Inflation Virus Strikes Fed

By John Mauldin

One little-noted aspect of central bank policy is how rarely “policy” happens. Officials at the Federal Reserve and elsewhere long ago learned how to achieve their goals without actually doing anything. Creating perceptions is often enough to modify people’s behavior.

For instance, if traders simply believe the Fed will intervene should interest rates go above or below a certain level, rates probably won’t breach that level, or even get close to it. No one wants to make the Fed pull its trigger.

This is why central banks are so obsessed with “credibility.” They don’t want to actually use their monetary firepower, and they don’t need to use it as long as financial markets respect it. Their most-used weapons are just words.

We saw another example in late August when the Fed unveiled changes to its long-term monetary policy strategy. Among other things, they now say they will let inflation “run hot” for extended periods in order to achieve a 2% long-term average.

Reasonable minds can differ on whether that’s a good idea, or whether the Fed can actually do it. But the Fed certainly wants us to believe its new plan. We know this from the enormous effort placed on communicating it.

The problem is that one person’s “policy” is another person’s unintended consequences. Today I want to argue that the unintended consequences from recent Fed “policy” changes, not to mention those initiated in prior decades, have been at the very epicenter of some of the national problems we have. The Fed would vigorously deny this course, but the results are plain for all to see.

We’ll begin with how some of my trusted sources view this Fed move. But first, I’ll let the Fed speak for itself.

Words Are Policy

You may have noticed a pattern recently. Jerome Powell’s speeches and media interviews usually coincide with some kind of significant policy move. I’m sure Powell gets all kinds of invitations. Not by accident, he accepts those he finds useful.

And sure enough, shortly after the Fed revealed its latest change, Powell was online to explain/defend it via his pre-arranged Jackson Hole virtual address.

Here is what the Fed itself characterized in a press release as “the more significant changes.” 

  • On maximum employment, the FOMC emphasized that maximum employment is a broad-based and inclusive goal and reports that its policy decision will be informed by its "assessments of the shortfalls of employment from its maximum level." The original document referred to "deviations from its maximum level." [One small word, so much meaning.]

  • On price stability, the FOMC adjusted its strategy for achieving its longer-run inflation goal of 2 percent by noting that it "seeks to achieve inflation that averages 2 percent over time." To this end, the revised statement states that "following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time" [We’re going to have to unpack these words carefully. It’s hard to even begin with the variety of potential for negative unintended consequences in these innocuous words.]

  • The updates to the strategy statement explicitly acknowledge the challenges for monetary policy posed by a persistently low interest rate environment. Here in the United States and around the world, monetary policy interest rates are more likely to be constrained by their effective lower-bound than in the past. [Am I the only one who is confused? They feel challenges from monetary policy caused by low rates that they have in fact engineered. It’s kind of like saying that adding water to gasoline poses challenges for the proper operation of your automobile.]

We’ll get into what all that means below. For now, savor the irony of a central bank explicitly admitting it “seeks to achieve inflation” at all, never mind the level. Central banks once sought to stop inflation, not achieve it.
Now generating it is the goal. Congress, which created the Fed, mandates that it create “stable prices” In a kind of Orwellian twisting of language, the Fed now interprets the mandate to mean 2% inflation. That means the value of your dollar loses about half its purchasing power every 36 years. At a minimum As we will see, it can get worse.

No doubt aware of this, the Fed went to great lengths to explain itself. Linked here you will find an overview, the statement itself, a marked guide highlighting changes since the last review (very handy), Powell’s Jackson Hole presentation, speeches by Vice Chair Richard Clarida and Governor Lael Brainard, and a bunch of background documents.

Why such elaborate explanation? Because the words don’t just explain the policy. The words are the policy. They do the work.

The Fed wants us to believe 2% inflation is a worthy goal and that the Fed will make it happen.

If we do, the Fed will have accomplished what it wants.

Price Instability

My friend Peter Boockvar may be one of the fastest thinkers I know. Every day, he digests the latest economic data and central bank statements and then issues a quick-take analysis, usually within an hour (and sometimes within minutes). I really don’t understand how he does this, but it’s quite useful.

So the very same morning the Fed announced this policy, Peter was out with a short but incisive essay on “The 10 Flaws of Inflation Symmetry.” Some excerpts:

  • Where inflation was in the past should have no bearing on where it should be allowed to go in the future. Is zero inflation one year and 4% the next the new definition of 'price stability'?

  • Letting inflation run above 2% for a period of time hurts the least able to afford it the most. In other words, LOWER real wages is a growth depressant.

  • There is nothing to equate low inflation with low growth and higher inflation with higher growth.

  • Longer term interest rates are not just going to sit there and let inflation run hot, they will tighten for the Fed. This would then hurt the housing sector and any overindebted company.

Peter starts where I would, with the glaring inconsistency between the Fed’s “price stability” statutory mandate and its official policy promoting the opposite. And that reducing real wages by raising living costs hurts most of the people the Fed supposedly serves.

But more important, Peter notes how this policy is self-defeating. If the Fed by keeping short-term rates low somehow gets inflation moving toward its goal, long-term rates will still rise to reflect the greater inflation risk.

This will raise mortgage rates, make it harder for companies to issue equity, and otherwise stifle economic growth.

Why anyone should want that outcome is unclear, but it’s where the Fed wants to take us.

Ideas Have Consequences

The concept of a 2% inflation goal simply did not spring full-blown out of the blue, like the goddess of wisdom Athena from Zeus’s head. It has been discussed in academic circles for quite some time.

I was able to attend a small invitation-only symposium in Boston some seven or eight years ago. It was under strict Chatham House rules but I can tell you had a “Who’s Who” of economic and financial talent.

One panel in particular was seared into my mind—a Nobel laureate economists and another economist whose name you probably know. There was general agreement that a 2% inflation target should be the minimum inflation target.

