Notes From Underground: A Riddle, Wrapped In a Mystery, Inside an Enigma

I’ve been thinking about the Churchill quote referring to Russia. Rather than referencing Russia my thoughts turn to the flattening yield curves that began on Monday. As commodity, global equities markets, the Chinese yuan and the precious metals all staged strong rallies, the long-end of the yield curve also rallied, especially the 10-YEAR. As a result, the 2/10 curve flattened to a 10-year low of 15 basis points. On Tuesday, the curves flattened even more as the 2/10 closed at 10.7 basis points. As Vizzini from the Princess Bride would say, “INCONCEIVABLE!” To support the rally in the long-end of the curve there was a retracement of the recent rally in global equity markets (the NIKKEI, DAX and S&Ps were all down substantially). This suggests that the positive news from the G-20 meeting has now been cast asunder because investors are struggling to comprehend what actually took place in Buenos Aires between the U.S. and Chinese delegations.

The more Kudlow, Mnuchin and Trump talk, the more confused business leaders and investors become. The Trump team cannot broadcast a consistent message so the markets are left to wonder what was agreed to at the end of the G-20 conclave. The official communique was a cacophony of platitudes reading like the Democrats or Republicans campaign platforms: 31 points of concern about world problems and promises to confront them all upon arrival home. There were promises to reform the WTO rules in a bow to Trump. Infrastructure was noted as a key driver of economic prosperity, therefore more money through public/private partnerships will be sought (a nod to Macron and the Italians). Point 27 was a nod to everybody but Trump as international trade and investment were acknowledged to be an “important engine of growth, productivity, innovation, job creation and development.” This was followed by promises to reform the WTO in an effort to improve a rules based multilateral trading system.

There was something for everyone. The Chinese even seemed to be willing to take a page from MAO. The effort to be non-provocative would allow time to reconcile the criticisms raised by the Americans and others. The Chinese view the world with a much greater respect for time. It takes more than a QUARTER for many things to unfold. (This of course was summed up in the exchange between Chou En-Lai and Henry Kissinger about the French Revolution in 1971 when they first met to discuss Nixon’s trip to China). Again, as the markets digest the multitude of White House leaks and tweets, the stock markets took three steps back, which supported Monday’s curve flattening.

Except I am not buying into the nonsense of this flattening for if the U.S. economy is beginning to slow and inflation is receding I offer this: The current deficit is going to explode, making the supply-siders in the Trump administration and their projections appear very wrong. I SAY IT AGAIN: ANYBODY BUYING U.S. long duration Treasuries need THEIR HEADS EXAMINED. Because the trillion-dollar deficit this year with a 3.7% unemployment rate is beyond reprehensible, especially since we have a president who has prided himself on being a “BIG SPENDER.” Why is the curve so dramatically flattening? There are numerous conjectures but I surmise that the combination of fed rate hikes and a balance sheet unwind is taking its toll, regardless of what New York Fed Vice President Simon Potter maintains.

Regardless, I am not looking to get long 10- or 30-year debt. I would be more comfortable buying steepeners, BUT I HAVE NOT MADE A LIVING DEFYING MARKET ACTION. I will be patient and wait. The 5/30 curve, which has been a far different story, flattened the last two days as the power of the 2/10 forced capitulation on the 5/30 and is back to testing its 200-day support. Pay attention. The only markets that held their Monday rallies were: yuan, oil, gold and silver, and BONDS. As I warned in the previous blog post, pay close attention to the YUAN.

One thing is certain: Robert Lighthizer is the lead negotiator with the Chinese and as a veteran of the James Baker team of the Plaza Accord BOB LIGHTHIZER KNOWS CURRENCIES. The appreciation of the YUAN will buy goodwill with the negotiator-in-chief. These are difficult times, indeed. Remember that some of the uncertainty in the bond markets is a residual of massive central bank intervention and is breaking the signalling mechanism of the bond vigilantes.

***Europe’s leaders did not suffer the wrath of Trump as there was no direct attack upon the European auto sector, while Chancellor Merkel and President Macron were saddled with their own problems. Also, Trump was very diplomatic in deference to the passing of President Bush 41. An attack upon the EU would have been an insult to George H.W. Bush as the media was gushing over the wisdom that it took to unify Germany and solidify a United Europe after the collapse of the Soviet Union. But on Tuesday, the three largest German automakers met with Lighthizer and Secretary Ross in an effort to dissuade the Trump administration from invoking tariffs of German auto exports to the U.S. under the guise of national security.

As previously discussed, Europe has many problems as the ECB QE program is set to end. There’s Italian debt, Brexit, a slowing German economy, and the rise of populism in so many EU nations. On Monday, there was a story in the Financial Times titled, “Scholz Says France Should Give UN Security Council Seat to EU.” The German Foreign Minister publicly chided the French for hoarding its veto on the UN Security Council when it should be a seat held by all of Europe. Another fissure in the EU edifice. Oh, and German bunds closed at 26 basis points. The most despised financial instrument in the developed economic world refuses to depreciate. A riddle, wrapped.

