore, a third of the value added in China’s exports is imported. Chinese exporters could also sell their goods elsewhere.

In the end, the fall in China’s GDP in such a trade war would be less than 2 per cent, other things equal. This is about four month’s growth. Moreover, it would not be hard for China to offset such a loss of demand. Meanwhile, the overall US trade balance would probably not change a wit, since that is determined by domestic supply and demand.

While Beijing prefers a deal, it will not pay a high price. All Chinese are taught about the “century of humiliation”. Xi Jinping, China’s president, is in a strong domestic position. Yet even he might not survive grovelling before a bully.

Mr Trump has made two characteristic mistakes. First, he has over-reached. China cannot deliver bilaterally balanced trade because it is unable to force Chinese people to buy goods they do not want. The point about US trade with China is not that its imports are so high: relative to GDP, they are much the same as the EU’s. The difference is the low level of its exports. That shows lack of competitiveness. Finally, China will not abandon hopes of technological upgrading. No power would.

Second, he has exaggerated US power. In other areas of trade policy, deals might be done. One could imagine changes in Chinese policy on intellectual property and exclusion of US companies. One could imagine a deal in which China gave up developing-country status, in return for being treated as a market economy. But to achieve these outcomes, or better, Mr Trump needs allies, especially the EU and Japan, whom he despises, maybe because they are not tyrannies. But it is not clear he wants such deals: if intellectual property were better protected, yet more US companies would invest in China. That seems the opposite of what he wants.

Mr Trump might surprise us by trumpeting the greatest trade deal in history in which he gets rather little. But suppose the conflict escalates instead, ending up with high bilateral tariffs. Who wins? The broad answer is nobody: trade is disrupted, the rules-governed trading system is devastated, relations between the US and China are damaged and the world becomes more perilous.

Yet, which side loses more? This is difficult to model, because no one knows what would happen. One possibility, analysed by the European Central Bank, is that the conflict goes global. Even the Trump administration might realise that trade diversion is working against them: they stop imports from China and get them from, say, Vietnam. So they go for a 10 per cent across-the-board tariff. The rest of the world retaliates with a 10 per cent tariff on the US. In this case, argues the ECB, the US loses in the short run and China even gains. In a trade war, the larger economy loses less, because the trade it loses is less important to it. The rest of the world’s economy is three times bigger than that of the US.

The US could get a deal on intellectual property and market liberalisation with China. But it cannot get a deal on balancing bilateral trade or stopping China’s economic development. It could get such a deal by co-operating closely with allies. If the US persists 0with pure bilateralism, it will not win. But it will do damage to itself, trade, the world economy and international relations. Trade wars are not good. With great powers, they are not easy to win either.

One Club Does Not Fit All in Europe

Jean Pisani-Ferry  

eu statue

PARIS – “Italy,” a contemptuous Metternich said two centuries ago as the peninsula was split into a myriad of fiefdoms, “is only a geographical expression.” Some in Beijing, Moscow, New Delhi, and even Washington regard Europe the same way. They acknowledge that the European Union matters for trade agreements and currency issues, but consider it too irresolute to be a real player in today’s global power game, and too divided to cope with security and migration challenges. Proving them wrong is the task that Europe must now tackle.

Existential debates are admittedly as old as the EU – and so pervasive that they seem to be part of its identity. But they are also as alien to the vast majority of citizens as they are familiar to the small circle of policy wonks who obsess over them. So, one could be forgiven for ignoring Europe’s latest identity crisis.

That would be a serious mistake. To survive in a different, much tougher world, the EU must redefine its purpose. It was mainly designed to steer internal integration; now it must confront external threats. It used to be the champion of rules; it is unprepared for the new, transactional game of geopolitics. The US looked after its security; President Donald Trump regards this responsibility as an excessive burden. Refugee flows were a negligible trickle; though they are back to low levels, the massive surge in 2015 exposed the dysfunctional character of the European asylum regime.