One Nobel laureate espoused letting inflation run 4% for a period of time.

There was discussion and pushback from some of the audience. An overall very enlightening sesión.

But the point is that the concept of a 2% (or more!) average inflation level, running even hotter at times, has been discussed in economic circles for many years. It has now reached into the Fed proper.

I am sometimes asked why I pay attention to discussions among academic economists. These discussions can become a preview to “policy.”

Ideas have consequences, and ideas pushed by those with prestigious academic authority have more consequences.

“One Hell of a Dilemma”

Another oddity is that the Fed has already generated ample inflation, but it’s not visible in the indexes policymakers watch, like the Fed’s preferred “Core PCE” measure.

Back in January, before the pandemic hijacked the news, I explained in Nose Blind to Inflation how none of the benchmarks truly capture the full inflation picture. Everyone experiences inflation differently based on their lifestyle and spending patterns. Yet the Fed indiscriminately forces the same strategy on everyone.

My friend Danielle DiMartino Booth and her Quill Intelligence colleagues recently explained how the Fed ignores the rising healthcare and housing costs that plague most American households.

Core PCE [Personal Consumption Expenditures] understates to the greatest degree of any inflation metric the cost of healthcare and housing. “Systematic” is the word that comes to mind when you look at the hard data. According to the Organization for Economic Cooperation and Development, in the United States, the average married worker with two children paid an 18.8% tax rate in 2019. In a January 2020 report, Harvard’s Joint Center for U.S. Housing reported that the median asking rent for an unfurnished unit completed between July 2018 and June 2019 was $1,620, 37% higher, in real terms, than the median for units completed in 2000. Median income in 2019 was $63,688.

Back of the envelope math based on take home pay of $51,714 gets you to 37.6% that renters were spending out of their paychecks on rent last year. The PCE gives housing a 21.4% weight.

In other words, core PCE captures only 56% of the median family’s rent, but families don’t have a choice to pay only 56% of their rent. Healthcare costs are similarly undercounted because PCE imputes them from Medicare and Medicaid reimbursement rates that are far lower than those paid by most individuals and their private insurers. And that’s without even considering today’s higher premiums and deductibles.

This isn’t a small problem. It is enormously consequential, as the Daily Feather analysis explained.

The core PCE they hide behind is, at best, duplicitous. Fed officials would, however, face one hell of a dilemma if they owned up to a metric that captured true pricing, including that of assets. Inflation would long ago have run so hot we wouldn’t be in the mess we are while interest rates would be normalized sending the zombies where they belong – not just dead but buried.

Inflation is already “running hot” for most Americans, but the Fed doesn’t see it. Core PCE serves the same function as those blinders you used to see on carriage horses.

The difference is that horses don’t voluntarily blind themselves. The Fed does, and as a result has kept interest rates artificially low and let zombie companies take over the economy.

Why would the Fed do this? Because using a more accurate benchmark would force them to get serious about price stability, and that would limit their ability to “stoke” the engine of the economy.

PCE lets them pretend inflation is low and achieve their unwritten policy objective of keeping the stock market bubbling along.

The Unintended Consequences of Federal Reserve Policy

A few thoughts on the Fed’s twisting the concept of stable prices into a 2% inflation goal.

1.   As noted above, 2% inflation cuts the buying power of your savings in half in just 36 years. Combined with a 0% interest rate policy, it means retirees following safe and prudent standards are guaranteed to lose buying power.

Whether you are just beginning to save for retirement, or you are already retired, such a policy makes you run faster just to stay in the same place. Yes, I understand that in a heavily indebted nation there is a perceived “need” for some level of inflation to lower the burden of debt. But lowering one man’s debt burden simultaneously reduces another man’s buying power.

All the words that the Federal Reserve used to describe this new policy never reveal exactly what time period they will use to achieve “average” 2% inflation. That makes a huge difference. It could mean letting inflation run at, say, 4% for several years while keeping short-term interest rates near zero. Does anyone seriously believe that will have no consequences!?!?

2.   It follows from the above that at 4% inflation, longer-term interest rates would rise. This, of course, is not what the Fed wants. There is another “policy” being discussed in academic circles today: yield curve control. Will they have to control government rates all along the curve? That will have consequences, too.

Further, the Fed now owns about a third of all US securitized mortgages. One. @#$%5ing. Third. Great for homebuyers. Will they continue this policy? How long? Will the US securitized mortgage market become like the Japanese bond market? That is to say, controlled by the central bank? The Federal Reserve is not buying jumbo loans. Does that mean jumbo loans will rise with inflation, shutting out wealthier people from buying homes, or at least larger homes, and driving down those home prices? Unintended consequences…

This massive manipulation of the bond market and the most important price in the world, the interest rate of the global reserve currency, is nothing but plain and simple price control. Can someone show me an instance where significant price controls actually worked over the long-term? Especially in a market this big? In the world’s reserve currency?

3.   Which brings us to another unintended consequence, or at least I assume it is unintended. This is going to have a result of putting significant downward pressure on the dollar, causing commodity prices and US consumer prices to rise and exporting deflation to the rest of the world. The Aussie dollar is already up by 27%. The Europeans are complaining.

4.   It is clear that the extraordinary quantitative easing has boosted equity prices. Not to mention home prices. That means that those with homes and equities have seen their net worth increase. For most of us reading this letter, that’s a good thing. But it also increases wealth and income disparity, which is tearing at the nation’s psychological roots. I don’t believe anyone at the Federal Reserve wants to increase wealth disparity, but that is the clear and obvious unintended consequence/result of their “policy.