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18 Responses to “Notes From Underground: A Riddle, Wrapped In a Mystery, Inside an Enigma”

  1. raymack1999 Says:

    great analysis as usual Yra!

  2. Mike Temple Says:

    Like you, I try to give way to the message of what Mr Market May do, no matter how irrational it may seem.

    Your disbelief about the curve flattening should not necessarily be so hard to fathom. Powell’s dovish “pausing” coupled with the extraordinary QT still adds up to tightening. The curve is not just inverting from 2/5 and 3/5, but 2/10 is COLLAPSING in a freight train like movement. Things only got worse after the market quickly realized today that Trump is still a “tariff” man and simply plotzed.

    Somewhere in economic heaven or hell, Messrs Smoot and Hawley are clinking their glasses and making way for Trump to replace them as the most idiotic “tariff” guys in the past 100 years.

    Invert we have and 2/10 seems headed that way, although a pullback seems likely as it is so overbot right now.

    I don’t think the steepener begins until Powell actually pauses,signaling that rate cuts are simply a matter of when and not if…In a recession, Treasury could be auctioning nearly $2 Trillion/year which will cause the indigestion you see. Personally, I would not rule out the following scenario.

    Long term rates do NOT soar. Rather, QE4 arrives and the Fed begins to own most of the auctions. Yield curve can still steepen as shirt rates plummet towards ZIRP. What will give? Or be the pressure release? The dollar finally crashes from whatever pumped up level it hits as the upcoming dollar debt squeeze plays out over 2019.

    All of this points/leads to yours and Peter Boockvar’s bullish outlook for the precious metals.

    If credit and equity markets do not reverse/bounce after this hellacious stumble and cascade lower, I think there is a non-negligible chance that Powell may pause here in December as the market has now called the two bluffs of Powell’s dovish back step last week and then Trump’s declaration of economic peace In Our lifetime (or at least for 90 more days) with his new best friend, Xi Xiping.

    Stay tuned as I think all of this is merely the First Act of a Killer Drama in 2019.

  3. Eugene Chumak Says:

    thank you for sharing, great stuff as always

  4. asherz Says:

    Kudos to Yra and Mike. Great comments.
    China needs a spotlight put on it. President Xi (Shee is not a sneeze) understands to get to his goal in the next decade or two he has to abide by a predecessor’s advise tp “Stay Low”, don’t make waves. Small incremental steps. Build some islands in the South Pacific and enlarge your area of control. Build up your military. Buy assets in Africa and South America. All as low key as possible. And when the temperature gets a little hot by a feisty world leader, become his friend and warm up personal relationships.
    The problem for Xi is his nation’s balance sheet ( I always come back to that). The banks are in a bad way. Debt/GDP 330%.Ghost cities . So stealing IP and 40% tariffs and control of all joint ventures now being challenged has to be finessed. Some concessions must be made. Hopefully Trump, Lighthizer and Navarro understand all this and I hope they do.
    As to the curve flattening, a suggestion. When any asset is sold, it is exchanged for something else. If I sell my equity, or junk bond, what do I want to hold that is available in the quantities I need. Currencies? Do I want to hold the Euro ( that is in the process of dissolving the Maastricht Treaty) ? The Yuan (see above)? Another paper currency, almost all of which have been debased by the pointy heads in the last decade. Bitcoin, and crypto currencies that are going the way of Peter Minuit’s trinkets that bought Manhattan?
    So the dollar and Treasuries are among the remaining last men standing, at least for now. But not for very long either with no desire to address the entitlement problem in the budget. As Everett Dirkson said, ” A billion here and a billion there, pretty soon you’re talking real money.) (Substitute trillion today). QT and trillion dollar treasury sales help the supply problem for the reserve currency.

    Oh, except for one other. Physical Gold and silver whose paper derivatives have been suppressed for a long time (see Kissinger, Volcker and Greenspan comments if you can find them.)
    But you say, there aren’t enough of these to take care of the safe harbor seekers. True at $1240 and $14. but at much, much higher price many more will be satisfied. All this while the bubbles pop greatly reducing the values of those assets seeking refuge.
    Crackpot theory? Time will tell. All one needs is the Chinese perspective of the hour glass and concept of time.

    • yraharris Says:

      Asherz–splendid rebuttal and the Kissinger,Volcker discussion which you have posted before is really worth a review—also happy Hanukkah and just received an interesting book,Listening to GOD

  5. Rob Syp Says:

    Deutchse Bank 9 bucks does it go to 5 or 14? It’s in a serious
    rabbit hole…

    • David Richards Says:

      Rob, who said the ECB is running out of stuff to buy? There’s the shares of DB and other technically insolvent Eurozone banks aplenty, chock full of bonds issued by technically insolvent Eurozone governments!

