Why I find Gold’s smackdown bullish

Last Sunday, an enormous number of gold contracts were dumped on the futures market, crashing the price below 1680 before it reversed. The week prior, gold was trading over 1800. This activity may seem strange, but it is very common with Gold and you just have to deal with it when trading in this market.

Here’s the part I find interesting:

You can get the attached commitment of traders reports here: https://www.cftc.gov/MarketReports/CommitmentsofTraders/index.htm

Swap dealers include the bullion banks, which are large banks routinely trading in gold futures contracts. They create the market for gold futures, taking the other side of the residual trades in the market.

Gold producers are almost always short because they are hedging the risk of their mining activities, ensuring that their gold will be sold at a profit after the time and expenses involved. The only times you see them go to neutral or slightly long is when gold prices drop below the cost of production and they start shuttering mines.

Managed money is the big investment funds, and other reportables is a wide swath of remaining sizeable players including central banks.

When gold investors greatly outweigh producer hedges, the swap dealers end up short. They are notorious amongst gold investors for hammering down the price of gold by dumping large numbers of contracts at thinly traded times in order to “run the stops.” Managed money includes a lot of algorithmic and momentum traders, often using stop losses and trading around price targets.

Last Sunday, the swap dealers dumped a lot of contracts on the market to hit some anticipated trigger points, and it worked very well. Not only did stop losses cause managed money to dump 26,486 long contracts, but price signals got momentum algos to open 29,162 short contracts. The swap dealers got to reduce their net short exposure by 32,710 even while the producers got less short and other reportables got considerably more long.

What does this mean? I’m thinking a it’s a possible sign of capitulation. While the bullion banks may try to stop out a few more longs, managed money is near it’s annual low in net bullish exposure so there might not be many more long positions that can be easily flushed out.

Gold is a market that routinely frustrates traders. The activity discussed above means it often has false breakouts and false breakdowns, making it difficult to use traditional technical analysis on shorter timeframes. Moves can be exaggerated, with painfully long corrections that can be followed by relatively swift up moves that are easy to miss.

I often point out that gold has many narratives. It can go up with inflation, as gold meaured in your local currency goes up while that currency drops. It can go up with negative real interest rates, as investors trying to diversify their holdings from stocks become less comfortable with bonds. It can go up with emerging markets or asian markets as the citizens of these countries tend to be big holders of physical gold. It can be a safe haven when investors struggle to find any asset they can trust. In a sense, the gold price is tossed around by many powerful and often competing forces causing the dominant narratives to fluctuate. Traders often get frustrated by this because they get too fixed on one or two narratives, and their signals simply stop working when the dominant narratives switch.

My favorite narrative is the de-dollarization of foreign trade. Major countries including China are tired of being reliant on US dollars for all of their foreign trade. Reasons include persistent Eurodollar shortages, booms and busts from foreign investment flows, and the keenly felt political pressure of US government sanctions. These countries aim to increase their trade in other currencies, such as China using the belt-and-road initiative to encourage trade in their own currency. This reduces their need to for their central banks to hold US dollars. Gold is a primary beneficiary of this sort of central bank reallocation because central banks have held it as an asset throughout their existence, and skeptical governments like having an asset that can’t be created at will by foreign powers. Note that this is a slow process and I expect the US dollar to dominate trade volumes beyond 2030. I just expect this process to provide a bullish backdrop for gold.

Here’s how my portfolio ended up:

  • DOWNSIDE BETS (29.5%)
    • 22.1% TLT Calls
    • 5.9% IWM Puts
    • 1.5% EEM Puts
    • 10.0% AG (Silver), mainly shares some calls
    • 6.9% SAND (Gold, Silver & others), all calls
    • 4.5% EQX (Gold), shares & calls
    • 4.5% SILV (Silver)
    • 3.8% LGDTF (Gold)
    • 3.9% MTA (Gold & Silver)
    • 3.3% SILVRF (Silver)
    • 1.5% WPM (Gold, Copper & Silver), all calls
    • 1.4% MGMLF (Gold)
    • 1.4% RSNVF (Silver)
    • 0.5% SSVFF (Silver)
    • 0.6% GOLD (Gold, Copper), all calls
    • 6.4% NOVRF (Nickel/Copper)
    • 6.2% CCJ (Uranium)
    • 3.4% UUUU (Uranium, Vanadium, Copper)
    • 1.5% BQSSF (Uranium)
  • CANNABIS (5.5%) split btw CRLBF, GTBIF & TRSSF
  • CRYPTO (2.8%) all ADA
  • CASH (2.7%)

Note that my portfolio declined by 7% over the past 2 weeks. I took advantage of the dump in miners by picking up MGMLF, but I haven’t made any other notable trades – aside from slightly reducing my crypto holdings into this fantastic rally.

My outlook hasn’t changed considerably. I’ll lay it out though.

  1. I’m still very concerned about the US stock market based on
    1. Extremely high US valuations driven by a small number of individual stocks
    2. A sharply reduced credit pulse from China
    3. US government largesse of the 2020’s dying off
  2. I am firmly in the deflationist camp as I see large and rising debt levels as a growing monetary black hole, which pulls more and more money away from everything else.
    1. This means I expect government interest rates to stay low and likely drop further, hence my heavy bullish allocation to TLT.
    2. This does not mean that I expect living costs to go down. I simply expect the trend to continue where costs of living rise significantly higher than wages, giving the average person less money to spend on other things.
    3. The CPI does not reflect the basic cost of living; it is heavily weighted by consumer discretionary spending, hedonic adjustments (costs rise but quality adjustments offset to make costs lower in the measurement), and housing as an “owner’s equivalent rent” fudge number which doesn’t tend to reflect cost increases well.
  3. I am bullish on the mining sector because of
    1. Significant underinvestment in mining over the last decade with lengthy downside corrections in precious metals and Uranium in particular. It takes a lot of time to go through the exploration/development/production cycle in mining so these long periods of underinvestment can turn into long periods of supply constraints.
    2. Increased need for Uranium in the future as many countries – particularly in emerging markets and Asia – as they are building a lot of nuclear plants to produce a lot more power without the environmental side-effects of coal or the price swings of oil and natural gas.
    3. Increased need for battery metals in the future as more and more spending is driven by government infrastructure projects, environmental regulations, and other subsidies towards anything considered green. Wind plants require enormously oversized copper power cables over long distances, solar plants require a lot of silver, copper, and other metals in their process, batteries and electric vehicles require a lot of copper and specialty metals.

As a final note, I don’t plan on skipping many weeks on my blog, but last weekend was very busy for me and I’ve been busier than ever at work. Good luck and happy trading!

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Feeling a bit cautious

We’re at an interesting point in the market where it could be turning but it is certainly difficult to read. Chinese tech is still under pressure while the US Nasdaq remains near all time highs. Breadth is still low, meaning most of the strength lies in the biggest 10 companies. Similar story in the S&P 500 and the DOW. The Russell 200 is a bit weaker, but still well within the same range as the last 6 months. While we could form a rolling top here, we could also see another burst to the upside.

There are certainly risks in terms of the political cycle, as the last of the stimulus rolls off and the infrastructure plan is likely to disappoint (chart source noted in red):

Precious metals had a nice rally last week, which pushed my portfolio up to gain 5.7%. That is certainly nice, but we’re still fighting a bearish technical picture and there is a decent chance of revisiting the March lows at some point. I’m just holding here, as my positions are large enough already and it could break either way.

I am tempted to buy some more defensive positions, such as TLT calls on a pullback or EEM puts if it rallies back to 54. I’m a bit more cautious about trying to bet against the S&P 500 or the Nasdaq though.

