Equities Extremely Complacent; De-lever and Prepare to Buy The Dip

Speaker A: The overriding piece of advice is be unlevered, uh, because there are things happening that haven't happened in a long time or ever. And they're happening and they're happening with increasing frequency. And so the Overton window of possibilities in markets, if you will, I think is as wide as I've ever seen it. And I've been doing this 30 plus years. And so it ties back to that prior point of very bearish in the near term, but ultimately very bullish, which is to benefit from the very, what I think is going to happen very bullishly over the next decade plus, you got to survive, you got to get there. And that to me, and says, just be unlevered. I think you want to own some gold and I think you're going to be real happy with where you are in five years, ten years, uh, for most investors.

Speaker B: Welcome to the Master Investor Podcast with

Speaker C: me, Wilfred Frost, where we celebrate and

Speaker B: learn from the success of the greatest investors, business leaders and politicians in the

Speaker C: world, giving you, our, uh, listeners, an edge.

Speaker B: The Master Investor Podcast is sponsored by LSEG Interactive Brokers, the World Gold Council and BMY Investments. Please do remember the views expressed in this podcast are for general information purposes only. Nothing in the podcast constitutes a financial promotion, investment advice or a personal recommendation. More on that in the show notes.

Speaker C: My guest today is Luke Grohman, the

Speaker B: founder of, uh, Forest for the Trees

Speaker C: fft, an independent macro research outfit that

Speaker B: tries to look where others aren't and

Speaker C: identify major long term actionable ideas that

Speaker B: most market participants are missing.

Speaker C: Luke, it's fabulous to have you with us.

Speaker B: Welcome to the podcast.

Speaker A: Thanks for having me here, Wilford. It's great to be here.

Speaker C: It's great.

Speaker B: Uh, I think I need to start

Speaker C: by saying that I love the name of your firm, but I also, for the Brits that are listening, wanted to point out, of course, that you draw the title from a phrase that is slightly different over here, which is not seeing the wood from the trees as opposed to the forest. But we get the gist, which is that you're trying to identify big themes

Speaker B: that Wall street is missing.

Speaker A: Now. That's exactly what we try to do. We aggregate a large amount of publicly available information, uh, in, uh, what we think is a unique manner and trying to identify what we call developing economic bottlenecks, uh, in different sectors. Because it's been my experience over those decades that sectors that are poised or sectors and companies that are poised to benefit from, uh, those bottlenecks or be hurt by, tend to outperform On a sector basis, publish two reports a week for 46 weeks. A, um, I do a lot of writing, do a lot of thinking. I think I've got the best job in the world.

Speaker C: It's certainly a very stimulating kind uh, of set of topics to cover, and I'm delighted that we're going to get to do that together for the next, uh, 45 to 60 minutes. And let's dive right in. You know, I want to talk about the Iran war. I know you've been looking at this a lot and talking about bottlenecks. Um, obviously, uh, the straight up Hormuz has been one that's come into focus. Um, the fact that the war has restarted in the last two weeks. Is that something that you think warrants

Speaker B: more immediate attention than has been getting?

Speaker A: Probably, uh, probably. And I think as we go back, it's been a topic where we have a saying where, or at least we used to, uh, in a former life. For me, you can be right for the wrong reason or you can be wrong for the right reason. And thus far in the Iran war, I've been wrong for the right reason, which is to say we published for clients. I had very high conviction that the war was going to last much longer than expected. If you recall, Wall street consensus was it's only going to last three to four weeks. Trump was saying, there's me, only three to four weeks. We, from day one were saying was going to last a lot longer. So we got that exactly right. Uh, as it's ongoing, I think going to accelerate, you know, probably, or continue from here for longer than people want to imagine. Uh, we also said that Hormuz was going to stay closed longer than expected, uh, which again early on was, hey, this is going to be over by April. We were telling clients, prepare for May, June, even July 4, for it to still be closed. Here we are, it's July 29th. It's essentially still closed. So we got that exactly right. And when we say wrong for the right reason, uh, got the reasons right. And if I would have known for sure that was the case, and I was pretty sure would, uh, have been very negative. And that was right for the month of March. Uh, S and P was down, whatever it was, 9, 9%. Uh, oil up big, uh, rates up big, uh, in the US and around the world, inflation picking up. And then everything changed in early April. And since then, uh, up until recently at least, that's been wrong. And, and there have been, uh, a couple reasons for that. The most important is I do think, uh, Underappreciated, uh, the ability to adjust by a couple different, uh, players and most particularly China. Uh, China's ability to, uh, reduce imports by 3 to 4 million barrels a day surprised me, surprised a lot of people. I also think there was probably more leakage through the strait than was being let on. But at the end of the day, when you total up the leakage, it was m incremental and marginal relative to what China did. And that, I think, is really important as we look forward, which is China has more leverage than we acknowledge right now. I think we're acknowledging they had more leverage in the past, but there's still this view that, you know, they don't have the leverage now. And I think what I mean by that is it. What is. What is China going to do is going to kind of determine. And I think on some level it is, it is in China's interest to extend this as long as they can keep oil prices and supplies relatively high enough high, uh, enough supply low enough prices for, for them, uh, because ultimately the US Getting stuck in another quagmire is good for China.