  6. Michael A Temple Says:

    Well reasoned…..I think you are very right that we will slowly see some “smart” money quietly begin to buy gold (and silver) here as the markets continue to spin wildly into 2019.

    A very wise markets mentor to me told me the following about why there is no fever like gold fever.

    A true bull market in gold (and he said they only come around once in a while, not every cycle) is not so much a bullish opinion on gold….Rather, it is the product of a hellacious bearishness on virtually all other assets, accompanied by a very black and dark societal outlook

    1970s Gold bull market went from $35 to a frenzied absolute peak of $800, or 22-23X whereas the 1960s guns and butter policy unleashed wild inflation that devastated stocks, bonds, and real estate. Nixon was forced out (possible parallel here in 2019?) and Ford told NYC to “Drop Dead” as it went bankrupt.

    Fast forward to today.
    As I said, on the political front, we eerily have a POTUS who is arguably more corrupt than Trump and who faces an angry Dem Congress and a determined Inspector Javert in Mueller.

    And, we have all seen/heard the recent DB report that so far in 2018, 89% of all assets have negative returns…..a phenomenon not seen since 1908.

    Conditions seem rather ripe for a possible PANIC in virtually ALL markets as VOL explodes everywhere. Perfect conditions for folks to begin to awaken to the centuries old (heck, millenia old) safeguard of gold….Heck, the Bitcoin frenzy may have already robbed gold of $100 or $200 of upside since that was the way to store capital “OUTSIDE the SYSTEM” (gold’s traditional rationale and why the Swiss gnomes–who dey?—always recommended every portfolio should contain 5-10% of the barbarous relic.

    While Puerto Rico is NOT NYC, it went bankrupt….How many municipal pension funds will go bankrupt as their woefully underfunded pensions really give up the ghost as their returns turn negative this year after 7ish years of QE-assisted gains, gains which still left them underfunded as the underlying liabilities simply exploded.

    So, yes, your analogy of how many elephants may try to get through that narrow “golden” doorway of $1240ish (let’s just call it $1200s entirely) before a stampede takes hold is perfect imagery.

    If/when that sensation overwhelms “everybody” (bitcoin collapse may even convince a millenial or two to buy gold—maybe the World Gold Council can hire a smart millenial and somehow create “digital gold”) may be “everybody” will buy some gold as headlines blare about $2 Trillion deficits, ZIRP, Chicago Pension Funds Bankrupt, Trump about to Resign, QE4 to Infinity….Etc Etc Etc

    Gold bottomed at roughly $250 back in 2002ish with Brown’s Bottom…..20X (the 1970s price action of gold) would put gold at $5000. PLENTY of ROOM to accommodate all those stampeding elephants….I am certainly not predicting that price any time soon. But, 4 years from now when the next President is presiding over all this madness, I am not so sure that that is such a silly price projection….Just imagine a little bitcoin fever applied to the barbarous relic as “Rome” burns around us…..Maybe NYC doesn’t go bankrupt….But, the Second City, Chicago, possibly could.

    And if you believe this scenario, the only thing cheaper than gold is Sister Silver, trading at a 1:85 ratio, marking it as an industrial metal cancer and not as a monetary unit….Well, if gold begins to motor higher next year as a “monetary” store of value (as you point out), then the “poor man’s gold” will climb relative to gold.

    Here are some interesting tidbits about silver. Currently, the gold/silver ratio has been at 80X or higher for over 81 consecutive trading days this year….In the 18 years to date of this new millenium, the previous record was “just” 17 back in 2016.

    Seems highly unlikely that silver will climb enough relative to gold to drive that ratio back to 79 any time this month…

    So, we are quite likely to end 2019 with gold/silver ratio having logged 100 consecutive days trading at 80X or higher. Traditionally, silver has logged an average gain of roughly 30% after the ratio hits 80X in the 6 months AFTER it jumps back to 79.

    So, how many standard deviations does 100 days of gold/silver ratio at 80X represent? 1 SD? 2 SD?

    The average gold/silver ratio so far in this millenium is 63.9X….Let’s just call it 64. And we only have to go back to just 2011 in the “wayback machine” to see that gold and silver peaked (admittedly, peaked not traded there continuously/smoothly) at $1900 and $50, respectively for a ratio of 38!!!!

    So, just playing with the math…..Let’s say you are right about the golden future. Let’s just stipulate that gold reaches “just” $1800 within the next 2 years (rather modest projection given the “sh*&T” storm outside). Let’s put the gold/silver ratio at a modest-ish 60 (again, the aveage so far in the 2000s is 64)…..

    Voila….$30 Silver That is a double from today’s $14.

