Lyn Alden's Macro Masterclass (w/ Raoul Pal)

Gold tends to do better in disinflationary environments while silver tends to do better in reflationary environments, as shown by gold outperforming until the March crash and silver coming up strong since then as inflation expectations shifted.

“gold was outperforming. It tends to do better than silver in these more disinflationary environments... silver tends to do better in a more reflationary environment... we had gold outperform until the March crash, and then we've had silver come up strong since then.”

My longer-term view is a reflationary environment and a trend shift from the past four decades of disinflation to a more inflationary environment, driven by the incentive structure where policymakers will keep printing money as long as there's no inflation, making inflation the eventual limiter to fiscal spending.

“I think that's why my longer-term view is a more reflationary environment and a trend shift from this past four decades of disinflation to a more inflationary environment. And I think that's because, if you look at their incentive structure, the main limiter on how much fiscal they do, while using yield curve control and other tools to keep yields low, the eventual risk to that is inflation, and unmistakable consumer price inflation.”

The fiscal stimulus bounces back and forth with markets reacting OK and getting currency weakness when they're doing fiscal, or seeing slowdowns when they pull back, similar to how Powell was on autopilot with tightening in 2018 until the market crashed in Q4 and made him change his tune.

“I view it as bouncing back and forth either they're doing fiscal, and markets are reacting OK, and we get, probably, more currency weakness, on one hand, or, when they pull back with the fiscal, we can see a slowdown in some of those indicators. But then, I think it's like how, for example, Powell, back in 2018, was on autopilot with tightening until the market crashed in Q4, and it made him change his tune.”

There's not a ton of new copper supply at current prices; more supply could be brought online at higher prices, but at current prices it's not incentivized, and there's been pretty significant exploration costs without finding much copper.

“there's not a ton of new supply at current prices. There's more supply they could bring online at higher prices, but at current prices, it's not really incentivized to bring any new supply online. And there's actually been pretty significant exploration costs, and they're still just not finding a ton of copper.”

Central banks around the world have been shifting more of their assets into gold over time to take away counterparty risk, sanction risk, and de-dollarize, seen especially from Russia, Kazakhstan, and China.

“We're seeing other countries around the world, central banks, have been shifting more of their assets a little bit into gold over time, because they take away that counterparty risk. They take away the sanction risk. They de-dollarize a little bit. We've seen more out of things like Russia, and Kazakhstan, and to some extent, China.”

The Fed is mostly out of ammo by itself now; it's more about fiscal at this point, and whether we get fiscal and how much affects my view of macro more than anything the Fed does now, because the Fed can't do almost anything about solvency issues while fiscal spending can.

“I think one of my base cases is the Fed's mostly, now, out of ammo by itself. And it's more about fiscal at this point. So whether or not we get fiscal, and how much and, what kind of areas it's in affects my view of macro more than anything the Fed does now. And the Fed's job will be to monetize some of that fiscal, but it's really more about the fiscal things, because the Fed can't do almost anything about the solvency issues, whereas the fiscal spending can do some things about the solvency issues.”

There is a strong historical relationship between real interest rates and year-over-year changes in gold prices; in environments where you can get positive real yields on treasuries or bank accounts, there's a large opportunity cost to holding gold, whereas in the current environment with near-zero real yields, the opportunity cost of holding gold is very low.

“Because you've looked back in history there is a pretty strong relationship between real rates and yearover-year changes in gold prices. It's not perfect, of course. There's other factors that influence it. And so in those environments where you can get a strong positive real yield on bank accounts or treasuries, there's a big opportunity costs for holding gold. Whereas, in this current environment, there's no real yield happening in the whole Treasury space or in bank accounts, and so it makes the opportunity cost for holding gold much lower.”

We're heading toward a solvency problem where lower GDP growth will create more job losses and slower growth, with job losses likely turning permanent and white-collar job losses still ahead, indicating a normal credit cycle that will play out longer and larger than normal.

“I think the solvency thing... I think the Fed is kind of vigilant... but solvency still has a lot to play out. I mean, we've seen a lot of the job losses turn permanent, and I think that's probably going to continue... I still think we have a normal credit cycle play out, and probably more than normal because it's bigger than normal. So I still think we have the more white collar job losses, or the more professional job losses that they were not, necessarily, directly tied to service sector pandemic stuff. So I still think this has a long way to go”

China dominates emerging market ETFs at ~40% weighting, making it important to diversify away from broad EM ETFs to get more exposure to Russia and India; single-country exposure provides better control.