Speaker C: So what's really interesting about that, Luke, is I guess, this idea that it'll keep continuing as long as oil prices are obviously elevated from where they started the year, but not over $100 a barrel or above in the way that they were for parts of the early March, April phase of the war. The thing that has changed, I'd argue, uh, in the last 10 days, though, is even if oil prices haven't got up to that level, bond yields have got to their highs again. How much of, uh, that do you think is a factor that will cause equity markets to wake up to the scale of impact that maybe this war should be having?

Speaker A: Yeah, I think, you know, you raise a great point. Right. We're restarting this thing. And, you know, we used to play street ball, right? You know, car go by, you know, game off, game on.

Speaker C: Right.

Speaker A: Feels a little bit like that. And we've got all the same issues, except we're starting from lower global stockpiles of oil and other commodities. We're starting from a higher baseline inflation. We're starting from higher baseline yields. We're starting from tighter global supply chains, um, slower US And Western economy relative to, say, three months ago. And so the rates story, to me is a big one. I think. I think rates are going to keep moving higher until something breaks. And, uh, I don't know if that's going to be in the US I don't know if that's going to be in Japan, I don't know if that's going to be in the uk, if that's going to be in the eu. Germany, French yield, Western yields are all rising. The only guy whose yields aren't rising is, is China of course. Right. When you look at 10 year yields, they're, they're just doing fine. So um, what will break? I don't know, um, to me maybe the most variant perception or one of them that we have is that whenever something breaks, uh, in the equity market probably, um, I do think you'll get long term Western yields to drop for a moment, um, five days, ten days maybe even if we're lucky, three weeks. But then they're going to stop going down and they're going to go up even faster as equities fall. And that to me is when the real crisis starts. I think we're still thinking traditional sort of crisis of hey, yields are rising, that's a problem. Eventually they're going to break something. Equity prices are going to fall and then bond yields are going to come down. And I see this, this view over and over and over and that's not what's going to happen. And it's fascinating to me because consensus still think that's going to happen even though what I describe has happened over and over and over since 2020. Right. We had the COVID crisis, 10 year yields down, then all of a sudden they stopped going down. They started going up really fast. 2022, Fed tightens rates, we start to have an issue. Long Yields go up 2023 in the SIVB and signature uh, bank yields went up at the long end, uh, fall of 23, yields went up at the long end. 2024 even in uh, in, in Liberation Day, long end yields went up, they went down for like two days and then they took off as equity markets fell. And even if we go back to when the Iran war started, there was an overwhelming view held by many that 10 year yields were going to go down on a flight to safety. And it was very vocal. You can go find the old expost, etc. Like there's no way they're going down, they are going to go a lot higher and we're up 70 basis points since then. Um, and I think that is the uh, biggest variant perception, uh, that is out there.

Speaker C: I guess I have two follow ups to that. One is what is the sort of level if we use the 10 year that you think would cause uh, Scott Besson and Donald Trump to change what they're doing to back down on whatever market unfriendly actions they're taking at a current moment in time, whether it's tariffs or war. Um, I mean, because I feel like the first phase of the war is like 4.4% but this time around it's obviously a bit higher than that where their pain threshold is. But I guess linked to that is will we get to a point where they can't put the genie back in the bottle again and yields rise to a damaging level regardless of if they back down in Iran, for example.

Speaker A: Yeah, my view of the yield pain threshold is about the same as yours from earlier. So. So 4.4% for a while you could see it like clockwork. 4.4. They back off 4,4. We get a tweet from, from Trump and I agree they've allowed that to rise to 4, 6, 5, 47 for the moment. Historically, over the last several years, anywhere from 4, 6 to 4, 8 up to 4 9. 4.9% on the 10 year has been a problem area. And so I think that is still the case. If only our debt levels are. Because our debt levels are higher. You know, Besson's three arrows program is in the toilet. He's going to get none of his three arrows as a result of this war. And that makes us more sensitive to 10 year yields, not less in terms of the deficit, etc. Is there a moment where the genie comes out of the bottle? Look, they can control yields as much as they want. It's just uh, an issue of what's the dollar do. And ultimately when they choose to either back off, you know, the challenge in backing off enough times is they're eroding their credibility. And I know when you say that there's a whole slew of a whole chorus of voices that will jump on you in the media and on social media to say, oh, you're anti American, you're. But that's a fact. Every time they are back down, they are eroding their credibility a little bit. A little bit. A little bit. And that doesn't matter. Until it matters, that's going to matter all at once. And so that um, has implications in the longer term for long term treasury yields in the United States. Because real politic of, real politic of it is historically, you know, people don't like to admit this, but part of the military's job has been to threaten people into buying treasuries that maybe don't want to buy treasuries. And so to the extent that the threat, the protection racket breaks down because you keep demonstrating that you cannot take pain over 4.6 or 4.7% on your 10 year yield. You keep demonstrating that your most powerful Navy in the history of the world, which is true, keeps getting stood off by missiles and drones, which are very cheap and easy to mass produce. You're eroding that underlying first principle dynamic that we've heard so many times in our careers, which is ultimately the US military backs the treasury market and the dollar. And so you have this backing off. That's sort of a bigger picture, not even threat, but just, just first principle issue. Tactically, they can stop anytime they want and they can, they can cap yields any number of different ways, particularly if their guy at the Fed plays along. Um, it's interesting, if Warsh won't play along, it starts to be much more problematic. And so if Warsh decides this war is not a good idea and decides he wants to run monetary policy in a way that forces the end of this war, he can do that. Um, that'll be really interesting. So that to me, when I think about where can yields go, will it get away from them? It really, Yields will only get away from them if Warsh wants them to get away from them, if Besant wants them to get away, wants yields to get away from them.

