Learn Why Axel Merk Sees Problems Ahead for the US Dollar…
Currencies / US Dollar Oct 29, 2017 - 10:54 AM GMTBy: MoneyMetals
Mike Gleason: It is my privilege now to welcome in Axel Merk, president and chief investment officer of Mark Investments, and author of the book Sustainable Wealth. Axel is a highly sought-after guest at financial conferences and on new outlets throughout the world, and it's great to have him on with us again. Axel, thanks for joining us today.
Axel Merk: Good to be with you.
Mike Gleason: To start out here, I wanted to ask you about the exuberance in the stock market that just can't seem to be derailed by anything. For instance, we have Wall Street seemingly accounting for the fact that the GOP Congress, along with Trump and the White House are going to get everything done when it comes to health care reform, tax reform, spending cuts, et cetera. But in reality, none of this has happened yet, and it's far from certain that anything meaningful will get done on the legislative front, but the markets seem to be pricing this is. What are your thoughts there?
Axel Merk: I think that this is just a symptom of the time we're in, and we've had similar things in the late '90s, and in the mid-2000s, and it's the buy-the-dip mentality that's become a self-fulfilling prophecy.
We talk a lot to investment professionals, and in order to preserve their job and not lose their clients, they have changed their strategies. Think about anybody who has been quote-unquote diversified. They still have a bunch in so-called risk assets, and that means on the way up they have underperformed, because the diversified stuff underperformed, and on the way down, because the risk assets are still a big chunk, they're losing money. And so the clients are saying, "Hey, on the way up I'm not keeping up with the indices. On the way down I'm losing money. Why the heck am I with you. Stocks go up all the time anyway," and so that drives everybody to be in that sphere that they buy the dip, buy the dip, and everybody I talk to, even the pessimists, are invested in the market, and the feedback I'm getting is, "I don't want to be the first one to sell here; it's okay to wait," and that very much reminds me of 2000, and I don't know how many of your listeners were around then, but in 2000, it wasn't all that obvious that we had the peak of the market in March 2000. Six, nine months later, many people still thought buying the dip is the right thing, and so those folks who are waiting might be waiting a long time, and lose a lot in the process.
Mike Gleason: Trump is expected to make an announcement regarding who will be appointed Fed Chair some time in the next couple of weeks. We learned last week that Janet Yellen is very much a contender. Trump was very critical of Yellen as a candidate for president, but now, less than a year into his term he says he, "really likes her a lot." First off, why do you think he's done this about-face, and then do you care to make any guesses about who will wind of running the Fed?
Axel Merk: Sure. A couple of updates on that. There have been stories out that by November 4 we'll hear it. The latest I heard was November 3. Politico just released that Yellen is out of the running, and yesterday it was said that Cohn is out of the running. But let me make a broader point before I go into some scenarios here.
If you are a good salesperson, the stuff that you like you'll talk down, and the stuff you don't like you'll praise. Think about it. You want to buy a car, if you want to have that car, you'll say it's a piece of crap, because then the price is lower, whereas if you don't want that car anyway, it is no problem to praise it, and so it doesn't cost Trump anything to praise Janet Yellen, because, "Hey, you're a lovely woman, you're fantastic, and now go to hell," type of thing, and then of course he's not quote-unquote buying something, except of course you're buying a Fed Chair in this instance, so-to-speak, so I am absolutely not surprised that he is providing flattering comments to people he would never consider hiring.
Now that said, the runners that are in the game right now are J. Powell, who is a current governor, and then John Taylor, and Kevin Warsh. I know the latter two personally.
Powell is a lawyer, and by all means we do not need to have a PhD economist to run the Fed, but a lawyer, a lawyer's job is to please people, and I hope I'm not offending too many lawyers who might be listening here, but J. Powell, he doesn't have any views on monetary policy. He's completely agnostic. He was appointed by Obama as a financial regulator, and gave a speech, said, "Oh maybe we have to dismantle some banks and break them up," and since the Trump administration has been in, he has been working on deregulating banks, so he does what the boss, so-to-speak, tells him to do. Regarding monetary policy, yeah, some people say he has this or that view, but he's just echoed whatever the Chair's position was at the time. And so some people will say, "Oh that means he's going to do whatever Trump is going to do if he becomes the Chair."