5.   My friend David Bahnsen highlighted another point in a recent market commentary. Quoting:

But the impact of present Fed policy on the stock market extends well past the zero interest rate policy. In fact, rate policy has not even been the monetary tool that has most impacted markets. The explosive interventions into debt markets, either through direct bond purchases (quantitative easing) or liquidity provisions (commercial paper, corporate debt, asset-backed securities) has had an incalculable impact on equity markets,

Besides the basic reality of $3 trillion (and counting) of new reserves in the banking system and liquidity that finds its way into financial assets far easier than it does the real economy, how significant is it to corporate profitability to have borrowing costs reduced to their lowest level in history? Fed interventions in the corporate bond market (shockingly, both investment grade and high yield) have created extraordinary access to capital for companies that know how to use that capital quite productively.

This pendulum shift cannot be overstated—many companies went from challenging business conditions with high cost of debt and limited access to new debt that they needed for this difficult time, to instead, less challenging conditions with brutally low cost of debt and unlimited access to capital needed for this time and useable for growth measures after this time. That shift from “what could have been” to “what is” in credit markets is the most underappreciated factor driving equity markets today.

6.   The combined impact of all this means that the Federal Reserve is putting its thumb on the scale between Wall Street and Main Street, between the haves and have-nots, between the wealthy and the middle class, let alone the poor. Not the intent, I get that. Powell and company are doing what they think will keep the economy moving forward. But unintended or not, the consequences are still there. Is the average man on the street unjustified in thinking that “the elites,” whatever the hell that means, are not looking out for his best interest? When a struggling corporation accesses the debt markets because the Federal Reserve made it easy to do so, they are acting in the best interest of their shareholders. They are simply trying to stay afloat in a crisis. But restaurants, hair salons, and small businesses in general don’t have that same access because they don’t have the same experience or connections.

We have come to this situation because a progression of “policy” decisions by the Federal Reserve and the US government backed us into a corner. No matter who wins the election in November, they will have no good choices. A $2 trillion deficit is not a good choice. And $2 trillion may not be enough to keep the wheels from falling off the economy.

Small business America is getting slammed. It is clear that at least 100,000 small businesses will permanently close. That number could double over the next year. Every one of those businesses represents jobs, including many jobs for lower income Americans. Which is where the brunt of this crisis is being directed.

That is why I wrote a few weeks ago that the economy should be viewed as having three parts. One is doing quite well, we could maybe even characterize it as in a boom. One is in a recession of indeterminate length, but is managing. A smaller but significant chunk is clearly in a depression.

And you wonder why emotions are running high?

I hope you can see the Federal Reserve’s words, and the changes in its “policy,” have consequences. And particularly troubling is the consequences that they did not intend.

By the way, Over My Shoulder subscribers already saw some of the reports I just quoted, including the Boockvar and Daily Feather analyses. I very rarely promote my own publications in this letter, but I am particularly proud of what co-editor Patrick Watson and I do with Over My Shoulder. We both spend a great deal of time digesting economic information. Between us, we probably read well over 100 items a week. And we narrow them down to three to five to send to our readers. Some are well-known sources, some more obscure, but all are powerful. You are literally looking Over My Shoulder, but only the best of the best.

Understand, after 30+ years of this, Patrick and I have a well-developed radar for interesting and thought-provoking ideas. Much of what is written in the mainstream media never makes our inboxes. Boring. So in a way, what we are reading is already “curated” before we narrow it down to what we send you.

Many readers say it is the most valuable service they subscribe to. Better yet, we have a limited-time offer that gives you this valuable information at a shockingly low price. Click here for details.

Puerto Rico and Lockdowns

The number one response to the letter last week was, curiously enough, people wanting my mother’s banana bread recipe. I was going to include it here, but we are running long. I will have the recipe next week for sure.

Have a great week and/or holiday weekend if you are in the US. We have new, more severe lockdown policies here in Puerto Rico, one of which was absolutely no one could leave their home on Sunday unless necessary, and walking for exercise is not officially necessary. Sigh. But at least I got more reading done.

Your fed up with Fed policy analyst,

John Mauldin
Co-Founder, Mauldin Economics

The risk of China-US military conflict is worryingly high

The two sides are sleepwalking into confrontation in the South China Sea

Zhou Bo

The US and China have settled into a pattern of military manoeuvring in the South China Sea that allows both sides to ‘save face’
The US and China have settled into a pattern of military manoeuvring in the South China Sea that allows both sides to ‘save face’ © Zha Chunming/Xinhua/AP

The relationship between China and the US is in freefall. That is dangerous. US defence secretary Mark Esper has said he wants to visit China this year, which shows the Pentagon is worried. That Wei Fenghe, China’s defence minister, spoke at length with Mr Esper in August shows that Beijing is worried too. Both men have agreed to keep communications open and to work to reduce risks as they arise.

The crucial question is: how?

In July, US secretary of state Mike Pompeo inverted a famous line of Ronald Reagan’s about the Soviet Union and applied it to China: “trust but verify” became “distrust but verify”. Washington suspects that an increasingly coercive China wants to drive the US out of the Indo-Pacific.

Beijing meanwhile believes that the US, worried about its global primacy, has fully abandoned its supposed neutrality on the South China Sea. Haunted by economic recession and the pandemic, and desperate for re-election, President Donald Trump has also made confronting China his last-straw strategy to beat his opponent, Joe Biden.

The risk of a mistake is therefore high. It is one thing for the two countries to point their fingers at each other. It is quite another if naval vessels collide in the South China Sea, triggering a direct conflict. In 2019, the US navy conducted a record number of freedom of navigation operations there. Mr Esper has vowed to keep up the pace this year.

So far, whenever a US ship has come close to China-controlled islands, Chinese naval ships have monitored it and warned it to leave.

This pattern might continue without accident, allowing both sides to “save face”. The US can claim its freedom of navigation operations have challenged China’s “militarisation” of the area. China can also say it has driven away intruders from its waters.