And all of this comes at a time when the EU is already deeply divided. The scars from the post-2008 split between eurozone creditors and debtors are still visible, and a new fight pits advocates of the open society against proponents of identity politics. External issues add to existing divisions, because attitudes about migration, perceptions of foreign threats, and willingness to use military power differ widely. Europe risks a protracted stalemate.

The EU traditionally resorted to two techniques to cope with its divisions. The first was to buy time, by pretending that all member countries, though not equally ready to act, shared the same ultimate goal of “ever closer union.” This multi-speed approach has reached its limits. We can perhaps still pretend, against the odds, that all member countries will ultimately join the euro; but we cannot ignore the gulf between those who claim one can be a proud European Muslim and those for whom Christianity is quintessential to European citizenship.

The second technique has been to transfer competences to the EU level and to sort out differences through majority voting. This is how the single market was built and how trade policy is successfully managed, despite widely different attitudes and interests. But such a process works only as long as member countries agree to abide by majority rule. Opposing stances on security, defense, or, again, asylum cannot be sorted out this way. It was actually tried – for refugees – and failed: a decision on how to allocate asylum-seekers to member states was reached, but it could not be implemented.

The prospective EU enlargement in the Western Balkans further complicates the problem. These countries have made great efforts to join Europe and deserve to be rewarded. But they would make the EU even more heterogenous and would likely add to its divisions.

This is why, in a recent paper, my colleagues from the think tank Bruegel and I advocate an overhaul of Europe’s architecture. We propose a new structure composed of a common base and a few optional clubs devoted to major policy areas.

The base would essentially comprise the single market, the customs union, and essential flanking rules and institutions to ensure consumer protection, uphold competition, and manage research, energy and climate, infrastructure, and regional policies. The institutional pillars – the Commission, the Council, the Parliament, and the Court of Justice – would also be part of the base, as would the EU’s founding principles: human rights, freedom, democracy, equality, and the rule of law. It would be a sort of bare-bones EU, consistent with the original project but stripped of would-be common policies.

Clubs would be built around key policy areas. Because their members would share the same goals, they would be more effective internally and externally. One club would combine the euro, fiscal coordination, bank surveillance, and resolution of financial crises. Another would combine asylum policy, border protection, and cooperation in police and judicial affairs; this area could retain control-free internal borders, which is increasingly difficult between countries with widely differing asylum policies. A third club would be devoted to defense and external security; inclusion in it would require contributing resources and participating in military operations. A fourth club could be envisaged for common policy areas that are still in their infancy, such as education.

To ensure that a structure of this sort retains enough unity and prevent it from degenerating into a spaghetti bowl of loose arrangements, key safeguards would need to be introduced. First, clubs should be coherent and not à la carte. Second, institutional consistency should be preserved. In particular, there should be only one European Commission (though there would be club secretariats), one Parliament (though its members could meet in club formations), and one Court of Justice for the bare-bones Union and the clubs. Furthermore, participation in and withdrawal from the clubs should require passing high enough hurdles to ensure stable membership.

Such an approach would not by itself prevent the EU’s dissolution or promote enlargement to less-developed countries. But built-in flexibility would help build a partnership with willing neighbors. A bare-bones EU would provide a sound basis for cooperation with a “ring of friends” that would not participate fully in the single market and the free movement of people but could be involved, on a multilateral basis, in a series of cooperative arrangements.

Is it risky to break taboos? Yes. But the biggest risk is to remain mired in outdated structures and to succumb to inertia. Europe is a bigger dream than the house we have built.

Jean Pisani-Ferry, a professor at the Hertie School of Governance (Berlin) and Sciences Po (Paris), holds the Tommaso Padoa-Schioppa chair at the European University Institute and is a Mercator senior fellow at Bruegel, a Brussels-based think tank.

