Bristol Gold Group

Bristol Gold Group, Moral Hazard, July 2020

In our March report, we outlined the breadth and depth of the early-2020 financial-market collapse and detailed the unprecedented scope of U.S. monetary and fiscal policy response. In our April report, we examined performance and prospects for gold equities. In this report, we present our perspectives on future implications for U.S. financial markets of the Fed’s year-to-date monetary policies.

Gold’s Full Monty

Even though gold has outperformed traditional asset classes since 2000, gold remains a fringe asset with limited institutional sponsorship. We believe gold remains inherently threatening to investor consensus because it is widely perceived as a catastrophe asset—gold performing well holds negative implications for the balance of investors’ portfolios. Similarly, investment advisers and financial consultants are generally loath to endorse gold for fear of frightening clients about overall market prospects. For these reasons, market participants most sympathetic to gold’s portfolio merits, such as the World Gold Council and precious-metal investment firms, generally strive to avoid negativity about general market conditions. This makes business sense—why risk startling potential investors as they warm to an enigmatic asset class?

Along these lines, it is not surprising that gold’s corporate proponents tend to soft peddle analysis of monetary and financial imbalances now roiling the global economy. Better to sidestep heavy topics like default and debasement in favor of less threatening concepts such as return frontiers, standard deviation and central bank accumulation. While this approach may suffice under normal investment circumstances, it significantly shortchanges gold’s true portfolio utility during times of pronounced market risk. In treacherous investment environments, too passive a stance by gold advocates can equate to silent endorsement of blatantly deteriorating financial conditions. Today, market and financial risks have never been more pronounced, and in establishing gold’s full investment merits it is therefore crucial not only to extol gold’s diversification benefits but also to document the precipitous valuation risks now inherent in traditional asset classes. Gold is the only investment asset which can neither default nor be debased. This is the most important reason why gold is a mandatory portfolio asset during periods of rampant monetary debasement.

Moral Hazard

It is generally self-impeaching to proselytize about moral obligation in U.S. financial markets. We recognize that market winners are always the ones with the most chips. However, the catastrophic mix of pandemic, lack of U.S. savings and egregious Fed liquidity has created a spectacle of inequity we find increasingly hard to watch. Having just been laid up for a spell, we have viewed more cable news in the past four weeks than we had during the prior four years. What we witnessed was very disturbing. The U.S. wealth divide is no longer an academic conversation. It has become a brute calamity spilling into streets across our country with startling desperation and violence. As reactionary as this may sound, it is time for Wall Street to recognize the Fed’s leading role in fomenting this social unrest through its continuous undermining of our nation’s “unit of account.” For thousands of years, no government action has caused more societal revolt than debauchment of money. Along these lines, Fed dollar debasement has long since crossed the line into wanton disregard for the purchasing power of our nation’s currency. We are literally aghast at the overreach of recent Fed liquidity facilities and, even worse, the unquestioning market response.

Why do we employ such strong language in our assessment of Fed policies? Because as Fed stewards posture behind their hollow pledge “to support the flow of credit to households and businesses,” they have orchestrated trillions-of-dollars of asset purchases and backstops specifically calibrated to benefit our nation’s most sophisticated investors and speculators, a group of individuals and investment vehicles least-in-need and least-deserving of such uncalibrated largesse. Because in recklessly reflating short-term asset prices, the Fed has (once again) eradicated relevant price discovery and mortgaged U.S. financial markets to years of bloated disfunction. Because the Fed has crossed the treacherous Rubicon between providing cyclical support for the U.S. economy and assuming the role of final arbiter of financial winners and losers. Worst of all, there can never be turning back from this new reality of government directed capitalism. The Fed’s overreach has become so complete, the U.S. economic system will never be able to return to rational, unfettered capitalism. In distinct departure from consensus, we find these developments utterly demoralizing.

First, let us begin with what recent Fed policies are not. It is important to recognize diametric differences between current Fed liquidity programs and those undertaken during the global financial crisis (GFC). Especially during QE1, the Fed created liquidity for the purpose of easing credit risk and reducing problematic exposures in highly stressed financial markets. The Fed printed money to move onto the Fed’s balance sheet defaulting assets held by over-levered market participants. In essence, Fed credit was used to ease the pain of market deleveraging and bubble deflation. In the current episode, which importantly dates well before COVID-19 to the repo-market freeze of this past September, Fed credit is being deployed with virtually opposite purpose and function: to juice asset prices and reenergize speculation, leverage and momentum-trading in both equity and corporate credit markets. Fed credit in 2008 was utilized to reduce general market risk. In 2020, Fed credit is stoking brazen embrace of increased risk.

Second, we are firmly in the Gundlach camp that the Fed has completely lost sight of its statutory charter. Large components of the Fed’s recent liquidity facilities (especially the Primary [PMCCF]& Secondary Market Corporate Credit Facilities [SMCCF]), if not patently illegal, certainly compromise the spirit of the Federal Reserve Act, which, incidentally, is not just a charter but also codifies into federal law (U.S. Code Title 12 Section 343) the clear restriction for the Fed to traffic exclusively in risk-free federal paper:

such definition shall not include notes, drafts, or bills covering merely investments or issued or drawn for the purpose of carrying or trading in stocks, bonds, or other investment securities, except bonds and notes of the Government of the United States. Notes, drafts, and bills admitted to discount under the terms of this paragraph must have a maturity at the time of discount of not more than ninety days, exclusive of grace.

Special purpose vehicles seeded by first-loss Treasury $billions may pass consensus muster as semi-legitimate workarounds, but they in no way validate the slippery ethical slope of the Fed purchasing individual corporate bonds and related ETF’s—not to mention the folly of 19 unelected academics shaping the post-COVID U.S. economy by whim through the Fed’s Main Street Business Lending Program. Untenable debt levels, combined with the Fed’s unwillingness to rationalize unproductive credits, have now fully exhausted the efficacy first of artificially suppressed interest rates, and, subsequently, QE asset purchases. The official policy options left include government directed capitalism, debt restructuring and currency devaluation. The only operative questions remaining are ones of timing and sequence.