But that ignores the chance of mishap. The air collision in 2001 between a Chinese jet fighter and a US reconnaissance plane caused the death of one Chinese pilot. In 2018, the USS Decatur and Chinese destroyer Lanzhou escaped collision by just 41 metres.

Both sides have pledged to keep at a safe distance during these encounters. Yet what is a safe distance exactly?

For the US, the Chinese islands are artificial land reclamations, so a US warship can legally sail as close as 500 metres. But for Beijing, these are natural Chinese territories that China has chosen to enlarge, and the fact they had names before land reclamation are proof they are not artificial. Under Chinese law, a foreign military vessel’s entry into territorial seas needs government approval.

China and the US could then even fight each other under the same international laws. Washington cites Article 58 of the UN convention on the law of the sea to justify its right of freedom of navigation and overflight. But Beijing can quote the same article, which says: “States shall have due regard to the rights and duties of the coastal State.”

How to de-risk the chance of a conflict that neither side wants but which they could nevertheless sleepwalk into?

During the cold war, the US and USSR competed via proxy wars, avoiding direct conflict. Should a similar competition arise today, America’s Asian allies most probably wouldn’t follow the US into war with a neighbour that has nuclear weapons and is their biggest trading partner.

Meanwhile, if US ships and aircraft continue to maintain high-intensity surveillance of the South China Sea, there is always the potential for a confrontation. Beijing has no plan to take Washington. From Beijing’s point of view, it is the US that comes provocatively close to China.

Eventually, it may be that the sheer size of China’s military prompts a US rethink. The Chinese army enjoys the convenience of geography, to say the least. Its navy also outnumbers the US navy in terms of warships and submarines, although the US fleet is more heavily armed. Admiral Philip S Davidson, commander of the US’s Indo-Pacific Command, has acknowledged that there is “no guarantee” the US would win a future conflict against China.

China’s foreign minister Wang Yi has said Beijing will remain “cool headed” whenever there are “impulsive moves” from the US. But in many ways, China hawks such as Mr Pompeo have made it hard for subsequent administrations to de-escalate US competition with China.

It is therefore reasonable to ask: what difference will Mr Esper’s trip to China this year make?

But the visit itself is a valuable step forward in communication and risk reduction. Talking past each other is better than not talking at all.

The writer is a senior fellow at the Center for International Security and Strategy at Tsinghua University, and a China Forum expert

Gold-Stock Correction Mode

Adam Hamilton


- Gold stocks are in correction mode. They shot parabolic into early August, surging too far too fast exhausting the capital firepower available for near-term buying.

- Then they quickly plunged into a mild correction, which has morphed into a high consolidation since. But a resurgent correction is likely given the lingering serious overboughtness and elevated greed.

- That could easily extend to 25% in GDX, another 20% lower from this week’s levels. The depth of this rebalancing selloff for gold stocks depends on what happens in gold.

The gold miners' stocks are mired in correction mode, which isn't surprising after their mighty post-stock-panic upleg. Huge buying catapulting them higher left this sector extremely overbought. Corrections are normal and healthy after prices get too stretched technically. They eradicate upleg toppings' excessive greed, rebalancing sentiment. That paves the way for bulls' next uplegs and offers great buying opportunities.

The most-popular gold-stock benchmark today is the VanEck Vectors Gold Miners ETF (GDX). It includes the world's biggest and best gold miners, dwarfing its peers in size. Launched way back in May 2006, GDX's first-mover advantage has grown insurmountable. This ETF's $17.9b in net assets this week are running 31.4x larger than its next biggest competitor's in the 1x-long major-gold-miners-ETF space. GDX is king.

Gold stocks have a well-deserved reputation for excessive volatility, which is a key reason they are so alluring. When the stars align right for them, meaning a big and persistent gold upleg, their stock prices skyrocket! We just witnessed that in this sector's enormous upleg following March's COVID-19-lockdown-fueled stock panic. The subsequent gold-stock gains were among the largest out of all stock-market sectors.

As gold temporarily got sucked into that stock panic, GDX was pummeled to a deep low of just $19.00. Those radically-oversold conditions gave the gold stocks massive room to mean revert far higher. And that's exactly what they did over the following 4.8 months into early August, where GDX rocketed a stupendous 134.1% higher! Contrarian traders who bought in soon after the stock panic multiplied their capital.

But such colossal gains in such a short span generated incredible greed, and left GDX way overextended technically. So over the next four trading days into mid-August, GDX corrected 12.2%. Since then it has been consolidating high, meandering in a tight trading range between that upleg top and initial correction low of $44.48 and $39.05. Until GDX powers to new bull-market highs, it technically remains in correction mode.

Many if not most traders hate these necessary selloffs after bull-market uplegs. Unlike powerful rallies to major new highs, corrections aren't any fun. But they do offer the best opportunities to buy relatively low in ongoing bull markets. Bulls' inevitable alternating series of uplegs followed by corrections also greatly expand their tradable gains. Correction bottomings are when to buy low before later selling high at upleg toppings.

Because GDX has spent the past six weeks or so mostly drifting in the low $40s, those levels increasingly feel normal. But they are actually quite high in the context of this 4.6-year-old gold-stock bull. This first chart shows the whole thing through the GDX lens. Gold stocks have run really far really fast thanks to that huge post-panic upleg! That's a big reason why they stalled out in early August to start correcting.

Relative to their bull market, the major gold stocks shot parabolic in recent months. The tail end of that gargantuan 134.1% upleg went vertical, leaving GDX extremely overbought at a 7.5-year secular high!

This leading sector benchmark soared way above both its 200-day moving average and 50-day moving average, rendered in black and white here. There's no doubt gold stocks are really stretched technically.

