Erik: Joining me next on the program is Alhambra Investments CIO Jeffrey Snider. The subject today is, of course, going to be yield curves.
Jeff, I think most people know that there is this statistic that every major post-war recession has been predicted by an inverted yield curve. The thing that strikes me is, first of all, I think there’s probably more information to gain from just whether or not the curve is inverted.
But, particularly, the statistic about all these post-war recessions – all of those recessions happened before the current era of central bank intervention in the Treasury market. And it was also before the breakdown in the Eurodollar system, which you described in Eurodollar University as not really occurring until 2007.
So why don’t we start with the big picture? What should we be thinking about when we think “yield curve?” What does it tell us? Is it just the inverted or not? Or is there more to it? And how has the picture changed since 2007–2008, when so many things about the structure of the market are different now?
Jeff: Well, first, Erik, you’re exactly right. The yield curve tells us a lot more than just when it’s inverted and when we should expect recession. There’s a whole lot of dynamic information embedded within the curves – and various parts of the curves – that we can look at that tell us a lot about where we are and where we’re going.
And it’s more than just recession or not. We can look at an even bigger picture than that. What is the baseline economic growth? What is the bond market telling us about not just the baseline economic condition, but how that relates to monetary policy.
And, in some ways, the yield curve is almost like a check on monetary policy. Because the short end relates to what the Fed is doing and monetary alternatives that the Fed can create through its various programs. While the long end says: Well, are those programs effective?
So the combination of the short end and the long end in real time gives us a lot of dynamic and very useful information. Far more than when it inverts in the recession. There’s a lot there that we need to pay attention to. And a lot there that people should have been paying attention to for a very long time.
Erik: Joining me next on the program is John Mauldin, founder and Chairman of Mauldin Economics. John, thanks so much for joining me on the program.
The question that seems to be on everybody’s mind right now is: Are we looking at the end of a relatively small market dislocation with this VIX complex blowup and so forth? Or is this actually just the beginning of something much bigger?
John: I don’t think you could characterize anything as the end. There’s always things that move forward. But let’s remember that there’s always another recession. I don’t think Trump has repealed the business cycle. He’s trying to repeal the wisdom of tariffs, but he hasn’t repealed the business cycle yet.
And when we have a recession we will have a 40%–50% or more drawdown. So whatever bumps that we get between now and then will just be that – bumps.
Now let’s remember something: The last drawdowns that we had – the corrections if you will – were not the unusual part. They weren’t the odd part. The odd part was 15 months in a row without a 2% correction. Never happened, ever, ever. So that was the odd part. That should have been what we were all looking at and going “this is scary.”
It wasn’t a 5% or 6% correction. The type of correction we just went through was something that we normally get at least once every 12 to 18 months. You get a 5% correction every 90 days, every quarter. So that was the normal, if you will. The not normal was no corrections and just almost straight up.
And we’re going to see probably more corrections. We’re going to see more volatility. But I would argue that any correction we see now, absent indications for a potential recession, are buying opportunities. If you’re a trader you, you know, see things – when they get to the top you raise a little cash, and when they go down some it gets into your buying session. You buy some, you go back in.
But market drops, absent a recession, are V-shaped. When you get a recession, that’s going to be ugly. And you want to be sitting somewhere on the sidelines and not involved. Because the buying opportunity will come.
Jim, I have so much been looking forward – ever since we launched this podcast two years ago with Jim Rogers, actually, as our first guest – I’ve been looking forward to getting you on the program. And, frankly, I’m glad it took this long because I don’t think there’s ever been a more important time in the last ten years to be very closely observing interest rates.
Before we get to interest rates, though, I want to start with a higher-level question. A new Fed Chair, Jay Powell, is running the show.
What is your expectation? Is Jay Powell a good pick to replace Janet Yellen? Do you think that we’re going to see a change in policy from the Powell Fed as opposed to the Yellen Fed? And what’s your overall reaction to the state of the Fed, so to speak?
Jim: Well, Jay Powell has one commanding credential. And that credential is the absence of a PhD in economics on his resume. I say this because we have been under the thumb of the Doctors of Economics who have been conducting a policy of academic improv. They have set rates according to models which have been all too fallible. They lack of historical knowledge and, indeed, they lack the humility that comes from having been in markets and having been knocked around by Mr. Market (who you know is a very tough hombre).
Jay Powell at least has worked in private equity. He knows a little bit about the business of buying low and selling high. Also he’s a native English speaker. If you listen to him, he speaks in everyday colloquial American English, unlike some of his predecessors. So I’m hopeful. But not so hopeful as to expect a radical departure from the policies we have seen.
Erik: Joining me next on the program is Alhambra Investments Chief Investment Officer, Jeffrey Snider. Our regular listeners, I’m sure, recognize Jeff’s name. Because of course he’s been the star of Eurodollar University, which is still available at macrovoices.com/edu (edu is for Eurodollar University). That is a very in-depth examination of the Eurodollar system.
We’re going to take a look today, though, at gold – coming from a different perspective. Jeff’s experience and knowledge of the Eurodollar system uniquely qualify him to understand a bit deeper picture than you hear and read about on the internet when it comes to gold.