Figure 1: History of Failed Consensus Projections for Fed Exit Strategies (2007-2015) [Incrementum AG]

Third, once traders’ reflexive ebullience runs its course in equity and credit markets, financial market participants will begin to recognize the most depressing aspect of the Fed’s 2020 balance sheet explosion—it will be permanent. Since the November 2008 launch of QE1, we have repeatedly warned that the downside of unconventional monetary policy is that it can never be reversed until debt levels and related malinvestment are allowed to clear. We have always been amazed at the degree to which this simple axiom eludes recognition. As shown in Figure 1, on the prior page, investor consensus has been incorrectly projecting Fed balance sheet “normalization” for more than a decade.

  • Throughout 2010, consensus projected the Fed to conduct outright asset sales in late-2010 to unwind QE1 asset purchases.
  • Throughout 2011, consensus projected outright asset sales in 2012 to unwind QE2. Instead, in September 2011, the Fed determined not only that outright asset sales were too risky, but that even allowing MBS to roll-off naturally was far too risky for financial markets, and launched Operation Twist.
    Throughout 2012, consensus projected outright asset sales in 2013 to finally unwind QE1 and QE2. Instead the Fed launched QE3, calibrated to gobble up Treasuries and MBS at roughly the rate of QE1 and QE2 combined.
  • Following QE3’s final taper in November 2014, consensus debated for three years the pace and scope of Fed balance sheet normalization. Beginning October 2017, the Yellen Fed finally attempted a highly graduated runoff which over 22 months allowed roughly $750 billion of assets to expire from the Fed’s balance sheet without replacement (through August 2019).
  • In mid-September 2019, the Fed reversed course and exploded its balance sheet $415 billion in four months. Now, as of 6/24/20, since this past September’s repo-freeze (“archaic financial plumbing”) the Fed has virtually doubled its balance sheet from $3.761 trillion (9/4/19) to $7.094 trillion, including a 10-week period (3/11/20-5/20/20) during which the Fed exploded its balance sheet by $2.725 trillion ($54.5 billion every business day).

Given the fact that the Fed was unable to unwind even 20% of the $3.6 trillion six-year total of QE1, QE2 & QE3 before causing a precipitous (repo) liquidity shortfall necessitating corrective balance sheet expansion ($415B in Q4 2019), does anyone viewing Figure 2, below, really believe the debt-addled U.S. economy will ever be able to withstand even partial withdrawal of the $3.4 trillion nine-month total of QE4? Never going to happen!

Figure 2: Total Assets on Federal Reserve Balance Sheet (2008-6/24/20) [Meridian Macro]

Demonstrating the Fed’s trademark detachment from reality, Vice-Chair Richard Clarida recently proclaimed to a clearly skeptical Bloomberg Surveillance team (4/13/20) that not only will the Fed be able to remove these fresh trillions in liquidity (without damaging the financial system) but also that the Fed will simply do so when the Fed deems it to be “appropriate.”

Tom Keene: The confidence that the Fed can move the balance sheet back to normal down the road. After this pandemic, after a number of years of return to economic growth, how do you get the genie back in the bottle?

Richard Clarida: …we have put in place these lending facilities under our authority to act under unusual and exigent circumstances. It’s an ambitious and entirely appropriate, aggressive and forceful use of monetary policy in these times. But, to your specific question, yes, I am very confident that as the economy recovers from this hit and begins to return and recover, that we, at the appropriate time, will be able to unwind these programs. You know…there is nothing fundamentally wrong with the U.S. economy. It came into the year in a very strong position both in terms of employment and growth and financial markets, and I am confident we can get back there and, at the appropriate time, we can scale back these programs.

Michael McKee: Let me follow up on that, Dr. Clarida, and ask you this: with probably billions-of-dollars in loans out to companies at near zero for over four years, are you ever going to be able to raise interest rates again…?

Richard Clarida: …In the term-sheets for these programs, you’ll see that these facilities are due to stop lending in September of this year. Obviously, we can extend that as needed. These loans will be in place, they’ll have a term of several years, and, no, at the appropriate time, I do not think that we will have, that that will be a challenge to us when it’s appropriate, but that’s a long way down the road…Tom essentially what we’re doing is we’re building a bridge until the economy can get to the other side and begin to recover, and if that happens sooner, we’ll certainly know what to do at that time.

There exists a wide range of explanations for Mr. Clarida’s Orwellian self-image, ranging from pure hubris to rank dishonesty to utter cluelessness. Frankly, all these possibilities are equally frightening. This time around, we suspect consensus confidence in the Fed is destined for calamitous conclusion.

Winners and Losers

The Federal Reserve is prohibited by federal statute from purchasing securities other than riskless federal paper precisely to bar the Federal Reserve from conduct of fiscal policy and to prevent the Fed from consciously or unconsciously choosing winners and losers among U.S. economic sectors—much less providing direct financial aid to individual corporations, companies, economic agents or investment vehicles. Yet, since the March 23 nadir of market collapse, the Fed has ignored both federal law and 107 years of precedent to empower itself to buy whatever it damn well pleases. By way of example, the Fed determined in its capricious wisdom that $750 billion is the appropriate amount of corporate paper it should monetize ($500B in its PMCCF & $250B in its SMCCF).

While lawyers have spent 10 weeks addressing and papering legal hurdles associated with these unprecedented facilities, the Fed, in its quest to “support the flow of credit to households and businesses,” wasted no time in jawboning to markets its intention to purchase prominent corporate bond ETF’s. For the life of us, we have never been able to discern how Fed purchases of corporate bonds in the secondary market could possibly enhance the “flow of credit to households and businesses.” For the Fed to then widen its shopping list to include monetization of ETF’s holding these secondary corporate bonds seems to us an even more far-fetched strategy for anything other than blatant manipulation of asset prices—to the direct benefit of investment banks and institutional investment vehicles—in an illiquid and overleveraged financial system. C’mon, households? Give us a break.

Just to cap off the insular, top-1% nature of Fed liquidity facilities, the Fed anointed the nation’s largest asset manager, Blackrock, to manage its corporate bond purchases. Never mind Chair Powell’s disclosure of personal investments with Blackrock in a range up to $11.6 million, Blackrock happens to be the sole purveyor of the world’s largest investment grade (LQD) and high yield (HYG) corporate bond ETF’s. Using these two behemoth Blackrock vehicles as our visual proxies, we present over the next three pages a graphical tour of what the Fed has so far accomplished with its corporate bond facilities.