When any prices surge too far too fast, they stoke excessive popular greed. Traders rush in to chase the quick gains, expecting them to persist indefinitely. But pulling forward big buying rapidly exhausts traders' available capital firepower. Soon everyone who wants to buy in anytime soon has already fully deployed their limited funds in the red-hot sector. Only sellers remain, and they soon overpower the dwindling buying.

The building selling momentum fuels corrections, which work off technical overboughtness while bleeding away excess greed. The gold-stock realm is like Texas, everything is bigger there! So corrections are as outsized as uplegs, making them nothing to be trifled with. Looking at the upleg-correction cycles so far in this secular gold-stock bull offers important insights into what is likely in our current young correction.

Gold stocks' massive post-stock-panic soaring this year was this bull's fourth upleg. All four averaged hefty 99.2% gains over 7.6 months. The first three uplegs were followed by corrections clocking in at a serious mean of 36.5% over 8.0 months. If today's fourth correction rises to that bull-market precedent, it would batter GDX all the way back down to $28.24! That's a heck of a long ways farther down from here.

But for a variety of reasons, the gold stocks probably won't have to collapse so far this time around before adequately rebalancing sentiment. This gold-stock bull's first three corrections were each dragged down to more-severe levels by unusual events. The first and largest one into late 2016 grew anomalously big after Trump's surprise election win. Gold and gold stocks were shunned as stock markets surged on tax-cut hopes.

The second correction into late-summer 2018 was exacerbated by extreme speculator positioning in gold futures, driving rare cascading stop-loss selling. And of course the third one earlier this year was driven by a full-blown stock panic, which are normally only seen about once a century. Typical corrections in gold-stock bulls run closer to 20% to 30%, which we can call 25%. That's much less painful than 37%.

Because of gold miners' high inherent profits leverage to gold prices, gold-stock corrections tend to mirror and amplify gold's own. The major gold stocks dominating GDX usually exaggerate gold's own upleg-correction cycles by 2x to 3x. And of course gold is much less volatile than its miners' stocks. So a normal 10% gold correction multiplied by 2x to 3x yields that same 20%-to-30% correction range, averaging 25%.

25% off of early August's euphoric gold-stock peak would drag GDX down to $33.36. That is still way under this past month's lower-$40s drift. Interestingly that would also push GDX back down near its 200-day moving average, which is running $32.15 as of the middle of this week. 200dmas happen to be the highest-probability bottoming zones technically for bull-market corrections without exacerbating factors.

A GDX 200dma approach today would likely signal the end of this necessary rebalancing correction. That is the ideal time to buy relatively low, aggressively redeploying in beaten-down gold stocks. While no one knows in advance how closely GDX will retreat to its 200dma, the closer it gets, the better the odds this correction has largely run its course. Considering price levels compared to their 200dmas is a great trading tool.

I've been researching this key technical relationship for a couple decades now, and actively trading gold stocks based on it with great success. I call this method Relativity Trading since it looks at gold-stock price levels relative to their 200dmas. This simple-yet-powerful relationship can be quantified by dividing GDX's daily closes by their current 200dmas. That yields the Relative GDX indicator, or rGDX for short.

Charted over longer periods of time, this rGDX ratio forms horizontal trading ranges. They effectively reveal how overbought or oversold gold-stock prices are, which are the best times to sell high and buy low. This rGDX chart tracks this multiple during this gold-stock bull to date. Visualize Relativity charts as flattening out 200dmas to 1.00x, and recasting price action around that in comparable constant-percentage terms.

Relativity trading ranges are based off the past five calendar years' price action. The Relative GDX has mostly meandered between 0.85x to 1.50x during this span, which coincides with this secular gold-stock bull. Gold stocks are extremely oversold when the rGDX falls under 0.85x.

At mid-March's stock-panic low, this metric plunged to a radically-oversold 0.694x! So we backed up the truck to aggressively buy then.

While our specific stock trades are only recommended to our paying newsletter subscribers graciously keeping us in business, I did flag that incredible buy-low opportunity publicly in a weekly essay in early April. Published on April 3rd when GDX was still under $25, I warned "All this argues that a major new gold-stock upleg is getting underway, portending big gains coming!" and "the gold stocks will power far higher."

While extreme technicals and sentiment alone supported that bold contrarian call, so did gold miners' amazing fundamentals. Higher prevailing gold prices guaranteed much-higher profits for the gold stocks, which indeed came to pass. Several weeks ago I did a deep quarterly dive into the actual Q2 operational and financial results of the major GDX gold miners. Sector-wide implied earnings soared 66.2% YoY last quarter!

But after GDX skyrocketed 134.1% in just 4.8 months out of those crazy stock-panic lows, that left gold stocks extremely overbought. That rGDX indicator stretched as high a 1.454x in late July, and was still way up at 1.448x when the major gold stocks crested in early August. In other words, GDX stretched a massive 45% over its 200-day moving average! That was challenging the 50%+ extremely-overbought levels.

Overboughtness is a short-term technical condition totally independent from underlying fundamentals that govern longer-term gold-stock fortunes. Once gold stocks run too far too fast exhausting all near-term buying potential, they need to correct no matter how profitable mining gold is. Excessive greed still needs to be bled away to rebalance sentiment. And excessively-extended technicals need to mean revert back to norms.

And that is exactly what has started happening in this sector over the past month since GDX peaked. The rGDX plunged as low as 1.259x in mid-August as GDX's initial sharp 12.2% 4-trading-day selloff bottomed. Since then GDX has drifted around 31% above its 200dma, with the rGDX running 1.299x in the middle of this week. While way less overbought than 45%, 31% remains far above the correction-ending 0%.