Here’s my portfolio today:

  • DOWNSIDE BETS (29.5%)
    • 22.2% TLT Calls
    • 5.8% IWM Puts
  • 1.4% EEM Puts
    • 10.3% AG (Silver), mainly shares some calls
    • 8.3% SAND (Gold, Silver & others), all calls
    • 5.1% EQX (Gold), shares & calls
    • 4.6% SILV (Silver)
    • 4.3% LGDTF (Gold)
    • 3.9% MTA (Gold & Silver)
    • 3.3% SILVRF (Silver)
    • 1.6% WPM (Gold, Copper & Silver), all calls
    • 1.3% RSNVF (Silver)
    • 0.6% SSVFF (Silver)
    • 0.7% GOLD (Gold, Copper), all calls
    • 5.8% NOVRF (Nickel/Copper)
    • 6.3% CCJ (Uranium)
    • 3.5% UUUU (Uranium, Vanadium, Copper)
    • 1.5% BQSSF (Uranium)
  • CANNABIS (5.1%) split btw CRLBF, GTBIF & TRSSF
  • CRYPTO (2.3%) all ADA
  • CASH (2.2%)

I was a bit nervous about losing my CCJ position again on Friday as I had $18 and $19 covered calls which just expired. I kept it though. That has been a great one for covered calls for me in general because they are often priced quite high.

Aside from that, I did take advantage of that hit in Chinese Tech stocks to sell off all of my EEM puts that had a Jan 2022 expiry. The strikes were way out of the money, but at least the increased downside volatility allowed me to salvage something out of them.

As for crypto, I actually sold 1/4 of my position in ADA back at the lows a couple weeks ago and I’m just holding the rest. I’ll re-assess whether to add or not over labor day weekend but I’ll let it sit until then. It’s important to wait a month before re-purchasing after selling at a loss to avoid triggering “wash sales” which basically don’t allow you to deduct the real loss. It might seem funny, but I can add to my miners when they plummet and feel confident that they’ll bounce back at some point, while I always tend to be nervous about the valuations of crypto assets.

Anyway, I’ll probably be thinking defensive these next few months, holding what I have while building a bit more of a cash position.

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QE, Margin Debt and Eurodollar Shortages

I’ll start with a chart on margin debt from Margin Debt and the Market: Up 2.4% in June, Continues Record Trend – dshort – Advisor Perspectives

I’ve seen some tweets on Margin Debt starting to roll over, but the latest data I have access to through google search shows a continued rise through the end of June. As you can see on the chart above, margin debt rolled over prior to both the 2000 and 2007 peaks.

A very interesting and important thing is happening with US treasury market right now as well:

Above you can see a chart showing foreign selling of US treasuries, latest data is May 2021. Source: Yet Another Key Warning Sign, Piece Of Strong Evidence: TIC & The Long Misunderstood History of Selling Treasuries – Alhambra Investments (alhambrapartners.com)

I’m a big fan of Jeff Snider’s work and I encourage you to look through his articles on the Market Research tab on that website. Basically, he explains how our Eurodollar system works.

Here’s the gist of it. Foreign countries build up reserves in US dollar assets – particularly US treasuries, but also in gold – when the dollar is weak. The world relies heavily on the US dollar for foreign trade, and they tend to build up debt in US dollars when it seems favorable. At the same time, US investment cycles tend to periodically flood into emerging markets seeking growth and then rush back out seeking safety. The ever-growing debt levels increase the foreign need for US dollars over time while the investment flows create periodic scarcity. When Eurodollars (US dollars held in the banking system outside of the United States) are scarce, it can cause defaults and wreak havoc on foreign economies, as in the Mexican Peso Crisis and Asian Financial Crisis of the 90’s.

Foreign reserve assets, particularly those denominated in US dollars, are sold to offset this scarcity in their home countries. This tends to be a sign of coming crisis because foreign CB’s can’t just sell these off indefinitely – it has limits just like tapping into a strategic oil reserve. Similar to the oil analogy, tapping these reserves only alleviates the pressure of a cycle rather than changing the supply & demand function; the hope is to get through until the market currents shift on their own.

In the chart above, Jeff Snider points out the repeating economic crises in the Eurozone throughout this last decade and how they relate to this period of chronic Eurodollar shortage.

Other articles talk about how the federal reserve does not create money through QE – it is mainly a ledger action exchanging bank assets such as mortgage backed securities and US treasuries for overnight reserve assets paying the fed discount rate. These reserve assets can be exchanged between institutional US banks and are counted as assets they can borrow against, but money is actually created through borrowing. There is a long rabbit hole to go down here, but essentially the US Central bank is not creating money to alleviate the dollar shortage, they are just encouraging large investors to borrow cheap and pour money into assets such as stocks, bonds, and real estate. Also, QE has a side effect of reducing the top-tier collateral (short-term US treasuries) from the system and forcing money to park elsewhere, which is why both the BOJ and SNB have been going as far as investing in both US commercial debt and US stocks.

How does this dynamic affect the performance of TLT?

I created the charts above to see how TLT (long-dated US treasuries) relates to foreign holdings of US treasuries. The 5-year chart seems to show that the foreign holdings of US treasuries corresponds somewhat with lower yields at the long end, but the 1-year chart doesn’t say much because the federal reserve reports this data quarterly. The dip in foreign holdings on the chart at the top right ends in Q1 2021 which corresponds with the March TLT low. I threw in the last few months of data with the rally in TLT because it’s there, but there is no corresponding data available for foreign holdings of USTs in that period.

There is an argument that the Fed’s QE tends do drive down interest rates over time, and this seems to hold up with the decade post 2008 but in a rough and volatile process. There are so many questions and uncertainties here it’s insane.

How much can long-term interest rates go down as they approach zero? How does the zero line affect the movements? Japan and Europe have both shown the possibility of negative nominal interest rates on securites going out for several years. UST bulls would point out the path of Japan since 1990 and shorting the Japanese long bond as the famous “widow-maker” trade. Here’s a chart: Japan Long Term Interest Rate, 1998 – 2021 | CEIC Data

Corresponding chart in US 10-year yields from Yahoo Finance:

You can see the implications here, if you believe we are following the path of Japan (which was endless bouts of QE and fiscal stimulus). The absolute bottom in US rates we saw so far was at 0.5%. A TLT bull would point out that Japan’s 10YR yield went negative and ours could too, while a TLT bear would point out the massive rate hike after the 10YR JGB plunged from 2% to a low of 0.5% back in 2002.

We know that the Federal Reserve does not want negative rates, which is why they quickly announced the reverse-repo program where they will essentially take unlimited money from US banks and pay them a 0.05% annual yield on it. We also know that this program has grown massively since announced, and that close to $900 Billion is currently taking advantage of the program.

We also know that the worldwide economy is still experiencing massive shocks, lockdowns, shortages of certain things, and transportation problems.

The most common theories I hear about these days are the following:

  1. Hyperinflationists. They go on about the Fed balance sheet, government defecits, and whatever rose in price lately, convinced that the currency is rapidly devaluing. Their understanding of the monetary system is incredibly superficial, and they show a complete lack of understanding about deflationary forces such as technology, demographics, and enormous debt levels. These guys drive me crazy when they focus on the horrors of wage growth being sticky when there’s been no real wage growth in my lifetime.
  2. Deflationists. They talk a lot about valuations, high debt levels, enormous margin debt and the fragility of our financial system. I identify heavily with this camp and it includes a variety of people such as Dave Rosenberg, Jeff Snider, Steven Van Metre and so on.
  3. Semi-inflationists. Raul Pal from RealVision is one of these (other big names are Cathie Wood from Ark Investments) and he put together an excellent argument on how the underlying economy may be weak and the debt levels may be high, but the federal reserve balance sheet is expanding the money supply by pushing more and more money into investable assets such as the stock market. He sees low overall growth, the continuation of a winner-takes-all economy, and the value of “network effects” which is pushing more and more money into both Cryptocurrencies and anything tech. He explains that it could all turn if the federal reserve tightens, but they will never do that because it would totally crash the economy. The result as they see it, is that we’re stuck in a society with an ever-expanding wealth divide and you have to either buy assets that are increasing in value or you fall further and further behind.

Argument #3 is the newest to me, and it is certainly compelling. However, I still have trouble with the idea of investing in tokens which have no intrinsic value and with the idea of piling into the same big mega-cap corporations that everyone else in the investing world is piling into. I also tend to believe that the federal reserve, while powerful, does not have complete control over interest rates and the economic system. It seems to me that they have been working ever harder to give the illusion that they have control when they are really just following what the market does. Just like 1990 Japan, our debt-driven asset bubble will pop at some point, I have no idea when that will happen, and many assets will remain in a manic rise until it does.