Blackrock iShares Inv. Grade Corp.Bond ETF (LQD) (4/15/10-3/19/20)[Bloomberg]

Blackrock’s iShares Investment Grade Corporate Bond ETF (LQD) is the world’s largest IG corporate bond ETF, with a current market-cap of $54 billion. In the nine trading days through 3/19/20, LQD crashed 21.76% to $105.05, its lowest closing price since May 2010. This means that in the span of nine trading days in early- March, 10 years of trading history fell “under water” (horizontal red line). Adding insult to injury, LQD’s 3/19/20 closing price represented a 5.08% discount to its net asset value (NAV), the steepest discount since the height of the GFC in September 2008.

Blackrock LQD ETF Total Shares Outstanding (4/15/19-4/24/20) [Bloomberg]

On 3/23/20, the Fed announced that its open-market purchases of Treasuries and mortgage-backed securities would become open-ended and that the Fed would expand its range of securities eligible for purchase to include investment grade corporate bonds and related ETF’s. Immediately upon Fed confirmation of this previously rumored policy change, hedge funds and institutional traders accelerated their purchases of Blackrock’s LQD, driving LQD outstanding shares up 49.94% in the five weeks ended

Blackrock iShares Inv. Grade Corp. Bond ETF (LQD) (4/15/19-4/24/20) [Bloomberg]

By 4/9/20, aggressive accumulation of LQD had driven its closing price back to $131.83, just 1.82% off its all-time closing high of $134.27 on 3/6/20. Along the way, LQD shares traded at consistent premiums to underlying NAV, including an all-time record closing premium of 5.04% on 3/25/20.

Blackrock iShares High Yield Corp. Bond ETF (HYG) (4/15/08-3/23/20) [Bloomberg]

On the junk side of the corporate bond ledger, Blackrock’s iShares High Yield Corporate Bond ETF (HYG) is the world’s largest HY corporate bond ETF, with a current market-cap of $27 billion. In the 13 trading days through 3/23/20, HYG wiped out 11 years of trading history (horizontal red line), crashing 21.22% to $68.63, its lowest closing price since April 2009. Adding insult to injury, HYG’s 3/20/20 closing price represented a 1.27% discount to its NAV, the steepest discount since November 2016.

Blackrock iShares High Yield Corp. Bond ETF (HYG) (4/15/19-4/3/20) [Bloomberg]

When the Fed abandoned 107 years of precedent in announcing on 3/23/20 its entrance into the corporate bond market, its calculated hope was that throwing unprecedented liquidity at investment grade securities would trickle down to the lower rated segments of the corporate bond market (which were experiencing far more pronounced stress). The Fed’s trickle-down gambit achieved only modest success. By 4/3/20, not only had HYG experienced a far more tepid bounce from its 3/23/20 low, but its share price was rolling over (again).

Blackrock iShares High Yield Corp. Bond ETF (HYG) (4/15/19-6/8/20) [Bloomberg]

By 4/9/20, credit stress was so rampant in non-investment grade sectors of the corporate bond market that the Fed crossed yet another Rubicon and declared that HY corporate bonds would be eligible for Fed open market purchase operations, with the legerdemain that the Fed would limit its purchases of junk paper to securities which had been rated IG prior to 3/23/20.

[The Fed’s liquidity firehose can manipulate market prices and hedge fund behavior but not credit quality. Lemming behavior aside, junk bonds are where the sharpest credit stress resides and there is nothing the Fed can do to manipulate their issuers’

Blackrock iShares Inv. Grade Corp. Bond ETF (LQD) (4/15/19-6/30/20) [Bloomberg]

On 5/12/20 (red arrow), Blackrock commenced direct open market purchases of corporate bond ETF’s for the Fed’s SMCCF facility. By 6/29/20, Blackrock had purchased stakes in 16 corporate bond ETF’s totaling $6.8 billion, with the largest single position, of course, being a $1.8 billion position in Blackrock’s LQD. Mission accomplished: The 6/30/20 closing price for LQD was $134.50, just three cents below its 3/6/20 intra-day high of $134.53

Blackrock LQD ETF Largest Institutional Holders (6/30/20) [Bloomberg]

The Federal Reserve is now the 3rd largest institutional holder of
Blackrock’s LQD ETF.


Blackrock LQD ETF Total Shares Outstanding (4/15/19-6/30/20) [Bloomberg]

From a 3/12/20 low of 23.950 million shares, outstanding shares in Blackrock’s LQD corporate bond ETF have skyrocketed 70% to 40.450 million shares on 6/30/20.

Blackrock LQD ETF Premium/Discount to NAV (4/15/19-6/29/20) [Bloomberg]

As if growing its LQD corporate bond ETF by 70% (and seeing its share price trade flat with its pre-crash high) were not enough reward to Blackrock for its efforts on the Fed’s behalf, all the recent Fed jawboning (and purchase activity) about corporate bond ETF’s has flipped the ratio-to-NAV at which LQD trades to a consistent premium. So much so that the Fed had to establish a maximum premium-to-NAV limit of 1% at which Blackrock can purchase corporate bond ETF’s for the Fed’s account!

With all due respect to the Fed, we can discern zero benefit to the “flow of credit to households and businesses” from the Fed’s inception-to-date ETF purchases. We can, however, discern one helluva’ benefit to program manager Blackrock, and, in turn, more limited benefit to hedge funds and traders front-running Blackrock’s well-telegraphed game plan. Households? Not so much.

Lest we appear jaded, we share former Fed Vice-Chair and New York Fed President William Dudley’s assessments of the Fed’s 2020 liquidity facilities (6/5/20):

That said, the Fed’s actions have a cost because they tend to encourage risky behavior that we want to avoid — a problem known as moral hazard. Not all of those who got help were blameless. Consider, for example, the Fed’s enormous purchases of Treasuries as trading began to seize up. It was, in fact, a backdoor bailout of highly leveraged hedge funds that were caught in an untenable trade of being long cash Treasuries and short Treasury futures…The Fed decided that the risk of a dysfunctional Treasury market was bigger than the downside of bailing out the leveraged hedge funds. Although the Fed helped stabilize the Treasury market, it also made it possible for the hedge funds to avoid bearing the full costs of their risky decisions.

The story isn’t much different in the mortgage-debt market. As volatility soared, real-estate investment trusts that invest in mortgage-backed securities were forced sellers as they struggled to meet margin calls. Again, the Fed purchases helped limit their losses.

