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Sayonara U.S.A.

The Japanese word for goodbye is Sayonara. But it doesn’t just mean goodbye, it means goodbye forever. Unfortunately, that is what our country is doing to American Capitalism.

In the quixotic fantasy world of Keynesian economics, the more money a government borrows and prints the healthier the economy will become. Those who adhere to this philosophy also believe such profligacy comes without any negative economic consequences in the long run. This specious dogma contends that it is ok for a government to dig further into a big deficit hole during a recession because massive public spending will help the economy to climb out faster. And then, a government can cut spending in the good times, which leads to big budget surpluses.

The trouble with this theory is the time never arrives to bring the scales into balance. Case in point, during the pre-pandemic year 2019, the U.S. had a deficit that was equal to 5% of GDP—one of the worst figures since WWII. This deficit occurred during a time which was purported to be one of the best economies in history. Today, there are negotiations for yet another “stimulus” package after having already spending $3 trillion (15% of GDP) earlier this year. Speaker Pelosi and the Democrats want to spend another $2.2 trillion and Republican President Trump says, “I would like to see a bigger stimulus package, frankly, than either the democrats or Republicans are offering.”

Unsurprisingly, Wall Street is also once again clamoring for another shot of heroin because all those trillions of dollars that were distributed in the spring and summer have already been spent. It seems both parties are ignorant of both history and real economics. The salient point must be stressed that no government has ever engendered a viable economy through the process of piling yet more debt on an already bankrupt pile. And no, having its central bank monetize the whole stinking dung heap is not a panacea.

We already know how this story turns out. A paragon for this experiment of unfettered fiscal and monetary profligacy in the nation of Japan.

Japan’s debt to GDP ratio is projected to rise to 250% by the end of 2020.

The Bank of Japan’s Balance Sheet has skyrocketed since 2000, as the BOJ has been compelled to frenetically purchase half of all JGBs (Japanese Government Bonds).

Meanwhile, all Japan’s borrowing (a quadrillion yen outstanding) and money printing has not moved the needle on the nation’s GDP.

Japan’s major equity Benchmark (Nikkei Dow) has endured three major crashes since the year 2000. The Index has only managed to increase about 15% from the start of the new millennia; and yet is still down 40% since 1989.

The conclusion from Japan’s experience is clear. Massive fiscal and monetary stimulus does not at all boost GDP in the long run. In contrast, in rots the economy to its core. Although it can provide for a small gain in stock prices, it also comes with major crashes along the way. And ultimately, it can lead to intractable inflation and economic Armageddon.

Turing back to the U.S., Jerome Powell said this gem in a speech given on October 6^th, “The US federal budget is on an unsustainable path, has been for some time, but this is not the time to give priority to those concerns.” Powell also stated that the risks of overdoing stimulus are smaller than the dangers of not borrowing much more money right now—all of which will be printed by him with alacrity. That’s tantamount to a doctor prescribing for a morbidly obese man with late stage heart disease to shove down boxes of fried Oreos rolled in pig lard until he feels well enough to begin the diet.

So, what economic benefit did the U.S. get for borrowing well over $3 trillion in new debt during fiscal 2020 and having it all monetized by the Fed’s printing press—an endeavor that has brought the National debt to a daunting $27 trillion? Oh, and by the way, the Nation’s total debt both public and private has now surged to $78 trillion, or a record 390% of GDP (for comparison, it was 350% at the start of the Great Recession)—ah the good old days! Well, it will generate a projected GDP loss of about 4% this year and has turned out a measly 5% gain in the S&P 500.

This begs a question for all those geniuses in government: if government borrowing and spending equates to higher GDP growth, then why is it that the debt to GDP ratio perpetually climbs? Exactly when are those Keynesian multipliers supposed to kick in?

This is what the U.S. will get for turning all Japanese…an anemic economy, an equity market that limps forward, and a nearly extinct middle class. According to a recent report on the Japanese experience since its bubble burst in 1989 by Oxford Economics professor Shigeto Nagai, “The share of low-income households has been rising at the expense of middle-income groups in a process of secular income decline across percentiles.” In other words, poverty is rising in Japan across all classes with the country’s middle class suffering the brunt. The U.S. is also preparing to enter into a secular period of Japanese style lost decades with the middle class eroding away. The poorest 50% of all Americans, about 165 million people, collectively owned about $2.08 trillion in wealth in the second quarter of 2020, according to Federal Reserve, that’s less than the net worth of our 59 richest billionaires, according to Bloomberg data sighted in the NY Post.

The Fed and D.C. are trying to squeeze more air into the gargantuan equity bubble, which is exacerbating these trends. A bubble that has grown to the most massively distorted proportion ever witnessed in economic history.

All insolvent governments eventually collapse. Our nation has also become addicted to asset bubbles, free money, and artificially-low interest rates. Indeed, the entire developed world is positioning itself for an interest rate death spiral of unprecedented proportions.

Expediting this perdition will be a move to state-sponsored digital currencies. Bloomberg reported on October 9^th that the BOJ has started to experiment with cryptocurrencies; joining Russia and China in this endeavor. And sorry, it is not Bitcoin. It will be a blockchain based currency that is completely controlled by the government of Japan. The primary reason for this is clear: Central banks are preparing to usurp all control of money from the private sector. Meaning, governments will impose profoundly negative interest rates on savers in an attempt to keep asset bubbles growing. However, to accomplish this nefarious task central bankers will need to ensure the public cannot take their money out of the banking system. Hence, investors will need to be on high alert for government blockchains and intractable inflations across the developed world in the future.

This means the saddest part of all is that the Japanification of the U.S. is actually the best outcome we can now hope for. The more likely eventuality will be the utter economic devastation coming from the implosion of the international bond market due to artificially produced record-low interest rates on insolvent sovereign debt that will slam into intractable inflation.

Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check” and Author of the book “The Coming Bond Market Collapse.”

Three Big Lies in One Small Press Conference

September 28, 2020

During the FOMC’s September press conference, Fed Head Jerome Powell managed to communicate three big lies in the space of an hour. The fact that bile spews from the mouth of a central banker isn’t all so surprising. However, having to suffer through three humongous untruths in about an hour was remarkable—even for the Fed.

Mr. Powell was asked by a reporter why the US economy needed an inflation rate of 2% to function properly, and why Americans would now need to have their savings depreciated to some degree above 2% for an extended duration.

So here was lie number one: Powell’s specious reasoning behind wanting higher inflation is that it would engender higher interest rates, which would then allow the Fed room to lower rates whenever a recession inevitably arrives. This means the Fed is oblivious to another zero figure to match its 0% return forced upon savers. There’s zero evidence, either historically or logically, that an economy needs a sustainable 2% + rate of inflation on the Core PCE Price Index to function properly.