For now I’m still in the bonds-bullion barbell approach because I see precious metals and mining stocks in general as relatively cheap while I want some protection in the case of a deflationary bust. It’s a tough slog when momentum is outperforming, but I can sleep at night without worrying too much. On the bonds side, I don’t think that long-term yields can rise too much without pulling down the financial system and causing a cascade of defaults. On the precious metals side, I am still convinced they go up considerably in the next decade and I don’t think they have much further to drop. Gold can revisit $1600 or even $1200, but these dips will be bought and they’ll be as temporary as the gold price crash in 2008-2009.

Here’s where my portfolio left off:

  • DOWNSIDE BETS (31.6%)
    • 23.3% TLT Calls
    • 6.3% IWM Puts
    • 0.2% QQQ Puts
    • 1.8% EEM Puts
    • 10.2% AG (Silver), mainly shares some calls
    • 8.0% SAND (Gold, Silver & others), all calls
    • 4.5% EQX (Gold), shares & calls
    • 4.5% SILV (Silver)
    • 4.3% LGDTF (Gold)
    • 3.9% MTA (Gold & Silver)
    • 3.4% SILVRF (Silver)
    • 1.5% WPM (Gold, Copper & Silver), all calls
    • 1.3% RSNVF (Silver)
    • 0.5% SSVFF (Silver)
    • 0.6% GOLD (Gold, Copper), all calls
    • 6.0% NOVRF (Nickel/Copper)
    • 6.4% CCJ (Uranium)
    • 3.5% UUUU (Uranium, Vanadium, Copper)
    • 1.5% BQSSF (Uranium)
  • CANNABIS (5.5%) split btw CRLBF, GTBIF & TRSSF
  • CRYPTO (2.3%) all ADA
  • CASH (0.5%)

Notable trades: I sold all my QQQ puts on Monday and used the money to buy Uranium miners. That turned out to be a good move. At the end of the week I couldn’t help but put a little into one QQQ weekly put because it gained so much and we’ve had past patterns of strong Fridays followed by weak Mondays in the past … patterns which have to do with hedging positions of market makers around options expirations. Overall I’m down 0.6% on the week. Have a wonderful and relaxing weekend!

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Bonds soar as Commodities struggle

It’s been a rough month for commodities in general. My last 4 weeks of performance were -10.8%, +2.9%, +0.4%, -0.9%. It looks even worse when you look at the miners:

I own all of these names above, and they make up more than half my portfolio, so it’s a wonder I wasn’t down more.

I sold some more TLT calls this week to pick up miners on some of these dips. I’m trying not to overdo it though, because bonds are currently working, and I am still selling them at a loss compared to my own buy-in back in mid February. One short-term trade I got right though … last week I had reduced my holdings of TLT calls roughly 25%. I expected a high CPI reading on Tuesday, so I looked for a dip in bonds and got 5 shorter dated TLT calls (Jan 2022), then sold them 2 days later for a decent gain.

Still, my performance has been downright lousy as my account balance is roughly the same as it was late 2019 even though I’ve been putting money in from every paycheck in between.

What can I say, I cut my teeth in markets that did this:

I started trading in 1999 and learned hard lessons about bubbles, cycles, and fundamentals. Stocks were mean-reverting beasts and you needed to take profits on any significant gains.

I never expected that markets could start doing this:

The hard lesson I’ve been learning is that fundamentals don’t drive prices – it’s all about cash flows. Who cares if earnings are roughly flat, as long as money piles into passive funds while interest rates are pinned at zero and corporations borrow like crazy for ever-bigger stock buyback programs.

It’s easy to think that this is a mega-bubble destined to pop at any moment. Everyone wants to be Michael Burry from “The Big Short,” proving that fundamentals actually do matter at some point. It’s a very compelling trap thinking “I’ve been wrong so far, but I’m really smarter than everyone else, just wait till this thing blows up!” Unfortunately, that simply leads to trading on emotions which will absolutely kill your performance.

My trading on the miners so far this last year actually wasn’t bad. I managed to get longer at the right times, owning more long-dated call options and such, and to get shorter at the right times by selling my call options down and selling covered calls on my shares. My performance was killed by my hedges … buying too many index puts at just the wrong times, then buying too many TLT calls too early.

I’m still thinking of these mining stocks as being in a beaten-down phase of a multi-year bull trend. These are capital-intensive cyclical businesses which take years to get more production on line. Bear markets (2012-2018) lead to underinvestment, which leads to tighter supply, which leads to rapid gains when demand goes up.

Right now the economy is about to face enormous headwinds as government stimulus programs die off while the total number of jobs fails to recover. The mining shares can be beaten down a lot more. However, I’m still more comfortable holding those than I am holding most other stocks with their extreme valuations. I figure that as long as I’m careful – meaning that I don’t use leverage, I stick mainly with shares (call options expire and must be considered trading positions), and I diversify or offset my risk a bit, these things will eventually start moving.

Here’s where my portfolio ended up:

  • DOWNSIDE BETS (35.0%)
    • 23.0% TLT Calls
    • 6.9% IWM Puts
    • 3.7% QQQ Puts
    • 1.5% EEM Puts
    • 10.2% AG (Silver), mainly shares some calls
    • 8.4% SAND (Gold, Silver & others), all calls
    • 4.9% EQX (Gold), shares & calls
    • 4.3% SILV (Silver)
    • 4.0% MTA (Gold & Silver)
    • 3.3% SILVRF (Silver)
    • 3.2% LGDTF (Gold)
    • 1.6% WPM (Gold, Copper & Silver), all calls
    • 1.3% RSNVF (Silver)
    • 0.5% SSVFF (Silver)
    • 0.6% GOLD (Gold, Copper), all calls
    • 5.6% NOVRF (Nickel/Copper)
    • 4.2% CCJ (Uranium)
    • 2.3% UUUU (Uranium, Vanadium, Copper)
    • 1.4% BQSSF (Uranium)
  • CANNABIS (5.7%) split btw CRLBF, GTBIF & TRSSF
  • CRYPTO (3.0%) all ADA
  • CASH (0.4%)

As you can see, I re-built my Uranium portfolio. On my May 29 post, I had 10% of my portfolio in CCJ and another 1.1% in UUUU. By June 20, these positions were totally gone because my covered calls expired in-the-money triggering a sale. The stocks continued higher for a time, but I waited it out, finally adding a little bit in early July. This week I added considerably, particularly on Friday.

Here’s the big reason for weakness this Friday, and why I bought into it:

This Friday was a significant options expiration. Certain miners like CCJ and AG have very heavy options volume – both in calls and puts. Options dealers sell these positions to retail, and hedge them by purchasing more shares as the price goes up and selling more shares as the price goes down. When these options expire, the dealers need to sell shares at the strike price if it’s in-the-money (for calls) or buy shares at the strike price if it’s in-the-money (for puts), and they automatically buy or sell shares in the market to cover these positions. The result is that share price moves are greatly accelerated into expiration – this time to the downside.

We’ll see how things move forward in coming months. My guess is that interest rates continue lower and bottom in the fall (TLT rises), and that commodities continue to struggle but their downside from here is somewhat limited.

We might see a turn in the major US indices, but I’m thinking of selling off my QQQ puts next week (at a loss) and getting what I can out of those. Big US tech has enormous market power and government support, they get the bulk of any index-fund inflows, and they buy back their own shares like crazy. Also, low interest rates are considered good for the tech sector. I’m more comfortable sitting on puts in IWM which is mainly supported by meme stocks like GME and AMC, but I’ll stay wary as I’ve learned not to overdo it with puts.

Good luck and be careful, these market forces are dangerous, powerful, and quick.