Heavily indebted corporation also got a helping hand. This is significant because many corporations took on lots of debt by choice. The Fed’s response was to set up corporate bond facilities, limiting the fall in lower-rated corporate debt prices and keeping these markets accessible for companies that needed to raise funds. These actions also protected investors in high-yield mutual-bond funds. Had the funds been forced to sell amid plunging prices to meet large redemptions, this could have set off a chain reaction in which falling prices begat more sales. Both the asset managers and the retail investors who bought shares in these junk-bond funds escaped bearing the cost of their actions.

As the Fed’s trillions-of-dollars of liquidity have bailed out sophisticated financial players, backstopped a wide array of complex financial instruments and fueled further speculative excess, absolutely no benefit is accruing to those most devasted by the pandemic. The Fed is directly exacerbating an ever-widening wealth gap. Making matters worse, Fed stewards are entirely unapologetic. Returning to Mr. Dudley’s trademark, matter-of-fact clarity (6/8/20):

The Fed’s choices: not have a recovery and have less inequality or have a recovery buoying financial asset prices and more inequality. The Fed’s tools are just not suited to address the inequality problem. I think it is pretty much that binary.

While the Fed has bailed out Citadel and Point72 from billions-of-dollars of highly-levered losing positions, the American consumer has been crushed by government-imposed lockdowns.

While the Fed’s liquidity tsunami has juiced credit markets to the tune of $1.12 trillion in investment grade issuance through 6/17/20 (exceeding the 2019 annual total) and an all-time monthly record of $51.5 billion in June junk bond issuance (26% higher than the prior monthly record), 48.4 million Americans have filed initial unemployment claims during the past 15 weeks. (To put this in perspective, prior to this year the all-time weekly record for unemployment claims was 695,000 (1982). The 7/2/20 total of 1.43 million initial claims marked the 15th straight week of at least double the prior weekly record.)

Bill Zox, high-yield PM at Diamond Hill Capital Management ($20B AUM) captured the Fed-induced frenzy in credit-markets perfectly (Bloomberg 6/23/20):

You get an invitation to a party from the Fed, Treasury and Congress—they offer to pick you up, take you home and bring you breakfast in bed the next morning. You know it is going to be a party like no other!

As Blackrock waded into the corporate bond market in mid-June with its first half-billion-dollars-worth of purchases for the Fed’s account (including Phillip Morris, Exxon and PayPal paper), TransUnion reported that through May, Americans had already skipped payments on 106 million revolving loans.

On 6/29/20, our diligent Fed stewards approved changes to the Volcker Rule to allow banks to package in their collateralized loan obligations (CLO’s) “junk bonds and potentially other, riskier securities alongside leveraged loans” (Bloomberg). Lauren Basmadjian, senior PM at Carlyle Group ($224B AUM), fairly celebrated, “I welcome the bond bucket coming back because they have stronger call protection—you could build 10 points profit by using a bond bucket.” Of course, the Fed’s latest liquidity tweak came during the same month that the Census Bureau (Household Pulse Survey 6/2/20) reported that 31% of U.S. households have “little or no confidence” that they can pay their July rent.

Figure 3: Leading Brands of Canned Meat Products

As the stock market completed its steepest 50-day rise in history, Bloomberg reported (6/22/20) that U.S. sales of canned meat surged more than 70% during the 15 weeks ended June 13. Bloomberg’s Ken Parks observed, “With millions thrown out of work in the last few months, consumers are looking for a way to cut back on grocery bills, and they’re trading in fresh meat for canned varieties.” Brian Lillis, senior brand manager for Hormel’s Spam, lent his perspective to recent upticks in canned meat sales (6/23/20):

The last time Spam saw a similar pattern in interest was back to when the brand started during the Great Depression. The economic situation wasn’t great—that was carried into World War II. What we saw over the last few months is really people all over the country purchasing the product.

All we can say is “thank God” that by June 29, the Fed was still focused on important stuff to “support the flow of credit to households and businesses,” like lifting the Volcker Rule ban on CLO’s owning junk bonds. Not a moment too soon!

The Stock Market

While clearly a non-consensus opinion, we view the single most outrageous byproduct of 2020 Fed liquidity facilities to be the roaring stock market. We understand that the stock market is a forward-looking discount mechanism, but the Fed should be ashamed of fueling such rank speculation. Just as Allan Greenspan must always bear responsibility for destroying the tradition of American home equity, the Powell Fed will always carry the burden of obliterating price discovery in U.S. equity markets at one of our nation’s most vulnerable economic junctures. It is just our opinion, but we suspect the Fed’s ill-advised suspension of risk will end sadly for millions of retail investors, and, to us, this constitutes a high crime. It is inexcusable that Fed stewards sit by and make no attempt to reign in the equity speculation they have directly ignited.

Figure 4: S&P 500 Index versus Boom-Bust Barometer (1992-June 2020) [MacroMavens]

There are scores of charts, tables and statistical series which capture the ongoing detachment of soaring equity markets from depression-type economic fundamentals, but none capture this contemporary disconnect more vividly than the MacroMavens graph we reproduce as Figure 4, above. Stephanie’s simple masterpiece juxtaposes the world’s most prominent risk proxy, the S&P 500 Index, against one of the most venerable proxies of economic health, the Boom-Bust Barometer, which Stephanie describes as “an age-old indicator of economic activity that simply looks at the ratio of the CRB Commodity Index to Unemployment claims.” For newbies, the implication is that the combination of rising commodity prices and falling claims generally foretells a cyclical “boom,” and the mix of falling commodity prices and rising claims serves as harbinger of imminent “bust.”

Demonstrating strong correlation to the S&P 500 for the past three decades (unconventional monetary policy and all), the Boom-Bust Barometer’s recent collapse has been so extraordinary that it correlates to an S&P 500 value of, gulp, zero! Obviously, “zero” is not a serious or even tongue-in-cheek valuation projection for the world’s leading stock index. It does, however, help to illuminate the degree to which Fed liquidity has divorced equity prices from underlying fundamentals.

