Trump Cabinet Choices Are His First Test; Fed Is Unchangeable for One Year

Mike Gleason: It is my privilege now to welcome in Craig Hemke of the TF Metals Report. Craig runs one of the most highly respected and well-known blogs in the industry and has been covering the precious metals for close to a decade now, and he puts out some of the best analysis on banking schemes, the flaws of Keynesian economics, and evidence of manipulation in the gold and silver markets.

Craig, it's always great to have you back. Thanks for joining us again today, and welcome.

Craig Hemke: Hey, Mike, thanks, and I appreciate all the kind words.

Mike Gleason: Well, Craig, I'm really glad I was able to get you on here today because I wanted to have you help us digest the election results and what it all means for the markets. Now, I want to ask you about the initial reaction of the economic markets once it became clear Donald Trump was going to win, but before we get into that, first off, what did you make of Trump not only defying the polls and beating Hillary, but beating her rather convincingly? What did that say to you about the state of our country and our economy that an outsider like Trump was able to pull off what he did?

Craig Hemke: Actually, it didn't come as a surprise for folks on my site. We've been speculating, and I guess we're starting to see this now in the analysis, the same thought. We've been speculating that there was a quiet, shy vote, as they call it, for Trump. It wasn't cool, it wasn't politically correct to tell a pollster or to tell your co-workers or to tell your neighbors that you were thinking about voting for Trump because you didn't want anybody to think you were racist or a bigot or a xenophobe or anything like that.

But there was a large group of people out there that any privacy in the voting booth, were going to look at it and go, "I don't know, this Trump seems like an ogre but man, but man, there's no way I could vote for Hillary Clinton." They pulled a lever, they checked the box for Trump. When it shook out that way and that the polls were actually wrong really didn't come as that big of a surprise, at least not to TFMR. Now, to make forecast now from here I think is a fool's errand.

I've been reading a lot of stuff here on Thursday about now it's assured that there's going to be big inflation and higher interest rates and infrastructure spending, and that means the stock market's going to 20,000. Man, I think, like I said, that's a fool's errand. People getting way out over their skis thinking that they know one day after Trump was elected what's going to happen now, not only in the next four years but even in the next four months. It's going to be a real interesting period time here, Mike, and we all need to be paying attention.

Mike Gleason: Okay, so for anyone following the markets on Tuesday night as the results were coming in, you saw global equities taking a huge hit. The Dow Futures were down some 700 or 800 points once it became clear that Trump was going to win. Gold was the primary beneficiary. It seemed as the yellow metal was, it seemed as the yellow metal surged and it appeared we were on the way to getting another Brexit like market reaction where metals got a safe haven bid. But then things quickly reversed course and by midday Wednesday the stock markets had not only stabilized, but actually closed the day substantially higher and metals were essentially flat by the time the day was done. So what did you make of all that, Craig?

Craig Hemke: Mike, I think we talked before about how the paper derivative futures market is primarily driven through high frequency trading computers, very little human interaction. You might get some special and volatile days like Tuesday. You might get some actual human beings and hedge fund managers, some traders, actually putting in trades, but most of it is just computer dominated trading. And these computers, as it relates to gold and silver futures, often take their cues from just a couple of inputs, the most important one being the dollar-yen. You can easily now trace what happened on Tuesday to movements in the dollar-yen, and you can actually trace movements in the S&P to movements off the dollar-yen as well. We saw the stock market futures, whether it was the S&P or the Nasdaq, it limit down for a while back on Tuesday evening.

At the same time, the dollar yen was down four points. It'd gone from 105 to just north of 101. Then as we were watching this, again, I was live following this on my site, suddenly dollar yen sprang back to life in chunks, moving in almost seconds 30, 40 basis points. At that point, it looked as if it was your classic Bank of Japan or some other center bank intervention. And lo and behold, here comes the stock market back and of course now anybody can pull up their own charts showing the stock market futures laid on top of the dollar-yen. You can see why it is that the stock market came running back. The dollar-yen now was again 101.20. Tuesday evening, it's now pushing 107. That is why these machines have been buying stock futures. I would take it one step further, Mike. Zero Hedge wrote about this yesterday.

