American politics

Is Donald Trump above the law?

Revelations and convictions will eventually force America to confront a simple question

IT WAS the kind of moment that would crown the career of a reality-TV producer. While the president of the United States was on his way to a campaign rally, his former campaign manager, Paul Manafort, was found guilty of eight counts of tax and bank fraud; and his former lawyer, Michael Cohen, pleaded guilty to eight counts of tax evasion, fraud and breaking campaign-finance laws. Cable-news channels needed so many split screens to cover what was going on that they began to resemble a Rubik’s cube. Amid the frenzy, however, something important changed this week. For the first time, President Donald Trump faces a formal accusation that he personally broke the law to further his candidacy.

Mr Manafort’s conviction did not surprise anyone who had followed his trial, or his long career as a political consultant available for hire by dictators and thugs. Mr Cohen’s plea was more striking, because he was not just Mr Trump’s lawyer; he was the guy who made his problems go away. This included making payments during the 2016 campaign to buy the silence of two women who appear to have had affairs with Mr Trump. (The president has denied the affairs and now says he learned about the payments later.) But Mr Cohen told a court under oath that the money was paid “at the direction of a candidate for federal office”. In other words, that Mr Trump told Mr Cohen to break the law, then lied to cover it up.

Neither Mr Manafort’s conviction nor Mr Cohen’s plea is directly related to the allegations of collusion with Russia that have dogged the Trump campaign, and are being investigated by Robert Mueller, the special counsel. Yet neither case would have been brought without his investigation. This week’s events mean that Mr Mueller now stands on firmer ground. It will be harder for the president to dismiss him without it looking as though he is obstructing justice.

And in such cases, convictions often lead to more convictions as those found guilty look for ways to save themselves. The question now is whether, and how far, Mr Manafort and Mr Cohen will turn against their former boss in return for leniency. As the slow drip of revelations and convictions continues, Americans will have to confront a simple question: is Mr Trump above the law?

Follow the money

Mr Cohen says Mr Trump asked him to make hush-money payments—something that is not illegal for ordinary citizens, but counts as an undeclared donation when done on behalf of a political candidate, as Mr Trump was at the time. So what? After all, America treats breaches of campaign-finance law much more like speeding tickets than burglary: they are often the result of filling in a form wrongly, or incorrectly accounting for campaign spending. There are good reasons for this indulgent approach. When voters elect someone who has bent the rules, it sets up a conflict between the courts and the electorate that is hard to resolve cleanly.

Mr Trump does not stand accused of getting his paperwork wrong, however, but of paying bribes to scotch a damaging story. That is a far more serious offence, and one that was enough to end the career of John Edwards, an aspirant Democratic presidential candidate, when he was caught doing something similar in 2008. There is no way of knowing if Mr Trump would still have won had the story come out. Even so, the possibility that he might not have done raises questions about his legitimacy, not just his observance of campaign-finance laws.

What of the convention, which has been in place since the Nixon era, that the Justice Department will not indict a sitting president? Again, there are good reasons for this. As with breaches of campaign-finance law, such an indictment would set up a conflict between the bureaucracy and the president’s democratic mandate that has no happy ending. The convention would doubtless be void if there were credible evidence that a sitting president had, say, committed murder. But the payment of hush money to avoid an inconvenient story about an extramarital affair falls a long way short of that.

The authors of the constitution wanted to allow the president to get on with his job without unnecessary distractions. But, fresh from a war against King George III, they were very clear that the presidency should not be an elected monarchy. If a president does it, that does not make it legal. The constitutional problem that America is heading towards is that the Justice Department’s protocol not to prosecute sitting presidents dates from another age, when a president could be expected to resign with a modicum of honour before any charges were drawn up, as Nixon did. That norm no longer applies. The unwritten convention now says in effect that, if his skin is thick enough, a president is indeed above the law.

Drip, dripping down the drain

This means the only solution to any clash that Mr Trump sets up between the courts and the voters is a political one. Ultimately the decision to remove a president is a matter of politics, not law. It could hardly be otherwise, as America’s Founding Fathers foresaw. In “Federalist 65”, Alexander Hamilton explained why it was the Senate, rather than the Supreme Court, that should sit in judgment on the president, for “who can so properly be the inquisitors for the nation as the representatives themselves?” No other body, he thought, would have the necessary “confidence in its situation” to do so.

Alas, that confidence has gone missing, leaving American democracy in a strange place. Thus far Republicans in Congress have stood by the president. The only thing likely to change that is a performance in the mid-terms so bad that enough of them come to see the president as an electoral liability. Although Democrats may well win a majority in the House, a two-thirds majority in the Senate—the threshold required to remove a president—looks unachievable.

Mr Cohen’s plea has made the president of the United States an unindicted co-conspirator in a pair of federal crimes. That makes this a sad week for America. But it is a shameful one for the Republican Party, whose members remain more dedicated to minimising Mr Trump’s malfeasance than to the ideal that nobody, not even the president, is above the law.