“one of the problems is that China dominates it so. It's like something like 40% China. So that's actually one reason I like to diversify away from the broad, emerging market ETFs and use some single-country exposure to, say, get more Russia, more India, things like that.”

Long-term debt cycles often get resolved partially with very large fiscal responses and some degree of currency devaluation.

“long-term debt cycles often get resolved just partially with very large fiscal responses and some degree of currency devaluation”

Raoul isn't convinced inflation will emerge, noting that fiscal stimulus in 2001 and 2008 didn't generate longer than two quarters of growth and didn't really change earnings expectations or consumer behavior because people treat it as an emergency measure, and Japan's massive infrastructure spending didn't work.

“I'm still not sure that that inflation genie comes out... fiscal stimulus didn't generate anything longer than two quarters of some sort of growth... people don't think of it as a perpetual state... earnings expectations don't rise... consumer behavior doesn't change because they think of it as an emergency measure... Japan... built tons of new stuff; didn't really work.”

It's rare for an equity market to do well in one decade and still do well in the next decade; the US dominated this decade, and I think we've squeezed a lot of juice out of that orange, suggesting emerging markets have decent opportunities over the 2020s.

“I think it's pretty rare for an equity market to do well in one decade and still do well in the next decade. So the US has dominated this decade, and now I think we've squeezed a lot of juice out of that orange, and I think that at least some of the stronger emerging markets have decent opportunities over the 2020s.”

From 2011 to 2018, gold was essentially in a sideways correction; it was a bad year-to-year trade but a longer-term consolidation; this was a period of less monetary largesse, and gold rested until stimulus resumed; the period teaches that gold is correlated to stimulus/largesse cycles.

“Yeah, essentially, we got it from 2011 to 2018, really. And what that was, in the big picture, it was just a sideways correction. Sure, it was quite a big range. But really, it was a sideways correction. Gold did its thing because there was less monetary largesse around, et cetera, and gold just rested. And then, as soon as things pick up again, then gold does its thing.”

I don't focus on copper as heavily as other commodities because I'm relatively bearish on industrial commodities over time, expecting more disinflation to come before a shift, with copper exposure tied to the reflationary outcome thesis.

“I was thinking of copper in the-- I think I put it on during the liquidity phase, and it was the only short commodity position I had on, because I'm relatively bearish over time industrial commodities, because I could get more disinflation to come before we might see a shift.”

Global real estate in many places is even more expensive than US real estate, and the US has always had these really big, deep capital markets with more global emphasis on the US equity market, creating a more equity-focused relationship than many other places.

“global real estate, in many places, is even more expensive than US real estate. A lot of foreign investors focus more heavily on real estate. And the US has just always had these really big, deep capital markets, and there's more of a global emphasis on the US equity market. And so I think our relationship between real estate and equity is a little bit more equity-focused than a lot of other places.”

Effective corporate tax rates, not headline rates, have been steadily declining for decades, currently around 10% for the federal side, and we're getting to a lower bound where rates could either flatline or reverse, which could pressure equity markets throughout the 2020s, with higher odds if Biden wins.

“if you look at effective corporate tax rates-- so not just the headline rate, but the actual-- a couple of different ways to calculate it, but the effective payment rate, that's been steadily declining for decades. And so even when there's not a headline change, there's still other changes that keep pushing that rate down. And I think that number, the effective version of it, is somewhere around the 10% range for the federal side. And so I think we're getting to a lower bound, probably, for corporate tax rates. And so very long secular bull market we've had has been in an environment of perpetually lower and lower effective corporate tax rates, and I think that that could either flatline, in some cases, or it could reverse, and we could get higher effective corporate tax rates.”

Raoul notes that real rates will likely rise in the near term because we'll get deflation mathematically, which would normally be bearish for gold, but his reaction function is that seeing real rates rise sharply would prompt the Fed to print more, so gold still goes up because the correction is driven by policy response, not a true trend change.

“But then think about it. And think, OK, so you're the Federal Reserve, and you see real rates rise sharply because inflation is lower than people expected. Their reaction function is just to do more. LYN ALDEN: Yeah, exactly. RAOUL PAL: So therefore, gold goes up. It seems it's only corrective, as opposed to a trend change, if real rates change.”

Latin America is pretty pressured; I have some selective stocks there but prefer individual names over indices; South Korea still gets classified as emerging but has better infrastructure than Jersey, shouldn't be classified that way.

“I think Latin America's pretty pressured. I have had some selective stocks down there, but I'm more selective on individual names rather than indices. I think some of the other countries in Asia-- I mean, South Korea, MSCI still considers it an emerging market, but they have better internet than I have.”