Regardless… let’s leave aside the insanity behind wanting to pursue inflation just so there is room to lower rates once the recession arrives—a recession that is always facilitated by its monetary largess in the first place. It is far from the truth behind the Fed’s real motivation. The actual purpose behind its stated goal to create a condition of permanently rising inflation is to pump up asset prices into a perpetually-expanding bubble. This condition has now become necessary in order to ensure Wall Street and banks get bailed out of what would otherwise be a condition of insolvency.

The second lie was that the Fed would continue to buy Treasuries and MBS equal to a pace of at least $120 billion each month. However, this is clearly not been the truth—at least not of late. If Powell was indeed adding $120 billion to his balance sheet each month, it would have increased by $360 billion, instead of being static over the past three months.

As to why the Fed Head would mislead regarding the recent pace of increase in asset purchases is unclear. What is very clear, however, is that he will not reach his newly-raised inflation target by simply claiming he is monetizing debt at a record pace. The balance sheet did skyrocket from March thru June by over $3 trillion. But over the past quarter of a year, the balance sheet has gone nowhere. Indeed, what the Fed really needs is the unholy cooperation of Treasury with a Universal Basic Income guarantee to get consumer inflation to really pick up the pace. Thankfully, that is not happening yet.

The third, and perhaps biggest lie, was that the Fed’s massive increase in its balance sheet, which did occur over the past dozen years, did not lead to any asset bubbles. Powell was asked directly in the press conference if the Fed’s QE programs and zero interest rate policy (ZIRP) put into place the dangerous conditions of asset price inflation and financial instability. His response was that the Fed’s seven years of ZIRP and $6.2 trillion in QE was “notable for the lack of the emergence of some sort of a financial bubble.” He continued, “I don’t know that the connection between asset purchases and financial stability is a particularly tight one.” Really?

The S&P 500 now trades at a trailing price to earnings ratio of 27.2, which is closing in on double its historical average of 16, according to data from Refinitiv. Not only this, but the all-important Total Market Cap to GDP Ratio has now surged to an incredible 175%, which is far above its historical average and even dwarfs the previous high of 145% set in March of 2000 just before the NASDAQ lost 83% of its value.

In reality, Powell knows his statements are a fallacy because the overvalued and unstable stock market fell apart in the late summer of 2018 when the Fed was undergoing a half-hearted attempt to normalize interest rates and pare down the size of its balance sheet by just a few hundred billion dollars. This is, of course, after blowing it up by multiple trillions over the past dozen years.

But it’s not just the stock market that is in a massive bubble. The economy is also in one as well. Data put out by the Federal Reserve show that total non-financial debt in the US increased at an annualized rate of 25.27% in Q2, –shattering all known records! That debt explosion was primarily due to a 58.86% surge in Federal Government debt and a 14.02% jump in business debt. And no, this humongous debt binge wasn’t even close to being commensurate with a rise in our phony GDP. Business debt is now 83% of GDP, whereas it was just about 60% at the peak of the NASDAQ bubble. Government debt was 40% in the year 2000, but now it is well above 100%.

Of course, record-low borrowing costs (provided by the Fed) compels businesses to take on more debt and enables the Treasury to also issue bonds at the central bank’s falsified interest rates. Mr. Powell appears to be ignorant of these conditions. And if the Fed remains blissfully unaware, how then can it assume responsibility?

Nevertheless, the Fed’s unstable economy and stock market bubble was on full display in the past few weeks. Tech stocks of the FAANG variety, which Wall Street has overcrowded into with unprecedented measure, were obliterated. Take AAPL, for example; it crashed by nearly 20% from the start of September. The mighty Google (Alphabet) plunged by 18%. And, even the S&P 500 hit an air pocket that saw a 3-day plunge of nearly 8% at the start of this month.

Hence, the value of having an actively managed strategy that is built on a solid model was again illustrated.

It is abundantly clear that the economy and markets are in massive bubbles. While the high-frequency components of the Inflation/Deflation and Economic Cycle model are not flashing red at this time (it’s just amber at this moment), our leading components do indicate we may be heading in that direction. The pending election chaos, along with a massive fiscal and monetary cliff, could be paving the way to even greater volatility. If you are still invested in a passively managed and long-only portfolio, the time to act is now.

Overvalued Stocks Head into the Bunker

September 14th 2020

The overvaluation of stocks relative to the economy has placed them in such rarefied space that the market is subject to dramatic and sudden air pockets. Our Inflation Deflation and Economic Cycle model is built to identify both cyclical and secular bear markets and protect and profit from them.

However, what it cannot do, nor can anyone else, is anticipate every short-term selloff in stocks. While the IDEC strategy protects and profits from bear markets, it also tends to soften the blow from short-term selloffs and prevents us from panicking at the bottom of every brief correction. This was the case in the latest plunge that started on September 3rdand lasted just three brutal days.

Having said that, I am very concerned about the market right now and heading into the election. The reasons are as follows: While it is true that the Fed is indeed stuck at the 0% bound for many years, it is also true that its balance sheet has stopped increasing at the multiple trillion-dollar torrid pace seen earlier this year. In fact, it has not only just plateaued; it has actually begun to shrink. The balance sheet has decreased by $100 billion in the past 3 months.

Another reason for caution is the upcoming vote this November 3rd. There is a good chance it could be marked by election-related chaos such as this nation has ever seen before. The normal peaceful transfer of power, which has been a hallmark of this country, is in huge jeopardy this time around because both parties will claim election malfeasance. If Mr. Trump loses the election, he has already stated that he may not accept the results due to massive mail-in ballot fraud. And, if Mr. Biden loses the election, the radical left, which is already taking over cities and burning them down, may light many more of them on fire due to its view that Russia has corrupted the results once again. In either case, the election seems to be a dead heat, and this nation appears to be moving closer and closer to civil war on both racial and economic fronts. The surging wealth gap is primarily to blame for this, and the Fed is primarily responsible for its creation and expansion.

In addition, the massive fiscal cliff that I have been warning about has arrived. The $3 trillion that was borrowed by the government and printed by the Fed has been exhausted. No further Paycheck Protection Program grants/loans have been approved, and those that have been disseminated have been spent. There are no more $1,000 checks per adult and $500 checks per child in helicopter money arriving any longer. The CARES ACT enhanced unemployment funds are dry. And, the Lost Wages Assistance program authorized by President Trump using FEMA dollars, which paid a $300-a-week federal supplement to unemployment benefits, will end by mid-September.