Figure 5: Barstool’s Dave Portnoy Selecting Symbols of Stocks to Purchase with Scrabble Tiles

Countless active money managers are heading into the July 4th holiday patting themselves on the back for their disciplined resolve (sic) in capturing the 45%’ish rebound of the S&P 500 Index from its 3/23/20 closing low. Of course, this impressive investment acumen should in no way be tarnished by the fact that Barstool’s David Portnoy and his 3.7 million twitter followers have achieved similar investment returns (over the same timespan) by picking stock symbols out of a bag of Scrabble tiles. Dave credits his admittedly rookie trading success to two simple rules now governing equity markets: 1.) Stocks only go up, and 2.) When in doubt whether to buy or sell, see Rule # 1.

Our hats are off to the intrepid “V” squad powering the ongoing equity-market rally. Impressive gains are nothing less than impressive gains (especially when successfully harvested). Maybe bulls will be right about a second-half recovery. Call us old fashioned, but we can’t help but worry that the fantasmical Q2 rally erupted against the most unanimous backdrop of impresario-investor skepticism we have ever witnessed. Buffett, Zell, Icahn, Druckenmiller, Marks, Singer, Jones, Miller, Cooperman, Tepper and El-Erian (among others) have all expressed deep skepticism about the equity market’s “V” trajectory.

While the Fed claims to be supporting the “flow of credit to households and businesses,” the Fed’s suspension of risk has actually spawned a new generation of commission-free Robinhood traders who are chasing worthless equities of bankrupt companies like Hertz. During March and April, E-trade, Charles Schwab and Interactive Brokers collectively added 780,000 new accounts, roughly three times the prior two-year average for those months.

Taking the cake, Bill Parsons, Group President of Data Analytics at data aggregation firm Envestnet Yodlee, reported on 5/22/20 that Americans of all income groups increased their stock trading in the week following receipt of their government stimulus checks, with percentages increasing the lower the income group. People earning more than $150,000 annually increased their stock trading by 50% over the prior week (after receiving their stimulus check); people earning $100,000 to $150,000 annually increased their stock trading by 82%; and folks earning between $35,000 and $75,000 annually increased their stock trading by 90%.

We will let Howard Marks speak for the august investor group we cited above (6/24/20):

It’s not healthy to have people who are buying stocks for fun. It reminds me of the people who were day-trading in 1999 and declaring day-trading a ‘can’t miss’ strategy…Some people think it’s a gambling game, and they think of it like betting on football. That’s not a great thing.

We are pretty sure the Fed should be more concerned about the widespread financial risks its liquidity facilities are fostering in the very households it claims to champion.


If this report has sounded a bit preachy, then we have struck the appropriate tone. We have learned that criticizing the Federal Reserve tends to erode one’s mainstream credibility. Nonetheless, we feel strongly that the Fed’s 2020 liquidity facilities and QE programs have stretched far beyond the pale. As crazy as this sounds, we believe the Fed may have just missed its last best chance to rationalize unsustainable debt levels and rampant malinvestment. The coronavirus constituted a devastating and unforeseen shock to economic activity. But you know what? In real life, bad things happen.

From the dinosaurs through collateralized loan obligations, nature, life, society and finance progress and grow stronger through setbacks, often devastating in scope. The Fed has squandered the perfect opportunity to let bad debts fail, zombie companies expire and malinvestment and fraud be exposed for what they are (Wirecard). Might this approach have triggered depression-like credit stress? Most probably. For a time. But especially with the level of fiscal stimulus we are likely to experience anyway, the economic contraction would have been finite in span and could have been fully rationalized by the exogenous shock of the virus—it would have been no one’s fault.

Then the U.S. economy, relieved of unsustainable debt burdens, could finally have begun its long trek back to true capital formation underpinned by real savings. Instead, the Fed has compounded its litany of errors with an amount of liquidity so absurd, the U.S. economy will likely never be able to reset productively—rebalancing can now only happen through inevitable crisis and collapse. The Fed’s largesse, misperceived by consensus as supportive and healing, will only heighten the systemic fragility of the U.S. financial system. In the inimitable
words of noted risk-meister Nassim Taleb (1/28/14):

Some things benefit from shocks; they thrive and grow when exposed to volatility, randomness, disorder and stressors…Yet in spite of the ubiquity of the phenomenon, there is no word for the exact opposite of fragile. Let us call it antifragile. Antifragility is beyond resilience or robustness. The resilient resists shocks and stays the same; the antifragile gets better. This property is behind everything that has changed with time: evolution, culture, ideas, revolutions, political systems, technological innovation, cultural and economic success, corporate survival, good recipes, the rise of cities, cultures, legal systems, equatorial forests, bacterial resistance…even our own existence as a species on this planet…

We have been fragilizing the economy, our health, political life, education, almost everything… by suppressing randomness and volatility. Much of our modern, structured, world has been harming us with top-down policies and contraptions… which do precisely this: an insult to the antifragility of systems. This is the tragedy of modernity: As with neurotically overprotective parents, those trying to help are often hurting us the most.

For gold investors, the only good news is that the Fed’s historic overreach reshapes the likely trajectory for the gold price. We have always been proponents of the slow-and-steady appreciation which has generally characterized gold’s advance from its 2000 year-end close of $272 per ounce. To us, gold has never been a “hockey stick” performance proposition. However, the Fed’s 2020 takeover of U.S. capital markets has seriously impaired the functioning relevance of a wide array traditional financial assets. We expect consensus to begin to recognize these facts during the second half of 2020, as shock and awe subside. For the first time in our two decades following gold markets, our assessment of probabilities now favors a breakaway advance in the gold price. The U.S. financial system is broken and gold’s stored force is about to explode.

We look forward to examining the fiscal side of recent U.S. policy response in our 7/16 report.

Happy Fourth of July!

Trey Reik
Managing Member
Bristol Gold Group LLC
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Dollar Sentiment Quotes

We know from a lot of serious academic research that when government debt reaches about 50% of GDP, GDP starts to be adversely affected. As you go up the rung, at 60% the deleterious effect is greater. At 70%, it’s still greater. When debt-to-GDP exceeds 90%, economies lose about a third of their growth rate against trend. And, unfortunately, we’re already outside the historical range of 107% before the coronavirus hit. And we’re going on up to around 130%…

Keep in mind, both the numerator and the denominator are deteriorating. We’re going to be facing something like 10% or greater decline in nominal GDP. And the two stimulus bills that were passed in the last couple of weeks are worth about $2.7 trillion. That’s equivalent to 13% of last year’s GDP, not this year’s GDP. So…we’re effectively at 120% right now. And soon we’ll be at 125% and then higher. Because keep in mind, there will be a falloff in the personal income-tax collections, corporate-tax collections, and built-in stabilizers, Social Security and unemployment compensation and food stamps and all of the like will have to kick in. And so, we’re going to have a truly astronomic level of debt-to-GDP. And this is going to push up public and private debt to about 400% of GDP. And that means that every dollar of debt will only be generating about 25 cents of GDP growth.