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Here’s how Jackson Hole could impact the dollar, bonds and emerging markets


          The spotlight will shine on Jerome Powell /  Alex Wong/Getty Images

Wall Street investors are watching a key gathering of prominent central bankers at Jackson Hole, Wyo., which could have implications for an array of assets, from international stocks and bonds to emerging-market assets.

The policy-maker proceedings started on Thursday, headlined by a speech from Federal Reserve Chief Jerome Powell at 10 a.m. Eastern on Friday.

Here’s what investors will be acutely watching as the meeting gets underway:

The U.S. dollar

Powell could hint at changes to monetary policy in his speech, though market participants aren’t prescribing a high likelihood of this outcome. On the other hand, Powell could talk about continuing trade tensions, notably between the U.S. and China, and their possible effect on the pace of interest-rate hikes, which he has tentatively touched on before.

“We think [Jackson Hole] is relevant in the context of extreme sentiment and positioning in favor of the dollar,” wrote Mark McCormick, North American head of FX strategy at TD Securities. “That leaves asymmetric risks to the dollar, as any signs of caution would reinforce a short-run positioning squeeze.”

In September, the Fed is expected to raise interest rates for an eighth time since late 2015, with fed-funds futures indicating a 96% probability of a hike. But a potential fourth hike of the year in December is less certain, at only 65.3%. Any additional guidance from Powell on the pace of policy tightening could alter the overall expectations for rate increases.

Complicating the Fed outlook, President Donald Trump suggested Monday at a fundraiser in the Hamptons that Powell was not as dovish as he had hoped. Though the central bank is likely to ignore criticism that it is normalizing monetary policy too swiftly, Trump’s comments “marginally increases the likelihood that the Fed will hike again in December to avoid any perception of political sensitivity,” said Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets, in a note.

Doubts about the health of emerging-market economies, sparked a by a shift into U.S. dollars amid concerns about negative effects from intensifying spats between the U.S. and other trade partners, also have been a focus in recent weeks. Market participants say a strengthening trend for the dollar, which has gained against emerging-market currencies and larger economies, has left it stronger than it should be, putting it in position for a possibly firm pullback against rivals.

According to data from the Commodity Futures Trading Commission, the number of bullish bets by speculators surpassed bearish wagers to hit a one-year high as of last Tuesday.

The ICE U.S. Dollar Index DXY, +0.58% , which measures the buck against six rivals, has strengthened 0.8% in August, and is up 3.6% year to date, according to FactSet data.

Emerging markets

The dollar’s strength has come at the expense of emerging-market assets. A stronger dollar has meant that emerging-market nations with heavy dollar-denominated bets face fiscal instability if they use local currencies to service outstanding loan obligations. Moreover, higher interest rates can make emerging-market assets less appealing, compared against the risk, relative to other assets like, U.S. government bonds, for yield-seeking investors.

If trade tensions are spotlighted, EMs could come under further pressure, leading the dollar higher in response, market participants said .

On top of that, the unwind of the Fed’s multitrillion-dollar balance sheet, which peaked at some $4.5 trillion, is hugely important for emerging markets, as it impacts global liquidity. Shrinking the Fed’s portfolio of assets would possibly drive down Treasury prices and lead yields inversely higher.

“The big question for global investors is whether the Fed not only acknowledges the recent market volatility, but also the fact that its own policy signals may be partly behind the deterioration in global risk sentiment,” wrote ING FX strategist Viraj Patel. “Under a Yellen Fed, we were pretty sure that these market conditions would have kept the US central bank in wait-and-see mode; however, all eyes will be on new Fed Chair Powell to see whether he formally adopts an ‘America First’ monetary policy approach.”

If Powell turns a Yellen-esque corner in his comments, EM assets could get some respite, Patel suggested.


Even if Powell does use the podium to give guidance on future rate hikes, traders are likely to see few surprises.

The strong economic backdrop and Powell’s consistent messaging on the need to normalize interest rates have already pushed investors to price in three to four hikes this year. Yet the nearly universal market expectation that the Fed will continue to raise rates hasn’t helped bond bears, who have steadfastly expected rates to hit, and remain above, 3%.

Instead, the yield curve — the gap between short-dated rates and longer-dated peers — has steadily flattened as geopolitical turmoil and fears of a trade war have anchored long-dated rates while nudging short-dated yields, the moves sensitive to Fed policy moves, higher. In August, the 10-year Treasury note yield TMUBMUSD10Y, +0.06% has slipped around 14 basis points to 2.83%, while the two-year note yield TMUBMUSD02Y, +0.32% has fallen 7 basis points to 2.60%, according to WSJ Market Data Group. That helped to narrow the yield gap between the two maturities, one of the most popular measures of the yield curve’s slope, to 23 basis points, or 0.23 percentage points, its tightest since early August 2007.

Fixed-income investors are likely to fixate on the bond market’s attention on the endpoint to the Fed’s balance-sheet reduction.

Terminating the balance-sheet runoff sooner than investors expect means the Treasury Department wouldn’t need to increase net issuance as much as planned. That’s because with a larger balance sheet, the central bank will absorb more of the supply as the pace of its monthly reinvestments would also run higher. Falling net issuance could thus give relief to the short end of the bond market, which has seen yields steadily rise, thanks in part to a deluge from this year’s lift to budget spending caps and a more-than-trillion-dollar tax cut.