Wall Street has one hope to propel the bubble higher; it is clinging to the much-anticipated and greatly-hyped vaccine that is supposed to arrive (conveniently) on November 1st. Of course, a vaccine would be wonderful news for the world. However, it does not at all mean the Wuhan virus will cease to be an issue immediately before election day. In contrast, the vaccine will herald at the beginning of the long process of hopefully eradicating the virus from humans. And it will also mark the start of when some very tough questions begin to get answered. For example: How effective is the vaccine, and how safe will it be? We received a wakeup call on that front on Tuesday, when AstraZeneca’s vaccine trial was halted due to safety concerns. Other concerns revolve around how fast a vaccine will get distributed to the general public–the initial FDA approval will only be for Emergency Use Authorization. And, what percent of people end up taking a vaccine that was developed at hyper-warp speed? Nobody knows the exact answers to those questions at this time, but what is known for sure is that the pandemic will be an issue well into the first half of 2021–at the very least.

What will also be an issue are the scars left behind…scars that Wall Street is completely blind to. Mainly, there are the growth and productivity-killing aspects associated with an economy that must now lug around an additional $3.3 trillion in National debt and a $3 trillion run-rate of new business debt. Keep in mind the level of business debt was already at a record relative to the economy before the pandemic surfaced. And now it has vastly increased the number of zombie corporations alive, whose current business model is to feed off of the Fed’s free money to satisfy debt service needs. And most regrettably, there is the number of people who have become permanently unemployed due to COVID-19. According to the August NFP report, the permanently-unemployed rolls soared by 534,000 to reach 3.4 million — the highest level since 2013. This figure has jumped by a cumulative 2.1 million people since February. As of August 11th, there are about 155,000 total business closures reported on Yelp since March 1st. About 91,000 of the closures are permanent. These are the businesses that have closed entirely, but countless more are suffering from revenue and earnings shocks, which is causing them to lay off employees at the rate of about 1 million per week.

The Predictive components of our IDEC Model are signaling the economy is heading into the macroeconomic conditions of disinflation and recession. This should be the case for awhile unless and until we get another massive fiscal package from D.C. The market-driven components are also starting to confirm the economy’s direction is going south. However, it is too early to get net-short until the high-frequency components give us a similar signal. We will continue to try and proactively protect your assets, instead of getting passively slaughtered like the rest of Wall Street is set up to suffer once again.

Inflation by Fiat

September 8^th, 2020

The Fed has now officially changed its inflation target from 2% to one that averages above 2% in order to compensate for the years where inflation was below its target. First off, the Fed has a horrific track record with meeting its first and primary mandate of stable prices. Then, in the wake of the Great Recession, it redefined stable prices as 2% inflation—even though that means the dollar’s purchasing power gets cut in half in 36 years. Now, following his latest Jackson Hole speech, Chair Powell has adopted a new definition of stable prices, one where its new mandate will be to bring inflation above 2% with the same degree and duration in which it has fallen short of its 2% target.

To be clear, the Fed has no idea what causes inflation. It also deliberately goes way out of its way to under-measure it. Is it any wonder then that the Fed’s historical record proves it has little ability to meet its own inflation target? As I explained in a commentary written a couple of months ago, the Fed has a tremendous amount of difficulty controlling inflation in either direction. In 7 out of the last 12 years, the Fed has been unable to achieve an average annualized CPI of at least 2%. Therefore, 58% of the time, the Fed has failed to reach its minimum inflation goal.

Conversely, inflation spiked to double digits by 1975 and, after a brief pause in’ 76-’77, eventually soared to 14.6% by early 1980. During this process, our central bank found it necessary to raise rates from 3.75% in February 1971, all the way to 20% by the middle of 1980. That doesn’t sound like inflation is easily managed does it? But the Fed is fond of trying to convince investors that is the case.

Since the Fed has no idea what causes inflation and how to really measure its rate, how can it then ensure a genuine inflation target—one that represents economic reality—is achieved? It cannot; it is impossible.

For example, the Fed has currently created massive inflation in real estate, fixed income, and equity prices. But it deliberately avoids putting asset prices in its inflation calculation and uses the absurd owners’ equivalent rent figure for home price appreciation. Also, inflation is already running well over 2% in the commodity space. The CRB Index is up 30% in the past four months.

Hence, although the Fed has raised its inflation target, there is no reason to believe it can reach it. After all, if it has clearly demonstrated that it cannot readily obtain a 2% target–using the Fed’s preferred core PCE metric–why would anyone think it can now magically boost inflation north of 2% by decree?

So, here is a lesson for the Fed about how overall consumer inflation is actually engendered: a rising rate of U.S. inflation comes from a market that is persistently losing faith in the purchasing power of the dollar. This comes about from a sustained rate of increase in dollar supply that has diffused throughout the economy due to a Fed that is monetizing an ever-increasing amount of Treasury debt. The Fed is forced to do this in order to keep rates low enough to maintain Government solvency.

Why So Much Trouble Creating Inflation?

Since the U.S. is a debt-disabled economy, the normal transmission of monetary creation is broken. As you recall, coming out of the Great Recession, consumers and banks were saturated in debt. Therefore, they could not readily borrow a significant amount of new money into existence. As a result, the overwhelming gravitational forces of deflation prevailed–with the exception of the certain asset prices (primarily stocks and bonds) that private banks were purchasing using new credit from our central bank. In other words, Wall Street was the recipient of the Fed’s largess, and consumers were, for the most part, left behind. Therefore, broader aggregate money supply growth was muted; whereas reserves in the banking system soared from $800 billion to $4.5 trillion from 2008 thru 2014.

What is necessary for consumer price inflation to rise in tandem with asset price inflation is the combination of both fiscal and monetary cooperation in USD debauchery. In order to combat the economic fallout from the Wuhan virus, the Treasury and the Fed joined forces to send direct payments to consumers and businesses. This was the reason there was a condition of stagflation earlier this year. The government borrowed $3 trillion of new money into existence, which was monetized by the Fed and doled out directly to consumers. This raised the money supply circulating around all sectors of the economy. The entire stock of M2 money supply surged by 18% from February to June of this year, and the Fed’s balance soared above a record-setting $7 trillion in a matter of a few unprecedented months.

So, here’s a news flash to Mr. Powell: Core PCE Inflation won’t rise above 2% just because you say you want it to get there. He can squawk all he wants about now wanting to exceed a consumer inflation target that has been unachievable for many years. In sharp contrast, with trillions of dollars in stimulus running off just as forbearance measures are ending, the consumer will be in a desperate search for cash to pay in arrears their mortgages, credit card bills., student loans, and car loans instead of taking on new debt and expanding the money supply. It’s the same story for businesses that have exhausted their PPP grants/loans and are now saturated in debt.