So, this will be a new low in debt productivity for the United States and that’s an indication of diminishing returns…And of course, everybody assumes that larger sums of debt produce bigger gains. They don’t understand that the relationship is nonlinear. They don’t even want to know the concept.

– Dr. Lacy Hunt, Executive Vice President, Hoisington Investment Management Company, 13-D Research, 4/2/20


There will be a vast angle of unpaid debts that cannot be cleared, and—what is different from 2008 and 2009—the model of foreclosures, evictions and repossessions to deal with them is going to be absolutely unacceptable. People sheltering at home without income are in no way responsible for their circumstances and will refuse to accept the terms of those contracts. So the contracts will have to be suspended, and the debts cleared away, or there will be a confrontation on a vast scale…The right model is that of the treatment of inter-allied war debts after World War II: They were canceled, because dealing with the common enemy was a common effort. So, the whole financial system will have to be reset. This is not an ideological point but a practical necessity for reestablishing a functioning economic system.

– James Galbraith, Professor of Government, University of Texas, 4/6/20


In finance, most surprising to me is that despite the trillions the U.S. is adding to our budget deficit and national debt, investors (many foreign) will lend the U.S. a virtually limitless supply of dollars for 0.6% for 10 years.

– Lloyd Blankfein, Former Chief Executive Officer, Goldman Sachs, 4/23/20


I have long time been an advocate for the need for the United States to return to a sustainable path from a fiscal perspective at the federal level. We have not been on such a path for some time which just means that the debt is growing faster than the economy. This is not the time to act on those concerns. This is the time to use the great fiscal power of the United States to do what we can to support the economy and try to get through this with as little damage to the longer run productive capacity of the economy as possible. The time will come, again, and reasonably soon, I think, where we can think about a long-term way to get our fiscal house in order. And we absolutely need to do that. But this is not the time to be, in my personal view, this is not the time to let that concern, which is a very serious concern, but to let that get in the way of us winning this battle.

– Jerome Powell, Chair, Federal Reserve [Permanent FOMC Voter], 4/29/20


Many companies that would’ve had to come to the Fed have now been able to finance themselves privately since we announced the initial term sheet on these facilities. The ultimate demand for the facilities is quite difficult to predict because there is this ‘announcement effect” that really gets the market functioning again. Of course, we have to follow through, though. And we will follow through to validate that announcement effect.

– Jerome Powell, Chair, Federal Reserve [Permanent FOMC Voter], 4/29/20


I am told the Fed has not actually bought any Corporate Bonds via the shell company set up to circumvent the restrictions of the Federal Reserve Act of 1913. Must be the most effective jawboning success in Fed history if that is true.

– Jeffrey Gundlach, Chief Executive Officer, DoubleLine Capital, 5/1/20


At its roots, QE is a mechanism of wealth redistribution. Zero rates transfer wealth from savers to borrowers and speculators. Moreover, there are myriad costs associated with central banks nullifying the business cycle. The toll the unfolding crisis will inflict upon minority and low-income families will be horrendous. Federal Reserve policies of unrelenting monetary stimulus and market intervention ensure an especially problematic downturn. The business cycle is absolutely essential to the functioning of capitalistic systems. Policymaker intolerance for even mild market and economic corrections promotes cumulative excess and distortions that will culminate in extraordinarily deep and painful busts.

– Doug Noland, Editor, Credit Bubble Bulletin, 5/2/20


Too many people are anticipating a kind of V-like recovery. We’re all going to be permanently scarred by having lived through this. How soon will anybody get on an airplane? How soon will anybody stay in a hotel? How soon will anyone go to a mall? The fact that these places may be open doesn’t necessarily mean that they’ll be doing busines… Bankruptcies are what you need to clear markets and what you need to end recessions and dips. The fact that there’s a lot more distressed players today will help clear the market, but it also means that there aren’t anywhere near as many opportunities as there were in the past.

– Sam Zell, Chairman, Equity Group Investments, 5/5/20


The bull market’s over and we’re in a bear market. We’re going to be in bear market territory easily for a good nine months, with no return of the bull market anytime soon. This market’s been highly concentrated in a handful of so-called ‘stay at home’ names…This market is divorced from reality, there’s such a strong bid to this market—particularly in the overnight futures trading—it just doesn’t make any sense.

– Chris Ailman, Chief Investment Officer, California State Teachers’ Retirement System, 5/5/20


We’re living through the most severe contraction in [economic activity] and surge in unemployment that we’ve seen in our lifetimes. We’re in a period of some very, very, very hard and difficult data that we’ve just not seen for the economy in our lifetimes, that’s for sure. But a third quarter rebound is one possibility. That is personally my baseline forecast…Realistically, it’s going to take some time for the labor market to recover from this shock. I do think the recovery can commence in the second half of this year…It’s important to make sure the rebound is as robust as possible, but can’t minimize that we are in recession, a global recession.

– Richard Clarida, Vice Chairman, Federal Reserve, 5/5/20


We manage the Global financial system, which transacts in the currency we print. We control the oceans to ensure the safety of the Global supply chain. Our legal system is an aspiration, and our military keeps hot spots localized to mitigate nuclear annihilation. So, WTF happened? The Chinese lied—of course they did! But that’s why we have some version of SkyNet watching. And let’s not forget Google, Facebook and Apple, that make The Matrix look benevolent. Whatever. Since the Government will not think two moves ahead, we shall be forced to do it ourselves; thus, let’s consider the next Black Swan.

– Harley Bassman, Creator, Merrill Lynch RateLab, Publisher, Convexity Maven, 5/5/20


Deceased and incarcerated individuals do not qualify to receive Economic Impact Payments. See FAQ #41 to learn how to return an inadvertent payment @

– U.S. Treasury Department “Tweet” @ USTreasury, 11:08 AM, 5/6/20


The shutdown can’t go on forever because if it does, deep into the second half, then I think you risk getting into a financial crisis or even a depression scenario. And if you get into that I think even health outcomes would be way worse…The jobs report will be one of the worst ever…So far so good. I think our liquidity measures are looking good.