“Should Powell hint that a larger balance sheet would be a reality the Committee is comfortable with, an earlier end to SOMA runoff would clearly be interpreted as very dovish, with the most immediate takeaway the realities of less Treasury issuance,” said Lyngen. SOMA refers to the System Open Market Account Holdings and amounts to the Fed’s total portfolio of securities.

Although seismic shifts are not expected, a lack of further market drivers including earnings and major data in the near-term could make the central bank convention a main attraction for Wall Street.

“Thus far Powell has been more Yellen than Bernanke in terms of jawboning the market, so we view the chance of any paradigm shifting remarks as low, but present,” said Lyngen.

Sprott Gold Report: Summer Test

By Trey Reik, Senior Portfolio Manager, Sprott Asset Management USA, Inc.

Gold is never easy. So many factors influence the gold price, it is impossible to predict bullion’s short-term reactions to individual economic or geopolitical developments. To us at Sprott, gold’s portfolio utility is shaped by long-term fundamentals and epic structural imbalances. Excessive global debt and related monetary debasement have been decades in the making. There will be no quick fix for a global economy weened on emergency liquidity. Given economic pain implicit in debt rationalization, central banks will always strive to delay the inevitable recalibration of bloated financial claims to underlying productive output.

In the meantime, gold remains a potent portfolio diversifier buffeted by a steady stream of short-term trading cues and knee-jerk reactions. Without question, the most trying times for gold investors are periods when big picture fundamentals are aligning solidly in gold’s favor, yet the market chooses to trade gold based on perceived correlations with short-term movements in other asset classes.

Early Bird Special: Join us for the 2019 Natural Resource Symposium in Vancouver.


In our decades in the investment business, we have learned that at least in the short run, the market is never wrong. Given our analysis of macro and monetary fundamentals which we have tracked for over fifteen years, we are a bit stunned by gold’s performance during the past few months and provide an in-depth analysis below. It is neither the first nor the last time we will be humbled by gold’s uncompromising autonomy. As my wife occasionally consoles me, “gold is not a trained seal.” Nonetheless, we maintain high confidence that a portfolio commitment to gold offers enormous portfolio utility in today’s complex and treacherous investment environment.

We have been encouraging Sprott clients to exploit summer price movements in precious metals to their maximum advantage. An extraordinary opportunity is now presenting itself.


The summer of 2018 has shaped up to be a frustrating stretch. The Fed’s dual policy agenda of simultaneous rate hikes and balance sheet reductions has ratcheted-up peripheral financial stress at a pace faster even than we had anticipated. To date, though, cognitive dissonance over the U.S. dollar’s contributing role has preserved its safe harbor status. As the scale of emerging markets dislocation expands on a weekly basis, the stored force in collapsing EM currencies is still funneling towards a strengthening dollar, and in turn reflexively pressuring the gold price. Even the weekly circus of President Trump’s impetuous tariff crusade, as unsettling as it has been for market confidence, has thus far weighed on gold through the tractor beam of a collapsing commodity complex. Do the headlines of the past three months really suggest gold’s portfolio merits are diminishing?

As shown in Figure 1, from year-end 2016 through 4/16/18, a 12.5% decline in the DXY Dollar Index supported a methodical 16.8% gain for spot gold. Then in mid-April of this year, everything changed. All of a sudden, the U.S. dollar regained its mojo, bolstered by 10-year U.S. Treasury yields surging through 3%, a hawkish Federal Open Market Committee (FOMC), favorable global capital flows, strong S&P earnings and whispers of 5% Q2 GDP growth. Since the dollar’s 4/16/18 turn, the DXY Index has rallied a crisp 8.1% through 8/15/18, while spot gold has retreated 12.7%.

Figure 1: U.S. Dollar Regains its Mojo in April 2018. Source: Spot Gold vs. DXY Dollar Index (1/2/17-8/15/18), Bloomberg. The U.S. Dollar Index (DXY) is a measure of the value of the United States dollar relative to a basket of foreign currencies.

As we discussed in our July report (Tariff Tension), gold’s prospects for the balance of 2018 and beyond will be heavily influenced by the U.S. dollar’s relative strength.

Updating the list of factors we cited for the dollar’s mid-April turnaround, 10-year Treasury yields have already retreated back below 3% (ominously in concert with a collapsing yield curve), the FOMC is having to resort to unprecedented measures to keep the effective fed funds rate from squirting above its targeted range, strong S&P earnings are being exposed as the reciprocal of an exploding federal budget deficit and reported Q2 GDP growth turned out to be fairly lame in the context of super-charged fiscal stimulus.

Despite gold’s star-crossed performance during the past three months, we remain confident that the U.S. dollar’s summer strength will soon prove to have been a countertrend rally within an extended decline.


Perhaps emblematic of late cycle financial markets, the recent rush to unanimity in U.S. dollar bullishness has been literally “off the charts.”