Extreme overboughtness can be worked off two ways, correcting or consolidating. Gold stocks can either sell off fast enough to mean revert back near their 200dma, or they can drift sideways long enough for that 200dma to catch up. While investors prefer the lower volatility and milder selloffs of consolidations, faster corrections are much more beneficial to speculators. They usher in superior buy-low opportunities quicker.

While GDX did plunge into formal correction territory over 10% in those initial days after it crested in early August, the gold-stock price action since has been more consolidation-like. But consolidations can morph into corrections at any time, depending on what gold stocks' dominant primary driver gold does. GDX can still easily slump into a bigger correction here, likely much closer to 25% than the mild 12% seen so far.

Gold's own overboughtness relative to its 200dma in early August proved far more extreme than the gold stocks'. The rGold indicator soared to nosebleed heights of 1.260x, an 8.9-year high! The last time gold was so overextended technically was back in September 2011 soon after its previous secular bull had peaked. That extreme exhausted gold's bull, birthing a bear that would crush it 44.5% lower in the next 4.3 years.

While gold's current secular bull isn't likely to fail yet for plenty of fundamental and sentimental reasons outside the scope of this essay, gold really needs to correct after such epic overboughtness! But at worst so far after peaking in early August, gold only dropped 7.5% in this selloff's initial few trading days. It is hard to imagine it not falling into 10%+ correction territory given those crazy technical and sentimental extremes.

A 10% gold selloff would drag this metal back down near $1856, which is another 4.5% lower from where it was trading in the middle of this week. And if the gold stocks amplify gold's losses by that usual 2x to 3x, that extends GDX's correction near 25%. While seeing GDX back down near $33.36 is no big deal at all in gold-stock-bull context, that is still another 20.1% lower than its mid-week prevailing level of $41.76!

With the major gold stocks undeniably in a correction, why buy now if they are likely to drift or plunge still another 20% or so lower before it bottoms? Trading, both speculation and investment which only differ by time horizons, is all about buying low then later selling high. The best times to buy relatively low within ongoing bull markets is when corrections have largely run their courses. GDX is nowhere near that point yet.

GDX has to retreat closer to its 200dma, which will be evident in that rGDX indicator and normal charts. This leading gold-stock ETF doesn't necessarily have to fully return to its 200-day moving average, but it has to get a heck of a lot closer than 30% above. Plenty of other factors will help determine when to resume pulling the trigger on buying fundamentally-superior gold stocks, which I discuss constantly in our newsletters.

But whenever and wherever this gold-stock correction bottoms, the gold miners' fundamentals continue to strongly support another major bull-market upleg. Once sentiment is rebalanced and technicals are no longer stretched, gold stocks' upside potential in the subsequent months is massive. So I'm really looking forward to redeploying hand over fist into excellent gold miners once the necessary green lights flash.

My recent essay on the GDX gold miners' Q2 results dove deeply into their fundamentals. You ought to read that if you missed it a few weeks ago. But in a nutshell, here's the current situation. With Q3'20 now 2/3rds over, gold has already averaged an all-time-record high $1910. Even if we assume gold corrects hard enough in the rest of Q3 to drag that average down to $1875, that is wildly profitable for gold miners.

Over the past four reported quarters, the GDX gold miners averaged all-in sustaining costs of $933 per ounce. AISCs are actually likely to fall in Q3 with gold output rebounding following Q2's shrinkage from government-imposed national lockdowns. But at $1,875 gold and $933 AISCs, the major gold miners are on track to earn a colossal $942 per ounce in this current quarter. That would surge 59.5% from Q3'19 levels!

So the gold stocks still have big bull-market gains to come after they weather this necessary and healthy correction. Even after that enormous 134.1% post-stock-panic upleg, additional massive upside is still fundamentally justified in this contrarian sector! Higher prevailing gold prices drive much-higher earnings for the gold miners, which ultimately support much-higher stock prices. Those come gradually over time in bulls.

All bull markets naturally flow then ebb, taking two steps forward before retreating one step back. Their price action gradually meanders around uptrends. This normal upleg-correction pattern keeps sentiment balanced, extending bull markets' longevity. And it is a huge boon for traders, offering excellent mid-bull opportunities to buy relatively low before later selling relatively high. That greatly expands bulls' potential gains!

The bottom line is gold stocks are in correction mode. They shot parabolic into early August, surging too far too fast exhausting the capital firepower available for near-term buying. Then they quickly plunged into a mild correction, which has morphed into a high consolidation since. But with gold stocks remaining very overbought technically, and greed still elevated after an insufficient selloff, a resurgent correction is likely.

That could easily extend to 25% in GDX, another 20% lower from this week's levels. The depth of this necessary and healthy rebalancing selloff for gold stocks depends on what happens in gold. The larger gold's own correction, the farther the amplifying gold stocks will drop. But bigger and faster is better for traders, yielding much-better buy-low opportunities sooner than if gold stocks instead keep drifting sideways.

The Real China Reshoring Isn’t What You Think

Foreign brands need to retool for more Chinese spending at home

By Jacky Wong

People line up outside a Gucci store in Wuhan. China sales at Kering, which owns brands like Gucci and Saint Laurent, were up over 40% year-over-year in the second quarter. / PHOTO: STRINGER/GETTY IMAGES

There has been lots of talk about shifting manufacturing away from China. But the most obvious reshoring that’s happening now is actually being done by the Chinese themselves.

People in China have started to travel again, though almost all within the country due to Covid-19 border restrictions. China’s domestic air-passenger traffic in June was down 34% from a year earlier, but has been rising steadily in the past few months. That is a contrast to international passenger traffic, which was still down 98%.

And that, in turn, is a big hit to companies selling to Chinese tourists, who made 169 million trips abroad in 2019. Shares of cosmetics companies and department-store operators in Korea and Japan, two of Chinese tourists’ favorite destinations, have plunged this year.

