Ask The Expert - Lyn Alden - July 2022

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Craig: Welcome back to Sprott Money News. It's sprottmoney.com. It is time for your monthly "Ask The Expert" segment, and that month is July of 2022. I'm your host, Craig Hemke. And joining us this month is Lyn Alden. You remember we had Lyn in, I don't know, six, seven months ago, and everybody was so enamored with the information she shared. They said, "You've gotta get her back as soon as possible." So she's joining us again today. Lyn, of course, she's founder of the Lyn Alden Investment Strategy, and you can find her on the internet. You can also find her on Twitter. And, look, you know, I know Twitter is a lot of trolls, and bots, and the like, but there's a lot of smart people on there that freely share information, and Lynn is one of them. So I would strongly encourage you, if you are on Twitter at all, to make sure you look up Lyn Alden, A-L-D-E-N, and give her a follow. Lyn, thank you so much for spending some time with me.

Lyn: Thanks for having me again. Happy to be here.

Craig: It's great to have you back. And, look, again, before we get started, just a reminder, this stuff doesn't just appear for free on the internet. Someone's gotta pay for this stuff to get this up there. And that means your sponsor here Sprott Money. So, if you wanna repay them for all that they do, at least give them a like or a subscribe, something like that on the channel on which you're listening to this content. That helps them to widen the net, get that information out there to a wider audience. But also, if you're listening to this, you probably have an interest in the precious metals. Sprott Money should be your dealer of choice anytime you are in the market for a precious metal, physical precious metal, or just simply a place to store that metal. You go to sprottmoney.com, check out all the deals, or, of course, you can pick up the phone and give them a call and talk to a human being (888) 861-0775. Lyn, you may recall from the last time we spoke, we've been soliciting questions from Sprott Money customers and people on the internet for the last couple of weeks once they knew you were gonna be a guest. You're very popular. I've got six questions for you. Can we get started?

Lyn: Happy to.

Craig: Let's just dive right in. This is timely. We're recording this here during the second week of July. And earlier this week, the euro, which has just been sharply declining has fallen all the way back to parody with the dollar for the first time since 2002. So the question then is, what happens next?

Lyn: Well, a couple, yeah. That's a kind of a crazy event, isn't it? Basically, Europe has severe energy problems. Now, really, the whole world has pretty severe energy problems at the moment, but Europe's is particularly severe because their natural gas prices have spiked dramatically. And for people who don't remember the order of events, they spiked back in late 2021, which is before the war. Right? And the war obviously added additional layers of uncertainty onto that whole situation. So Europe has a more acute energy crisis than the rest of the developed world.

And so, you know, if you look at the dollar compared to, say, the Canadian dollar, it's up a little bit recently, but it's below where it was in, say, 2020. Same thing for the dollar compared to the renminbi and a number of other, you know, kind of major, semi-major currencies, but it is up significantly versus the euro and the yen. And that's mainly because the euro and the yen are specifically weak, you know, compared to a broad range of currencies, whereas the dollar is kind of in the middle against a lot of other currencies, but really strong against those two. So, basically, Europe find itself at crossroads here. They've mismanaged their energy policy, and then they have just kind of a challenging framework for the euro because it's a monetary union without a fiscal union. And so they have a lot of tough choices ahead of them. And so, you know, I'm not shocked that, basically, the euro has been particularly weak compared to other major currencies.

Craig: You expect... I mean, we'll get to the Fed in a minute. What could drive a bounce back in the euro at this point? I mean, it's obviously not going to...well, maybe it is not so obvious that it's not going to zero, but at some point, it will bounce. What would drive a bounce?

Lyn: You could get a bounce if the Fed has to stop raising rates. Right? So right now, we have a rising differential between U.S. rates and European rates. And if that were to stop increasing, you know, macro happens on the margins, it happens in rate of change terms. And so if the Fed finds itself unable to keep tightening, that's when the euro could start to find some semblance of a bottom, I think.

Craig: Okay. Well, then that's a good lead-in, excuse me, to the next question because this has to do with the Fed. I'm sure you remember. I remember about the time that the metals and everything else started to really go down in April was shortly after some comments by Bill Dudley who used to run the New York Fed. And he said that it was the current Fed's, I guess, job, or what they intend to do was to crush demand by making stock and bond investors get inflicted with losses, I think, was the term that he was using. Like, they were gonna drive a reverse wealth effect. So question two then, Lyn, is, I guess is that basically what was being referenced, the Fed thinks that they can break inflation by, well, in those words, crushing demand. So can you break inflation that way? Will that work?