It will take the unholy cooperation of a Treasury that is increasing debt and has it all purchased by the Fed with its fiat money. That is what is needed if Mr. Powell wants to greatly reduce the dollar’s purchasing power from here.

However, what the Fed did accomplish by raising its inflation target was to ensure (at a minimum) a protracted period of economic malaise, with the vast majority of its new money showing up in asset prices. To what degree consumer inflation does end up rising above Mr. Powell’s new target all depends on how much new debt the Treasury is willing to take on to satisfy Washington’s new Universal Basic Income mandate—all of which will need to be monetized by the Fed.

Unfortunately, what this also virtually guarantees is that if the Fed is ever able to reach its asinine 2%+ level on core PCE inflation–and keep it there for multiple years–the Fed will then eventually have to slam on the brakes with QE and begin raising interest rates sharply; just as it did 40 years ago. Otherwise, Treasury yields will skyrocket and crash the economy and stocks regardless. The only difference is that the value of equities was just 40% of GDP back in 1980, while today, it is an incredible and unprecedented 185% of GDP. The result will be the absolute and unprecedented carnage of asset prices, as they fall from the thermosphere once long-term rates begin to spike inexorably. In order to get some perspective on what should occur, just think about what happened to the stock market during the October Black Tuesday 1929 crash, the October Black Monday 1987 crash, the Great Recession calamity of 2008, and the 2020 Wuhan virus Depression; all rolled up into one.

To sum it up, the current condition of economic stagflation should morph back into deflation and recession if D.C. doesn’t assent to another massive multi-trillion-dollar fiscal spending package very soon. The Fed will fight the next round of deflation with its usual “tools,”; expanding its balance sheet with another multi-trillion-dollar QE program, which will push equities valuations further into the twilight zone and an even greater distance away from economic reality. And, as mentioned, God help us if the Fed is ever able to achieve its new inflation mandate!

This is why identifying the cycles of deflation and inflation is essential to your retirement success. A diversified portfolio that holds stocks and bonds will not protect you because both are concurrently in a massive bubble. Investors will need to have their portfolios actively managed to stand a chance of increasing their purchasing power and standard of living in this new pernicious paradigm.

Fiscal and Monetary High-wire Act

August 11, 2020

Bankrupt Balance sheets

The US National debt has now soared to 130% of GDP; that $26.6 trillion equates to around 1,000% of Federal revenue. Our government will add $4 trillion to that dung pile this year alone, which is an incredible 20% of GDP. The Wuhan virus has completely destroyed the balance sheet of the US Treasury. If not for the Fed’s promise to purchase an unlimited amount of sovereign bonds, the bond market would have already collapsed.

State and Local government balance sheets are suffering greatly as well. Revenues are plunging just as expenses are soaring, with a huge number of businesses closing their doors and 10’s of millions of people getting laid off. Indeed, many states are projected to lose between 20-25% of revenue. The Center on Budget and Policy Priorities reported that in just the last four months, state and local governments have furloughed or laid off 1.5 million workers— twice as many as in all of the Great Recession. And now, state budget shortfalls expected from COVID-19’s economic fallout will be a cumulative $555 billion over state fiscal years 2020-2022, according to Federal Reserve and CBO data. In addition, major US cities, such as New York, L.A., and Chicago, were already on thin fiscal ice prior to the pandemic. The Wuhan virus has now melted all that the support away.

Corporate balance sheets are not faring any better. The first half of 2020 saw the most retail sector bankruptcies on record, according to Bloomberg. There have been 75 filings among all companies with liabilities of at least $50 million in the last three months, matching the same period of 2009—making it the second-worst quarter ever. Business debt was already at a record high as a percentage of GDP before the Wuhan crisis broke out. And now, Non-financial business debt has reached an incredible $17 trillion—surging at a further 24.27% annual pace in the first quarter. Hence, corporate and government balance sheets are thoroughly saturated in debt.

Now for the good news. Consumer balance sheets are in much better shape in comparison. But this is solely thanks to Washington’s efforts to offset the consumption crash from COVID-19 by further exacerbating its own fiscal imbalances. Lawmakers approved back in late March the distribution of Helicopter Money for most Americans; to the tune of $1,200 per each adult making less than $198k married filing jointly, and $500 per dependent child under age 17—even if you did not lose your job. And, for those that did become unemployed, enhanced unemployment insurance paid you on average about $1,000 per week, which in most cases was more than their previous income derived from being employed.

So, this is where the rubber meets the road: since the government’s balance sheet is already utterly destroyed, its ability to keep borrowing and printing money with impunity is almost over. Therefore, in order to keep consumption habits in place, the Wuhan virus needs to cease being an issue within the next few months. Otherwise, the consumption-driven economy will collapse. Also, there must be a place for consumers to regain employment once the danger finally ebbs.

However, as I’ve thoroughly laid out in the past few communiques, this, unfortunately, should not be the case. The announcement of FDA approval of a COVID-19 vaccine does not at all equate to automatic sterilization immunity. What it does mark, though, is the time when the real challenges could begin: How long will it take to distribute the vaccine across the globe? Will it be a one-shot deal or will there need to be multiple doses given? What percentage of the population rushes off to take a vaccine that was developed at “warp speed”? And, of course, how effective is the inoculation, and how long does the immunity last?

This is where the MSFM gets it wrong. They are promulgating the false notion that the worst economic contraction in US history is all about the virus and has nothing to do with the economics behind a typical economic contraction. But the fact is, the path towards recession was already firmly in progress well prior to 2020. Hence, the reason why the Fed had already cut rates three times and was re-engaged with QE before the pandemic struck. The Wuhan virus served to severely weaken balance sheets that were already very much in disarray. So, what we have now is an abnormally severe recession that features the very normal component of an overleveraged economy.

What happens next is crucial. Will consumer balance sheets become debt-disabled just like those in the corporate and government sectors? The answer is probably yes because government’s willingness and ability to further support the private sector is ending.

Let’s be clear. The consumer wasn’t in terrific shape prior to the health crisis. Household debt was already at a record $16 trillion prior to the Wuhan outbreak. However, this figure is much lower as a percentage of GDP than it was leading up to the Great Recession. But now, with 30 million people still unemployed and one more round of government assistance on its way, the household balance sheet should start to crumble in the next few months just like the other sectors. That is, once the Helicopters bearing government transfer payments become grounded.

To sum up the situation: our government will not be able to continue borrowing $4 trillion deficits per annum. Neither can our Nation’s debt to GDP ratio leap past 130%, and then just continue soaring upwards from that level without dire consequences. And, the Fed cannot assent to expanding its balance sheet at a rate that has seen its asset holdings surge by 75% in the last six months alone. These trillions of dollars in debt were monetized for the purpose of suppressing borrowing costs and inflating asset bubbles into even more rarified air. But how much longer can it continue at this pace without destroying the purchasing power of the dollar?