 This Is What A Paper Gold Short Squeeze Looks Like  

Huge recent imbalances in the gold futures market led many to predict that speculators (usually wrong at big turning points) would be forced to close out their historically extreme short bets. Put another way, too many traders were using gold futures contracts to bet that precious metals will go down, and when those bets are reversed out it will make gold and silver go up.

Last week this prediction started to come true, with gold rising and speculators reacting by closing out a big part of their shorts. The shift displayed below is one of the biggest on record for a single week:

Gold futures
Silver COT gold futures

Here’s the same data for gold displayed graphically. Note how unusual it is for speculators (the gray bars) to be net short and commercials (red bars) to be net long, and how quickly that part of the imbalance was extinguished.

Gold futures chart

But even after these big changes, speculators are still less long than usual and commercials less short.

To restore a normal structure to the paper gold and silver markets, another few weeks of rising prices will probably be necessary — which, yes, precious metals investors deserve. After all the chatter about a short squeeze, it would hugely anticlimactic for this single week’s action to be all there is.

On that longer-term note, mining stocks have begun to lead the underlying metals, which, according to the Rosen Market Timing Letter, indicates that the precious metals bull market is about to resume.
… both the silver and gold shares have closed above their most recent peak. Could this be a sign of the resumption of the bull market in the precious metals complex? Having started my Wall Street career in the year 1956 this truly Old Timer says, “Yes indeed.” There is nothing new about the precious metal shares moving up before the precious metals. All that is required to know that this is happening is the simplest form of technical analysis. No fundamentals, nothing fancy, no degrees of any kind required in order to see who’s leading who or what’s breaking out first. Just draw a few lines and “Voila” the answer will be yours. 

Rosen XAU gold futures

This is the front line of Saudi Arabia’s invisible war


A battlewagon roars through the gates of a beach villa on Yemen’s Red Sea coast, a luxury property with a 20-foot chandelier and indoor pool, now repurposed as a busy field hospital.

Young fighters, drenched in the sweat of the battle, leap from the pickup and hoist a wounded comrade, blood streaming down his face, into the emergency ward.

A piece of shrapnel had sliced his nose and lodged in his right eye. The fighter, a portly young man named Ibrahim Awad, groans. “Please, Hameed” he calls to a fellow fighter, a glint of panic in his one good eye. “My head feels heavy.”

The Saudi-led war in Yemen has ground on for more than three years, killing thousands of civilians and creating what the United Nations calls the world’s worst humanitarian crisis. But it took the crisis over the apparent murder of the dissident Jamal Khashoggi in a Saudi consulate two weeks ago for the world to take notice.

Saudi Arabia’s brash young crown prince, Mohammed bin Salman, under scrutiny over the Khashoggi case, now faces a fresh reckoning for his ruthless prosecution of the war in Yemen — yet another foreign policy debacle for Saudi Arabia, and a catastrophe for the Arab world’s poorest country.

Outside Yemen, the catastrophic war has been largely overlooked.

The Saudis barred foreign journalists from northern Yemen, scene of the biggest airstrike atrocities and the deepest hunger. The conflict is mostly unknown to Americans, whose military has backed the Saudi-led coalition’s campaign with intelligence, bombs and refueling, leading to accusations of complicity in possible war crimes.
Since June, the war has centered on the Red Sea port of Hudaydah. After a tense journey along a coastal highway prone to bombs and ambushes, we made a rare visit this month to the chaotic battlefield at the city gates.

There we saw what Prince Mohammed’s war looks like up close, from one side, among those Yemenis who are fighting and dying in it.

In 2015, Prince Mohammed sent Saudi warplanes to bomb Houthi rebels who had seized control of western Yemen and who he saw as a proxy for Saudi Arabia’s regional rival, Iran.

Originally a movement of Shiite guerrillas from the mountainous northwest, the Houthis rose to power in the turmoil that followed the Arab Spring in 2011. After capturing the capital, Sana, in 2014, they soon controlled Yemen’s three largest cities. Iran aided their advance with supplies of military equipment, including missiles.