Mnuchin, the Treasury Secretary, really would love to have Powell. My view is that the guy is intelligent, I have no grudge against him, but because he doesn't have any view on monetary policy, somebody else will be the most important person. I happen to think that in this case it's going to be the Vice Chair. Historically the Vice Chair at the Fed is a purely ceremonial role, but it is likely to be either Taylor or Warsh. Of the two, different sort of scenarios can happen.
Warsh is somebody who really wants to clean up the Fed, doesn't like the way it's run, and I think Warsh would love to have the job, and he could do that. Taylor is an accomplished person in his own right, has very strong views, and I don't know whether he wants to be the second in command. He might be convinced if he thinks he can control Powell, and he would be the quote-unquote more hawkish choice of all of the bunch.
Mike Gleason: There is little doubt the Fed's extraordinary stimulus over the past decade has achieved some of the results they wanted. We've got higher asset prices, and even some economic growth, but to us and a lot of other Fed critics, the question was never whether a few trillion dollars of quantitative easing and zero interest rates would produce result, the question was whether there would actually be real economic growth, or if the Fed would simply blow up another bubble, creating even bigger consequences when the bubble pops. Perhaps the question is about to get answered. The Fed is in the middle of a modest rate-hike cycle. Do you think officials there are serious about normalizing rates, and if they do jack up rates a whole lot more, how do you expect the markets will react to this?
Axel Merk: If Janet Yellen were serious, she would tell us where we're going. She hasn't said where she wants to take the balance sheet, because the FOMC has no clue, and she has no clue, so in that sense it's very important who is going to succeed. Powell won't have a clue either. Both John Taylor and Kevin Warsh do not like to have excess reserve in the system and would unwind the balance sheet probably faster than others. So it is incredibly important who is going to succeed Yellen, and in that sense, if it's Powell, it's very important who's going to be the Vice Chair.
By the way, there's another scenario that just some technocrat at the staff of the Fed is going to become very important and influence things, because ultimately all these lawyers who are on the governing side of the Fed, not the regional presidents, they have no clue about monetary policy, they don't have their own staff, so they just look at all of the presentations during the FOMC meeting and then do whatever the Chair say, and so it's possible that some back-office person gains influence, but back to your question.
QE, the one thing it has achieved, in my view, it has compressed risk premia. That means risk assets, everything from junk bonds to equities, have a very low risk premium. That means junk bonds don't yield much. That means volatility in the market is very low, and the stock market is very low, and when you have quantitative tightening, and it is not, even under the program suggested by Yellen, the one that we are about to embark on, it is not watching paint dry on the wall.
Risk premia, to me, almost by definition, has to expand. That mean volatility is going to go up, and that provides a headwind to risk assets. That means everything else equal, prices are lower, and that's one of the reasons why even with the quote-unquote tightening, I'm positive, at least on the precious metals, on gold in particular, because there is less economic component on that side, and so it's a more pure reflection of the monetary conditions, and if financial conditions tighten, and that's by the way the definition of raising rates or quantitative tightening, then equity prices are at risk, and something like gold may do quite well in that sort of environment.
Mike Gleason: Kind of leads me right into my next question, and I'll ask you to expand a little bit there on that last part of your answer. One of the challenges in the metals markets right now is that U.S. retail investors just aren't buying a lot of safe havens, as you mentioned. Either there isn't much perception of risk, or perhaps people can see risk but discount it because they expect the Fed will step in with their magic money machine if problems arise. In any event, it looks like the metals markets are waiting for some catalyst to introduce the notion of risk to the markets. Do you see anything developing right now that might shock the markets to give metals a boost?