The hope is that science can kill the virus in the next few months with treatments and vaccines that are now in development. Then, consumers will immediately head back to being fully employed. But how realistic is this scenario? Well, Yelp—a company that offers a platform for businesses and consumers to engage and transact–reported that 132,440 businesses who listed on their site had closed their doors since the outbreak. And of that number, 72,842 have closed their doors permanently. Of course, the data from Yelp provides only a partial glimpse of the full damage report.

What condition will the nation be in whenever the virus is finally subdued, and some semblance of normalcy returns? The catalyst towards “Normalcy” (a vaccine) may also bring about the end of government’s fiscal and monetary high-wire act without a net. After all, it is an untenable position that the Treasury’s lotto-for-life windfall for most Americans—all of which is monetized by the Fed—can last much longer without destroying the dollar and bond market.

We must look to history for answers, …and the verdict is clear. The longevity of viruses (especially those of the corona variety) tends to last much longer than those nations that seek to engender prosperity through the printing press can remain solvent.

Will Vaccines Become a Bridge to Nowhere?

July 20, 2020

The monthly U.S. budget deficit for June 2020 was a heart-stopping record $864 billion. For reference, last year’s deficit for all of fiscal 2019 was just under $1 trillion. In other words, the June deficit was almost as much as the entire amount of red ink spilled one year ago. This year will see the worst annual amount of fiscal hemorrhaging ever—and by a whole lot. The figure will be at least $4 trillion in total, which is $2.6 trillion more than the peak suffered under the Great Recession. One has to imagine that with the Department of Labor reporting, there are now 32 million people collecting unemployment insurance as of June 27^th–the amount of additional debt continues to pile up fast.

Along with the Federal Government, corporations around the world have seen their balance sheets suffer. They have issued an additional $2 trillion in new debt in the first half of 2020–a record amount. That is a 55% increase from last year’s pace. $800 billion of that total dung pile was in the U.S. Of course, our central bank has destroyed capitalism by ensuring the businesses that still make typewriters and white-out can continue to borrow money. This means a tidal wave of bankruptcies has been put temporarily on ice, but the size of the insolvency storm is rapidly intensifying. Indeed, 1 out of every 5 U.S. companies are now considered Zombies. Meaning, they don’t make enough profits to cover the interest expense on existing debt. The number of these zombies is surging because they feed off of the Fed’s falsification of credit markets.

Corporate profits are not doing much better. The Q2 earnings season has kicked off this week, and S&P profits are expected to plunge by 44%. It is indeed prudent in these uncertain times that these companies are refusing to put out EPS guidance as well. However, the total market cap to GDP ratio has surged back to an all-time high of over 153% of GDP. But only a small number of stocks are carrying the market higher. The equal-weighted S&P 500 returns so far in 2020 are down about 12%. However, you have just a handful of tech stocks in that market-cap-weighted index, which has caused it to be down only 1% this year and have also carried the NASDAQ to a record high. In fact, AAPL, AMZN, and MSFT have a market cap that is equal to nearly 25% of the entire GDP of the United States!

Consumers are feeling the pinch too, despite receiving a windfall from Uncle Sam, 32% of U.S. Households did not make a full mortgage payment in July, according to a survey done by Apartment List. That is the case even with the extra $600 per week in Enhanced Unemployment (E.U.) and the one-time $1,200 per adult and $500 per child sent via central bank helicopters. Once July 31st comes and the E.U. expires, 10’s of millions of people will see a 60% reduction in their income. That is unless D.C. extends the program, which they are highly unlikely to do in its current form, but will instead seek to give a small one-time bonus for those rejoining the workforce.

The Great Wall is Getting Higher

President Trump recently reported that any hopes of an imminent phase 2 trade deal is dead–there was no phase one deal in reality either. He also signed an executive order ending the preferential treatment for Hong Kong stipulating, “Hong Kong will now be treated the same as mainland China. No special privileges, no special economic treatment, and no export of sensitive technologies. In addition to that, as you know, we are placing massive tariffs and have placed very large tariffs on China.” But Mr. Trump didn’t stop with China; he is also placing 25% tariffs on $1.3 billion worth of French goods starting Jan 1^st 2021.

Adding to this poop pile is the fact that the number of Wuhan virus cases are spiking with; infection rates, hospitalizations, and deaths rising alongside. This is prompting states and cities to re-locking down parts of their economies.

Also, we have sleepy Joe Biden trouncing Trump in the polls. And, the former V.P. has indicated he will be no friend of Wall Street. Translation, corporate tax rates will be heading higher along with a re-regulation of the economy.

To recap:

we have the most narrow and expensive stock market in history
the worst earnings season in the last 12 years
there are nearly 32 million people collecting unemployment insurance when you include all government programs
the fiscal cliff is nigh
increasing hospitalizations and deaths from the Wuhan virus,
a deteriorating relationship with China and Europe
a socialistic surge in November is becoming more likely

Will Vaccines Be A Panacea?

Wall Street is hoping that all of these troubling situations will be offset by potential vaccines coming in the fall. July 14^th‘s intraday rally on inside information about some good results from Moderna’s vaccine trial, which was released after the close, is a great example. It should be noted that COVID-19 vaccines will not be cure-alls that produce sterilization immunity, like inoculations against measles and polio. Rather, the vaccines in development should be more like those that protect against the influenza flu virus–reducing the risk of contracting the disease and lowering the chances of becoming gravely ill in some instances. Also, the immunity period will be measured in months, not years, according to vaccine experts reporting to STAT News.

Therefore, the salient questions remain; how effective will these prophylactics be, and what percentage of the population will actually take them? Most importantly, to what extent do consumers’ and businesses’ balance sheets become impaired while we wait for a solution? In other words, once treatments and vaccines restore confidence to consumers, the benefit to the economy will hinge on if they have the spending power to consume. There must be a good job waiting for them and they cannot be encumbered by the debt accumulated while the economy was shutdown.

The odds of a significant market correction between now and November are rising. That is, unless, D.C. agrees to dig a much bigger fiscal hole to stick its head into. Of course, we are still headed for a more permanent wipeout of these asset bubbles once the stagflation sets in. Unfortunately, the inflationary and insolvency wipeout of the bond market will be devastating for those without an effective investment plan.

Fiscal Cliffs and the Self-destructing Treasury

July 13, 2020

We can all be very confident that there will be no change to monetary policy for a very, very long time. But there is a fiscal cliff coming—and indeed has already begun.