Speaker C: But, but what's interesting, I guess you're saying, is even in, uh, in the, the positive scenario towards yields, there, it's kind of negative towards the dollar, which maybe we'll come back to in a moment.

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Speaker C: sticking on yields and Treasuries, but stepping back long term. I'm, uh, just kind of interested to get your take on the extent to which there still is major demand for U.S. treasuries. Um, how that's changed over time, the sort of history almost of who the main holders of them are and the kind of trends you've observed in the last 12 to 24 months of how that's changing.

Speaker A: Yeah, we have seen, um, there's still plenty of demand. The demand has shifted from very patient and non profit oriented creditors, which are the ideal creditor to basically now extremely fickle, very profit, very short term oriented investors in the form of hedge, uh, funds based uh, out of the Cayman Islands etc. You um, go back to 2014. Global central banks stopped buying Treasuries on a net basis in 2014. Their holdings of Treasuries are actually down on a net basis over the last 12 years. So your big patient creditors, they're gone and they've been gone for a long time. That has been papered over in the ensuing, in the intervening period. But by regulatory changes, ah, such as um, 2014 US change so that Treasuries uh, were classified as high quality liquid assets for banks and increased bank regulatory capital requirements to hold Treasuries, um, and banks bought a ton of treasuries. Then in 15 and 16 there were changes to money market fund rules in the United States mandated by the sec, whereby private money market funds holding non Treasuries, so right, municipal paper, commercial paper, whatever, they would not get backstopped in a crisis. Whereas government money market funds would massive shift out of private money market funds into government money market funds. It was effectively uh, a form of QE if you will. It raised rates on the private sector, it was a crowding out the US Government, crowded out the private sector, uh, in short term money markets to deal with this lack of demand. Then you had in 2018, uh, Trump in his first term changed uh, tax rules to give uh, Treasuries more favorable status to US pensions who bought more treasuries. Starting around 2018 you saw a significant uptick in the treasury basis trade, the hedge fund base where you're shorting uh, futures and buying spot cash futures, um, as a way of closing an arbitrage that had existed. And you're doing this on massive amounts of leverage. And so you can see that the biggest marginal buyer of Treasuries, the biggest marginal foreign buyer of treasuries since 2018 certainly. But really since 2014 has been what we call the Eulix, uh, UK, Luxembourg, Ireland, Caymans, Switzerland. So UK hedge funds finance private sector Luxembourg tax haven. Ireland is an American tax haven that's not really a foreign holder. Those are U.S. corporations. Cayman Islands are primarily um, U.S. hedge funds, uh, a lot of them engage in this basis trade. And then Switzerland, another tax haven. And so there was a Fed white paper, uh, late last year, October of 2025, you can find it online. It showed that since 2022, 37% of the net issuance of notes and bonds. So the belly of the curve and the long end, everything but bills was Cayman Islands hedge funds. So it was this, it was, it's the private sector demand for, for Treasuries is still rising. It's heavily short term US hedge funds. And that's fine. There is a trade off to that though, which ties back into my prior point about when we have whenever yields do get too high and we have a risk off in equities, you're going to get a momentary drop in long term treasury yields and then they're going to take off like a scalded cat, like they did in 2020, 22, 23, 24 and 25. And we know this, it's a certainty. And the reason it's a certainty is because 40% nearly of the notes and bonds bought since 2022 have been bought by hedge funds on high, high leverage to some extent because that's what the basis trade is. What that means in plain English is if you have a pickup in volatility in equities. The first thing the risk managers do with these hedge funds is once volume gets too high in equities, they get flat, they sell everything. They take down volume across the book. Well, if equity volume rises, they've got to get flat across the book. They've got to reduce leverage across the book. They turn sellers at Treasuries, the biggest buyer Treasuries over the last four years turn sellers as equity comes. And we've seen this over and over. And so in the short run that drives yields up in a risk off and keeps it going because the higher Volcos it feeds back on itself. Higher yields and a risk off. I got to degrowth equities, more equities, uh, degross more equity volume up. Equity volume up. I got to degrow everything more. I got to degrow more Treasuries rates up. And we've seen this playbook happen multiple times until essentially US regulators, US policymakers cry uncle and inject more dollar liquidity any number of ways. And we've seen that any number of ways. You know, 2020 it was with massive QE 600 billion a month in the crisis. 2022 it was at the end of it, Yellen coming in and weakening the dollar by at a 40% annual rate between October of 22 and February, March of 23. Uh, and also later in 23 it was her shifting issuance to the front end, uh, and running down the reverse repo, which was Effectively just delayed QE that she had control over. Um, then you saw her do, uh, treasury repurchase programs for the first time in this country in 24 years. In 2Q24, Bessant criticized the whole thing, became treasury secretary and promptly doubled the rate of treasury buybacks that she was doing. Again mostly focused on shift from long end to front end. So you can see all of these things when I describe this process to my friends in emerging markets or that have traded emerging markets, they're like, this is just an emerging market debt crisis with the American flag pasted on the top. And that's fine, but that just has implications for asset allocation, um, inflation, etc.