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Significant rally in US treasuries capped with Friday selloff

It’s been quite a week for the US Long Bond:

I actually think that the TLT rally we see still has legs to it. There are a number of reasons to expect economic weakness and reduced CPI going forward including the following:

  1. Stimulus programs such as added unemployment benefits are coming to an end. These have already ended in many states but will expire nationally this September.
    1. This includes the extra $300/week payment, as well as the Pandemic Emergency Unemployment Compensation (PEUC), and the PUA programs.
    2. During the Great Financial Crisis, regular unemployment duration was extended from 26 weeks to 99 weeks. The covid response varied state by state, but still added a maximum of 20+26 weeks before expiring completely: Policy Basics: How Many Weeks of Unemployment Compensation Are Available? | Center on Budget and Policy Priorities (cbpp.org)
    3. In short, a large amount of government money that was going into the economy is about to stop. This will force spending downward and put downward pressure on the CPI, inflation expectations, and treasury rates.
  2. Forbearance programs in rents, mortgages, and student loans are also coming to an end. This will divert even more money that previously went into spending.
  3. Inflation measures in the US are based on annual changes. The comparison against the lockdown months is gone, future months will be compared against an economy that combined initial re-opening and massive government stimulus including PPP and stimulus checks.
  4. Dollar shortages are showing up in a number of countries. Many emerging economies responded with interest rate hikes while developed economies responded with some form of tapering of their asset purchase programs.
  5. China just responded this Friday by reducing their Reserve Rate Requirement (RRR). This article explains what they were doing, but I’ll sum up below: How Do You Spell Escalating? C-H-I-N-A-R-R-R – Alhambra Investments (alhambrapartners.com)
    1. US treasury interest rates spiked on Friday when China announced that they were reducing their RRR. The thinking is that this will enable their banks to lend more to stimulate the economy, and that a credit pulse in China could boost commodities and inflation expectations like it did back in 2008 when they were building skyscrapers everywhere.
    2. However, China has done this a number of times in the last decade in for a very different reason; their system is short US dollars. In the 2000’s, China was building up US dollar reserves like crazy, which added a lot of assets to their bank’s balance sheets. They would raise the RRR to lock a lot of this money in the financial system in order to prevent credit spikes and keep domestic inflation under control. Now the process is simply going in reverse; China needs to alleviate a domestic dollar shortage by selling US treasuries, which will reduce the assets on their bank’s balance sheets, and they don’t want this to create a domestic credit freeze as their banks hit the old RRR limits.

In short, I expect interest rates in US treasuries to continue lower throughout the year and I wouldn’t be surprised to see weakness in stocks and commodities.

So why did I reduce my position so heavily? In short, because I was over-allocated. Look at my allocations from my posts in February – I jumped in too fast putting nearly half my portfolio into TLT calls, and I got killed as rates moved against me. This over-allocation prevented me from being able to safely and methodically add as rates went higher. I don’t want to exit the trade completely because I’m still confident in the overall thesis that bond yields will bottom in the next few months – but I can’t responsibly manage an options trade that’s 50% of my portfolio, even if it doesn’t expire for another 18 months.

Whenever you trade on a macro thesis, you have to realize that your trade can turn against you and plan accordingly. It’s better to hold back enough where you can responsibly add as you wait for it to play out, and it is better to reduce a bit on the rallies in case of a head-fake and further weakness down the road.

I’m still nervous about the leverage in the financial system causing problems (it can’t increase forever, right?), so I’m not going to make a long bet on general US stocks. Ironically, I feel more comfortable with the mining stocks mainly because they’ve been missing out on much of the post-covid gains. These are cyclical in nature – bear markets lead to under-investment which leads to shortages which leads to bull markets which leads to over-investment then repeats. The miners (gold, silver, uranium, copper) had a terrible bear market from 2012-2018 and they have just started to recover. I don’t feel as comfortable with Oil because it seems to have shorter production cycles due to fracking technology, and OPEC can always increase supply.

As for emerging markets, I remember being over-allocated to them back in 2008-2009 with de-coupling and all that. I learned that EM stocks get hit hard on developed market weakness as foreign investment turns risk-off and rushes back home. Then they miss the initial upside after a bottom (like 2009) but they rally hard on the growth part of the cycle that follows. I’m still short EEM, and I fully expect the same cycle to play out. If the US stock market seriously tanks, then stabilizes and starts to recover, then I will allocate to emerging markets and not before.

For now, I think I’m over-allocated to precious metals miners so I will try to refrain from adding there. Same goes for copper – I have more than I need with NOVRF plus the exposure in my other mining stocks. I would still like to add to CCJ (uranium) on weakness, and I do expect to see more weakness this month. I’m thinking about just sitting on a stronger cash position when I close out my TLT calls. Maybe I’ll get a few more long-dated index puts if we continue to hit all time highs in IWM & QQQ in coming months …. but I’ve lost so much doing that these last 18 months that I’m not too sure about that one.

Anyway, my portfolio was actually up slightly on the week. Here’s where it landed:

  • DOWNSIDE BETS (36.9%)
    • 26.1% TLT Calls
    • 5.5% IWM Puts
    • 3.4% QQQ Puts
    • 2.0% EEM Puts
    • 9.8% AG (Silver), mainly shares some calls
    • 8.1% SAND (Gold, Silver & others), all calls
    • 5.5% EQX (Gold), shares & calls
    • 4.7% SILV (Silver)
    • 4.3% MTA (Gold & Silver)
    • 3.2% SILVRF (Silver)
    • 3.0% LGDTF (Gold)
    • 1.5% WPM (Gold, Copper & Silver), all calls
    • 1.5% RSNVF (Silver)
    • 0.6% SSVFF (Silver)
    • 0.7% GOLD (Gold, Copper), all calls
    • 4.7% NOVRF (Nickel/Copper)
    • 1.7% UUUU (Uranium, Vanadium, Copper)
    • 1.1% CCJ (Uranium)
    • 0.8% BQSSF (Uranium)
  • CANNABIS (6.3%) split btw CRLBF, GTBIF & TRSSF
  • CRYPTO (3.4%) all ADA
  • CASH (2.3%)

I really don’t know what to predict going forward these next couple months. I could just as easily see gold re-test the recent lows around 1670 as I could see it swiftly rally back to 1900 resistance. I could see IWM and QQQ stocks crash big time in a major de-leveraging event, go through a minor 5% correction, or continue hitting all-time highs. All I know is I’m feeling a bit cautious. Good luck and happy trading.

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Modeling the effects of UBI

UBI, or Universal Basic Income, is a topic which has growing interest.  Some people think it is inevitable as we transition into a world where technology makes supply so abundant relative to labor that it is the only way to include the average person in the modern economy, ending in a Wall-E type world where the robots produce everything for its human passengers on a cruise ship out in space.  Other people think it is terrifying and would quickly spin out of control into a hyperinflationary collapse, noting the Weimar Republic, Zimbabwe, and Venezuela.  Regardless of your opinion on the matter, it does raise some fascinating questions.

UBI can be instituted in a number of ways, but the most common is the idea of giving an equal monthly payment to every US Citizen which is treated as taxable income. The only question of eligibility and relative amount is whether you have a social security number.

Small-scale experiments to date

There have been a number of small-scale experiments to date on the effects of UBI, focusing on giving a small group of people a monthly payment for a period of a year or so and focusing on how they spent that money and the overall effects on their lives.

Unfortunately, these small-scale experiments can’t really answer any of the underlying questions about UBI.  Everyone knows that getting a small cash windfall tends to make people happier, reduce their stress levels, and so on.  The question is what happens when everybody gets paid a small amount every month.  The first question is the effects on overall demand, because people spend money and plan differently when they have a reliable long-term income rather than having a short-term windfall.  The second and more important question is what happens with inflation?  People have vastly different opinions about what causes inflation and whether it is a linear phenomenon. 

What causes Inflation?

In a previous blog post, I wrote about what causes inflation here: https://johnonstocks.wordpress.com/2020/08/16/what-causes-inflation/

For this post, I put together and attached this chart:

As you can see, the last sustainable bout of double-digit inflation as measured by the CPI was back in the 1970’s.

The Vietnam Draft as a model for UBI

In the 1960’s, two very important things happened: The Greater Society infrastructure spending, and the Vietnam War.  This is a very interesting test case for the effects of UBI because it effectively paid a lot of people incomes for work which had nothing to do with meeting demand for consumer goods and services.

The draft really started to ramp up these mass-UBI payment effects from 1969-1975.

Inflation didn’t really start to accelerate until 1973, when OPEC proclaimed an oil embargo targeted at all nations supporting Israel, causing oil prices to quadruple in less than a year. 

This inflation peaked in 1974, a full decade after that massive UBI-scale money was going out.  This was the date of the important Bretton Woods conference where the US dollar and the world effectively de-coupled from the price of Gold. 