Since 2015, Saudi Arabia and the United Arab Emirates have led a military coalition in a war aimed at ousting the Houthis and restoring an internationally recognized government. But early promises of a swift victory have given way to a bloody stalemate, while the war has inflicted a catastrophic toll on Yemenis, including widespread hunger and the worst cholera epidemic in history.

In Hudaydah, the war has settled into a kind of desultory rhythm. The fighting crests at dawn and dusk, when fighters on both sides rain mortar shells across the front line.

Within minutes, pickup trucks screech to a halt outside the field hospital, off-loading wounded fighters — men smeared in dirt and blood, peppered with shrapnel or felled by a sniper’s bullet.

Civilians soon follow: mothers hit by falling mortar shells, badly malnourished children suffering from acute diarrhea, elderly people with legs blown off by land mines.

Yemeni medics established the field hospital at Durayhimy, on the southern edge of Hudaydah, in June, when they landed on the beach outside the villa as mortar shells landed around them, and waded ashore.

Now financed by the Emirati Red Crescent, the hospital has an air of quirky, controlled chaos.

It has no restrictions on guns or drugs: Young fighters slinging Kalashnikovs crowd the emergency room, standing anxiously over medics working to save their wounded comrades.

Some nurses chew khat, the narcotic leaf beloved by Yemenis. At night, they gather in crowded dormitories to swap stories and gallows humor, and avoid enemy fire.

Just before we arrived, they said, a Houthi drone had exploded over their rooms. Dr. Hazza Abdullah, 34, the doctor on duty, told of going for a swim in the sea during a lull in the fighting, only to be confronted with a spiky sea mine floating toward him. “I got out very quickly,” he said.

Back in 2011, when the Arab Spring protests swept Yemen and other Arab countries, Dr. Abdullah embraced the promise of change.

“I thought it would be like the French Revolution, that it would open doors," he said. "Instead we are going through hell.”

The battleground arcs across a sandy wasteland of deserted farmhouses on the southern edge of Hudaydah, between the city's land-mine-infested airport and a strategic junction called Kilo 16.

There, we saw pickups loaded with fighters racing through the desert, wheels spinning and engines revving, dodging sniper fire and enemy mortars. Closer to the front line, fighters in sarongs hunkered behind sandy berms or clustered under trees. Warplanes whizzed overhead.

A pair of cows, caught in the crossfire, lay rotting in the dust.

We joined a group of jihadist fighters for lunch at their flophouse near the front line. Mortar tubes, surrounded by the refuse of emptied packaging tubes, were positioned outside the gate. Inside, fighters scooped up handfuls of rice and chicken, led by a cheery commander with a large bandage on his forehead where he had been grazed by a sniper’s bullet.

Boxes of Russian anti-tank missiles, stacked in a corner, bore markings that identified their Emirati purchasers.

A fighter whipped out his phone.

“Look at this,” he said gleefully, playing a video of a missile curling toward five Houthi fighters gathered under a tree. The video ended when they vanished into a ball of fire.

Later, as darkness fell, the fighters returned to their positions. 
In seeking to capture Hudaydah’s port, the coalition hopes to deprive the Houthis of millions of dollars in monthly tax revenues and force them to the negotiating table. But Hudaydah is also the gateway to a starving nation: Three-quarters of Yemen’s 28 million people rely on some form of relief aid, and the vast majority of it passes through the port.

Under intense international pressure, the coalition promised Western officials they would not fight in the city or the port, and would instead seek to encircle it. Now both sides are dug into positions on the city’s fringes, exchanging fire but gaining little territory.

A secondary front extends for about 80 miles to the south, parallel to the coalition-controlled coastal highway, where the fight takes place in remote villages and small towns, as both sides try to cut off each other’s supply lines.
The United Nations says this secondary front is the deadliest area for civilians. At least 500,000 people have fled their homes, many forced to shelter in squalid refugee camps in towns further down the coast like Mokha, a small port once famous for its coffee exports, and nearby Khokha.