Speaker C: I guess what comes to mind M to me off hearing you say that is that when we see what sounds like it will be a correlated fall in equities and bond prices together, that it might well be sharp but quite short lived if one way or another, uh, whether it's treasury led or Fed led or united between them, the base case expectation, which sounds like, correct me if I'm wrong, is your expectation that the authorities will step back in again.

Speaker A: They have to, uh, we've seen this over and over since 2021. I've used a phrase that Jerome Powell, uh, coined, which was treasury market functioning. We're still doing QE with inflation where it is and home prices running like they are because we need to ensure treasury market functioning. That's why we did the big QE. Well, that's the Fed's shadow third mandate. And with debt to GDP at 120%, 6% deficits, it's the Fed's number one mandate. It is. And consensus is that Warsh will subordinate treasury market functioning to price stability. And there's not a chance. The only question is how long. To your point of your question, how long will he allow treasury, uh, market dysfunctioning to occur in his fight for price stability? Until he has to bend the knee and intervene in treasury markets in order to ensure the stability, the functioning of those treasury markets. It is a, it's as close to a sure thing as, you know, you just don't, you know, what is that intervening period of time? It has to be short by definition, just given the leverage in the system and the centrality of treasuries as collateral, et cetera.

Speaker C: Well, I hope you'll come back on and tell our listeners if and when you see that moment as a big buying opportunity. But uh, let's fast forward sort of to that hypothetical anyway. And I wonder if there is Going to be moments where even they can't actually, uh, put the floor in, uh, so to speak. And what I was going to ask about on that is they're not the only country with the same kind of problem. And these things often kind of snowball in a way you can't control. When you look at other nations, which ones stand out to you as flashing red with similar problems or worse problems?

Speaker A: Yeah, it is, uh, see it's the old, in the land of the blind, the one eyed man is king problem.

Speaker C: Right, yeah.

Speaker A: Um, look, I think the uk, Japan, Germany, France, um. No, I think what's really interesting is these are all our allies historically. Right. You know who isn't having a problem? You know who's not flashing red? China. You know, since 2008 to now, China's gone from the highest of all those yields at the 10 year level to the lowest, um, their yields are below Japan now. And so it's kind of interesting when you hear some people say, well we're doing this Iran war, there's uh, a, There's a greater 5D chess play here. We're going to close down the straight. We're going to choke off China like. Yeah, but you're going to choke off your own allies way first because their bond markets are going to break first. Yeah, but that's okay because we want the Europeans to sort of get on board with China. Like you understand that the UK and Japan, Japan and UK respectively are the number one and number two foreign creditors of the United States. Now the uk, which is an astonishing statement in and of itself. Right. The private holdings of Treasuries in the UK are higher than Saudi, higher than China, higher than Russia, higher than Germany, higher than all these. And I say it's astonishing because the UK is the only other developed, you know, twin deficit nation. They're, they are in at least as bad a fiscal problem as ours. The financial center is buying a lot of our bonds, which is fine until UK bond yields rise because then you can see if you call up a 10 year or 5 year chart of 10 year UK Gilts and you run it against 10 year US treasury yields. If you want to know where 10 year US treasury yields are going to trade, just look at where UK gilts are today. They just lock step, they're tied at the hip, which makes perfect sense. And so I, that to me leads me to the conclusion of the. I don't know where it's going to break first, but once one of them breaks, they're all going to break in very short order. Again, for that exact reason, when, when two of the three biggest creditors have at least as big a debt problem as you and you're the biggest debtor, you know, it's, it's, you know, you're going to hit the wall, you know, a millisecond after them.

Speaker C: So, Luke, with that all in mind, how complacent do you think equity markets are? Even if a pullback will be short lived? But how complacent do you think they are at the moment?