I like some Chinese tech stocks like Tencent, acknowledging China is a black box with reported data uncertainty, but selective exposure at current valuations makes sense because China has corporate debt in real estate sector not visible in companies like Tencent.

“I like some of the Chinese tech stocks. I like Tencent, for example. Now, China is a black box, to some extent. It's not a trade I like too much. But especially when you look at, say, an emerging markets ETF, one of the problems is that China dominates it so... I do think China at current valuations, especially for some of their companies that aren't-- China, of course, has that really large corporate debt problem, but a lot of it's in their real estate sector, so you don't really see it in companies like Tencent.”

The critical distinction in electoral outcomes is not whether you win, but how decisively you win—a gridlock scenario with split government looks like the Obama presidency's last six years, while a sweep enables more aggressive spending on either side, with different spending priorities between Republicans and Democrats.

“Because a lot of people's big question is who wins, whereas my question is more about how decisively whoever wins wins... If you get a Biden victory, but the Senate is still red, right? Then, I think we're in a situation that looks a lot like the Obama presidency, the last six years of it, where you had that gridlock... If you get a blue sweep, I think we're going to, obviously, be in a very spendy environment. If you get a pretty strong red hold, I think we could still see a pretty strong spending environment, because Trump's going to want to spend.”

The behavioral relationship between Fed policy and US equity performance is very fragile; the recent equity run went further than expected, and a few quarters of worse economic data than people think could unwind everything the Fed is doing.

“I think it's very fragile. I think this big equity run was, in some ways, expected, but, for example, it went further than I would have guessed a few months ago... I think it's potentially quite fragile, and there can always be just a few quarters of just worse economic data than people think, and this whole-- everything the Fed's doing could just be unwound to some extent.”

Break-evens have traded far above nominals since March, mirroring only one prior period (2012-2013), suggesting the Treasury is pricing in higher/rebounding inflation while keeping nominals low, which is unusual and worth monitoring closely.

“we've had a divergence between break-evens and nominals. So if you look back over the past 15-plus years of data, there's only ever been one period where we had break-evens trade so far above nominals, and that was in about a year from 2012 to 2013... nominal yields came down, and they've stayed low in this range. Whereas break-evens, after they hit that March low, they popped right back up. So the Treasury's pricing in higher inflation-- or at least a rebound in inflation; not, necessarily, higher inflation, but a rebound in inflation-- and yet they're still keeping nominals low.”

I like Russia for its slow growth but very cheap valuations, strong fiscal position going into the crisis (fiscal surplus, trade surplus, very low debt, more reserves than external debt), and the highest gold-to-M2 ratio of any major country.

“On the opposite end of the spectrum, I actually like Russia. It's slow-growth, but it's super cheap. It's been cheap for a while, but it's still cheap. And they actually-- so they went into this crisis with a fiscal surplus, a trade surplus, a very low debt, more reserves than external debt, and they have the highest, say, gold-to-M2 ratio, pretty much, of any major country.”

I favor India among emerging markets, historically one of the most expensive, but it's not in bubble territory now compared to 2007, with great demographics, low debt levels, and low dollar-denominated debt, though economic data has been weaker than expected during COVID.

“I like India, for the most part... They're one of the few countries where the COVID cases are still rising very quickly, and some of their economic data has been weaker than I would have guessed. So that I think that still takes time to play out, but I'm pretty bullish... Its valuations, it's always one of the the more expensive markets... its not in bubble territory... the demographics are great. The debt levels are pretty low. They're not one of those countries that have a ton of dollar-dominated debt.”

After international diversification underperformance in the past decade, emerging market valuations have worked themselves out from 2007 bubble levels, and diversification could increase returns over the next decade as these markets have healthier valuation bases.

“if you look at the big period of underperformance, it made sense, because back in 2007, emerging markets got extraordinarily expensive. India's CAPE ratio was the same as like the US in the dot com bubble. You hit almost dot com bubble-like valuations in China, India, to some extent Brazil. So that's worked itself out. Equity valuations have come down, even though there's still been an increase in some earnings and GDP growth in those areas. So now we're at healthier valuation levels.”

Raoul observes that the break-even/nominal divergence could be flows-driven, as seen in the UK 20 years ago where the pension system had long-term liabilities and forced apart the relationship in hedging, making the signaling in nominals more useful than break-evens for inflation.

“we saw this in the UK 20 years ago, and it was the pension system. Because the pension system had long-term liabilities, they were forcing apart the relationship between break-even and nominals in hedging that out... the signaling for inflation ended up being better in the nominals than it did in the break-evens because with flow into break-evens”

I combine India and Russia trades together in a portfolio because India prefers lower commodity prices while Russia prefers high commodity prices, so together they hedge out some of the commodity question and whose performance is determined by commodity prices.