After 1974, CPI inflation actually declined from double digits back to 5%. Then it accelerated rapidly following the heavy oil disruptions from the start of the Iranian Revolution in January 1978 and peaked at nearly 15% in 1980.  Volcker, appointed fed chair in 1979, was credited for beating this inflation as the CPI dropped below 5% in 1983 and has rarely hit that level since.  At the same time, oil collapsed between 1980-1986. During 1979-1981 alone, oil demand collapsed 13% as countries adjusted to higher oil prices by diversifying electrical grids away from oil while fuel efficiency rapidly increased.

As you can see, a lot happened to cause the inflationary spikes during the 1970’s.  So how does this relate to UBI?  There is still an enormous debate on the biggest underlying cause of the 1970’s inflation, with many arguing that the wage-price spirals went out of control due to the tight labor market and the powerful labor unions.  Others argue about cost-push inflation from the oil shocks, or supply disruptions combined with heavy war-related demand, or monetary debasement culminating in abandoning of the gold link at Bretton Woods.

I would argue that if you took the annual Vietnam war spending and applied that same level of money to a UBI, than the result would be only the level of inflation attributed to the wage-cost spiral effect during the 1970’s.  Thus inflation would not only be limited to the levels seen during that decade, but would be substantially lower because it would not cause the other inflationary effects of the 1970’s.

How would we pay for UBI?

The most common question about UBI as how would we pay for it? In order to model that you have to ask how do we pay for anything?  We spent enormous sums in WW2 in the 1940’s after a decade of great depression, to be followed by rapid growth in the 1950’s and 1960’s. We spent enormous sums in Vietnam as well, also followed by rapid growth in the 1980’s and 1990’s.  Here is a chart of overall government debt over the years, source: https://www.thebalance.com/national-debt-by-year-compared-to-gdp-and-major-events-3306287

End of Fiscal YearDebt (in billions, rounded)Debt-to-GDP RatioMajor Events by Presidential Term
1929$1716%Market crash
1930$1617%Smoot-Hawley reduced trade
1931$1722%Dust Bowl drought raged
1932$2034%Hoover raised taxes
1933$2340%New Deal increased GDP & debt
1935$2939%Social Security
1936$3440%Tax hikes renewed depression
1937$3639%Third New Deal
1938$3742%Dust Bowl ended
1939$4043%Depression ended
1940$4342%FDR increased spending & raised taxes
1941$4938%U.S. entered WWII
1942$7243%Defense tripled
1944$20190%Bretton Woods
1945$259114%WWII ended
1946$269118%Truman’s 1st term budgets & recession
1947$258103%Cold War
1950$25786%Korean War boosted growth and debt
1953$26668%Recession when war ended
1954$27169%Eisenhower’s budgets & Recession
1958$27657%Eisenhower’s 2nd term & recession
1959$28555%Fed raised rates
1961$28951%Bay of Pigs
1962$29849%JFK budgets & Cuban missile crisis
1963$30648%U.S. aids Vietnam, JFK killed
1964$31246%LBJ’s budgets & war on poverty
1965$31743%U.S. entered Vietnam War
1969$35435%Nixon took office
1971$39834%Wage-price controls
1973$45832%Nixon ended gold standard & OPEC oil embargo
1974$47531%Watergate & budget process created
1975$53332%Vietnam War ended
1978$77233%Carter budgets & recession
1980$90832%Volcker raised fed rate to 20%
1981$99831%Reagan tax cut
1982$1,14234%Reagan increased spending
1983$1,37738%Jobless rate 10.8%
1984$1,57239%Increased defense spending
1986$2,12546%Reagan lowered taxes
1987$2,35048%Market crash
1988$2,60250%Fed raised rates
1989$2,85751%S&L Crisis
1990$3,23354%First Iraq War
1993$4,41164%Omnibus Budget Act
1994$4,69364%Clinton budgets
1996$5,22565%Welfare reform
1998$5,52661%LTCM crisis & recession
1999$5,65659%Glass-Steagall repealed
2000$5,67455%Budget surplus
2001$5,80755%9/11 attacks & EGTRRA
2002$6,22857%War on Terror
2003$6,78359%JGTRRA & Iraq War
2004$7,37960%Iraq War
2005$7,93361%Bankruptcy Act & Katrina.
2006$8,50762%Bernanke chaired Fed
2007$9,00862%Bank crisis
2008$10,02568%Bank bailout & QE
2009$11,91082%Bailout cost $250B ARRA added $242B
2010$13,56291%ARRA added $400B, payroll tax holiday ended, Obama Tax cuts, ACA, Simpson-Bowles
2011$14,79095%Debt crisis, recession and tax cuts reduced revenue
2012$16,06699%Fiscal cliff
2013$16,738100%Sequester, government shutdown
2014$17,824102%QE ended, debt ceiling crisis
2015$18,151100%Oil prices fell
2017$20,245104%Congress raised the debt ceiling
2018$21,516104%Trump tax cuts
2019$22,719106%Trade wars
2020$27,748129%COVID-19 & CARES Act

Notice that the dollar amount of US government debt never declines after 1951, even in our so-called government surplus year in 2000. Between 1940-1945 it went up 600% while debt/gdp went from 38% to 114%. Over the following decade (1945-1955), US debt barely budged and debt/gdp was cut in half. Contrast this to the Vietnam war where debt only went up 68% and debt/gdp went down from 43% in 1965 to 32% in 1975.  How did that happen?

Perhaps it went to the central bank balance sheet? https://www.stlouisfed.org/publications/regional-economist/january-2014/the-rise-and-eventual-fall-in-the-feds-balance-sheet

Note that this is the central bank balance sheet/GDP, but it is still interesting that this measure actually declined in both WW2 and the Vietnam war.  Compare that to today where the central bank balance sheet more than doubled between July 1, 2019 and July 1, 2021 while US GDP went from $21.4T to $22.7T bringing us to a debt to gdp of $8T / $22.7T = 35%. 

However you look at it, the only thing that seems to stand out in periods of heavy government spending related to these wars was the periods of higher inflation.  It looks like its fair to say that we ultimately paid for these wars with inflation, and that a UBI program would be paid for in the same way.

Why do central banks want higher inflation? How have they been reacting? Are their policies working?

The US Central bank in particular has a mandate to achieve full employment as well as price stability.  In order to achieve full employment, we need to have continuous growth to at least match the growth in population.  The idea is that in a deflationary period, prices are going down because demand is lower than production, so production needs to decrease and employees are laid off.  Contrast this to a period of inflation which signals to the economy that more production is needed and people are hired in order to achieve it.

Sounds simple, right? How well does this work in practice?

The above chart shows the labor force participation rate for prime working age 25-54 declining steadily since 2000.  In fact, the labor force never even recovered from the great financial crisis before the covid crisis hit.  This is despite the Federal Reserve trying to “create inflation” by pegging interest rates near zero and increasing the size of it’s balance sheet via “quantitative easing”

Why isn’t this working?  Rents have definitely been increasing.  Housing prices have been going up.  Asset values in general have climbed at a rapid pace with this policy:

Has production decoupled from the labor force? Has the stock market as well?  In a word, yes. With automation and globalization, it takes a lot less labor for a company to generate the same earnings:

The above chart should be more empowering than it is shocking.  We have more productivity than ever before – we just need to figure out how to allow the labor force to participate.

Supply side vs demand side economics

Supply side economics has a long history on its side.  During the amazing productivity booms of the Industrial Revolution, the expansion of global trade led to a world of seemingly limitless demand for products. Factories were being built for everything, and anything produced was sold.  Andrew Carnegie used the famous Bessemer process to create the world’s biggest steel manufacturing plant, borrowing all he could to finance it’s construction.  One it was built, the sky was the limit as skyscrapers began to fill US cities creating nearly limitless demand for his products.  During this time, manufacturing was very labor-intensive and more production meant more factories filled with more workers.

Contrast this to the amazing computer age, where productivity could grow by leaps and bounds while the workforce was pruned.  We’ve had an increasing problem of excess productive capacity for decades:

Where do we go from here?

We have more productive capability than ever and nowhere near enough demand to meet it.  Sounds like a success problem right?  Not so fast… remember the problems of labor force participation among prime working age adults. Think of the rapid growth in our homeless populations over the last decade, along with the deaths of despair.  We have a system that treats people as a commodity called “Human Resources.” When a commodity is in oversupply, less is needed – hence the decline of our labor force and our birth rates as political unrest soars.

