Everyone Has A Plan Until They Get Hit In The Mouth

Written by Gerardo Del Real
Posted February 26, 2018 at 4:43PM

Just last month I wrote that you should expect volatility to return.

Everywhere I look I see signs that the volatility we’ve seen in the past month is here to stay and will become a global trend that lasts for years.

For the past 10 years stocks have benefited from ultra-loose monetary policy that has punished savers by artificially keeping rates and volatility low.

Last month I explained that “the bond bubble hasn’t burst yet but air is starting to leak out slowly but surely.”

The 10-year Treasury note just hit a four-year high as it surged to 2.95%.

It’s up approximately 160 basis points since bottoming in July 2016.

Some have speculated that the ECB has tapered bond purchases, driving yields higher.

Others — including myself — have noted that the market likes to test new Fed chairs right away to see who they’re working with.

All last year, central banks telegraphed that 2018 would be the year that they would finally begin to tighten by reducing bond-buying programs and raising interest rates.

Officially, central banks have all agreed on the talking points.

Inflation must be watched carefully as the global economy shows signs of improving and the first tool against inflation will be to raise rates.

Even JPMorgan Chase believes inflation is back and if it's right, that will be very bullish for commodities and the tiny sector I speculate in.

The bank went on to say:

"Assuming the present cycle will stretch beyond 2018, the current expansion is just beginning one of the strongest periods for metals prices broadly."

Recent data does bolster the case that inflation is ticking up. But what effects have inflation and rising rates had on stock performance in the past?

Ben Carlson from Bloomberg recently looked at data from the Federal Reserve and found that, since 1962, in each instance where rates rose more than 100 basis points (17 times in all), the average performance of the S&P 500 was approximately 22% in total returns.

When looking at inflation data from the same time period, Carlson found that in years where inflation data was lower than the previous year, the median return was 18.3%.

In years when inflation data was higher, the return in stocks was just 5.6%.

Some perspective. Inflation came in at 2.1% recently (this excludes food and energy categories because nobody eats or uses energy), which is lower than the annual rate since 1928 of approximately 3%.

Inflation or not, tightening is the only option central banks have right now.

Reload now to have some ammunition for the next real crisis.

There is always a next crisis.

None of this is new, what is new is that the tightening is actually happening now.

As Mike Tyson once said, “everyone has a plan until they get hit in the mouth.”

Rising rates and volatility together are the punch and many fund managers have never been in a fight.

In an environment where volatility returns and capital seeks a safe home, gold will do well. But that will require a seismic event.

A big earthquake doesn’t just show up, there are always signs.

In the case of gold, it hasn’t broke out yet but did recently break above its six-year trend line. A break of the $1375 level is necessary technically to break out, put in a new bottom, and begin to test the $1,400 level.

Many of you know I believe that seismic event will be a bond blowup that begins in Europe and strengthens the dollar, which will lead to defaults that create a rush out of overseas bond markets.

There would be enough capital looking for a home to prop up the U.S. indices, gold, and even crypto markets.

The tremors are here. Rates are rising globally, which means servicing global debt is also rising globally.

In Europe, the ECB has purchased 40% of European government debt for nearly 10 years. For all its troubles, the 10-year German bond rate is 0.70%.

Traditionally, when there is volatility, bonds represent the flight to quality. The safe harbor.

That may be the initial reaction this time around as well, but how much capital can be absorbed rationally into a negative or next-to-nothing-yielding asset?

What happens when the music stops and the ECB is no longer there to be the buyer?

Junior resource speculators know the answer well. When there is no liquidity and you need to sell, you sell at whatever price you can get.

Imagine that with the bond market. Imagine all that capital moving away from government assets and into private ones like stocks, gold, cryptos, art, and collectibles.

That will be the big one.

To your wealth,

gerardo-sig

Gerardo Del Real
Editor, Junior Mining Monthly and Junior Mining Trader.

For the past decade, Gerardo Del Real has worked behind-the-scenes providing research, due diligence and advice to large institutional players, fund managers, newsletter writers and some of the most active high net worth investors in the resource space. Now, he is bringing his extensive experience to the public through Outsider Club, Junior Mining Monthly, and Junior Mining Trader. For more about Gerardo, check out his editor page.

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