“to some extent, I like to combine that with my India trade, because India prefers lower commodity prices. Russia prefers high commodity prices. And besides those two factors, I like them both long-term here. So having them both in a portfolio takes out some of that commodity question to some extent, and which one does better, I think, will depend a lot on commodity prices.”

I have a physical metals layer I'd be very slow to sell, the only time ever sold physical was 2011 and partly luck, a liquid miners/ETF layer I'd be quicker to sell, and applying the same approach to Bitcoin with cold storage I'd be slow to sell and liquid layers I'd trim if we see significant price action.

“I described my precious metals exposures as layers. So I have physical layer, which I'd be very slow to sell. The only time I ever sold physical was 2011, and part of that was luck... I have the miners, some ETFs... So I'd be quicker to sell some of those liquid positions... I have a similar approach... I have a layer of that in cold storage which I'd be slow to sell... a more liquid layer that I-- my plan is to taper some of that out if we see price action”

A lot of my macro framework comes from control engineering, which involves managing systems with hundreds of inputs and outputs and figuring out relationships where for every action there's an opposite reaction, similar to how a thermostat works but with hundreds of variables instead of one or two.

“So a lot of it, actually, in my view, comes from control engineering. So my engineering discipline is mostly controls analysis. So it's like managing a system that has hundreds of inputs and outputs, and figuring out the relationships, and making sure for every action, there's an opposite reaction. So if you think of, say, a thermostat as a simple control system, if the temperature goes up, it kicks in, and it reduces the temperature. So a control system is like that, but there are hundreds of variables instead of just one or two.”

The ECB can do as much as they want, but it won't drive Euro stocks up and down the same way the Fed drives US stocks, while the top five or six US stocks have lifted the whole index whereas the other 490-something stocks have been flat-ish for the past decade, behaving more like Euro stocks.

“the ECB can do as much as they want, but it won't drive the Euro stocks up and down... If you separate out the top five or six stocks from the US equity market and just look at how the other 490-something stocks behave, they look, in some ways, more like the euro stock index, right? So they've been flat-ish for the past decade or so, whereas the top five, six, seven, stocks have really lifted the whole index.”

My base case is that because it's an election year, they're likely to pass something and kick the can down the road for another few months, with markets really hard to look more than a few months ahead because it all comes down to the next round of fiscal.

“my base case is that because it's an election year, they're likely to pass something and kick the can down the road for another few months at a time. But in this market, it's really hard to look more than a few months ahead, because it really all comes down to the next round of fiscal.”

If fiscal injections don't generate sustained growth (as seen in Japan and following 2001 and 2008), we could eventually see something much larger than incremental stimulus—a New Deal-style massive spend that differs based on which party controls government.

“if, let's say, we have a couple of shots of fiscal, and it just inflates for a bit, falls again, Japan-style, then there's a chance that they're going to say, fine, we're going to do a 5 trillion, x trillion, New Deal-style spend. And it'll be different depending on whether it's on the left or the right.”

I've been in a weird phase for the past couple of years being bearish from a business cycle perspective, thinking we're late in a business cycle and things are expensive, but also being somewhat more bullish than I would otherwise be on equity and risk assets, which has played out well because I expected such a large fiscal response.

“I've been in this weird phase for the past couple of years because I've been bearish from a business cycle perspective. Thinking we're late in a business cycle, things are expensive, but also still being somewhat more bullish than I would otherwise be on equity and risk assets, which played out pretty well so far because I expected such a large fiscal response this time.”

Bitcoin dominance (Bitcoin's market cap as a percentage of total crypto market cap) shows a surprising correlation to the US dollar index (DXY), suggesting some informational value about the relationship between Bitcoin and currency regime shifts that hasn't yet been fully processed.

“I saw it, and I looked at it, and it's very similar if you look at the Ethereum-Bitcoin cross rate against the DXY. And that will be the same, I guess, as the gold-silver cross rate. So there's some informational value I've not yet processed withing that.”

Raoul tracks a basket of 27 currencies versus gold and says it offsets all the currency weakening of these 27 currencies, doing exactly what you'd imagine it should do, demonstrating gold's de-dollarization function.

“One thing I do is I've got a basket 27 currencies versus gold. And that's super interesting, because it does exactly what you'd imagine it should do. It offsets all the currency weakening of these 27 currencies.”

It's almost an inevitable situation that copper will rise, but the timing has multiple years of variance for how long that trade takes to play out, so I like having some copper exposure but with patience.