The venerable Bernstein Daily Sentiment Indicator (DSI) has been quantifying sentiment across U.S. futures markets every trading day since April 1, 1987. The DSI scale ranges from a low reading of 1% bullish to a high reading of 99% bullish. On 8/14/18, the DSI for the U.S. Dollar Index measured an eye-popping 96% bullish. To give some perspective to how rare a 96% reading actually is, during the entire 7,966-trading-day history of the DSI for the U.S. Dollar Index, the buck registered a more bullish reading on exactly five days. Needless to say, when traders are 96% bullish any currency, there is not much left for the other 4% to accomplish! Similarly, the 8/13/18 DSI for spot gold registered an almost-as-rare reading of 6% bullish (94% bearish). During the entire 7,938-trading-day history of the DSI for spot gold, a more bearish reading has occurred on only 48 days.


At least in Western markets, short-term prices for all commodities are heavily influenced by positioning on COMEX. With scant position limits, 4% margin requirements and no need to pre-borrow collateral to sell short, COMEX is the “wild west” of U.S. securities exchanges.

Anyone with a multi-billion-dollar hedge fund and a view is welcome.

Every week, the U.S. Commodities Futures Trading Commission releases its Commitment of Traders Report, disclosing aggregate outstanding positions for all traded commodities. The COT reports organize trading firms into general categories of “speculator” and “commercial” participants. In the gold space, the speculator designation includes money managers, hedge funds and CTAs (commodity trading advisors), and the commercial designation is composed of jewelry manufacturers and bullion banks. Historically, speculators (“specs”) are always net long and commercials are always net short (jewelry manufacturers’ sole goal is to hedge their precious metals inventories). Commercials are overwhelmingly viewed as the “smart money” in the gold trade, because bullion banks have far superior visibility (compared to specs) into order flows and supply/demand dynamics, extremely deep pockets and, most importantly, are virtually immune to the pain of mark-to-market losses when representing their best customers (central banks).

Positioning in COMEX gold futures during the week ended 8/7/18 had become virtually unprecedented, as shown in Figure 2. In the bottom panel, the red bars represent the net-long positions of large specs, the overwritten lines near the bottom of the red bars represent the net-long positions of small specs (not considered relevant for analysis), and the blue bars represent the net-short positions of the commercials. Because futures are zero-sum markets (for every long contract there is a precise offsetting short contract), the blue bars always represent a mirror image of the two red bar components.


As of 8/7/18, the net-long position of large specs had contracted to just 12,688 contracts, and the commercial net-short position had contracted to just 25,609 contracts (zero-sum difference being a 12,921 net-long position held by disregarded small specs), both new lows dating all the way back to the week of 12/1/15, which marked the end of spot gold’s four-year bear market and kicked off bullion’s 31.4% rally during the first half of 2016.

Figure 2: Top: Spot Gold (8/15/09-8/15/18), Bottom: COMEX Gold-Futures Positioning (8/7/09-8/7/18), Red Bars = Large Speculators, Blue Bars = Commercials. Source: Ned Laird; Sharelynx.

Interestingly, the dynamic behind the collapse in the large-spec net-long position has been an explosion in gross shorts by hedge funds (not their normal bailiwick). In the eight weeks between 6/12/18 and 8/7/18, large specs actually increased their gross longs modestly, from 192,752 contracts to 208,292 contracts, but over the same span almost tripled their gross shorts, from 72,512 contracts to 195,604 contracts. While we tip our hat to hedge fund prescience in aggressively establishing gold shorts these past eight weeks, it will now require repurchase of the equivalent of 12.3 million ounces to determine the degree to which recent hedge-fund bearishness has been self-fulfilling. In the meantime, participating hedge funds should find it a bit ominous that their highly atypical gross short position (195,604 contracts) currently exceeds the gross short position of the wily commercials (179,812 contracts) for the first time in the history of these statistics! Classic!


We find two basic flaws in prevailing dollar bullish reasoning. First, it relies on longstanding relationships between asset classes which hold diminished relevance amid contemporary realities of excessive global debt levels and systemic fragilities. Citing just one of many examples, dollar bulls are content to extrapolate Fed tightening as telegraphed, and conclude that FOMC policy divergence will simply power a strengthening dollar as it always has in the past. This reasoning, however, sidesteps the likelihood that existing debt levels have become too onerous for the Fed to tighten meaningfully without triggering a damaging wave of debt defaults. We would cite the collapsing Treasury yield curve in concise counterpoint to dollar bulls’ expectations for rising U.S. rate structures. For the past 37 years, any meaningful backup in 10-year Treasury yields has quickly led to financial crisis. Why do dollar bulls think U.S. rates are suddenly free to rise without causing collateral damage today, when they have been unable to do so for almost four decades?


Second, bullish dollar arguments turn a blind eye to rapidly hardening global resentment of the dollar standard system. Historical burdens endured around the globe from unilateral impacts of Fed policy pale in comparison to President Trump’s outright weaponization of the U.S. dollar. By way of recent example, Russian resentment of President Trump’s capricious April sanctions on selected Russian companies spurred the Russian central bank to liquidate $81 billion of Treasuries within weeks.