It is clear that Mr. Powell is all-in on his unlimited QE and ZIRP. And, that he is “not even thinking about thinking about raising interest rates.” Therefore, the stock market does not have to worry about a contraction in the rate of money printing any time soon. However, equities could soon plunge due to the crash in the amount of fiscal support offered to the economy.

Last month, the auto-loan and credit-card forbearance period ended
On July 1, state and local government budget cuts kicked into high gear, as the $330 billion in aid already dispensed has been wasted
Come July 15, the delayed federal income tax payments are due
On July 31, the $260 billion in enhanced unemployment insurance expires
September 30 sees the end of student loan forbearance
August 31^st marks the end of mortgage foreclosure forbearance
The end of 2020 will mark the end of the Payroll Protection Program grace period, which will coincide with most of the $1.1 trillion already being exhausted
The $290 billion in helicopter money ($1,200 per adult and $500 per child) given to households back in April will have been spent

Of course, I’m all for helping people through this pandemic. But, why are we incentivizing people to remain unemployed by paying them more than they would being gainfully employment? Why did the Treasury send thousands of dollars to families even if they didn’t suffer any damage from the virus? And, why is the Fed printing money to buy junk bonds and making loans to bankrupt businesses?

In any case, in order to prevent the sharp fallout from this fiscal train wreck, Trump and the democrats want yet another round of stimulus to be enacted. The House of Representatives passed the $3 trillion Heroes Act on May 15^th, which was dead on arrival to the Senate. Incredibly, President Trump has stated that he wants to spend even more on direct payments to consumers than the democrats on the next round of aid…fiscal prudence has gone extinct in both parties.

But there is good reason for D.C. to panic. The Labor Department reported that the total number of people claiming benefits for unemployment insurance in all programs (including PUA) for the week ending June 13^th was 31,491,627, an increase of 916,722 from the week prior. To put this number in context, continuing jobless claims are now 4.7 times higher than they were at the peak of the Great Recession in 2009. To make matter worse, the total number of people claiming benefits in all programs for the week ending June 20 was 32,922,335. This crucial figure is going in the wrong direction. Hopefully, the real continuing claims number will shrink significantly in the near future; but it must get much better just to get back to the worst level during the financial crisis.

There is little doubt something will get done in Washington, as both parties have shown an intense proclivity to spending money. But adding more debt to the insolvent Treasury pile is very dangerous for the world’s reserve currency. And, even if one more round of fiscal prolificacy does get passed, all that will do is temporarily reset the clock on the inevitable fiscal timebomb. The U.S. already has a $4 trillion deficit and $26.5 trillion in National Debt. Our debt has grown to a daunting 850% of revenue.

The problem is, Washington needs to pass another multiple trillion-dollar fiscal boost just to maintain the economic growth rate and to prevent consumer and business balance sheets from suffering further damage. But by doing so, it will pour more incendiary fuel on the Treasury’s balance sheet that is already self-immolating. Making matters worse, the gigantic pile of new debt being added is of the unproductive variety. Meaning, it was not incurred to generate capital goods, but rather merely printed to try and prevent consumption levels from falling off a cliff.

Our government has once again managed to defer the ultimate reconciliation of asset prices and the economy by taking on trillion of dollars in new debt that is primarily monetized by the Fed. But, it has also destroyed any vestiges of capitalism that remained in the process. The markets are now completely dependent on Fed purchases of government and corporate debt, while the economy is completely reliant upon consumers receiving a stipend from Uncle Sam to keep up the pace of consumption. In other words, without exploding deficits that are monetized by our central bank, the whole economy will meltdown in spectacular and devastating fashion.

This is one of the reasons why monitoring the progression or regression of the virus is key. The longer it takes to produce a vaccine (if there is one coming that works and people actually get vaccinated) the further away from recovery the economy gets. And, the more reliant t becomes on continuous massive deficits and helicopter money. This is especially true given the recent surge in new cases and, more importantly, hospitalizations and deaths.

In contrast, the deep state of Wall Street will claim that once the virus dissipates into history, the fiscal and monetary crutches can be safely removed. However, the rate-rebellion that occurred during the fall of 2018 and the REPO crash in the second half of 2019, have already proved beyond a doubt that markets can’t function on their own. This is exactly because asset prices and interest rates have been so egregiously falsified that any move towards mean reversion equates to economic Armageddon. After all, it is virtually impossible for interest rates to normalize in innocuous fashion when normalization entails the 10-year Note surging to 6% from 0.6%.

The Fed is now the 3rd largest holder of the biggest corporate bond ETF (LQD). And, it owns big positions in 15 other corporate bond ETFs–including junk bonds. You can forget about our central bank ever selling these holdings. However, whenever Mr. Powell stops buying these assets, the carnage will begin. Unfortunately, this is the mandatory result that will occur when a record number of insolvent junk bond issuers get to borrow a record amount of money at the lowest rates in history.

A successful money manager needs to stay on top of all these dynamics in order to correctly allocate a portfolio. And, knowing how to navigate these cycles of inflation and deflation is an investor’s only chance for improving their standard of living.

Trampoline Cliff Diving

June 29, 2020

We start this week’s commentary with some rather depressing news from Reuters:

The ratio of downgrades to upgrades in the credit ratings of leveraged loans has spiked to a record level, five times above that hit during the last global financial crisis, reflecting the unprecedented stress in risky assets due to the coronavirus pandemic. Leveraged loans, which are loans taken out by companies that have very high levels of debt, usually with non-investment grade credit ratings–tend to be used by private equity firms as a way to fund acquisitions of such companies. The U.S. leveraged lending market has grown to more than $2 trillion, up 80% since the early 2010s, according to credit rating agency Moody’s Investors Service.

Add in the $1.2 trillion junk bond market and the $3.2 trillion in BBB debt, which is just barely above the junk category, and you end up with nearly six and a half-trillion dollars’ worth of corporate debt that is primed for varying degrees of default. The catalyst for this default is the worst economy since the Great Depression.

Is it any wonder why the Fed doesn’t allow even a small correction to occur in the stock market or a slight decline in GDP any longer? But perhaps it’s about time that it did. The valuation of equities is now back to an all-time high of 150% of GDP. And incredibly, just three stocks (AAPL, AMZN, and MSFT) are valued at $4.4 trillion. This means Wall Street has deemed it ok that just three companies have the same worth as 22% of the entire U.S. output per year. Of course, this makes Mr. Powell’s cronies, along with the top 10% of households—who own 88% of stocks—most happy for sure.

The consumption-driven U.S. economy is under attack from many angles. There are still 29 million people collecting some form of unemployment insurance. This includes the over 9 million “off balance sheet” individuals covered under the Pandemic Unemployment Assistance program that the MSFM and the White House are fond to ignore.