There are many ways we can solve this problem, and a UBI is only one of them.  Others include employment guarantees, with the idea that it is better to have employees in money-losing government owned enterprises than unemployed protesters on the street.  There are a lot of useful and creative activities that we can incentivize people to do whether it’s environmental cleanups, infrastructure building, scientific research, or artistic endeavors.

With our current focus on debt levels, it seems that our many problems are insurmountable.  How will we ever modernize our infrastructure?  How will we pay for our people’s retirements?  How will we provide decent health care to our lower wage workers?  How will we protect and restore our environment?  It seems ironic that our problems stem from a world of excess capacity.

We have had problems with debt and spending many times in the past.  These have tended to resolve with periods of mild inflation followed by rapid growth.  Currently, we have a federal government that is focused extensively on minimizing the debt alongside a central bank which is trying desperately to fix the labor market by throwing money into inflating asset values.  Perhaps we could replace this counter-productive activity with a different solution.

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Big drops in precious metals

It’s been a crazy couple of weeks for precious metals.

The weekly candles on the top chart still show a decent uptrend case, with gold breaking out and successfully backtesting a bull flag formation, and carving out a potential reverse head-and-shoulders pattern. Gold slipped below the 50 week moving average but is well above the 200 week.

The daily candles on the bottom chart are not that clear. You have a descending channel with a false breakout in January forming a bearish double-top and hitting a new low in March, where it formed a bullish double-bottom, broke out of the descending wedge, but failed to re-test the 1950 double top and landed above support around 1750. The 50 day moving average plummeted below the 200 day back in February, which is bearish, and just recently re-tested that level. However, the price remains below and the 200 day moving average topped and started trending downward. This spells trouble unless gold can break to the upside fairly soon.

The lines you draw on technical analysis are more art than science and really only give you an indication of trend. These trend lines are important in determining whether the big money is moving into or out of the asset class. Imagine yourself running a large fund, where you need to buy or sell a lot to move your performance needle, and that amount will move the market. If you are selling out, then you are slowly selling rallies but trying not to make the price plummet. If you are accumulating a position, then you are slowly buying dips but trying not to make the price rocket in the short term.

Speaking of what the big players are doing, here’s a chart from cotpricecharts.com (choosing basic charts, then GC):

On the chart above, large speculators have trimmed down their long positions considerably while commercial has reduced its short positions considerably. I put in the orange lines and text so that you could see how these levels reacted at significant points in the gold price chart.

The commercials here are gold miners. They spend large sums developing mines and conducting mining operations, and these short positions allow them to hedge so that they won’t go under if the gold price collapses. There is a considerable time lag between getting the metal out of the ground, refined, and sold to market so they use these positions to lock in a profitable price for this work. When they can buy back their contracts for the same price as mining new metal, then they will start closing out these contracts and their short position shrinks. The other side is large and small speculators who are simply betting that the price of gold goes higher. In many ways it just mirrors the gold miner positions, but you could also interpret it as some of the speculative longs being washed out and as investor sentiment becomes more bearish.

Essentially, commercial short positions tend to be a lot smaller at lows and a lot bigger at highs (inverse for large speculators). I remember seeing charts like this with very rare neutral positions in commercials back in 2018-2019 before price spikes. Take this all with a bit of a grain of salt though, because the movement of commercial positions is not so much predictive as by design. If gold producers can buy gold cheaper on the Comex then it can mine, it will start closing its comex positions and then start shuttering mines. Supply goes down and eventually price goes back up. This activity is even more apparent in the Uranium sector, where you had big producers like Cameco, who shut down their big Cigar Lake mine around 2019-2020 and then purchased cheap Uranium on the spot market to fill their sales contracts.

I’ll finish this segment with why I’m positioned so heavily in precious metals miners.

  1. Precious metals topped in 2011 and then carved out a bottom over the next decade. During that time, their was a lot of consolidation in the sector along with a lot less exploration and mine development. Exploration and mine development take years to build out, so supply will take time to increase and overtake demand.
  2. There tends to be a powerful sector rotation in the markets that changes every decade. Since 1990 you had alternating bull/bear runs of tech then commodities, and it makes sense to me that the current major tech run will turn in favor of commodities at some point.
  3. Gold remains an important asset in the global financial system and central banks are still net buyers. Many countries do not like being overly dependent on the US dollar after our overuse of weaponized sanctions, and gold is one of the assets that countries will turn to in order to diversify from their US dollar holdings.
  4. I am very worried about the leverage in our financial system. A small amount of selling can avalanche with margin calls into a market rout.
    1. The heavy “downside bets” positions in my portfolio, containing index puts and TLT calls, reflect this fear. If this happens, I expect precious metals to get hit with everything else, but to a lesser extent and with a quicker recovery just like in 2009.
    2. The market could avoid a significant correction for years and my “downside bets” positions – which are all long-dated options – can get crushed. If this happens, then my positions in mining stocks should be okay because they are primarily shares so they have no expiration date. These miners are making really good money at current precious metals prices, and they won’t collapse to zero even if current market trends prevail for 2 more years.
  5. The market is rising along with heavy liquidity. If the nearly $1 billion in reverse-repo action combined with continuously expanding mortgage and margin debt reflects a financial system that is flooded with money looking for any opportunity to grow, then sector rotation is very natural and precious metals miners will look like bargains at some point.

That being said, I can’t help but share this chart:

Equinox Gold is one of my bigger precious metals plays. I’ve been following it for a couple years because director Ross Beaty has a long successful history in the sector. My portfolio got hit pretty hard with the recent share price collapse from $9.50 down below $7.00. I tried really hard not to add much to this apparent falling knife, but I did break down and add some. This last two weeks has been really hard on a lot of the miners though, so I’ve been focusing on adding to ones that I’ve been meaning to increase my stake in.

Here’s where my portfolio ended up:

  • DOWNSIDE BETS (38.2%)
    • 28.0% TLT Calls
    • 5.2% IWM Puts
    • 3.5% QQQ Puts
    • 1.5% EEM Puts
    • 10.4% AG (Silver), mainly shares some calls
    • 9.2% SAND (Gold, Silver & others), all calls
    • 5.4% EQX (Gold), shares & calls
    • 4.9% SILV (Silver)
    • 4.4% MTA (Gold & Silver)
    • 3.4% SILVRF (Silver)
    • 3.0% LGDTF (Gold)
    • 1.6% NEM (Gold, Copper & Silver), all calls
    • 1.6% RSNVF (Silver)
    • 0.7% SSVFF (Silver)
    • 0.7% GOLD (Gold, Copper), all calls
    • 4.9% NOVRF (Nickel/Copper)
    • 1.9% UUUU (Uranium, Vanadium, Copper)
    • 1.2% CCJ (Uranium)
    • 0.8% BQSSF (Uranium)
  • CANNABIS (6.2%) split btw CRLBF, GTBIF & TRSSF
  • CRYPTO (3.5%) all ADA
  • CASH (-1.8%)

I changed my previous gold/silver breakdown into an overall precious metals category because a lot of the mining and royalty streaming companies have some of both. I also put in a rudimentary description of what their main exposures are.

My cash position is slightly negative because I dipped into margin a bit. Having a margin account allows me to buy into dips when they occur, but I typically like to keep this slightly positive.

TLT was strong this week and my account actually managed a 2.9% gain (vs a 10.8% loss last week). I calculate this ex-crypto (because it is in a different account) and I subtract out deposits so that I can see actual portfolio gains and losses. I did sell a couple of TLT contracts off this week to move that toward miners, but I didn’t sell as many as planned because my limit sell orders didn’t hit. Although I expect long treasury rates to continue lower, I’m not sure we’ll revisit last year’s low so I don’t mind repositioning some of that to buy into miners on weakness.

I suppose I’ll end be re-stating my nuanced position on inflation. I believe that we are in a debt-driven asset bubble, and that costs of living have been skyrocketing this last decade – primarily in housing which has become a speculative investment asset – while wages have remained subdued. Overall deflationary forces of high debt greatly eclipse our fiscal deficit spending, and many of the inflationary forces we’ve been seeing are transitory. However, inflation/deflation is very nuanced and some commodities are set to do really well based on supply/demand constraints.