Speaker A: I think I'm going to answer that on a dual timeframe. In the very short run, I think they're extremely complacent, um, because ultimately big tech, AI, et cetera, has become very debt financed, very debt, you know, cash, cash negative debt financed. And when you have a segment that is valued extremely highly in equity in terms of equity valuations, that is a very large portion of the equity indices in the biggest equity market in the world in the United States, they can't have anything go wrong. And yet they need to keep borrowing more and more money. And the underlying rate is rising on them, is going to keep rising on them. And that is a very bad combination. Uh, so I don't know when that creates a problem, but that is in the very short term, tactical. I think equities are extraordinarily complacent to what I was describing is occurring secularly and tactically in sovereign bond markets, Western sovereign bond markets in particular. If we take a step back, I think equities are pretty rational in dollar terms. Uh, M. If we say, hey, this is just an emerging market debt problem with US and UK and German and Japanese characteristics. Uh, look for several years, if extremes inform the means, for several years, the number one percentage performing equity index in the world was Venezuela, as the currency was just getting destroyed. And in that same way, again, I don't think the US or any of those Western nations are going to hyperinflate. That's not my point, but my point is, is that equities rising the way they are and being so resilient are in some manner telling us what is happening, which is it's the currency, it's not that's driving it. And we can see that a couple different ways. Number one, if you look at a chart of The S&P 500 over, say, the TLT Long Bond US ETF, it is exponential. There's just money going out of bonds into stocks. And we can see that both on a price basis, we can see that on a flow basis, the Other way you can look at it is equities. If you price them in gold, which is in the Great Depression when the Dow fell 85, 90% from 29 to 33 US was uh, on a gold standard. That was the Dow falling in gold terms. That wasn't the Dow falling in dollar terms. And in that same light equities priced in gold are still down 40% since January 2000.com highs uh, equities priced in gold are down 8% since 4Q18. And this is the S and P total return. So this includes dividends. S and p is down 8% in gold terms since 4Q18. Um, s, p is down in S and P total returns down 21% since January 22 when the Fed started hiking rates even with this recent gold sell off year to date and the rally in S and P since, since April. So I think the uh, the equity markets on a structural secular basis, away from sort of the very tactical near term that we described, are acting perfectly rationally, which is if you see the debt situation the way it is and you know that the Fed has proven five times in six years that their number one mandate is not price stability, it is treasury market functioning. And you see the US government doing things that are only going to increase that debt and deficit, like this war in Iran, then it's pretty simple. Don't own long term bonds and own equities instead. And you know when, when you have these momentary risk offs then you, you know, you buy, you buy all the dips. And so I think they've been conditioned to do this. They, they being investors and equity markets as a result have been conditioned to do this. And I don't see any reason why that's because ultimately this is another variant perception. The equity market backs the treasury market because they've allowed this to go too long. Whether when you look at it on a, um, through the consumption link and through the US Federal receipt link of non uh, withheld stock based computer. Uh, if equities go down 20% and stay down, the deficit will blow out. We saw this in 2022, 2023 and you will go into a debt spiral. And so paradoxically this, the stock market backs the treasury market and the treasury market backs the stock market, which has sort of always been true. So they're very much in a position of what chess players call zoogzvan, which is you have to make a move, but every move you make is going to make your present position worse. Um, so I think markets or equity markets are being rational in dollar terms and I think they're being rational in gold terms.

Speaker B: Hi guys, it's Wilf. I hope you're enjoying this episode. Just a quick reminder to please hit follow or subscribe on your podcast or video app so that you never miss an episode. And if you've got time, please do give us a five star rating and leave us a comment. It really helps other people find the podcast too. Now back to the episode.

Speaker C: So Luke, my immediate follow up to that is that the dollar hasn't priced what you're talking about in yet. Um, I mean it might be weak ish over the last year or two but um, are you expecting a much weaker dollar in the year ahead?

Speaker A: I think it will be weaker in the year ahead. I don't know. Much weaker. It's been much weaker against gold. Right. The dollar has essentially collapsed against gold in the last three years, right. We've gone from 1800 to 5400. That's the dollar down almost 70% against gold. Um, and I think the dollar will over time continue to collapse against gold. When you look at what is being done, which to me seems coordinated because they came out of the NATO meeting and all said the same thing which is us, Japan, Germany, uk, Korea, all getting together and essentially doing what appears to be defense stimmies. Right? If we go back to Covid, of course we had stimmies. The government ran a deficit, borrowed money and handed cash to people to go buy TVs et cetera. They seem to be all running the same playbook except instead of TVs they're now buying Patriot missiles and uh, stuff from metal Gesellschaft in Germany and the uk etc and the reason I bring this up is I think there has been a decision made amongst western countries that are having this debt problem to address that. Right? The way you get out of a debt problem is you have high nominal growth and relatively low rates relative to that nominal growth. You inflate your, your debt down and the sim, the, the simultaneous problem of we're losing in a lot of areas, losing ground or losing outright to China and we need to rebuild our, our defense industrial base and bases by doing defense stimmies. And so we're seeing that now. The corollary to that is all of their bond markets sell off at the same time which we're seeing. And the nice thing about that from a policy standpoint as it relates to the dollar and your question on the dollar is if they all go kind of off the cliff at the same time or devalue the same time against gold, but not against each other because they're all doing the same thing. The declines will show up as against the Chinese yuan and against gold rather than against each other. And I think that's what we're watching. And so when you look at something like the DXY that has I think important financial market implications and I think it needs to get weaker on a relative basis in the near term, I think ultimately the dollar gets much weaker. Um, but I don't think that's going to happen in the next year. I think they're managing this process and I think gold will continue to uh, rise secularly against all these currencies, um, all these Western currencies over the next year. Plus.