We also have 2.2 million people that are finding gainful employment inside Zombie companies. Unfortunately, these businesses were being kept alive by record-low borrowing costs for junk debt and a reasonably good economy. However, now the cost of rolling over this debt has increased while their business models have been torpedoed by the Wuhan virus.

The major averages are struggling to get back towards all-time highs, but the underlying economic support is disintegrating quickly. Hence, the economic chasm between the rich and poor is plunging deeper into record depths. But the mirage of semi-normalcy is being perpetuated by massive and unprecedented fiscal and monetary stimuli.

Therefore, what we are witnessing now is the economic equivalent of a person’s bounce off a trampoline after a 1,000-foot cliff dive. That is, a dramatically sharp ascent from the bottom but nowhere near from whence you started—and with a quick retreat back down from that much lower high. At the core of this “V”-shaped illusion is the $2.3 trillion fiscal stimulus already approved by D.C.

Now, the house has approved an additional $3 trillion package known as the HEROES Act; but the Senate Leader McConnel only wants $1 trillion. And, the President has indicated that he desires to split the difference with a $2 trillion package. Of course, all of it will be monetized courtesy of Fed Chair Jerome Powell. But here’s the point, none of this new red ink is guaranteed to be passed into law, and even it is, there is no chance such budgetary lunacy can continue. The national debt is already at $26 trillion and that is 850% of annual revenue. Our fiscal deficit for 2020 is slated to come in at record breaking $4 trillion (20% of GDP). And, total U.S. debt has soared to $72 trillion! A continued pace of this red-ink hemorrhaging would surely place our bond market in the ICU. In truth, it is already on the life support system of the Fed that has expanded its balance sheet by $6.4 trillion in the last dozen years to keep the Treasury’s debt service payments low and the government appearing solvent.

This leads us to the fiscal cliff diving exhibitions coming in August and early 2021. The over $1.1 trillion in the PPP program will be mostly exhausted, $260 billion in enhanced unemployment insurance expires, the $330 billion given to state and local governments will have been already wasted, and the $290 billion in helicopter money given to households making under $198k will be spent. Therefore, unless there is another multi-trillion-dollar rescue plan passed come this fall, the economy will go over Niagara Falls without a barrel. Of course, even if the democrats and republicans agree to force Mr. Powell to produce more monetary magic before August arrives, the inevitable free fall will still occur. And, even in the event of a relatively small infrastructure package getting through congress, the vast majority of aid to consumers and businesses will expire in the February thru May 2021 timeframe.

So, which path will the Fed and D.C wander? Will they keep on borrowing and printing multiple trillions of dollars each year until stagflation destroys all asset prices, and the market for Treasuries disintegrates? Or, will they voluntarily cut off the fiscal and monetary spigots and watch the Greater Depression unfold before them? I have a good idea as to the direction they will take, but I’ll be prepared to try and profit from their inextricable conundrum either way.

Intractable Inflation

June 22, 2020

The Fed mistakenly believes it can control the rate of inflation with relative ease. While it believes it is far easier to fight a rising rate of inflation than deflation, it is still completely convinced the puppet strings of extant price levels rest firmly in its hands.

To start with, the academics that sit on the FOMC don’t actually know what causes consumer price inflation (CPI)—or at least that don’t want to admit to its actual progenitor. The Fed has been historically wedded to the belief that CPI is related to the unemployment rate. This is known as the Phillips Curve. Phillips curve analysis relies on the belief that inflation comes from a low unemployment rate and that deflation comes from a high level of unemployment. But this logic is both simplistic and specious in nature. Indeed, throughout history, it is commonplace to have a rising rate of unemployment associated with higher rates of inflation and a falling unemployment rate correlated with low rates of inflation.

Inflation is not caused by how many people are successfully employed in gainful and productive work. It is the result of degradation in the faith of a fiat currency’s purchasing power. Such a loss can come from a nation losing the ability to defend itself. More often, a currency begins a protracted and significant erosion when extreme fiscal profligacy causes an insolvent government to begin massively monetize its own debt.

What we now all should be fully aware of is that the Powell Fed will keep interest rates at zero percent and will continue Q.E. until inflation runs well above the 2% target. He learned a painful lesson in 2019 when the FFR was raised to just 2.5%, and the stock market and economy began to fall apart. The FOMC is now extremely reticent to raise rates and is not “even thinking about thinking about raising interest rates.” Hence, its target rate has become completely symmetrical. Meaning, it very well may have to go above 2% for the same duration and extent that it went below the target rate. The Fed’s balance will continue to explode higher until holders of USD become convinced that its value will erode on a perpetual basis with a floor of at least 2% per annum.

The clueless and fatuous Fed is once again turning a blind eye towards asset bubbles. Only this time around its existence is so humongous that one would have to be totally and willfully ignorant to ignore it.

But once the Fed achieves escape velocity on inflation is when its luck runs out. This is because it is a historical fact that all central banks have displayed a tremendous amount of difficulty controlling inflation in either direction. It cannot easily raise CPI above 2%. In 7 out of the last 12 years, the Fed has been unable to achieve average annualized CPI of at least 2%. Yep, 58% of the time, the Fed has failed to reach its minimum inflation goal. This is true despite the fact that our central bank printed $6.4 trillion and left interest rates at 1% or below for 9 of those 12 years. And, by the way, it is easier for the Fed to achieve its 2% target using the CPI metric than the more benign Core PCE Deflator.

Also, contrary to what the Fed and the MSFM would have you believe, our central bank has also had a miserable history of getting inflation under control once it becomes intractable. Back in 1971, both the Fed Funds Rate and CPI were in the mid-single digits. This was when the great monetary experiment began when President Nixon ceased all redemptions of the USD for gold. Inflation then spiked to double digits by 1975 and, after a brief pause in ’76-’77, eventually spiked to 14.6% by early 1980. During this process, our central bank found it necessary to raise rates from 3.75% in February 1971, all the way to 20% by the middle of 1980.

The truth is there is nothing in this data that lends any credibility to the idea the Fed can easily fight deflation. It is also true that it cannot easily bring inflation under control after the confidence in the dollar begins to get significantly hurt.

There is zero evidence the Fed can eventually bring year over year inflation to 4%–or whatever rate it thinks is symmetrical after years’ worth of disinflation and deflation–and then automatically prevent CPI from rising higher from that point. As mentioned, the great Fed Chair Paul Volcker had to raise rates to 20% before the inflation monster was vanquished. But while Mr. Volcker did engender a sharp recession in the early ’80s to accomplish this task, he had a much better economy to start off with. Total U.S. debt to GDP was just over 150% during the ’70s and early ’80s. Today, that figure is close to 400%. And, the stock market was much less inflated 40 years ago. That ratio spent most of its time, around 40%. However, that ratio now stands around 150%!