Once a sleepy fishing town, Khokha buzzes with a lawless air, a melting pot of the war. Fighters mill about in the town center, chewing khat. The main drag is often jammed with military convoys headed for the front. Refugees, soldiers and Houthi spies mingle in the town bazaar.

Gunfire erupts at night, though usually it’s celebratory from weddings. The United Nations and most Western relief agencies have deemed the area too unsafe to serve. A notable exception is Doctors Without Borders, which recently opened a hospital in Mokha.

For most refugees, the main worry is their next meal. At the city dump in Mokha, Thabet Bagash rummaged for glass bottles and tin cans.

Before fighters ejected him from his home, he was a farmer. Now, he said, he was reduced to this. His face wrinkled with disdain. If he collected a bagful of cans, he might earn $1.40 — enough to feed his five children for a few days.

Just 80 miles from the garbage dump, two upstairs rooms at the field hospital might as well be on another planet. In one, the Emirati Red Crescent has installed a gleaming new operating theater, in the other a six-bed intensive care unit.

But the expensive and much needed medical equipment is pristine and untouched. The authorities couldn’t find medical staff to work there — Yemeni or Emirati.

That seemed emblematic of the Emirati way of war. The United Arab Emirates pays wages for fighters, and equips them with rockets and million-dollar armored vehicles.

But Emirati generals direct the fight from the relative safety of Aden, the main city in southern Yemen, where the bulk of the estimated 5,000 Emirati soldiers in Yemen are based. Emirati warplanes and naval boats pummel targets in Hudaydah from the air and sea.

Saudi naval boats also patrol the waters off Hudaydah.

But on the front line, Emirati and Saudi soldiers are hard to find. Coalition bases along the coastal highway are guarded by Sudanese recruits, many from Darfur.

At the field hospital, the dead and wounded we saw were Yemeni.

It was probably too late for Mohammed Kulaib by the time his friends rushed him to the hospital at 7:30 on a Sunday morning. The 20-year-old had been shot in the chest during a skirmish at Hudaydah airport. After a brief attempt to resuscitate the fighter, a medic declared him dead.

Mr. Kulaib's brother, Yahya, stood over the body in the emergency room. "The Houthis hit us suddenly," he said. "The mortars were so intense, it was hard to even retrieve his body."

The brothers were part of the Tihama Resistance, whose fighters come from the coast — one of at least a dozen Yemeni militias, with widely divergent ideas, that fight under the coalition banner.

In a corner of the emergency room, when the medics were gone, Yahya Kulaib leaned over his dead brother. He kissed him on the forehead, pulled a gray blanket across his face, then gently tied a knot in his shroud.

The sight of long convoys, laden with troops and ammunition, as well as a sharp uptick in airstrikes, have stoked reports in recent weeks that the coalition is preparing to make a new push on Hudaydah. But even if they capture the city, experts are skeptical it will turn the tide of the war.

Despite over 18,000 coalition airstrikes since 2015, the front lines remain largely unchanged. Around Hudaydah, the Houthis have seeded vast tracts of land with mines, on a scale second only to that of the Islamic State in Syria and Iraq, according to Conflict Armament Research.

United Nations-led efforts to broker a peace have repeatedly failed – largely because sides feel they have more to gain from fighting, said Gregory D. Johnsen, a scholar on Yemen at the Arabia Foundation. 
“Years of airstrikes failed to dislodge the Houthis, and their leaders now feel secure,” Mr. Johnsen said. “They think they can wait out the Saudis.”
In the meantime, a humanitarian catastrophe looms. A war-induced plunge in the value of Yemen’s currency last month has hastened a steep economic collapse. The United Nations humanitarian coordinator, Lise Grande, warns that 14 million Yemenis risk starvation in the coming months.
For Crown Prince Mohammed, the war ranks as a calamitous blunder, alongside the failed embargo he led against Qatar, the kidnapping of the Lebanese prime minister and now, as mounting evidence suggests, the officially sanctioned operation that led to the death of Mr. Khashoggi in Istanbul.