Along with levying metal tariffs on Canada, Mexico and the EU, the Trump administration has now imposed sanctions on no fewer than 11 countries: China, Columbia, Cuba, Iran, Libya, North Korea, Pakistan, Russia, Syria, Turkey and Venezuela. As if Triffin dilemma strains were not burdensome enough for the archaic dollar standard system, President Trump is now expanding the dollar’s role well past being a stable unit of account or serving as a global reserve currency, to becoming a blunt instrument for the punishment of nations not on board with the Trump agenda. Are dollar bulls so jingoistic they believe the world has no choice but to accept a global monetary framework subject to borderline blackmail?


In our June report (Periphery to Core), we employed periphery-to-core analysis in documenting incipient financial stress in emerging markets economies. In recent weeks, Turkey has become the blazing focal point of what clearly threatens to become a rolling EM contagion.

As would be entirely expected, consensus still emphatically dismisses Turkey’s plight as isolated, because other EM’s don’t share Turkey’s unique mix of toxic fundamentals. Needless to say, we find the rush to containment highly amusing because it misses the seminal nature of what is transpiring in Turkey.

Analysts focused on schedules of Turkish external obligations are confusing analysis of “ability to pay” with an assessment of “willingness to pay.” To us, it seems clear President Tayyip Erdogan has determined Turkey’s debt obligations are too onerous to service now that the era of free central bank credit has ended, and he is proactively positioning Turkey for absolution of its external burdens. Along the way, he has effectively baited President Trump into aggressive actions that have decimated the Turkish lira, facilitating the perception, at least in Mr. Erdogan’s neck of the woods, that it is the Turkish President who is assuming the high ground.

Mr. Erdogan’s fiery vernacular should be signaling to Wall Street that the situation in Turkey is well past the point of spreadsheets and debt-service models.

“I call out to those in the United States. You cannot tame our people with threats….Those who assume they can bring us to our knees through economic manipulations don’t know our nation at all. If they have got dollars, we have got our people, our right, our Allah….Failure to reverse this trend of unilateralism and disrespect will require us to start looking for new friends and allies.” ― President Erdogan addressing supporters in Ordu on August 11.

These words do not sound like a leader who is concerned about the impact of a 40% lira collapse on the serviceability of Turkey’s $467 billion external debt (50% of Turkish GDP). It seems increasingly likely that President Erdogan will soon impose capital controls, effectively defaulting on Turkey’s external obligations. What we are witnessing may be an emerging blueprint for debt resolution in countries feeling exploited by a decade of unlimited, no-questions-asked central bank liquidity, which in essence has provided a Western rope for developing countries to hoist their own petards.

Figure 3: Total Offshore Debts for Six Emerging Markets Countries(Nominal and Percentage of GDP). Source: Q2 2018; Haver Analytics; Gluskin Sheff.

To us, President Erdogan’s populist blueprint has broader applicability than just a few basket case EM economies. As shown in Figure 3, above, South Africa, Argentina, Mexico, Indonesia, Brazil and Russia, with $2.4 trillion worth of total offshore debts (denominated in various currencies) look like prime candidates for an Erdogan-like approach. Populist defiance is a logical step for an overly indebted world in which 10 years of emergency monetary policies haven’t accomplished a damn thing other than compounding obligations of servitude. A eureka moment for gold will be when consensus finally recognizes that rolling financial stress in emerging and more developed markets is not being triggered by anything country specific, but instead by the single but universal development that after flooding the world with cheap credit for 10 years, the Fed is electing to drive the cost of dollars up and their availability down. This is not just an emerging markets issue—all countries are in the same boat. Debt levels are absurd everywhere, all the way to the top of the debt pyramid in the United States. The only unknown is how far up the chain the Fed is prepared to drive the process of global debt rationalization.


Here at home, we see two prominent hurdles to protracted dollar strength: overhyped U.S. growth prospects and a rapidly deteriorating U.S. fiscal position. With respect specifically to Q2 GDP, the ever cheerful David Rosenberg and his Gluskin Sheff team helped us slice and dice the 4.1% GDP gain down to its starkly unflattering components. First, Rosenberg points out that U.S. real GDP has historically improved on the order of 3.5% in quarters immediately following large fiscal stimulus (Kennedy, Reagan, Bush 43 twice and Obama), so assuming recent trend growth of 2.25%, Q2 should have registered at least a 5.75% gain.

Despite widespread celebration for having achieved the elusive 4% handle, Q2 GDP of 4.1% was actually a dud right out of the box. Worse still, Rosenberg has convinced us (by way of signature Rosenberg math) that three non-recurring Q2 items added roughly 170 basis points to the final GDP tally. By subtracting 90 basis points for a tax-cut induced savings-rate drawdown (Q2 delta of a 4% personal consumption increase over a 2.6% gain in disposable income), 60 basis points for a boost in soybean exports (motivated by transitory effects of tariff schedules), and 20 basis points for an outlier defense-spending number, 4.1% Q2 GDP gets whittled down to a sustainable real growth rate closer to 2.4%, or only two-thirds of the anticipated fiscal boost itself! Others may accuse Rosenberg of cherry picking GDP components, but as he loves to point out, “This is analysis, not reporting.”