Foreign brands that are well-established are softening the blow by selling to Chinese consumers trapped at home. That’s particularly the case for luxury goods as their buyers are less hurt by the pandemic. China sales at Kering, which owns brands like Gucci and Saint Laurent, were up over 40% year-over-year in the second quarter. BMW delivered 17% more cars in China from a year earlier in the quarter, when sales everywhere else fell.

The strong sales in China weren’t enough to offset weakness in other regions for these companies, but it’s likely they will devote more attention to selling their products to consumers in China going forward. Morgan Stanley has estimated China’s “consumption reshoring” could amount to $140 billion to $165 billion this year. While global travel should gradually come back to normal, such reshoring could still bring about $70 billion to $130 billion annually in the next three years, according to the bank.

And Beijing is rolling out policies to encourage domestic spending. The government has relaxed limits on duty-free purchases in the tropical island of Hainan, sometimes dubbed China’s Hawaii, and more such policies could be coming. That means consumers, who used to have to fly to Korea or Japan to bring back their favorite cosmetics, could instead make their shopping trips inside the country.

Investors are certainly riding on the theme: Shares of Hainan Meilan International Airport, an operator of an airport in the southern Chinese province, have gained 732% this year. State-backed China Tourism Group Duty Free Corp. has surged 148%.

The rallies are probably overdone, but the new policies will likely encourage more shoppers to stay in the country even after the pandemic. Foreign brands may need to put more effort into building their sales channels accordingly.

Brands will need to sell more inside of China. That may not be the reshoring China hawks in the U.S. had envisioned, but it’s the most obvious one happening now.

Is California Over?


By now it’s painfully obvious that we humans tend to ruin our favorite places by overrunning them.

And no place makes this point better than California. An absolute paradise 25 million people ago, parts of it are now a hellscape of Mad Maxian proportions.


Rolling blackouts due in part to bad planning and in part to overpopulation are disrupting businesses and making homes unbearable in 100-degree summer heat.

Wildfires, due in part to excess people being shunted into “suburbs” surrounded by brushland, are burning thousands of houses and roasting the unlucky wildlife that used to call those canyons and hillsides home. See Sanctuary for endangered condors burns in California wildfire.

As for California’s cities, well, here’s podcaster Joe Rogan’s brutal discussion of LA’s homeless situation:

And the above is just the physical manifestation of an unsustainable development model. The financial side of things is even uglier. Public-sector unions now control state politics and have engineered pension plans that are both wildly overgenerous and catastrophically unfunded. So even in the absence of fires, blackouts and rising homelessness, the state would be careening towards bankruptcy.

What is California’s solution? Retroactive wealth taxes that reach out and pick the pockets of people who have already left.

Now even the New York Times, which generally sympathizes with California’s political model, acknowledges that the left coast is sliding into the abyss. A snippet from NYT columnist Farhad Manjoo:

California, We Can’t Go On Like This

Across much of California in the last two weeks, many of my friends and neighbors have faced a dead-end choice: Is it safer to conduct your life outdoors and avoid the coronavirus, or should you rush inside, the better to escape the choking heat, toxic smoke and raining ash?

Such has been the gagging unwinnability of life in the nation’s most populous state in the sweltering summer of 2020, in what I have been assured is the greatest country ever to have existed. The virus begs you to open a window; the inferno forces you to keep it shut.

When the coronavirus first landed in America, California’s lawmakers responded quickly and effectively, becoming a model for the rest of the nation. But as the early wins faded and the cases spiked, each day this summer has felt like another slide down an inevitable spiral of failure. The virus keeps crashing into California’s many other longstanding dysfunctions, from housing to energy to climate change to disaster planning, and the compounding ruin is piling up like BMWs on the 405.

Consider: To keep the pestilence at bay, many of California’s children began attending school online last week. But to satisfy surging energy demand linked to record-shattering heat (and a host of other mysterious reasons), state utilities had to impose rolling blackouts, forcing schools to come up with energy contingency plans to add to their virus contingency plans, now that millions of students face the threat of intermittent electricity.

For decades, California has relied on conscripted prisoners as a cheap way to fight its raging fires. But to stave off coronavirus outbreaks in our long-overcrowded prisons, authorities released thousands of inmates earlier this year. Now, as climate change has ushered in a new era of “megafires” that includes some of the largest blazes the state has ever faced, the early release of inmates has left the state dangerously short of prisoners to exploit in battling the flames.

What is California’s fundamental trouble? Neither socialism nor Trumpian neglect and incompetence, but something more elemental to life in the Golden State: A refusal by many Californians to live sustainably and inclusively, to give up a little bit of their own convenience for the collective good.

Californian suburbia, the ideal of much of American suburbia, was built and sold on the promise of endless excess — everyone gets a car, a job, a single-family home and enough water and gasoline and electricity to light up the party.

But it is long past obvious that infinitude was a false promise. Traffic, sprawl, homelessness and ballooning housing costs are all consequences of our profligacy with the land and our other resources. In addition to a hotter, drier climate, the fires, too, are fanned by an unsustainable way of life. Many blazes were worsened by Californians moving into areas near forests known as the “urban-wildland interface.” Once people move near forested land, fires tend to follow — either because they deliberately or inadvertently ignite them, or because they need electricity, delivered by electrical wires that can cause sparks that turn into conflagrations.

As the fires blazed around us this time last year, I warned of the “end of California as we know it” — that if we didn’t begin to radically alter how we live, the climate and the high cost of living would make the state uninhabitable for large numbers of people.

The take-away? Beyond a certain point even a place like California, blessed as it is with both Hollywood and Silicon Valley, can’t support the unsupportable. So either the state, along with most of its nearly-as-badly-managed peers, gets a bailout of historic proportions with all the currency crisis/moral hazard implications that that implies. Or California and its iconic car-centric/suburban lifestyle devolve into chaos.