Axel Merk: A big voice in the gold market mentioned to me the other day, "Why should retail buy gold anymore? America's going to be great again." Ever since Trump go elected, a big segment of the retail sector lost interest. What I have seen, and I can't really talk to that, what is have seen is that on the professional side, the interest has increase substantially, and the reason it has increased is that if you think about what are you going to do with your money? Everything is expensive, and are you just going to hold your nose and continue buying the stuff? And some people do, and obviously many people do to a significant extent, but how do you diversify? Now, cash is one thing, but if you're professional, you don't earn any money on cash, and so you're not going to use cash. So, gold is just the easiest diversifier, and I emphasize easy rather than best.
I like gold, by all means, but there are other things you can use to diversify. It's easy because it's easily understood, and the correlation of gold to other assets is, to the S&P in particular, is zero over the long term, and then I mentioned, as risk premia go up, gold may do very well, so from that point of view, professional investors increasingly use it to diversify. As far as retail is concerned, obviously they are confused, and if you're not confused you haven't paid attention.
My view is the Fed is behind the curve, at least under Yellen, and will continue to be behind the curve. If we get someone like John Taylor, who is considered to be more hawkish, the odds are rates are going to move higher. Ultimately, it matters where real rates are going to be. In every bear market in stocks since the 1970s, gold has done very well, with the big exception of the early '80s, where (Fed Chair Paul) Volcker put real interest rates up very much. Now if you think that a John Taylor can do that, by all means stay away from gold.
My take is, the initial reaction of a Taylor is likely to be that maybe bonds will sell off. That means yields will be higher. Maybe that's a negative for gold, but very quickly thereafter, and I don't think it may be months, it could be minutes, people are going to realize, "Oh my God, that tightening is going to be bad for risk assets," and what happens, if you have a selloff in equities, if you have a selloff in junk bonds, where does that money go? Well, it tends to go into Treasurys, and so that means the long-term rates are not going to move up. All this, the Fed was trying to explain to you that getting out of the quantitative easing, out of this big balance sheet, is going to raise long-term interest rates. I'm not so sure it will, because I see substantial volatility in the markets, and that will keep those yields lower. So, in that sort of environment, I happen to think, that gold is as good a diversifier as ever.
Remember, historically gold has done well. People are always worried about what it's going to do tomorrow. The truth of the matter is gold doesn't really do anything, because gold doesn't change.
Mike Gleason: Right. Exactly. It's the fiat money that changes value. At the end of the day, gold is really an anti-dollar investment, and since you've made a name for yourself over the years as a guy who follows the currency markets probably as closely as anyone, let's talk about the U.S. dollar here a little bit more. Now metals fared pretty well during the first half of the year as the greenback slipped to multi-year lows. In recent weeks however, the dollar has perked up and metals have stalled. Have we seen a short-term bottom in the dollar, or is this rally likely to fail?
Axel Merk: The dollar bulls will never shut up. Let's put it this way, and just as we’re talked European central bank just had a meeting, and there wasn't a big surprise. Mr. Draghi said he can do more if he wants to. That said, even Mr. Draghi is, starting October 2018, later than here obviously, is expected not to print any more money. That means the printing presses are grinding to a halt throughout the world. It's happening in stages, and there are some changes happening.
Remember, when the Fed first started talking about tapering, they talked and talked and talked and didn't do anything, but for years the dollar was grinding higher. And then when they finally acted, the dollar weakened, so now you have the Europeans that are expected to taper, expected to print less money, and the expectation of that has pushed the euro from about 1.05 to 1.17 or so, and so that is going to continue to happen.
The short of it is that in the U.S. we're much further along, in fact I think in the U.S. we are closer to the end of the tightening cycle, and in Europe we're in the beginning of the tightening cycle, and so yes, there are people that say, "Hey, in the US we're going to have a hawkish Fed person," and this and this, I would never bet on the conventional wisdom that that's exactly how it's going to happen, and going to translate.