Speaker C: That's really interesting. And I guess gold obviously, as you said, hit 5,400. It sort of settled back to the low, low four thousands. Um, uh, interested to know what you think short term and long term on that price action.

Speaker A: Yeah, I think it had sort of traits of a blow off top when you, when, when we saw it go from up to 5,400. Um, you're getting sort of the, the vertical lines and charts which makes everyone in our business nervous and take some profits. And so I think it was, it's, it's a, it's been a healthy pullback. Um, it's been interesting to see what has happened since, uh, it has fallen back in terms of Chinese buying and central bank buying. More broadly, central, uh, banks after, with the exception of March and maybe in April a bit with the war, they've stepped right back up. Uh, which makes perfect sense, right? Because globally if you're watching what the big Western nations are doing in terms of the defense stimmy, which is borrow money and reinvest in defense industrial base and equipment, that is both a lot more bond supply bearish for bonds higher yields and inflationary bearish for bonds higher yields. And so what do you want to own? You want to own gold. And they've continued to buy gold. Uh, and I don't think the west and in particular the US necessarily is opposed to that. I think they want that on some level. But then when you see what China has done, which is I sat on a sales trading desk for 15 years and I've seen this before, right? So gold goes from 5,400 down to 5,000 or uh, down to 4,800 and China buys 80 tons which was the most in, you know, X years. And then the next month it goes down to 4400 and China buys 2x the most in 2x years. And then the next month it goes down and China buys 3x the most in 3x years. And last month they bought 173 tons imported. Um, and, and uh, which is the most in like 12 years? And so I, I think they're kind of telling you what the story is, which is we will. And it's interesting when you look at that 173 tons of Chinese imports last month. That's, if I recall my math correctly, it was about 23 billion dollars at current valuations, that 23 billion dollars of gold imports by China compared to a 105 billion dollar trade surplus by the Chinese that month. So they're putting almost a quarter of their trade surplus into gold on a de facto basis. And so when I say what do I think gold's going to do? I think gold's going to continue going higher over time. I think it's going to go way higher than the 5,400 record. Uh, because what we're watching in real time are China's surpluses being settled in gold. And ultimately people say, well, there's not enough gold. Well, no, not at 4,000, but at 10,000, at 15,000. And it's also, I think, part of a solution to the problem that so many policymakers and economists are highlighting, which is, well, you know, the Chinese are exporting way more than they're importing and we need them to import more. Well, great. In June, they imported $23 billion of gold and they exported $105 billion net worth of stuff. If gold was at 16,000 instead of 4,000, in other words, up, uh, 4x, China would have imported $100 billion worth of gold and they would have exported $100 billion net worth of stuff. And China's balance of trade is flat. Now why is this not an acceptable solution? Simple. If Gold's at 16,000, guess where the dollar is. I don't know where it is, but it's a lot lower. Um, now that's where we need it to be. That's inflation is going to be a lot higher. That's what we need it to be to reshore. But there is an element of the west that doesn't want to see that because that's a very big political move that has geopolitical implications.

Speaker C: Yeah, it certainly does.

Speaker B: This episode is sponsored by BNY Investments. BNY Investments is part of bny, a, uh, global financial services company supporting investors and institutions around the world. This sponsorship does not constitute investment advice. This episode is Sponsored by the World Gold Council, the global experts on gold, they champion gold as a trusted strategic asset. Providing market leading research to help investors understand gold's role and modernize how gold is owned, traded and used. Developing industry standards and market infrastructure. Learn more@goldhub.com what I find interesting in

Speaker C: this, and it brings me to something I've heard you talk about before, is that China doesn't so much want the yuan to become the reserve currency of the the world, but they want gold to replace the US treasury being the backstop safe asset of choice. Um, just expand on that for us a bit.