But for Yemenis, this is their home. The fight for Hudaydah is shaping up to be the most destructive chapter of the war that has shattered their country.

More brothers will bury brothers, it seems likely, before it is over.

Gold Is Becoming Cool Again

The sentiment shift is still subtle, but it’s both real and widespread. After a few years of being ignored and/or dismissed as basically useless, gold is cool again, attracting positive press and increasing accumulation by big investors.

India, for instance, imported less gold than usual in the first part of this year but lately has ramped up its buying, with August imports more than double the year-earlier amount.

Indian gold imports gold is cool

Hungary just did something even more dramatic:
Hungary Boosts Gold Reserves 10-Fold, Citing Safety Concerns
Hungary’s central bank increased its gold reserves 10-fold, citing the need to improve its holdings’ safety, joining regional peers with relatively high ownership in the European Union’s east. 
Following a similar move by Poland, the central bank in Budapest now holds 31.5 tons of the metal, taking the share among total reserves to 4.4 percent, in line with the average in the region, according to a statement published on its website Tuesday. 
Hungary gold reserves gold is cool
Meanwhile, the long-dormant South African gold miners are seeing sudden interest:

Is the Canary in the Gold Mine Coming to Life Again?
Back in late 2015 and early 2016, we wrote about a leading indicator for gold stocks, namely the sub-sector of marginal – and hence highly leveraged to the gold price – South African gold stocks. Our example du jour at the time was Harmony Gold (HMY) (see “Marginal Producer Takes Off” and “The Canary in the Gold Mine” for the details). 
As we write these words, something is cooking in South African gold stocks, that much is absolutely certain. Here is a chart of the JSE Gold Index in ZAR (South African rand) terms: 
South African gold miners gold is cool

While we cannot be sure why investors have suddenly become enamored with the precious metals sector, it is probably a good guess that gold stocks are by now so cheap that they are considered a worthwhile target for rotation purposes.

And it’s not just South African miners. The industry’s big names are suddenly outperforming tech stocks. From yesterday’s Wall Street Journal:
Investors Are Digging Gold Again
In times of market turmoil, investors often embrace gold. And when that happens, gold-mining stocks tend to do even better. 
That has certainly been the case so far this month. New York gold futures are up about 3% so far in October versus a roughly 4% decline for the S&P 500. Shares of many of the world’s biggest gold miners, meanwhile, have notched double-digit gains. 
Companies like Toronto’s Barrick Gold Corp ABX +0.75% , South Africa’s AngloGold Ashanti AU -0.15% and Acacia Mining are all up around 15% to 19% after a bruising summer. The VanEck Vectors Gold Miners exchange-traded fund and the iShares MSCI Global Gold Miners fund—which track indexes of global gold-mining firms—are up around 9% to 11% this month.

gold miner stocks gold is cool
Gold-miner stocks allow investors to double down on bets the gold price will rise. These companies have higher fixed-investment costs and can become much more profitable when gold prices climb. Many of these companies pay out hefty dividends, too. 
An added bonus: Hopes for further consolidation are adding to the momentum after Barrick Gold in September agreed to buy Randgold Resources Ltd. for $6 billion.Investors have poured $278 million into the VanEck gold miner ETF over the past month, according to FactSet, while flows into EPFR-tracked gold funds climbed to an 11-week high last week.

Notice the WSJ appealing to investor animal spirits by touting the benefits of gold miner leverage:

“Gold-miner stocks allow investors to double down on bets the gold price will rise. These companies have higher fixed-investment costs and can become much more profitable when gold prices climb. Many of these companies pay out hefty dividends, too.”
This is the kind of thing that hasn’t been said of gold miners for a long time, because when the metal’s price is declining extreme leverage works in reverse to crush earnings. Now, however, the other, happier edge of the leverage sword is starting to cut.