    The gold and silver doors are certainly open for business and can accommodate any and all right now……And it may remain rather open throughout the $1200s and $1300s…But once we break above the key $1360/70 resistance that has repelled the last two bull impulses in the past 3 years, I think your “door” will begin to close a bit.

  7. Michael A Temple Says:

    Some corrections

    Silver will have recorded 81 trading days at a ratio of 80X or higher as of this Friday.

    Inspector Javert…..He chased a man accused of stealing just a loaf of bread. President Trump may have (according to his most fervent opponents) stolen a presidency and corrupted our Republic.

    Far more than a loaf of bread.

    Final note…..Gold Fever is just the opposite side of the coin marked as “FEAR”….So, it won’t just be the hellacious and vicious markdown in prices for stocks/bonds/real estate/art/bitcoin (still $4000 to go to reach its marginal unit of value/worth) that will move gold. It will be FEAR about EVERYTHING that provides the STAMPEDE that could propel gold WAY WAY higher than anybody dares to imagine.

    Who would have ever thought that bitcoin was going to hit $19000?

    And yet it did…..I actually sat in my local library during late 2017 (a mere 13ish months ago) listening to one reference librarian tell her colleague how bitcoin works and how she could arrange to buy some……Modern day “shoe shine” boys of Joe Kennedy’s famous story about how he knew it was time to liquidate his stock holdings because even the “shoe shine” boys were telling him what stocks to buy.

    So FEAR will stalk the investment landscape in the years ahead and gold could see true GOLD FEVER to match the last big bull market in the 1970s…..Consider even the frenzied run up in 2011 to $1900 in just a matter of months. It was FEAR that Europe was going to break up that drove sovereign debt of all the non-core nations into the ground….That fear saw capital flee not just into USD, but gold, too.

    It took “everything” that Mario had in his arsenal to stuff that evil genie back into the lamp…..What’s left in the arsenal of the next ECB head if existential crisis hits the Euro/Europe again.

    We talk non-stop about the potential Black Swan called Italy/Itexit.

    Mon Dieu….We need look no farther than Paris today which is aflame (literally) as the populists/Street RAGE against the imposition of higher petrol taxes.

    France is THE CO-FOUNDER of the entire EU Project, dating back to their 1950s accord with W Germany…..And that pillar of the EU project is going wobbly over petrol tax increases.

    How can we blithely assume that Italians have not taken notice and will similarly burn “Rome” to make their anger heard.


    Got Gold?

  8. David Richards Says:

    > Infrastructure was noted as a key driver of economic prosperity

    Doesn’t work. China did that to internally replace demand from Western consumption that collapsed, never fully returned and likely never will.

    While the build-out did provide some short-intermediate economic boost in China, plenty of snazzy new facilities, airports and a comprehensive automated high-speed rail network that’s the envy of the world (and turned a lot of corrupt CCP officials into crazy rich Asians), another legacy is a big boatload of debt in connection with it especially among SOE’s and the problem it causes.

    Considering that every major Western country is starting today from a position of technical bankruptcy, unlike the strong financial position and trillions in each of three sovereign wealth funds that China had when it embarked upon its infrastructure binge, the last thing any major Western country can afford or needs today is debt-funded infrastructure boondoggles like the bridge to nowhere in Alaska, a legacy of the last infrastructure binge in the US.

    Who will pay for it? What sane person will lend them the money? I know, the loons at their central banks. Short currencies, all of them.

    Read the Dalio book Principles about debt super-cycles. The stuff that’s happening is textbook – and it’s not a happy ending.

    • David Richards Says:

      Ray Dalio’s book, Principles For Navigating Big Debt Crises, also available in a free PDF version as a public service:

    • yraharris Says:

      David –Japan announced a 27 billion program for infrastructure last night

      • David Richards Says:

        Yra, I’m guessing Japan never read the book Dalio wrote, which is for them too. I understand that Japan needs more people, not more infrastructure as that won’t help their demographic or debt problems. Apparently, many Japanese millennials don’t even date, much less marry or reproduce.

  9. Chicken Says:

    Count me as one struggling, exploding defecit (receipts secondary to expendatures) compels hard astern?

  10. yraharris Says:

    From Yra—this BLOG Notes From Underground is now performing at a high level thanks to the great discussion taking place where it is discourse and NOT VALIDATION—as long as arguments are supported by solid research this works well—2+2=5 is what Dostoyevsky promoted and it is found here—all these posts will be answered with a BLOG as I have much experience with the Gold/Silver ration as learned from the brilliant H.G. but also pay attention to Silver/Copper–do your technicals to get a risk profile you can live with—tonight the markets are dealing with a new Prairie Fire—many sparks igniting fires

  11. Chicken Says:

    FWIW, I’ve always wanted you to write 2+2=5i to denote the resulting imaginary component, it’s what I see in my head. 😉

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