Jeff has provided an outstanding slide deck to accompany this interview. You’re definitely going to want to download it. You can find the download link in your Research Roundup email. If you’re not yet registered just go to macrovoices.com and look for the download instructions next to Jeff’s picture on our home page.
Jeff, why don’t we go ahead and dive right into your slide deck here? As you talk about the history of paper gold, starting on Slide 4 you talk about the “gold swap.” And I think that’s a really important concept. A lot of people know that central banks engage in these gold swaps, but, frankly, a lot of us don’t understand the backstory of why they do this, how it affects the system, and what the mechanics are.
So, what are gold swaps? Why do central banks engage in them? And how did this all come about?
Jeff: Thank you, Erik. I think the first gold swap, or at least the first recorded instance of a gold swap, is a good place to start. There were some gold swaps that happened earlier in the 19th century. But at least the for one in 1925 there is some recorded history with it and some information about it.
I think that your listeners, at least those who are interested in gold, are going to recognize the year 1925 for its significance. Which was that the United Kingdom in that year went back to the gold standard after being off of it since the beginning of World War I. Winston Churchill had insisted that, if the UK were to go back on the gold standard, that it do so at the pre-war parity. Which meant that there was significant strain in the financial markets and in the economy for doing so.
The US central bank, the Federal Reserve, stood ready to aid the Bank of England in trying to defend the pre-war parity, despite all of those of difficulties. And one of the ways in which it did was this first gold swap in 1925.
Essentially, what happened was the Federal Reserve Bank of New York on behalf of the Federal Reserve system made $200 million of gold bullion available to the Bank of England for its disposal in whatever transactions it might take in defending sterling at that pre-war parity price.
What’s important about that is that it aids both sides of the equation. Because the way a gold swap works is that, essentially, the central bank agent that is providing the gold exchanges it for what’s called a gold receivable.
If you look at Slide 5, for example, I’ve sketched out roughly what this gold swap meant. $200 million in gold was made available to the Bank of England, which it would then sell in the market for sterling at the price that it wished to defend. They put the sterling currency into an account in London on behalf of the Federal Reserve Bank of New York.
So what really happened was gold disappeared from New York and ended up as cash in the UK denomination in London. But, for accounting purposes, the Federal Reserve Bank of New York showed a gold receivable where gold used to be.
You’ve heard the expression “as good as gold.” In this case it’s literally taken to be that. A collateralized account on behalf of a counterparty central bank was, in the thinking of people in New York and London, as good as having gold.
Because if (for whatever reason) the Federal Reserve Bank of New York needed its gold back, there was sterling in an account where it could theoretically buy it back. So the gold receivable was taken as equivalent to actually having bullion on hand in a vault in New York City.
So both parties were satisfied. The Federal Reserve Bank of New York got to continue reporting the same amount in its possession, while the Bank of England was supplied additional metal in order to help defend the sterling at pre-war parity.
Erik: Joining me next on the program is Rick Rule from Sprott Global. And, for anyone who’s not familiar – which is hard to believe, because he really gets out there and explores new opportunities in the resource space, whether it’s getting off the next airplane to go look at a junior goldmine or whatever is going on, Rick has the reputation for being the guy who knows the most about it.
And, Rick, what I’d like to start with is we have so many people that are Wall Street guys, whereas you tend to be out in the field really looking at natural resources. I think this really is a different animal. It’s a different style of investing.
So why don’t we start with the big picture? How do you think about the world around you? Where is the opportunity? Why natural resource investing in the first place? And how do you approach it?
Rick: Well, I think probably every one of your specialists would suggest that they were off Wall Street in a way, but not all businesses correlate. I would of course agree with your premise that natural resource investing is different than most mainstream forms of investing.
The first is that resource investing is unusually capital-intensive, which means that it is unusually cyclical. The truth is that, in resources, the old truism: “A bear market is the author of a bull market and a bull market is the author of a bear market” is particularly true.
And that’s important to understand. Because, during periods of time when mature natural resource companies appear cheap (that is their enterprise value relative to their EBIT is low), they normally correspond with periods of very high commodity prices. Meaning that the price of the commodity is about to go down, so that the free cash flow is about to go down, so that the debt is about to go up.
When, by contrast, mature natural resource companies seem expensive on an EBIT to enterprise value basis, it’s normally when commodity prices are low. Meaning that cash flow is going to get higher and debt is going to get lower.
So it turns out that, from an investor’s perspective, the best of times herald the worst of times. And the worst of times herald the best of times.
In truth, in the 40 years that I have been involved in the game, one looks first for commodities where you believe that ongoing demand for five or ten years is assured, because of the utility afforded by that commodity to society. That is where ongoing demand is assured. Where the price of the commodity – the price that the commodity sells for worldwide – is below the median cost of production.
In other words, you buy the best producers in industries that are literally in liquidation. What that means is that you have a circumstance where, either the price of the commodity goes up, or society does without the commodity. In terms of the broadly traded commodities, the truth is that our way of life depends on commodities. And I would suggest that that’s what sets apart the resource business from other businesses.