WSJ also predicts a surge in M&A — which is always exciting because it offers a sudden payoff without the long wait for earnings to accrete over time — and then points out that money is pouring into related ETFs, thus reassuring new investors that they’re not alone, but part of a growing trend. These are the kind statements that get people excited.

If history is any guide, end-of-cycle dynamics should now take over, with rising volatility sending capital pouring out of “risk-on” assets and into safe havens. So expect a lot more media accounts explaining the advantages of sound money and the benefits of miner leverage.

Creating an Arab NATO

It is hard to imagine an Arab alliance that can cohere as a military giant.

By George Friedman        

The United States has announced plans to hold a summit in January to launch what’s being called an Arab NATO, officially the Middle East Strategic Alliance. On the sidelines of the U.N. General Assembly meeting last week, U.S. Secretary of State Mike Pompeo held preliminary talks with the other main countries involved – namely, the six members of the Gulf Cooperation Council plus Egypt and Jordan – to discuss the summit. The idea has been batted around before, but for the first time, the U.S. president is planning to preside over a meeting intended to discuss its creation. The story didn’t receive much coverage last week, with other stories monopolizing the press, but in other times, it would have dominated the news.
In the past, the idea of an Arab NATO was motivated by a desire to unite Arab nations against jihadists. Political realities delayed its creation, but this time around, it’s being motivated by the expansion of Iranian influence, which poses an existential threat to Arab states. Iran already has a dominant position in Iraq, substantial influence in Syria and Lebanon, and is supporting Shiites fighting in Yemen. And though its economy is under extreme pressure, particularly with the addition of U.S. sanctions, Iran would become a more direct threat to Arab regimes, if only it could consolidate its position. Iran’s interest in the Arab world is to guarantee its own security and, as important, to gain control of Persian Gulf and Arab oil. It's a distant threat, but distant threats should be addressed early rather than later. Hence the meeting between the leaders of the future Arab NATO.
In creating the invitation list, however, the summit hit its first snag. Saudi Arabia and the United Arab Emirates are deeply hostile to Qatar. Qatar is close to Iran geographically and in policy. Given the direction the winds are blowing, cozying up to Iran was prudent. For the Saudis and the UAE, it was a betrayal. This and undoubtedly other less visible issues triggered a diplomatic crisis last year, when a Saudi-led group formed a blockade against Qatar. The U.S. position seems to be that including Qatar – which hosts U.S. bases – would protect Doha and shift it away from Iran.

This is one of the virtues of an Arab NATO. It would bring Arab nations together and lock them into place, just as NATO did in Europe. It would start as a defensive platform, providing military, economic and political support to limit Iranian influence. Later, it could take on an offensive role, reversing Iranian gains in the region.

There are several questions still unanswered. Would the alliance include a collective defense clause, similar to NATO’s Article 5, stating that if one member is attacked, all the others must take action? Would the United States make such a commitment? Would it have a command structure with forces from each country committed to war plans, as NATO does?

It also poses some strategic questions. If this alliance actually works, then the Arabs go from being a divided and mutually hostile people to a united and potentially powerful entity. There’s a very real chance this could threaten both Turkey and Israel. Since both countries have large militaries, this could wind up, in the worst case, as an Arab power surrounded by non-Arab powers (Israel, Turkey and Iran). That would make quite a battle.

I am likely looking too far in the future of an organization that doesn’t yet exist and is still struggling over what to do with Qatar. It is hard to imagine an Arab alliance that can cohere as a military giant. But in geopolitics, imagination is a more powerful tool than common sense, since history constantly confounds common sense. The likelihood of this alliance surviving and growing powerful is small, but it is not impossible. If it happens, it could change the region, threaten other powers, and generate conflicto.