  • The excess supply available in oil will keep it’s price somewhat capped, though I don’t expect it to collapse down to last year’s levels unless we hit a major deleveraging event.
  • Lumber spikes were transitory – it grows on trees and there is no shortage of supply, just a temporary shortage of processing in mills.
  • Copper demand has been surprisingly strong despite the covid situation, and much of that has to do with a “green” push by governments into EV’s and such – I expect copper to remain strong in the coming decade.
  • Uranium just overcame the biggest supply glut ever with the Japanese nuclear shutdowns post Fukishima, and we are set for a large number of reactors coming on line in future years.
  • Precious metals are simply a great semi-defensive bet when interest rates are forced super low worldwide, and I expect gold to see steady strength this coming decade as much of the world tries to reduce its heavy reliance on US dollar assets. Crypto may have been a somewhat bearish influence in the past as it pulled speculative money from hyperinflationists and such, but the technology will be long term bullish from gold as countries such as China will use it to expand their international trade into digital Yuan, bypassing the US-dominated Swift payment system and helping them reduce their need for US dollars to facilitate foreign trade.

I’ll stop there. Good luck trading and developing your overall market thesis. Remember that anything can happen, the market is in an extremely volatile position, and now more than ever you need to keep the mental flexibility to ask yourself “what if I’m wrong” no matter what your market view is. This is certainly the most exciting market I’ve traded!

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Melt-ups and pullbacks

This week I have a nearly 11% drawdown. My TLT calls were off a lot, my index puts and mining stocks were off a little, and nothing really went up. Here’s a visual representation of what happened:

One of my biggest mining stocks, EQX, dropped hard from the low $9 range last week to the low $7 range at the end of this week due to labor disputes/work stoppages at some of their mines. I have to admit I chased into it a bit on Wednesday, but I stopped after that … it’s a common rookie mistake to cut from winners and add to losers as we’re emotionally wired to expect a mean-reversion in these things. Right now I’m planning on holding my EQX position but not adding any more regardless of price action.

I added a small amount to MTA, which I had been meaning to increase my stake in. Everything else was added to diversify my holdings a bit including a bigger stake in NOVRF (copper/nickel), CRLBF (Cannabis), and ADA (Crypto). All three were struggling and bought on dips. My thinking there is that base commodities are a different bucket than precious metals, and cannabis and crypto won’t move with either one. At this point I’m at my limit with NOVRF and close to my limit with ADA, so I may end up either building cash or just running back into CCJ with covered calls immediately sold on my positions.

The markets are still in a bit of a narrative struggle here, with the main questions of where is inflation going, where are interest rates going, and what should we invest in. Some reflationary plays have been strong, such as oil, small caps, and emerging markets – though its hard to tell in some ways because IWM is dominated by meme stonks such as GME and AMC which are at eye-popping highs and EEM is dominated by Chinese tech companies.

Financials (XLF) did really well this week, and they usually follow expectations of a steeper interest rate curve. However, expectations that the bank stress tests will allow them to start stock buyback programs weighed heavily in their favor.

Growth companies and tech (QQQ) tend to do well when interest rates are low because a lot of their perceived earnings are in the future, but they are also dominated by companies like AAPL with high earnings and big stock buyback programs. Stock buybacks have been absolutely soaring this year and their shares are doing well.

Cryptocurrencies are still in a big correction as China clamps down on companies supporting them. Much of the selling is done on the weekends during Chinese daytime hours, as their citizens reduce their crypto holdings.

Precious metals are still pulling back from last year’s high. They tend to do well on a weak dollar or negative real interest rates, but the dollar is strong and interest rate expectations aren’t low enough to move the needle. They are currently pulling back to test support after failing to break out to the upside.

TLT launched higher last week, then pulled back and quickly bounced of the 20 day moving average. It looks to favor the upside, but bond market volatility (MOVE) has been falling, which significantly reduced the value of my Jan 2023 TLT call positions.

Here’s where my portfolio ended up:

  • DOWNSIDE BETS (38.8%)
    • 27.9% TLT Calls
    • 5.2% IWM Puts
    • 4.3% QQQ Puts
    • 1.5% EEM Puts
  • GOLD (19.6%)
    • 10.0% SAND Calls
    • 4.8% EQX Calls
    • 2.4% WPM & GOLD Calls
    • 2.4% LGDTF
  • SILVER (24.7%)
    • 10.1% AG
    • 0.8% AG Calls
    • 5.1% SILV
    • 3.6% SILVRF
    • 2.9% MTA
    • 1.6% RSNVF
    • 0.7% SSVFF
    • 4.4% NOVRF (Nickel/Copper)
    • 0.8% BQSSF (Uranium)
  • CANNABIS (6.3%) split btw CRLBF, GTBIF & TRSSF
  • CRYPTO (3.3%) all ADA
  • CASH (2.1%)

It’ll be interesting to see how this all plays out, but I’m actually not that worried about it for a number of reasons.

  1. Cashflow positive. I have regular money coming in from my job, and I keep my expenses low.
  2. No leverage. If my accounts go to zero I’ll still have no debt. If you use margin, then a significant drop can lead to forced sales which push your account to zero – but without margin your positions will hold positive value even in big drops.
  3. Directional diversification. I am clearly betting on a slowdown and pullback in interest rates with my heavy long positions in precious metals, long-dated treasuries (TLT), and index puts. However, splitting between those makes it less likely that all three blow up. Then I have some counter-trend plays such as base metals, cannabis, and crypto which should do well if we’re back to soaring stock prices with no worries.

The final thing I should add is that I’m still relatively young and my portfolio is still relatively small. I need to take risk to get anywhere, and I can still recover from missteps. That’s why my investments are highly directional – because I’m looking for an outsized win.

As for inflation, the main problem with the debate is that people who discuss it are generally talking about different things. The cost of living in the US has been soaring over the last 20 years and I have no doubt it will continue to do so. However, the CPI will remain weak for the following reasons:

  1. CPI inflation is greatly reduced by technological improvements (they call it Hedonic Adjustments) which mean that automobiles have been relatively flat in the CPI during a time when new car prices have been soaring and the majority of buyers had to turn to the used car market. This works with computers, software, electronics, and many other things.
  2. The CPI also tends to favor discretionary purchases over necessary ones. Flat nominal wages with rising costs of living means less money is spent on these discretionary purchases, which pressures the CPI downward. In fact, the CPI tends to correlate better with wages which have been going nowhere for years.
  3. Sustained inflation requires continued demand beyond current capacity. We are in a period of massive worldwide lockdowns and high unemployment. Productive capacity has been reduced while stimulus checks kept demand from collapsing, leading to higher prices, but the phaseout from Covid means that production will be increasing while government support will be pulled so that capacity will increase while demand stays subdued.
  4. Many people are led to believe that the growth of central bank balance sheets represents new money creation which is injected into the economy. It doesn’t work that way – it really has to do more with replacing high duration debt such as mortgages and treasuries of various durations with overnight reserve assets. In other words, it is a way of reducing long duration interest rates while spurring banks to lend. Lending in a weak economy greatly favors corporate debt (for stock buyback programs) and asset-backed debt (for mortgages, cars, and forms of stock portfolio leverage). The result is a debt-driven asset bubble, not a one-sided addition of cash to the system.
  5. Many people point to large and growing government fiscal deficits as a source of renewed inflation. They are correct that this is new money injected into the economy which adds to inflationary pressures. However, they often neglect the enormous counterweight of high debt levels. Debt servicing regularly pulls money out of the economy. Inflation from newly issued debt is short lived, while deflation from existing debt lasts a long time. This is why Japan saw very little inflation despite decades of government spending on big projects … their public sector growth merely counterbalanced the continued private sector weakness as high debt levels kept a chokehold on the private sector.

Anyway, I still do expect some kind of 2008 Lehman moment, when a hedge fund collapse leads to a bout of forced selling as stop loss orders trigger and margins are called. This in a market that has few price-sensitive buyers as passive funds and corporate buybacks are oblivious to prices, very little money is positioned short, momentum funds are not designed to chase dips, and value funds are few and far between (Berkshire is the most famous of those). When this happens I expect that the index puts will pay off, TLT will spike, and precious metals will both fall less than the US market indexes and recover faster after the next reaction. If this doesn’t happen in the next 18 months, my “downside bets” will go to zero but the rest of my portfolio will hang in there.