Rosenberg’s work unequivocally suggests the U.S. housing sector (the portion of GDP with the most reliable leading attributes and the most powerful multiplier effects) is firmly in recession. The 1% contraction in Q2 residential fixed investment, on the heels of a 3.4% swoon in Q1, satisfies the technical recession definition (not to mention declines in four of the past five quarters — a pattern not seen since the depths of the recession between Q4 2008-Q1 2010), but recent industry trends paint an even grimmer picture. During the past three months, amidst a generally bullish economic narrative, housing starts have collapsed at a 39% annual rate, building permits have receded at a 23% annual rate, new home sales have declined at a 22% annual rate and existing home sales have contracted at a 15% annual rate.

Figure 4: DXY Dollar Index vs. Citigroup U.S. Economic Surprise Index (1/1/18-8/16/18) Source: Meridian Macro.

Finally, beneath residual momentum in growth and small-cap sectors, Rosenberg cites a growing list of domestic cyclical groups, including homebuilding, autos, transports, media and various retailing groups, which are beginning to signal “sharply decelerating growth.” Coincidentally, as shown in Figure 4, above, the mid-April liftoff for the DXY Index has occurred precisely as the Citigroup U.S. Economic Surprise Index has turned sharply lower. Stay tuned!

To us, the dollar’s most significant challenge is the rapidly deteriorating U.S. fiscal position. Surprise, surprise, the Treasury Department reports that Trump’s corporate tax cuts have reduced first-half 2018 tax revenues far more than expected. H1 year-over-year corporate tax receipts fell by a third, greater than the 2009 collapse and near a 75-year low (nominally and as % of GDP). The Trump administration OMB (Office of Managament and Budget) mid-year review (July) tacked $100 billion to annual budget deficits for each of the next several years (2019-21 now $1.1 trillion, $1.1 trillion and $1.0 trillion). As shown in Figure 5, the DXY’s summer rally is likely to be overwhelmed by harsh budget realities in very short order. Should historical relationships hold true, a DXY target in the low 80’s should be in play by mid-2019!

Figure 5: DXY Dollar Index vs. 12-Mos. Federal Budget Deficit (12/31/09-7/31/18). Source: Meridian Macro.


During the final four months of 2018, we expect euphoria over “strong” S&P Q2 earnings to fade into consensus recognition that corporate profits have been financed through the zero-sum misdirection of an exploding federal budget deficit. As the Treasury conducts its second half issuance now projected to total $769 billion (bringing total 2018 issuance to $1.33 trillion), we expect significant erosion in feverish dollar sentiment now in play. Additionally, modest 2018 upticks in the average interest rate paid on U.S. public debt are already straining Federal budget projections with geometric increases in debt service obligations.

As final perspective on the U.S. fiscal position, we offer Figure 6, the IMF’s five-year forecasts for the percentage change in government debt-to-GDP ratios in “advanced economies.” Note there is only one nation projected to increase its debt-to-GDP ratio during the next five years. Does this look like a recipe for relative dollar strength?

While gold is never easy, we still like its chances. Indeed, an extraordinary opportunity is now presenting itself.

Figure 6: IMF 5-Year Forecasts for % Change in Government Debt-to-GDP Ratios for “Advanced” Economies (April 2018), Source: IMF, Deutsche Bank.

The war on drugs has been lost

As production moves to the developed world, policymakers are struggling to keep up

Misha Glenny

Death by marijuana intoxication is so rare as to figure in no government statistics around the world © AFP

Get ready for some high old times. Three phenomena are conspiring to upend the global market in illicit narcotics, which are set to become more available and be better quality than ever before.

First there is the relationship between North America and marijuana. Nine US states and the District of Columbia have already legalised marijuana, while it is available for medical use in 30 states. Were New York to join California in legalising, as seems quite possible, then over a quarter of the US population will enjoy unfettered access to weed.

But the real game changer comes in October when smoke shops open across Canada. Official estimates put turnover in the country’s marijuana industry at over $8.2bn, but analysts agree the figure was arrived at assuming the low price of $7.15 a gramme. Pension funds, banks, venture capitalists and entrepreneurs are punching and kicking to secure a place in the starting grid of investment in the new industry.

The US attorney-general, Jeff Sessions, has repeatedly threatened to apply federal law, which still considers marijuana illegal, against states that have legalised, California in particular. Yet so far, President Donald Trump’s administration has shied away from making good on those threats, almost certainly because resistance on the West Coast would be fierce and the political risk to Mr Trump too high.

In Britain, the government has finally been shamed into allowing very limited access to medicinal marijuana to children with the most severe forms of epilepsy. One of the problems that a century of the so-called war on drugs has thrown up is that governments across the world have not allowed any serious research into the effects and medical impact of a drug like marijuana. This is despite the fact that all empirical research makes it clear that the damage wreaked by alcohol on the human body and society far outweighs that inflicted by marijuana. Yet because of an ideological obsession around the drug, its often miraculous medicinal properties have been ignored until very recently.