– James Bullard, President, Federal Reserve Bank of St. Louis [2022 FOMC Voter], 5/6/20


No one I talk to is looking at a V-shaped recovery, they really think this will be gradual and it will take time to build confidence back up for both workers and consumers.

– Mary Daly, President, Federal Reserve Bank of San Francisco [2021 FOMC Voter], 5/7/20


I think for the country the short-term outlook is really bleak. The best-case scenario would be a quick bounce-back, but it’s hard for me to see that until we get some type of technological breakthrough in a vaccine or a therapy. We should plan for a much more gradual recovery.

– Neel Kashkari, President, Federal Reserve Bank of Minneapolis [2020 FOMC Voter], 5/7/20


One of the roles of economists like myself that are in academia…is to really try to push us into a much better place. I really believe that fifty years from now people are going to look back – economists are going to look back – as the existence of cash much like we look back at the gold standard. We look back at the gold standard as a period which really hamstrung monetary policy and created huge amounts of unemployment as a result during the Great Depression. People are going to look back at the existence of cash and the zero lower bound – the inability to go much below zero with interest rates – in the same way, hamstringing the ability of central banks to provide sufficient support to the economy – and thereby creating excessive unemployment and robbing people of their jobs.

– Naryana Kocherlakota, Former President, Federal Bank of Minneapolis, 5/7/20


COVID-19 is a one-of-a-kind virus that has triggered a one-of-a-kind policy response globally. The depth and magnitude of the economic drop-off took modern monetary theory—or the direct monetization of massive fiscal spending—from the theoretical to practice without any debate. It has happened globally with such speed that even a market veteran like myself was left speechless. Just since February, a global total of $3.9 trillion (6.6% of global GDP) has been magically created through quantitative easing. We are witnessing the Great Monetary Inflation (GMI)—an unprecedented expansion of every form of money unlike anything the developed world has ever seen.

The best profit-maximizing strategy is to own the fastest horse. If I am forced to forecast, my bet is it will be Bitcoin…Bitcoin reminds me of gold when I first got into the business in 1976.

Speaking of gold, in a low-carry world, gold remains a very attractive hedge against the Great Monetary Inflation and hedges against other risks clouding the outlook, including a renewed flare up in the China-US relationship where financial sanctions could eventually be used in a brute-force decoupling. How far can gold rally from its current price? A simple metric based on the ratio of the value of gold above ground to global M1 suggests gold could rally to 2,400 before it reaches valuations consistent with the lowest of the last three peaks in this valuation metric and 6,700 if we went back to the 1980 extremes.

– Paul Tudor Jones, Chief Executive Officer, Tudor Investment Corporation, 5/7/20


The states and the local governments are definitely going to need more help, and I think the federal government should be thinking about the best way to do that…I think there’s a possibility of opening up in the second half of the year, but it has to be done in a very careful way to avoid having to go backwards, because that would be a devastating outcome.

– Loretta Mester, President, Federal Reserve Bank of Cleveland [2020 FOMC Voter], 5/8/20


I mean the worst is yet to come on the job front, unfortunately…What I’ve learned in the last few months, unfortunately, this is more likely to be a slow, more gradual recovery…It’s really around 23%-24% of people who are out of work today, and if this is a gradual recovery the way I think its going to be, those folks are going to need more help…If this is going to go on for a long period of time—I think its going to go on in some phases for a year or two—I think Congress is going to need to continue to give assistance to workers who’ve lost their jobs.

– Neel Kashkari, President, Federal Reserve Bank of Minneapolis [2020 FOMC Voter], 5/10/20


Since there is a robust Fed liquidity backstop, and we do not know the depth or duration of the current economic downturn, spending any time looking at economic data releases or focusing on corporate earnings is a colossal waste of time. For economic data, the signal-to-noise ratio is essentially zero, and for corporate earnings, N-T results are meaningless with regard to L-T earnings potential. The item to focus on is the Fed and its direct support for the financial and non-financial IG corporate sectors.

– David Zervos; Chief Market Strategist, Jefferies LLC, 5/11/20


You will get business failures on a grand scale and you will be taking risks that you would go into depression…[Q2 GDP] will be a staggering figure and way beyond anything experienced in the post-war era in the U.S. We cannot hit the pause button for very long in major economies around the world, certainly not in the U.S. There’s a 90-day limit or shelf life on this policy, maybe 120-day shelf life.

– James Bullard, President, Federal Reserve Bank of St. Louis [2022 FOMC Voter], 5/12/20


Our outreach at the Cleveland Fed is painting a very painful picture. Since mid-March, we have watched confidence among regional businesses and households drop from week to week as the negative effects of the virus have risen. Regional firms are taking defensive positions, pulling back from risk taking, conserving cash, putting capital expenditures on hold, and drawing on their credit lines. At the start of the shutdown, many told us that they intended to keep their employees on their payrolls, but over time, an increasing number have felt the need to lay off or furlough workers. The Cleveland Fed’s national survey of consumers indicates that most respondents initially thought the virus outbreak would last less than six months. More now believe it will last one year, and a growing number think it could last two years.

– Loretta Mester, President, President Federal Reserve Bank of Cleveland [2020 FOMC Voter], 5/12/20


The consensus out there seems to be: ‘Don’t worry, the Fed has your back.’ There’s only one problem with that: our analysis says it’s not true…I pray I’m wrong on this, but I just think that the V-out is a fantasy…[The CARES Act] was basically a combination of transfer payments to individuals, basically paying them more not to work than to work. And in addition to that, it was a bunch of payments to zombie companies to keep them alive.

– Stanley Druckenmiller, Investor, 5/12/20


The committee’s view on negative rates really has not changed. This is not something that we’re looking at. I know that there are fans of the policy, but for now it’s not something that we’re considering. We think we have a good toolkit, and that’s the one we’ll be using.

– Jerome Powell, Chair, Federal Reserve [Permanent FOMC Voter], 5/13/20


“The scope and speed of this downturn are without modern precedent, significantly worse than any recession since World War II. We are seeing a severe decline in economic activity and in employment, and already the job gains of the past decade have been erased. Since the pandemic arrived in force just two months ago, more than 20 million people have lost their jobs. A Fed survey being released tomorrow reflects findings similar to many others: Among people who were working in February, almost 40 percent of those in households making less than $40,000 a year had lost a job in
March. This reversal of economic fortune has caused a level of pain that is hard to capture in words, as lives are upended amid great uncertainty about the future.