Lyn: Not in the long term, I don't think so. I mean, obviously, it can work in the short term. I mean, if you cause a severe enough recession, you can reduce energy and commodity demand, and that can suppress prices. And so we've seen basically dry-up of fiscal stimulus and a very tightening of monetary policy. The problem in the longer term is that, you know, this really is not gonna be addressed until more commodity and energy supply comes online, and that takes years. And then, number two, there's a lot of negative feedback loops. So, for example, when the dollar is strengthening this much, generally, you see that the foreign sector's not buying many treasuries. And you also generally see that when asset prices in the U.S. stop going up, tax revenue stops going up. Basically, we're so financialized, we have 200% stock market capitalization in GDP like we recently had.

Basically, the tail wags the dog. So, if financial markets roll over, tax receipts also roll over. And so as we go on today, let's say next year, 2023, we could easily find ourself in a situation where tax revenues are going down, the dollar is strong, foreign sector is not buying treasuries, the question becomes who buys treasuries? And so back in March 2020, they had a similar situation where you had a spike in the dollar, the foreign sectors sold hundreds of billions of dollars' worth of treasuries to get dollars, and that caused the treasury market to break. It went illiquid. And the Fed had to come in and buy a lot of treasuries.

And so I see a similar type of environment building. Maybe not as fast acting as that particularly, you know, notable event, but I think we're building towards a similar thing. Maybe later this year, maybe 2023, we have to kind of monitor it as it goes along, but we're seeing rising problems in the treasure market, not just the yields, but under the surface, looking at liquidity, looking at volatility in the treasure market. It's getting pretty wobbly because, you know, basically, the supply-demand mismatch is getting pretty messy. And I think that could eventually be one of the factors that contributes to them having to pause rate hikes, even though inflation is still potentially hot at that time, or, you know, even if it cools off temporarily, it's hot and ready to bounce back as soon as they take their foot off the brake.

Craig: All right. That's pretty funny. Everybody listening, I did not tell Lyn the questions ahead of time because I knew that having known the questions, I knew that they'd be right in our wheelhouse. Well, Lyn, which like goes right into question three, which I think is pretty funny. It was simply when...the question is assuming the Fed will pivot, it will get power pivot too. When they pivot, what will have driven the change? Just now, you mentioned is it bond market liquidity? Is it they finally get inflation back down under 2%? Is it the recession that looks like it may have already begun? Could it be a stock market crash? Maybe it's all of those things, but what do you think is the most important driver for the Fed's decision?

Lyn: So I think there are three major things that could cause it, and it could be a combination of them. But basically, so the short answer is no, I don't think it'll be the stock market itself. Basically, the stock market itself does not force the Fed to pivot. I mean, usually, the things that force the Fed to pivot are occurring alongside stock market crashes. So it kind of can look like the stock market's doing it, but it's actually stuff underneath the surface. And so number one would be, say, credit market's breaking. So when the Fed had to start pivoting rate hikes in late 2018, it was because the junk bond market completely froze. So even though we had a 20% correction in the S&P 500, the bigger problem under the surface is that the weaker end of the corporate bond market just completely froze for like six weeks, not a single junk bond was issued. And that's a more alarming signal to the Fed than just stock markets going down.

Number two would be something at the core of the system breaking. And an example, in late 2019, was the repo rate spike, you know, the overnight lending rate between financial institutions, that broke. So that forced the Fed to stop producing their balance sheet literally that day, and they never went back until, you know, just recently. And then, two, like I said, March 2020, the treasury market broke. And so the Fed had to basically have an emergency meetings and just throw literally a trillion dollars at that market in a three-week period, which was unprecedented.

And so something close to the core of the system in financial markets breaking like credit markets, treasury markets, something like that would force the Fed to, you know, start basically changing their course. The other potential option that could coincide with some of those or could be separate is I think if you get unemployment rates officially start going above 4% or so, if you get a market deterioration in the job market, I think that could do it. Right now, we've already seeing kind of early recession signs, but that would be kind of a full-throttle recession sign. So I think one of those options is probably what causes them to eventually pivot.

Craig: Lyn, this kind of came up with Danielle DiMartino Booth a couple of months ago, the idea of bond market liquidity being so important. And she keeps an eye on the MOVE Index. Is that something you follow too?

Lyn: Yes. And she covers this really well. I think she's one of the analysts that I think is totally on point on this subject. The MOVE Index is kind of like the VIX for treasuries. And so you can measure volatility. That's the best way to look at treasure market volatility. And we're currently at like decade-highs in the MOVE Index. You had a spike in that index in, you know, March 2020, and we've had another grind higher, even to higher levels than that. So we're not quite as high as we were in the great financial crisis, but we're the highest since then. So that's number one. You can also look at treasury bid, ask spreads, and auction performance, basically, if you have kind of ugly tails in the auction, meaning that, you know, they start at one price, and by the end of the auction, they're at a notably different price in the bonds. That's basically, you know, kind of a sloppy auction, and that's a measure of illiquidity.