Death by marijuana intoxication is so rare as to figure in no government statistics around the world. But the second phenomenon turning the drugs market upside down is by no means so benign. In the US in 2016, 42,000 drug deaths involved opioids. This was not caused by the Mexican cartels or the Taliban in Afghanistan. The origins of America’s opioid tragedy lie in the strategies of big pharmaceutical companies, Purdue Pharma in particular, which, for almost 25 years, have been aggressively pushing painkillers containing synthetic opioids through the US private healthcare system. This has resulted in millions of Americans becoming hopelessly addicted.

Physicians still prescribe these drugs in large quantities every year, ensuring the addiction wave will continue. But when patients can no longer afford the drugs, or they cannot get them prescribed, they are turning to heroin or, more recently, fentanyl, a ferociously powerful opioid that North American dealers have been ordering in large quantities from Chinese manufacturers.

In order to deal with this, the US government will need to rein in Big Pharma and introduce drug law reform. That is almost certainly too big an ask for the Trump administration. Indeed, Mr Sessions has indicated that his preferred approach to the problem is to police his way out of the crisis. The deaths, in that event, will continue.

A major part of the opioid challenge is actually the third phenomenon that is revolutionising the recreational drugs market. How do Americans buy their fentanyl? The answer is on the dark net, a part of the internet not accessible to search engines. Online drug sales have exploded. Dark net users say it is safer and more reliable than scoring off traditional dealers.

In the UK and most of Europe, the most popular drug sold over the internet is ecstasy (or MDMA). But unlike cocaine, which originates in the Andean region primarily, or heroin, which is sourced largely from Afghanistan, the centre of MDMA production is North Brabant in the Netherlands.

As synthetic drugs replicate the highs of organic narcotics with ever greater accuracy, or indeed surpass them, production is shifting to the laboratories of northern Europe, the Balkans, Israel, Canada and east Asia. This shift is placing huge strains on police forces that are already badly stretched because of austerity policies introduced in the wake of the financial crisis of 2008. One of the unspoken reasons for the slow move towards the legalisation of cannabis is that police forces simply cannot cope, especially with a drug that does relatively little harm.

Until now, the deaths and chronic insecurity associated with drugs have been concentrated in zones of production and distribution. The war on drugs has enabled the Taliban to resist Nato for 17 years as it funds its weaponry and social base through the sale of opium. In Mexico, the state has ceded large parts of the country to the rule of the cartels, thanks to the money they make distributing cocaine and opioids around the US. While the deaths and violence have been largely restricted to those faraway places, the war on drugs, for all its consistent failures, has continued. But change is coming.

The writer performs his one-man show, ‘McMafia: My Life in Organised Crime’, at the Edinburgh Festival Fringe this month

China, Trade, and Technology: A Worst-Case Scenario

By Reshma Kapadia

Employees work on a micro motor production line at a factory in Huaibei, China. Illustration: Agence France-Presse/Getty Images

The odds of a full-blown trade war are low, but they just got a little bit higher.

On Friday, China threatened tariffs of up to 25% on $60 billion of U.S. goods, in retaliation for the Trump administration’s latest threat of 25% tariffs on $200 billion of Chinese goods. That was more than double earlier proposals of 10%. That escalation is likely to continue into September, when those tariffs are supposed to go into effect.

All this has money managers, strategists, and economists mapping out the worst-case scenarios.

The tit-for-tat over tariffs can only go so far, since China imports just $130 billion while the U.S. imports $505 billion. The primary worry is that China turns to other measures, like letting its currency devalue or taking the battle into the technology sector.  

China has used its currency in the past to soften the blow from unfavorable developments—until the rest of the world protests. China-watchers say that this time, the decline in the yuan, down 7% against the dollar in two months, was probably a reaction to market forces, such as a stronger dollar and a weaker Chinese economy. But there’s no question a weaker yuan blunts the impact of tariffs—exporters usually benefit from a weaker currency, since it makes their products cheaper to buy. On Friday, China’s central bank took steps to rein in the yuan’s devaluation and pledged to keep it largely stable, though the yuan right now is at its lowest point in more than a year.

China has been trying to reduce its debt across the board, including cleaning up its state-owned enterprises and shadow banking system. Now, though, strategists are speculating that China will try to stimulate its economy by increasing credit to small businesses and service-oriented companies. That’s worrisome for investors who have long been wary about China’s debt. “The worse-case scenario is that this goes on long enough to push China’s leverage over the brink,” says Michael Kelly, global head of multi-asset at PineBridge Investments.

Next worry? Technology. Some say the trade spat isn’t about deficits, but rather technology dominance. “I worry that this will end up as a cold war of technology,” says Neil Dwane, global strategist for Allianz Global Investors. Dwane’s darkest scenario plays out like this: China and the U.S. create their own technology ecosystems so that a company that makes products for Apple or Google can’t supply Chinese companies, and vice versa, forcing suppliers to choose sides. That would ripple through the markets, especially Asia and U.S. where technology is more well-represented. It would also put a pall over corporate confidence globally, affecting investments and jobs, as companies grapple with a new set of rules.

GLD Options Are Looking Quite Attractive

by: Lyster Analytics 

- Gold is currently realizing unusually low volatility, which is unlikely to last very long.

- I see various serious risks seemingly unaccounted for by Mr. Market.