The record shows that deeper and longer recessions can leave behind lasting damage to the productive capacity of the economy. Avoidable household and business insolvencies can weigh on growth for years to come. Long stretches of unemployment can damage or end workers’ careers as their skills lose value and professional networks dry up and leave families in greater debt. The loss of thousands of small- and medium-sized businesses across the country would destroy the life’s work and family legacy of many business and community leaders and limit the strength of the recovery when it comes. These businesses are a principal source of job creation—something we will sorely need as people seek to return to work. A prolonged recession and weak recovery could also discourage business investment and expansion, further limiting the resurgence of jobs as well as the growth of capital stock and the pace of technological advancement. The result could be an extended period of low productivity growth and stagnant incomes.”

– Jerome Powell, Chair, Federal Reserve [Permanent FOMC Voter], 5/13/20


I’m 77 years old and I’ve never seen this level of uncertainty. This cycle is different than the other seven bear market cycles I lived through because this is the only one where we had a broad scale shutdown of the economy, which I view as a mistake.

– Leon Cooperman, Chief Executive Officer, Omega Advisors, 5/14/20


Can the Fed keep it up forever? Those of us in the markets believe that stocks and bonds are selling at prices they wouldn’t sell at if the Fed were not the dominant force. So if the Fed were to recede, we would all take over as buyers, but I don’t think at these levels…There are large, highly levered companies and investment vehicles that the government and Fed rescue program is not likely to reach and take care of…And in theory, if they bought aggressively, they could make all the markets rise. Now everyone would know that that’s a Potemkin market, a fake, and the minute they stopped things would collapse.

– Howard Marks, Co-Chairman, Oaktree Capital Group, 5/18/20


We face two fundamental questions. First, how strong and how long will the underlying deflationary forces that need offsetting last? Second, how much is going to be spent on relief and where will all the money be coming from (i.e. borrowed or printed)? The US borrowing requirement is $3trn in Q2 alone and $4.5trn for this fiscal year, though the Democrats have already unveiled a further $3trn coronavirus relief package of their own. It is politicians, not the virus, that are responsible for the sudden economic stop and their solution, throwing huge amounts of money that doesn’t yet exist at anyone who might be suffering from their actions, betrays a complete lack of monetary understanding. Even Lenin was reputed (by Keynes, who probably made it up) to have said that ‘the best way to destroy the capitalist system is to debauch the currency.’ Now we get to find out if he was right.

– James Ferguson, Principal, MacroStrategy Partnership, 5/19/20


My guess is we are going to need to do more. But my guess is also you’re going to need more fiscal action, whether it’s aid to governments or other fiscal action as we go through this. The problem is that we’re going to have an unemployment rate that peaks at around 20%, which we’re going to reach very soon. We’re going to end the year with an unemployment rate as high as 10%, and we’re going to need to grind that down, and it’s probably going to take more fiscal action to help grind that down.

– Robert Kaplan, President, Federal Reserve Bank of Dallas [2020 FOMC Voter], 5/20/20


I don’t believe it’s going to be enough just to go back to where the economy was. We’re going to need to stimulate the economy, and government has a role to play in that. It always has.

– Andrew Cuomo, Governor, New York, 5/24/20


JP Morgan is prepared for a scenario where recovery is slower…The Fed’s liquidity, bringing out the bazooka, is propping up stock prices.

– Jamie Dimon, Chief Executive Officer, JP Morgan, 5/26/20


That said, the Fed’s actions have a cost because they tend to encourage risky behavior that we want to avoid — a problem known as moral hazard. Not all of those who got help were blameless. Consider, for example, the Fed’s enormous purchases of Treasuries as trading began to seize up. It was, in fact, a backdoor bailout of highly leveraged hedge funds that were caught in an untenable trade of being long cash Treasuries and short Treasury futures. When volatility was low, these positions could be leveraged up to generate attractive returns. But when the pandemic hit and volatility soared and those trades lost value, margin lenders who financed the positions asked for more equity. This led to fire sales, with many sellers and few buyers. The result was a climb in Treasury yields, a widening in bid-offer spreads and a sharp drop in liquidity in what is normally the most liquid market in the world.

The Fed decided that the risk of a dysfunctional Treasury market was bigger than the downside of bailing out the leveraged hedge funds. Although the Fed helped stabilize the Treasury market, it also made it possible for the hedge funds to avoid bearing the full costs of their risky decisions. The story isn’t much different in the mortgage-debt market. As volatility soared, real-estate investment trusts that invest in mortgage-backed securities were forced sellers as they struggled to meet margin calls. Again, the Fed purchases helped limit their losses.

Heavily indebted corporation also got a helping hand. This is significant because many corporations took on lots of debt by choice. The Fed’s response was to set up corporate bond facilities, limiting the fall in lower-rated corporate debt prices and keeping these markets accessible for companies that needed to raise funds. These actions also protected investors in high-yield mutual-bond funds. Had the funds been forced to sell amid plunging prices to meet large redemptions, this could have set off a chain reaction in which falling prices begat more sales. Both the asset managers and the retail investors who bought shares in these junk-bond funds escaped bearing the cost of their actions.

– William Dudley, Former President, Federal Reserve Bank of New York, 6/5/20


Even after three years, my projected recovery places us below where the economy would have been had the virus not occurred. The economic impact has been catastrophic for an extraordinarily large number of people and businesses, and sadly, the cost has fallen most heavily on some of our most vulnerable populations…Risks are weighted to the downside. Other forecasts with more severe effects on economic activity are almost equally as plausible in my view. More [monetary policy support] may be necessary.

– Charles Evans, President, Federal Reserve Bank of Chicago [2021 FOMC Voter], 6/24/20


The equity market does seem to be a little ahead of my view of the future earnings performance of businesses. If I’m right about that you’ll see a rebalancing of that over time.

– David Solomon, Chief Executive Officer, Goldman Sachs Group Inc., 6/24/20


Many people living in the West are dissatisfied with their own society. They despise it or accuse it of no longer being up to the level of maturity by mankind. And this causes many to sway toward socialism, which is a false and dangerous current.

– Aleksandr Solzhenitsyn, Commencement Address, Harvard University, 6/8/78