If we're going to have a risk-off environment, treasuries are going to rally. People have this conception that the dollar is going to rally in the risk-off environment, which happened in 2008, but if you look at the last two years, whenever we've had a risk-off environment, we didn't have a substantial one, I grant you, the euro rallied, and the reason the euro rallied is because the euro has become a funding currency. People borrow in euros because interest rates are negative, they're so darn low, and so it's acting much more like the yen. And so, these correlations are morphing, they're not stable.
I would be very hesitant to say that, especially with the budget deficits that going to blow out in the U.S., potentially anyway, that the dollar is the one that's really going to rule the day here. So, I'd be very, very cautious about jumping on the bandwagon of the conventional wisdom here.
Mike Gleason: Well finally, as we wrap up here, any final thoughts you want to leave us with? Anything that you're focusing on specifically over the short term?
Axel Merk: Well, I happen to believe that investors should stress-test their portfolios, that if and when the buy-the-dip mentality is over, that they'll be okay with that. I happen to think diversification is not that you move from one sector to the other, but you actually think about how to generate uncorrelated returns in other ways, and then one of the things we're digging into quite deeply are just what's going to happen here, both on the long and the short end of the yield curve, in various countries around the world.
I don't think that the low rates in the Eurozone are sustainable, despite what Mr. Draghi's trying to tell us, and so there will be some repricing of risk, and by the way, even though the exact opposite is in the news, of course, today, as we talk anyway, with the European Central Bank sticking where they are – if they are going to be more assertive, ultimately, because Mr. Draghi's term is also going to be up at some point, he's going to stick around for a little while longer – then there's going to be a repricing there, and so again, things are not going to evolve the way that everybody's telling you.
I'd be very cautious about risk assets. I would not bet that the dollar is going to be the big winner. I would not bet that Treasuries are going to sell off too much, and not because I don't think that deficits are not going to blow it up, or maybe the quantitative tightening will, but that the risk-off environment, the volatility is going to push money into Treasuries, and so those waiting for this big Treasury selloff may have to wait, and then with regards to broader commodities, a lot of it depends on China, that we haven't talked about, and that's, of course, a big wildcard because who knows what's going to happen there.
Mike Gleason: We'll leave it there for now. Thanks for the fantastic insights Axel. It was great to have you back on, and we really appreciate your time today. Now before we let you go, please tell listeners a little bit more about your firm, and your services, and then also how they can follow you more closely.
Axel Merk: Sure. Come to our website, MerkInvestments.com, follow me on Twitter or on LinkedIn. I'm Axel Merk, as you find me on Twitter, on LinkedIn, wherever you want. We have a newsletter. Live tweeting is really the best way you can get the direct interpretation of the news. Anybody can curate their own news channel on Twitter, but folks who don't like it, LinkedIn is okay as well. It's a little bit more in-depth for those sort of things. We do have some investment products focused on currencies and precious metals. Look it up on the website. So browse around on the website, but by all means engage by following my on Twitter, LinkedIn, or even Facebook.
Mike Gleason: Great stuff. Thanks again Axel. We look forward to checking back with you down the road, and get more of your thoughts on these ever-changing markets. Take care and thanks for joining us.
Well that will do it for this week. Thanks again to Axel Merk, President and Chief Investment Officer of Merk Investments. Manager of the Merk Funds. For more information, be sure to check out MerkInvestments.com.
Thanks for listening and have a great weekend everybody.
By Mike Gleason
Mike Gleason is President of Money Metals Exchange, the national precious metals company named 2015 "Dealer of the Year" in the United States by an independent global ratings group. A graduate of the University of Florida, Gleason is a seasoned business leader, investor, political strategist, and grassroots activist. Gleason has frequently appeared on national television networks such as CNN, FoxNews, and CNBC, and his writings have appeared in hundreds of publications such as the Wall Street Journal, Detroit News, Washington Times, and National Review.
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