“So I think that it's almost an inevitable situation, but the timing is-- there's multiple years of variance there for how long that trade takes to play out. So I like having some copper exposure.”

India could be a pretty big source of copper demand in the 2020s because it has a much smaller copper installed base per capita than China, and China itself has less copper per capita than Western countries.

“I do think India could be a pretty big source of copper demand in the 2020s. They have a much smaller copper installed base per capita than China. And even China, even despite all its infrastructure, they have less copper per capita installed than the Western countries.”

I use individual stock selection to identify companies with longer-term positive outlooks and the strongest balance sheets in their industries to minimize equity risk, rather than relying on broad indices where it's challenging to identify safety.

“I still use some individual stock selection to augment my risk exposure, rather than rely on indices. So I can identify companies that I think have longer positive-term outlooks, that have the strongest balance sheets, at least in their industry-- either in absolute terms, or strongest in the industry.”

Markets are still going up like Wile E. Coyote after falling off the fiscal cliff when the $600 extra unemployment benefit expired at the end of July, and the big question is whether we get another large fiscal round or if gridlock delays it for months.

“now we're off this fiscal cliff, and the market's still kind of going up like Wile E. Coyote. So I think the big question the next couple of months... is whether or not we get this big fiscal thing that they're talking about, or if that gets gridlocked for months.”

The current fiscal gridlock makes me nervous on equities and I've been contemplating de-risking further because my outlook is fiscal-heavy, and if we get fiscal hold-ups, we'll see more pullbacks in risk assets, especially given bad breadth where only a handful of winners have driven the market.

“I have been contemplating de-risking a little bit further now because this fiscal gridlock is currently in place. And I think, as I'm saying, because my outlook is pretty fiscal-heavy, the big question is if we get these fiscal hold-ups, I do think we risk more and more seeing pullbacks in some risk assets. And we've been seeing really bad breadth in the market. So it's only a handful of winners that have really driven this market up.”

There's not a lot of range for bonds because they can either hit the zero bound (deflationary shock) or be capped by the Fed (inflationary scenario), leaving bonds trapped in a narrow range with poor risk-reward for the next 1-2 years.

“my case is, essentially, that there's not a lot of range for bonds. Because sure, we could have another deflationary shock. We could have one of those risk-off events that I talked about potentially spurring them to do more fiscal. So we could have, say, a lower low in bonds. We hit the zero bound, perhaps. There's not a ton of room there. And if they go up-- which I think they might try to do when we get a more inflationary environment-- if that outcome works out, I do think they cap it.”

We're in the early stage of a halving cycle and it's possible this cycle could totally flop, but it's a reasonable bet to risk a specific percentage of capital for 1.5 years to see if the same pattern (supply cut, demand remains, price rises, momentum traders and FOMO traders push it higher) plays out as in previous cycles.

“I think a really asymmetric bet is to say, OK, we're in the early stage of a halving cycle. It's possible this having cycle doesn't play out anything like the other ones and it just totally flops. Or, just to say, OK, I have a specific time frame. I'm willing to risk a specific percentage of my capital to see how this plays out for a year and 1/2 and just see if that same pattern happens.”

My highest conviction trade for the next year or so is Bitcoin, because it's clearly operating on its own cycle separate from other asset classes based on its halving points and uncorrelated nature.

“Well, for the next year or so, probably Bitcoin... where we are in the halving cycle, and how uncorrelated Bitcoin is to other things. If you look at the Bitcoin log chart and compare it to the halving points, it's clearly operating on its own cycle.”

For Bitcoin, daily/weekly/monthly action can be affected by liquidity and reflation on/off, but the price difference between now and end of 2021 won't be strongly influenced by other factors—it's mostly influenced by how much Bitcoin demand there is compared to reduced supply from the halving.

“things like liquidity and reflation on or off can affect some of the some of the daily, weekly, monthly action. But I think that the price difference between now and, say, the end of 2021 is not going to be strongly influenced by other factors. It's mostly influenced by how much Bitcoin demand there is compared to the reduced supply. So I think that at least in managing position size, I think that's one of the easiest asymmetric trades at this current time”

Retail money can switch from bankrupt companies to cryptos and have a blast (trading on Robinhood), and the 'front-running opportunity' is clear: you know where the herd has to go, which is all the institutions; as the market cap increases, the bigger the market, the more they have to do it.

“if some of that-- instead of buying bankrupt companies, they can switch over to the cryptos and have a blast with that... it's one of the biggest legitimate front-running opportunities I've ever seen, because you know where the herd has to go, which is all the institutions. And the movie goes up in price, the bigger the market cap is, the more they have to do it.”