- On an implied vol basis, gold options are a cheap and effective hedge against these risks.
Investment Thesis
Long-dated tail options on GLD are looking like a very cheap hedge against monetary and political risks, many of which loom on the horizon. If (or when) these risks become glaringly obvious to markets over the next few years, price movements in gold are likely to react accordingly.
Gold and precious metals in general, have received very little attention in mainstream financial media in recent years and rightly so: In the current Goldilocks period of strong economic growth, low inflation and sturdy financial markets, there seems to be very little potential for either large upside or downside movements in the price of gold. Post 2012/2013 correction, the SPDR Gold Shares ETF (GLD) has been hovering around the 100-130 level with low volatility, historically low volatility to be clear. Trailing 6-month realized volatility of gold currently stands at 5.63% annualized, well below the historical average of around 14% - the lowest it has been since 1997 (FRED).
I believe, however, that the macro environment is setting the stage for what may be a period of global monetary shenanigans that should beget significantly higher vol in the price of gold. Setting aside the stew of non-US risks such as the risk of Italy’s new regime to the Euro, China’s dangerous debt situation, trade wars, divergent monetary policy and various geopolitical risks (all of which I believe pose a great threat to stability in financial markets) - my bold prediction for the US macro environment going forward, is as follows:
The fed has turned on auto-tightening, draining dollar liquidity and raising short end rates (long-term rates too, just not nearly at the same pace - hence the gradually inverting yield curve). The treasury is planning to issue new debt to finance Trump’s $804 billion deficit (bearish for bonds, i.e. higher yields) This has been strong for the dollar, and will quite likely be for as long as the Fed keeps auto-tightening engaged (which is likely given that strong economic data continues to roll in and inflation has been ticking higher).
The double whammy of a strong dollar and attractively yielding treasuries will continue to be a short-term downer for the price of gold. Higher rates will have a bite on the real economy and at some point (nobody knows when, but my feeling is sooner rather than later) US equities will take a hit (then of course global equities will too). When equities do unfold, they will do so rapidly (if you would like to know why, I recommend reading Volatility and the Alchemy of Risk by Chris Cole of Artemis Capital Management).
Central bankers will be caught off guard (as they always do) and therefore it is likely that in response to financial turmoil of this kind, the Fed and CB’s globally will resort to a second wave of unorthodox stimulus/QE/money synthesis that will test the market’s trust in central bankers (and fiat currency) in a very real way. Ultimately, as this scenario begins to play out and the atmosphere in markets will shift from elation to uncertainty/fear as CBs and governments try pull a rabbit out of a hat. A significantly higher price of gold should reflect this, as it did in the years succeeding the GFC.

To summarize, there is great potential for both: A) significantly higher treasury yields and a stronger dollar in the short term (which I believe provides a great entry point for this trade) and B) a market crash/recession/monetary policy freak out and U-turn that will ensue. It is this potential that does not seem to be priced into GLD options.
To buy pure long-term volatility exposure, with no directional bias one would buy an equal quantity of both ATM calls and puts on GLD at a given expiry date far into the future (a straddle). Analysis of return data, along with some intuition, would suggest that owning tail options on the right tail of the distribution makes more sense. Statistical analysis of the monthly return data of USD-Gold since 1971 (sourced from FRED) suggests there is a positive skew to the return distribution of Gold, with a moment coefficient of skewness of +1.163.
This makes sense intuitively as gold is a commodity that is thought of as a safe haven asset that some investors keep as an important “keep and hold” part of their portfolio and others rush to buy in times panic or uncertainty. In other words, those who own gold are usually in no rush to sell it but those who do not own gold, in times of panic every so often, do rush to buy it.
In options markets, return distributions with a negative skew such as that of the S&P 500 (coefficient of just over -1) result in a “smirking” or skewed volatility curve where far out of the money put options (options that mitigate risk of large sudden draw downs in price) are priced higher in terms of implied volatility than call options equidistant from the underlying price. As for options on GLD, you do not see a volatility curve that reflects the positive skewness of historical returns. In fact, the volatility profile of GLD options is unusually flat.
If a truly adverse scenario does play out in global markets, one would expect to see gold right tail options reprice to meet higher forward expectations of potential gold price movements in the positive direction. In that sense, owning long-dated OTM calls on GLD could serve as a decently cheap hedge (as opposed to S&P options, VIX futures, etc.) against the kinds of risk mentioned prior. January 2020 and March 2019 tail options are trading at an implied vol of about 15%, which is very attractive, considering gold’s historical average vol of circa 14%.
Gold has a lot to offer in times of stress, and in times of stress, you want to be hedged. It is my opinion that buying long-dated (Jan 2020), OTM calls on GLD are an effective and cheap hedge for any global and systematic tension in financial markets that we may face in the future. In the meanwhile, it would be silly not to expect gold to sink lower in the present strong-dollar dominated, Fed tightening environment.
So, it may be shrewd to be a little patient and wait for Gold to truly bottom out before you begin to accumulate a tidy position in these instruments. But I wouldn’t be too patient. Hedges are used to prepare you for the unexpected and so waiting patiently to hedge against an unforeseen event sort of defeats the purpose of hedging.