Good luck, happy trading, and be careful out there!

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Commodities off, dollar on

I just got back from a weekend visiting a cousin up in Portland Oregon, and I was pleasantly surprised that my portfolio is actually up on the week.

I am heavily invested in gold and silver miners as well as 18 month calls in gold and silver miners, and I expected those to get crushed with the precipitous drop in Gold and Silver last week.

At the same time, the my various put positions gained slightly, and my overweight TLT calls position went up considerably. Note that I am still down in those trades, but it is good to see them playing a buffering role here.

The inflation trades got crushed this week in general, but my overall outlook hasn’t changed – I think the 30 year treasury yields are likely to re-visit the lows as economic weakness begins to show with the stimulus measures such as extended unemployment benefits and forbearance programs on mortgages, rents, and student loans phase out while the amount of additional stimulus passed disappoints. At the same time, I think the fed will react to any significant pullback, and that we are starting a long bullish trend for the miners in general – gold, silver, uranium, copper, etc – and I plan to add to those on weakness.

I am also planning on following Rauol Pal’s advice and keeping something in Crypto. I’m sticking with Cardano as I explained last week, and I am being very cautious about adding more unless I get a significant dip (next small adds at $1.30, $1.20, and $1.10).

Here’s where my portfolio landed. Note that I didn’t add to any hedge positions this week, though I did add a bit to my gold and silver miners. Also note that I’m pretty much out of Uranium at the moment as all my UUUU was called this Friday, and I’m not planning on jumping back in just yet. The huge change in my “downside bets” is simply because they went up in value while the rest of my portfolio went down.

  • DOWNSIDE BETS (42.6%)
    • 30.6% TLT Calls
    • 5.8% IWM Puts
    • 1.5% EEM Puts
    • 4.7% QQQ Puts
  • GOLD (18.6%)
    • 2.1% WPM & GOLD Calls
    • 5.3% EQX Calls
    • 8.9% SAND Calls
    • 2.2% LGDTF
  • SILVER (21.2%)
    • 9.3% AG (w/ covered calls)
    • 0.8% AG Calls
    • 4.6% SILV
    • 1.2% MTA
    • 1.5% RSNVF
    • 3.3% SILVRF
    • 0.6% SSVFF
  • COMMODITIES (4.4%)
    • 0.9% BQSSF (Uranium)
    • 3.5% NOVRF (Nickel/Copper)
  • CANNABIS (4.9%) split btw CRLBF, GTBIF & TRSSF
  • CRYPTO (2.1%) all ADA
  • CASH (6.2%)
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An Indecisive Market

The market does seem very indecisive at the moment. For my two biggest bets, gold has been struggling at 1900 for nearly a month, while silver has been struggling at 28 for over a month. QQQ (Nasdaq) just passed the February highs and is approaching the April highs again but hasn’t yet broken out. IWM (Russell 2000) just bounced lower off the highs set in March, and has also been in the same choppy range since February.

Bitcoin certainly looks bearish, but there is an interesting dispersion among the cryptocurrencies here:

My view right now is that cryptocurrencies have not yet peaked for the cycle, but there is a significant rotation away from Bitcoin. A significant part of the narrative here is around the relatively high power usage of Bitcoin and the challenge of the power-intensive “proof-of-work” model with the “proof-of-stake” model.

I tend to think that the reason just as much to do with the size of these assets:

  1. Bitcoin market cap $673 Billion
  2. Ethereum market cap $280 Billion
  3. Cardano market cap $49.4 Billion

A big part of the investment thesis in cryptocurrencies is the potential for multi-bagger returns. Speculators looking for these returns can easily expect that if Bitcoin doubles then you could easily see a 4x gain in smaller Ethereum and an 8x gain in a smaller altcoin such as Cardano. Where is the money going to pile in?

I’ve been building a small stake in Cardano personally – big enough so I can be happy riding it if crypto shoots skyward, but small enough to allow me to add if it corrects down more. The main reason I chose this altcoin is because it trades on Coinbase (which I still use), it has a narrative of superior software for building smart contracts, and it seems an obvious #3 after Ethereum. The closest competitors by market cap are BNB and XRP (which I can’t buy on Coinbase) and DOGE (which I still see as a highly inflationary scam coin which Elon is pumping as a joke).

I’m happy about the solid breakout of TLT past 140, we’ll see if it backtests and continues skyward. I’m still down a lot on my TLT calls, but I’m still in the camp that sees government bond rates turning lower shortly after “recovery” as they have in every recession in the past 40 years. I’ll expect different results when our government has a different playbook. For now, here’s the way I see it with bonds …

Government bonds are NOT intuitive investments. Why?

  1. They not only have many uses in the banking system which are highly complex, involving massive leverage and derivative agreements as well as strict regulatory rules based on asset safety as defined by government regulators. Treasuries are Tier 1 capital, which is key.
  2. Many participants, such as insurance funds and money market funds, have to hold assets that they can liquidate immediately in a crisis at full value.
  3. Many participants, such as foreign central banks, are not market sensitive investors looking for the best gain – they are looking for the deepest and most liquid US dollar markets that they can use to manage their currencies.

One thing is even more strange with government debt – it is the only asset that can actually increase in value with increasing supply. Here’s how it works:

  1. High debt levels are very deflationary because they continually pull money out of the system for servicing long after the money was spent & went through the economy.
  2. The primary way we create money in our system is through lending.
  3. The higher debt levels get, the more money is needed to combat this deflationary force just to keep cash flows even. If these debt levels aren’t allowed to climb, you end up with a deflationary bust like we saw in the Eurozone in the mid 2010’s.
  4. This requires more and more lending, which typically shows up as higher government deficits. This pushes debt levels even higher, requiring even more lending to compensate.
  5. Thus deficits skyrocket and once their short-lived passage through the economy completes even bigger deficits are needed until something in the system changes.

Essentially, we are caught in a debt/deficit sandtrap and we’re still digging ourselves deeper, which ironically results in lower interest rates on government debt.

Please note that the above view does not necessarily mean a stock market collapse is imminent. I certainly fear the possibility, but margin lending has shown no signs of slowing and corporate share buybacks have been accelerating. If much of the debt we create goes straight into the stock market through these paths, I’m not sure the market can crash – which means you really need to brace for rotations from one sector to the other, and I’m convinced that these rotations will start to favor precious metals miners a lot more as interest rates drop.

Enough for today – here’s where my portfolio left off:

  • DOWNSIDE BETS (37.5%)
    • 26.4% TLT Calls
    • 5.0% IWM Puts
    • 1.4% EEM Puts
    • 4.7% QQQ Puts
  • GOLD (19.0%)
    • 2.7% WPM & GOLD Calls
    • 5.4% EQX Calls
    • 10.9% SAND Calls
  • SILVER (22.5%)
    • 10.2% AG (w/ covered calls)
    • 1.0% AG Calls
    • 5.3% SILV
    • 1.2% MTA
    • 1.5% RSNVF
    • 2.6% SILVRF
    • 0.8% SSVFF
  • COMMODITIES (5.1%)
  • 1.1% UUUU (w/ covered calls)
    • 0.9% BQSSF (Uranium)
    • 3.2% NOVRF (Nickel/Copper)
  • CANNABIS (5.4%) split btw CRLBF, GTBIF & TRSSF
  • CRYPTO (2.3%) all ADA
  • CASH (8.2%)

I should note that my CCJ position is gone because I sold covered calls a month ago and they landed in the money. There has been no significant pullback to buy into, so I’ve been waiting on that one. I didn’t actually add to TLT – that just went up in value – but I did add QQQ puts in recent weeks as I anticipated a significant pullback which hasn’t materialized yet. If it does, then I’ll probably sell off a number of these put positions as I can’t dismiss Rauol Pal’s view of another end-of-year melt-up in markets.

This is honestly why I put so much in gold and silver, and probably also why they have been performing poorly over the last year – these are some of the few positions where I can comfortably see higher prices a couple years out. The way markets work is that if a play seems obvious then it is probably overcrowded and will probably fail.

Someone tweeted the idea of going long ROOT for a short squeeze, maybe I’ll jump on that next week. The one-week call options certainly show a lot of volume. Good luck and happy trading!

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