Speaker A: Sure, yeah. There's a lot of people that will say, oh, the Chinese yuan is never going to be, never going to replace the dollar because you have to have an open capital account. And I always say, exactly, there's zero chance the yuan is going to replace the dollar. As the dollar has been structured since 1971 where the treasury bond and from a bigger picture standpoint, U.S. financial assets replace or uh, replaced, uh, gold. Right. You end up with dollars by virtue of doing trade with the United States. What do you buy? You buy treasury bonds, you buy mortgage backed securities, you buy equities, whatever. Uh, that system China doesn't want that. They want to own, they want gold floating in all currencies. That is how they're internationalizing their renminbi, which is to say hey Russia, hey Iran, hey Saudi, probably let us buy oil in our own currency. And this is another point that a lot of people miss about what I say specifically, but more broadly is why is China saying this? It's not because China hates America. It's not because China is trying to tip over the United States. The reality is that if China does not get the ability to buy oil, gas and commodities in the Chinese yuan, they will have a financial crisis, um, as they run out of dollar reserves with which to import commodities. And then they will go through a late 90s Southeast Asia currency and financial crisis. And that's a political red line for Beijing. And so the problem is, is if you want to pay and yuan, you either have to open your capital account fully, there's zero chance they're going to do that. They don't want to do that. They would have too much flood out, et cetera, et cetera. So you need to keep the capital account closed. Well, how do you keep the capital account closed but also get people to take Chinese yuan which is not accepted for all that much at least 10 years ago? Uh, well, you tell them number one, you can buy goods from us in Chinese yuan. And, you know, 10 years ago, 15 years ago, 20 years ago, that was, you know, plastic squirt guns and, you know, crap at Walmart. And that wasn't good for that much. Well, now it's good for Chinese AI, it's good for Huawei equipment, it's good for BYD cars, it's good for solar panels, it's good for stuff, a whole lot of stuff that most of the world buys anyway, uh, or would like to buy. So number one, China's trade, China's factory base, increases the acceptance of yuan for the imports that China can buy in yuan, the commodity imports. But then to the extent that you end up running a surplus still against the Chinese, in other words, you sell them oil and gas, whatever, they end up with, um, yuan, and then they buy some of Chinese goods with yuan, but they end up with excess yuan. The Chinese have gone around the world and they've set up offshore clearing banks, uh, offshore yuan clearing banks in every major gold hub in the world. So London has an offshore yuan clearing bank. Switzerland has an offshore yuan clearing bank. Dubai, uh, Singapore, um, Hong Kong, of course, and then of course, Shanghai. So you can show up with yuan, get your gold, and you can take it home. You can take gold, Chinese gold, out of those places. China's capital count is two way through gold on a limited basis. And so that is why I say that gold is replacing the treasury bond as the reserve, as the, as the reserve asset. That's how China's doing it. And people say there's not enough gold. Well, of course there's not enough gold at current prices. This leads to higher gold prices. People say, well, the yuan is going to collapse. It did. While everyone's been waiting for the yuan to collapse against the dollar, take a look at the price of gold in Chinese yuan over the last five years. It's down like 80%. And that's fine because guess what the Chinese did first in 2002. They said to their people, buy as much gold, buy gold, buy gold. They've been very, very clear for 25 years. The, uh, Chinese people should buy gold. Chinese banks should buy gold. So when the price of gold goes up in value, when the Yuan collapses by 80% against gold, that starts to look like a recapitalization of the Chinese household balance sheet and of bank balance sheets, which is exactly what it is. Gold's just collateral, right? Gold is a 0% yielding bond of finite issuance, infinite face value. What's a Treasury Bond? A 4% yielding bond of Infinite issuance, finite face value. In a time where everybody's running defense stimmies, where you have secular deficits. Everything we talked about before gold is imminently superior to treasury bonds to anyone that has a sixth grade math understanding.

Speaker C: So I have so many follow up questions and we're nearly out of time and I want to ask you, uh, obviously, uh, I can conclude that you should tell your clients to buy gold, but where else they should put their money? But before getting to that, if we get to this world that China is trying to design, where the US treasury bond ceases to be the backstop and gold is, what will the world's risk free rate be?

Speaker A: It's a very interesting question. Um, it's probably very low, right? It's probably.

Speaker C: Which is bullish equities.

Speaker A: Very bullish equities, exactly right. Because historically you can kind of back into that, right. If you go back to when the US went off the gold standard and you can, and you can see that, that debts risen 8% and, and gold's risen 9% keg or something like that. Right. So over the long run gold is basically like a positive 1%, 1 to 2% real rate instrument going back hundreds of years. And so if I think about it that way, I would say your risk free rate probably drops to 1 to 2%, um, based on that number, which is very attractive to very indebted governments. It's very good for equity prices, it's very good for businesses. That to me is, is, it's another variant perception, right, which is, oh, if we go back to gold and gold's going to 20,000, there's gonna be zombies in the street. Well, I was told there would be zombies in the street when Gold went to 5,000. Gold will never go to 5,000. There'll be zombies in the street. I look around, I don't see any friggin zombies. Um, you take it at 10, spoiler alert, there aren't going to be any zombies. You take gold to 20,000, there aren't going to be any zombies. Now will the real value of bonds get crushed? Yeah, but that has to happen. That's in the cake. Bonds are going to get crushed by either devaluation or war.

Speaker C: Really interesting. So I guess you tell your clients that they should be buying this dip on gold. Um, what are the other kind of core buys today? Uh, in that environment?