So when you have volatility and illiquidity, that's showing that the market's getting pretty wobbly. Now, right now, it's not broken the way that it was, you know, for brief period of time in March 2020, but it is getting messy. And that's, you know, like I said, when the dollar is super strong, you don't really have foreigners buying treasuries. We also currently don't have banks buying treasuries. Now, the one thing in the treasuries department's favor is that due to just the timing of tax revenues and expenditures, they don't have a lot of net issuance of treasuries in either the prior quarter, quarter 2, or the current quarter, quarter 3.

And so, right now, they're kind of able to get away with this because they're not trying to just flood the market with treasuries. But as we look towards the very end of the year, or, like I said, as we look into next year, they're probably gonna have to increase their treasury issuance quite a bit. And if this situation, the liquidity and the, you know, the lack of buyers is still present, that's when they have a problem. And that's when either the Fed has to potentially absorb some of that issuance itself, which would be a reversal of their policies, or they can do things like change the SLR, supplementary leverage ratios, for commercial banks to basically allow the banks to buy more treasury. So they'd have to do something to reliquify the market if those conditions remain this way, you know, a year from now.

Craig: Okay. All right. Well, we're halfway done, Lyn. Those are all of our Fed questions. And now the final three questions have more to do with commodities. And I know that's a specialty of yours as well. Question number four is...I think most everybody listening to us probably understands this. We've had a pretty tough 90 days or so in the precious metals, gold and silver. What do you think is next in the back half of the year and headed into 2023?

Lyn: I think a lot of this kind of hinges on the Fed, right? Because right now, when you have the dollar screaming higher, especially against the euro and the yen and you have sharply rising rates in the face of a slowing economy, we also have a decrease in the rate of money supply growth, right? So we had, you know, kind of historically high money supply growth over the past two, three years, and we've slowed down very significantly recently as they try to put on the brakes. And so that's putting a lot of pressure on the precious metals, you know, silver more so than gold, stocks more so than gold. But certainly, gold miners, in particular, are getting kind of a hit here because they have the combination of high energy prices and gold not really going up.

So I think that basically what you wanna look towards is when the Fed is kind of forced to pause and you get some sort of relief in the dollar going up against a lot of other major currencies, that's when I think you could see signs of, you know, potentially a reversal in some of the precious metals. Right now, we do see...you know, if you look at the copper to gold ratio, that's rolling over pretty sharply. And so I do continue to be more bullish on gold than copper, although right now that's more so, you know, to the detriment of copper than the favor of gold.

Craig: Okay. Now we've done this twice, Lyn. I'm starting to wonder if you can read my mind through the internet. I think this is pretty funny because, I mean, seriously, question number five is, what are Lyn's thoughts on copper?

Lyn: Oh, that's hilarious.

Craig: It's been dramatic, the drop over the last month. So what do you think?

Lyn: Yes. It's understandable that I could kind of see the questions coming because these are the major macro questions facing this industry, right? So gold and copper, obviously, huge drivers of things, and then all of the Fed policy, and the big question is, you know, what's happening with currency markets? What's happening with inflation? That sort of thing. So when we look at copper, basically, if you look at the copper to gold ratio that I mentioned, you'll see this kind of like, you know, three-year cycle, roughly, right? It looks kinda like a sign wave going up and down. And if you overlay that with macro indicators, let's say the PMI, the purchasing manager's index, which is one of the simplest macro indicators to look at, you'll see basically a three-year sign wave.

And so the copper to gold ratio and the PMI is kind of the same chart, except that, you know, the copper to gold ratio one looks a little bit more volatile. And that's generally because in economic accelerating environments, so rising PMI environments, generally, you get a lot of copper demand. It's a risk on environment. There's construction happening. And so copper generally does well. In declining PMI environments, there's reduction in construction, and manufacturing, and things like that. And so you start to see weaker demand for copper, and then potentially, you get a bid for gold, or at least gold is holding up better because it's a risk-off type of environment. So stocks are going down, and copper's going down, and, you know, a lot of things are going down. And gold, you know, maybe it's going up, or maybe it's going down less, and so, you know, it's kind of holding up better than copper.