Just imagine the carnage that would occur to asset prices and the economy if our current regime of central bankers had to boost interest rates from 0% to double digits!

Therefore, in the not-too-distant future central banks may have to decide whether to let inflation run wild on the back of absolutely unprecedented monetary and fiscal madness (bankrupt governments + unlimited Q.E. + permanent ZIRP), which will wipe out our standard of living. Or, progressively jack up interest rates and cut spending in dramatic fashion, which will obliterate the asset bubbles and the economy in the process. Sadly, in either scenario, the pernicious outcome is very much the same.

Gold

June 8, 2020

The sad truth is that few people really know very much about gold, especially when it comes to investing in the metal. They don’t understand what makes it so valuable and unique, and they know even less what moves its price. Since I don’t want to spend an hour on why it is so precious, I’ll just try and sum it up in a sentence: Gold is extremely rare, beautiful, portable, transferable, divisible without losing value, and virtually indestructible. Very few things on this earth can meet all those criteria, and that is why it is the most perfect form of money humankind has ever found.

Now more than ever, investors desperately need to know what really influences the dollar price of gold. This is the case given the unprecedented falsification of asset prices and debt monetization taking place today. Gold is not driven by the fear of a crash in the major market averages. Nor is it even primarily concerned about the inverse correlation to the U.S. dollar (USD). Indeed, the massive interest rate suppression scheme by the Fed since the Great Recession has been the main reason behind the outperformance of gold compared with the S&P 500. This is true even in the context of a rising USD.

This is why the astute investor begins his portfolio allocation with a 5% investment to physical gold.

The above chart proves that a secular gold bull market can and does occur while the USD and stocks are rising. So then, what does have the highest correlation with the price of gold? The direction of real interest rates is what matters the most. Hence, it is always important to determine both the direction of nominal interest rates along with the rate of inflation in factoring in how much above the minimum 5% physical gold allocation investors should garner.

If nominal Treasury yields are rising in the context of relatively benign Consumer Price Inflation (CPI), then gold may significantly underperform. This is especially the case with the miners, which are simply a leveraged play on the price of the metal. It is clear that exposure to miners during a gold bear market can be a very dangerous thing.

However, when bonds yields fall in the context of rising inflation, gold can really boost your overall performance. Just take a look at the Gold Miners Index (GDX) shown in blue vs. the Physical Metal (GLD) shown in green in the chart below.

The truth is physical gold competes with cash and the “risk-free rate” on U.S. Treasuries. This comparison is calculated by using the interest your money receives in the bank and/or sovereign bonds, minus the rate of decline in its purchasing power (inflation). This is what hedge funds and the machines on Wall Street are most focused on. Another way of looking at this is that the carrying cost of gold moves in tandem with real interest rates. Therefore, the ideal scenario for gold ownership is when real interest rates are falling. And, that environment is best when nominal interest rates are virtually zero and inflation is rising. This means the carry cost on gold becomes negative, while the lost opportunity for holding cash is next to nothing.

So, where does the gold sector go from here? Well, we can be fairly certain that the Fed will peg the short end of the yield curve at zero for the foreseeable future. But the salient question remains to what extent Mr. Powell will allow longer-duration Treasury yields to rise. Our central bank rejoined the ECB and BOJ in the yield capping game back in Mid-March when the 10-year Note shot up to 1.26% on March 18, from 0.31% on March 9. Such volatility in Treasury yields is indeed off the standard deviation chart and scared the Fed out of its mind. Since then, Mr. Powell has authorized the purchase of $1.5 trillion worth of bonds during the past ten weeks. However, as yields have since settled back into the mid-single-digit range, the Fed has reduced its purchases from the peak of $75 billion per day, to just $4.5 billion. For now, the bond market is ok with Fed tapering in the context of a $4 trillion annual deficit.

Perhaps this is because the predicted depression is now here. For example, in 1930, the U.S. Gross Domestic Product plunged by 8.5%. Economists now predict that 2020 GDP will crash by 6% after a sharp rebound from Q2, which is expected to suffer an output catastrophe of more 52.8%, according to the Atlanta Fed! This type of data is helping to suppress yields even while the Fed exits the market. Hence, yields are still near record lows.

In contrast to the depression I predicted earlier this year, I am now predicting some of the best economic data on record to be reported in late June and July. Of course, this will only mean we are moving from a deep depression to a seriously bad recession. Nevertheless, the rate of change in the data will be profound. For example, Continuing Jobless Claims, which surged from 2 million in March, to 25 million in May, will be plunging by the millions each week during the summer. This should still leave the unemployment rate, which is above 20% currently, a budding teenager by year’s end. But again, it is the rate of change in the data that is most important. Will Mr. Powell cap the 10-year Note yield at 1%, or will it be 2%? Or, will he just let real rates rise until gold and the stock market once again fall apart under the weight of surging borrowing cost on an overleveraged corporate sector?

Again, determining the direction of real interest rates—and therefore, the direction of gold—is critical because getting caught on the wrong side of this trade can become a complete portfolio debacle. For instance, from 1980 through 2000, gold fell from $800 to $250 per ounce, as CPI was falling faster than nominal rates. Likewise, it can spare you from the $1,900 to $1050 plunge that took place from 2011 through 2015 when a similar dynamic was in place. By the way, this is also why gold tends to crash during times when the rate of deflation is profound—nominal rates tend to stop around the zero percent floor, but real rates can still rise due to rampant deflation.

Therefore, in the next couple of months, I will be myopically focused on the “better” news and how it affects interest rates and the rate of inflation. An improving economy in the context of a dissipating Wuhan virus–coupled with Fed tapering–could (temporarily) send nominal yields rising much faster than inflation. This is especially true given the ridiculously low level of Treasury yields and the incredible amount of supply that must be taken in by whatever is left of the free market.

But this is the purview of active managers like myself who try to avoid big drawdowns in the portfolio. Of course, in the longer-term stagflation is the most likely macroeconomic destination, which is the perfect storm for gold. The inflation will come from the Fed’s new proclivity towards Helicopter money and its unshrinkable $7 trillion balance sheet that has grown 7-fold in the past dozen years. The stag part will be derived from trillions of dollars in unproductive new debt being issued and the damage it is causing to public and private sector balance sheets.

This means the Fed will be forced to peg the entire yield curve close to the zero-bound range indefinitely, as the economy does not recover sufficiently enough to allow the 10’s of millions of newly unemployed people to find work. Hence, your stated return on risk-free money will be zilch, just as rising CPI causes real yields to fall into record-low territory.

The Conclusion: Knowing when (and when not) to overweight gold in your portfolio can provide an opportunity to vastly increase your overall returns.