Speaker A: Yeah, the other core buys of mine are, uh, electrical infrastructure. We've been talking about for a lot of time, us, uh, has added us. If you look at electricity generation in the United States from 2004 to 2024, uh, a time of massive wealth growth. On paper, the US electricity generation was flat. Essentially the US was generating the same amount of electricity in 2004 or 2024, excuse me, as it was 20 years earlier, which is an astonishing statement again on a real basis because electricity consumption and real GDP growth are very tightly correlated. So what that tells you is the US inflated a lot from 2024, 24 to 2024 and there was growth that was unevenly distributed. But on a net basis the US didn't really grow on a real basis for 20 years. And now we're reversing that. And it's AI related, uh, initially, but it's reassuring. If you have factories, you need grid. And so for me, I think, uh, ETFs like the pave P A V E grid grid. If you look at those ETFs, if you look at the companies in those ETF and I have no financial relationship with either, either of them. They're just things that we've recommended for clients over the last several years. Those are the types of companies and types of things that are essentially set to be the people selling picks and shovels to the mining boom that is reshoring the US industrial base and rebuilding the US grid and building out AI. The other thing I think that I've increasingly really come around to, thanks to a friend of mine, is Japan, Japanese uh, equities and Japanese industrial equities in particular, which have not performed as well as a headline, uh, Nikkei. And the reason for that is simple. There's, there's an old saw in production, right? You can have something fast, cheap or made well, pick two. And the US needs to reshore fast and they need it done well. But if they don't do it cheaply, the bond market's going to blow up because of the inflation. So if we need to try to manage to the bond market and we need to do it well, we're not going to be able to do it fast. And uh, the reality is we've also, we've gone too long and so we don't have the skilled trades, we don't have the grid, we don't have the machines to make the machines. None of it. It's all gone. And in that world there's one, there's, there's three countries you can get that stuff from. Germany, China and Japan, Korea to a lesser extent. And that's an over, overgeneralization. But bear with me, we're not going to get it from China for obvious reasons we don't want to. We're avoiding that at all costs. The Germans are getting beat up by the Chinese. The Koreans can service some of that, but their indices are basically, they're, they're. The Cosby is trading like a, like a, like a, an altcoin because it's basically, you know, two AI stocks right now, AI related stocks, uh, memory stuff, uh, or you can get it from Japan. And the Japanese do a lot of the stuff that the Chinese do, and in some ways better than the Chinese do it, uh, on the industrial side. And so by, by, uh, process, um, of elimination, the Japanese industrial companies are going to have to make a ton of money reshoring the US they are going to have to do the heavy lifting of reshoring the US Defense base and building out the US Electrical grid. So US Electrical infrastructure names and Japanese industrials, I think, set the benefit from this trend as well.

Speaker C: Really fascinating that. And again, I refer people, uh, back to our, uh, last, uh, episode with Jim Mellon, who made the bull case then for the Japanese yen as well. Um, Luke, last couple of questions. Firstly, just bring us back to the final conclusion on US Equities. It sounds to me like you're very bearish short term, but almost oddly, think that long term it's going to be a screaming buy on the dip.

Speaker A: Yeah, I think that's exactly right in terms of how I would phrase it.

Speaker C: Um, and then as I flagged you before the episode, we like to end by asking, uh, our guests what their overriding piece of investment advice is for our listeners. So over to you.

Speaker A: The overriding piece of advice is be unlevered, uh, because there are things happening that haven't happened in a long time or ever. Um, and they're happening and they're happening with increasing frequency. And so the Overton window of possibilities in markets, if you will, I think is as wide as I've ever seen it. And I've been doing this 30 plus years. And so it ties back to that prior point of very bearish in the near term, but ultimately very bullish, which is to benefit from the very, what I think is going to happen very bullishly over the next decade plus. You got to survive, you got to get there. And that to me, and says, just be unlevered. I think you want to own some gold. And, um, I think you're going to be real happy with where you are in, in five years, ten years. Uh, for most investors, Luke, it's been

Speaker C: an absolute pleasure thanks so much for joining us here on the Master Investor podcast.

Speaker A: Thanks for having me on, Wilfred. It was a great chatting with you.

Speaker C: That was of course, Luke Grohman, uh, founder of Forest for the trees, um, fftt-llc.com check out his website. We'll also put a link, uh, uh, in it in the show notes. Well worth, uh, subscribing to his bi weekly newsletter.

Speaker B: Um, we're going to take a break

Speaker C: here on the Master Investor Podcast. We'll be off for the next, uh, three weeks. Uh, forgive us for that. And we will be back ready for action in the first week of, uh, September when we'll be joined by Liz Ann Saunders from Charles Schwab. And we really do have an action packed autumn and winter lined up for you. So, uh, have a wonderful summer.

Speaker B: Until then, thank you so much for

Speaker C: being one of our treasured listeners and we look forward, uh, to joining you again the first week of September.

Speaker B: The Master Investor Podcast is sponsored by Elseg Interactive Brokers, the World Gold Council and BMY Investments. Please do remember the views expressed in this podcast are for general information purposes only. Nothing in the podcast constitutes a financial promotion, investment advice or a personal recommendation. More on that in the show notes. This podcast is produced by Paradine Productions and Master Investor limited In association with Birdline Media. If you've enjoyed the show, please do subscribe on YouTube and subscribe or click Follow on your podcast platform and you'll be automatically notified each time a new episode drops.