And so, right now, we're in a declining PMI environment. And as one would expect, we're seeing a sharp reduction in copper compared to gold. But this is where I think timeframes differ. So I'm super bullish on copper with, say, a 10-year view, but, I'm, you know, bearish on copper relative to gold over, let's say, the next six months. And, you know, back in 2020, I wrote about copper producers. I was very bullish on copper. I expected to hold them for years, and then it all went up very, very rapidly, more rapidly than I would've guessed. And so I had to reduce, in some cases, eliminate my positions, and I'd be happy to buy them back. Once we start seeing a bottom of this particular cycle, rising PMIs, some sort of momentum shift in the copper to gold ratio, that's when I'd be quite bullish on copper going forward. Because I think, you know, when you look out long-term, there's not really enough copper to, you know, meet all of the projects that people wanna do, especially as it relates to electrification, but also just the things like rising emerging markets, India, for example, has huge copper demand in the decade ahead.

Craig: Really lower prices is often the fix for lower prices, I think. Rick Rule always says that, right?

Lyn: Exactly. Yes.

Craig: All right. Well, Lyn, I got one question to go. So now, since I've told you about commodities and you've been predicting all the other questions, what do you think this one's about?

Lyn: That's tough.

Craig: I know. I thought for sure you would know right off the top of your head. It's very, very popular subject these days.

Lyn: Is it crypto?

Craig: No, we're gonna go with crude oil.

Lyn: Oh, yes, it's to crude oil.

Craig: And it's so important, obviously, because energy costs drive inflation. You mentioned how it is impacting the gold miners and the copper miners too, you know, for that matter. Here's the thing, I guess, the crux of the question. Over the last week, I've seen this too, there are some investment banks, I can't remember which one said they thought crude could go to $380 or something like that. And then hot on the heels, there was another investment bank, some, you know, sell-side outfit that said it was going to 60. So that's pretty wide range. What do you think?

Lyn: So I think it's normal that there's volatility and a lot of uncertainty here because you have huge variables in either direction. So, on one hand, as the U.S. and Europe probably go into recession, that should suppress demand. And we also generally see right now, I mean, the U.S. is selling part of a strategic petroleum reserve to try to suppress prices. We see China engaging in pretty severe lockdown that reduces the country's oil demand, right? So less jet fuel, less gasoline, just less demand in general. So there are some downward pressures on oil. But, in general, I'm a lot more bullish on oil than I am copper here. Basically, I think that, you know, to whatever lows we reach from demand destruction, will probably not be as low as some of the bears think.

And I think as we look out forward, the main bullish drivers are that there's not a lot of new supply ready to come online quickly, right? So you have little things like shale and OPEC that can tweak things to some extent, but we need much bigger projects to come online. And we also need some of the surrounding infrastructure, right? So LNG exports, or refining capacity, or pipeline capacity, it's not just the production. And so I'm pretty bullish on oil, but I think that it's one of those things where if you use leverage or if you're trading it too closely, it's very easy to get caught off guard because I think that with such strong macro factors pouring in either direction, I would not be surprised with like $20 swings in the price in a given week or month.

And one thing I would differentiate is between OpEx commodities and CapEx commodities. So, you know, an example of a CapEx commodity is like copper. That's something that we can use a lot less of for periods of time due to a recession or something like that. You know, for example, we can defer building projects and things like that, and so you can get these bigger swings in demand. Whereas energy, I mean, outside of forced lockdowns like 2020, you don't see a huge range of changing demand. You know, it's basically used in operations. So it's mostly non-discretionary how much energy we use. And so I'm a lot less bearish about oil and gas and things like that than I am with copper in this kind of, you know, cyclical downturn that we're in. But when we look out very long-term, I'm very bullish on copper and I'm also very bullish on oil, gas, those that produce them, and those that transport them via pipelines and things like that.

Craig: Lyn, it's been great to have you back on. And I think everybody listening has certainly found this to be valuable. I mentioned following you on Twitter just to find out, like I said, multiple times a day, what your current thoughts are. But tell everybody else as we go where they can find you on the internet.

Lyn: I appreciate that. I'm at lynalden.com. That's my hub. That's where I, you know, put public articles and research. And I'm also, like you said, on Twitter @LynAldenContact.

Craig: And it's A-L-D-E-N, just one word. L-Y-N-A-L-D-E-N, Correct?

Lyn: Yes.

Craig: Awesome. Lyn, thank you so much for your time. And again, everybody, before you go, be sure to check out sprottmoney.com, keep them on your list every time you're in the market for precious metals. But even, again, thank us with a like, or a subscribe, help us cast a wider net of distribution for this information. Again, we are speaking with Lyn Alden here for "As The Expert" in July. Lyn, thank you so much for your time. It's been great.

Lyn: Yup, thank you.

Craig: From all of us here at Sprott Money News and sprottmoney.com, thank you for listening. Talk to you again in August.