Here’s hoping for the latter, which will at least provide a cautionary tale for other places now traveling the same road.

Minimizing the Social Cost of COVID-19

Efforts to turn an effective institutional response to the pandemic into a political or ideological battleground are misguided, at best. As the late Nobel laureate Ronald H. Coase showed, regardless of ideology or politics, each society must develop institutional arrangements that constrain individual freedom.

Andrew Sheng, Xiao Geng

sheng104_Lintao ZhangGetty Images_chinacoronaviruspublictransitsocialdistance

HONG KONG – In 1960, the Nobel laureate economist Ronald H. Coase introduced the “problem of social cost”: human activities often have negative externalities, so individual rights cannot be absolute. Institutions must intervene. There is no better example of this dynamic than the COVID-19 crisis.

While virtually every country has suffered as a result of the pandemic, some have done much better than others. Whereas some have reduced COVID-19 cases to near zero, others have had steadily climbing infection and death rates for months. As McKinsey & Company has noted, economic activity associated with discretionary mobility has returned to normal for the former group. Among the latter, such activity remains about 40% below the pre-pandemic level.

Not everyone is suffering equally. Low-paid workers with inferior access to medical care and less opportunity to stay home – say, because their jobs are classified as “essential” – are bearing the clinical and economic brunt of the crisis.

This puts everyone at risk. After all, even if a country contains the first wave of COVID-19 infections, it will remain vulnerable, as the virus continues to be imported from worse-performing countries. In other words, the social costs of inadequate institutional arrangements in some countries are spilling over to those with well-functioning institutions.

The first step toward addressing this problem is to identify which institutional arrangements are most effective for reducing the social costs of the COVID-19 crisis. This is not, as one might assume, just a matter of having strong institutions. The United States and the United Kingdom are institutionally robust, and both had weeks, if not months, to prepare before their outbreaks began, but both have had among the world’s highest infection and mortality rates.

By contrast, East Asian countries were the first to be infected, meaning they had little, if any, time to prepare. And yet many of them are among the countries that have reduced COVID-19 cases to near zero. The difference comes down to attitudes: what role and responsibilities each society attributes to government, and to what extent it expects the community to act as a collective agent of the common good.

In the US, there is a long-standing emphasis on personal freedom. “Small government” is a commonly heard refrain, with many arguing that individuals acting as self-interested participants in markets and in social and political processes will naturally produce positive outcomes. Government intervention – even in the event of a pandemic – infringes on individual rights and, indeed, on the very meaning of being an American. Protests over shelter-in-place orders and mask mandates reflect this view.

This is very different from the prevailing mindset in East Asia. For example, many Western observers have attributed China’s success in containing COVID-19 to its authoritarian regime, which supposedly infringed on individual freedoms, privacy, and economic efficiency in a way no democratic government ever could.

Coase’s theory shows why that logic is flawed. As he explains, the market may be able to minimize social costs if all actors have full information and face near-zero transaction costs. But those conditions are unrealistic even in normal times.

During a pandemic, no individual can possibly receive comprehensive and current information on the virus. In fact, the very existence of asymptomatic carriers precludes the possibility of “full information.” And, because the transaction costs of mask wearing, quarantining, testing, and contact tracing are high, making compliance a matter of individual choice will never be enough to contain the virus.

But Soviet-style centralized intervention is not feasible: agents of the state cannot observe every move every person makes and enforce every precautionary behavior at all times. And, contrary to popular belief, that is not what China has done. Instead, recognizing that fully voluntary action was inadequate, the state provided comprehensive and mandatory rules to facilitate individual and communal compliance, as well as fiscal and logistical support for implementation.

To illustrate, upon arriving in Shenzhen from Hong Kong, one of us headed to a designated hotel – equipped with medical staff conducting tests and monitoring temperatures – for a 14-day mandatory quarantine. On the way to the hotel, both the landlord and a community contact person got in touch, having been informed by the authorities to prepare for a new arrival from abroad.

From the airport to the quarantine hotel to home, every single individual – immigration officers, bus drivers, security screeners, medical personnel, and hotel staff – wore full personal protective equipment. Common areas were regularly disinfected. The state provided all needed resources.

Of course, a traveler would prefer to go home, rather than stay in a quarantine hotel for two weeks. But ostensibly high compliance costs for individuals do not outweigh the overall social costs of partial interventions. So, with institutional support and clear guidance – delivered via many channels, including social media – people have taken the necessary precautions. Responsibility for implementation has also been clearly delineated across government agencies.

The results – sharply reduced COVID-19 infections and deaths – speak for themselves. Other East Asian countries – such as Japan, Singapore, South Korea, and Vietnam – have achieved similar success, using very similar institutional approaches. In every case, the government intervened early, devised comprehensive rules and guidance, and provided the resources needed to apply relevant measures. And in every case, society was receptive to government intervention aimed at advancing the common good.

Crucially, these countries have very different cultures and political systems. Attempts to turn an effective institutional response to the pandemic into a political or ideological battleground are thus misguided, at best. The Coasian lesson is that, regardless of ideology or politics, each society must develop institutional arrangements that minimize social costs. After all, those suffering the consequences of others’ decisions are unlikely to revel in their “freedom.”

Andrew Sheng, Distinguished Fellow of the Asia Global Institute at the University of Hong Kong and a member of the UNEP Advisory Council on Sustainable Finance, is a former chairman of the Hong Kong Securities and Futures Commission. His latest book is From Asian to Global Financial Crisis.

Xiao Geng, Chairman of the Hong Kong Institution for International Finance, is a professor and Director of the Research Institute of Maritime Silk-Road at Peking University HSBC Business School.