There have only been three other occurrences in history that have had a turnaround in the Dow Jones, the U.S. stock market, of the magnitude we saw Tuesday and into Wednesday. Those other three occurrences, two of them were in the fall of 2008 when we were deep in the throes of the U.S. financial crisis and people were worried on a daily basis that they had never any idea if the stock market would maybe even open, much less how far down it was going to open. The other occurrence was right after the Black Monday crash of 1987.

Most market historians, even just people that are objective, ascribe those three other turnarounds to the interventions of the president's working group on capital markets, also known affectionately as the Plunge Protection Team. In those previous three occurrences, if that was all Plunge Protection Team action, I don't know why anybody would assume anything different for what happened Tuesday into Wednesday. Whatever. That's all we know. It's all speculation. What I think people should be worried about now is the actual market action in the 36 hours since. I'm not talking the stock market. I'm talking about the bond market and what the bond market and maybe the strength of the dollar might be warning you about what is to come next.

Mike Gleason: That leads me right into my next question. Another thing we saw after the results came in was the 10-year Treasury yield spiked by 10%, which is a massive one-day move. One could argue that a pickup in bond yields make precious metals, which offer no yield, less attractive, but higher rates definitely do not always correlate with lower metals prices, particularly if the rise in rates is signaling higher inflation or if there's some sort of turmoil that drives safe haven buying in metals. Any thoughts on why bonds are getting hit hard, and what do you expect these higher yields might mean for gold and silver?

Craig Hemke: Biggest one-day move in history, Mike, in the 10-year Treasury. Largest in history. And this happens the day after Trump is elected, so now we got to begin to try to connect the dots and try to figure out why. I don't know anybody that would think that all of a sudden this means there's some big change in monetary policy or some sudden spike in inflation. I don't know about that. I would instead, as I was searching for reasons yesterday I was looking for a large state actor that might be bumping their treasury positions in anticipation of this change in geopolitics, change in U.S. policy.

Then I found some charts, again, from our friends at Zero Hedge that showed the 10-year Treasury selling off at the same rate as a Chinese yuan. Offshore yuan was devaluing. Remember, now, the People's Bank of China pegs the yuan to the dollar, right? That is something they can manipulate a little bit that pegs some, but again, it moves with the dollar and so a stronger dollar means a stronger yuan. And that's not what the Chinese. We went through this now, and this is the history lesson. This is what people need to be aware of.

We just went through this 11 months ago. When the Fed raised rates December of last year, the dollar index spiked all the way up to 100. And that was putting extreme pressure, not only on the Chinese, but on every emerging market currency that is linked to the dollar. All of those currencies were strengthening with the dollar and putting extreme pressure on, again, not only China but every other emerging market. I will pause at this point and ask everybody, if they're listening, to watch what's going on in the emerging markets, not only today, Thursday, we'll see what happens tomorrow and into next week because we're already starting to see this trend.

What happened back in December of last year, and especially January of this year, the Chinese, trying to ease that pressure started selling dollars. Well what happened yesterday? The Chinese were selling bonds. What are they getting in return? Dollars. Now, what are they going to do with those dollars? Back in January, they sold those dollars and bought things like the yen instead. This rising yen, remember, the yen rallied 10% in 10 days in early February. This was putting extreme pressure on the U.S. stock market, again, because of those high frequency trading linkages that we talked about earlier.

This all could come to pass again. If the Chinese are, in fact, liquidating bonds. That is why we had the biggest move in the bond market, like I said, ever. Biggest one-day percentage move ever yesterday. Again, why would they do this yesterday? Perhaps they see a trade war coming. Perhaps they believe Trump and all his rhetoric about China. Okay, so maybe they're taking preemptive action. They're selling treasuries. They're going to take the dollars that they get from those treasuries and they're going to put it, again, somewhere like the yen as a way to weaken the dollar and ease that pressure on their own currency.

And again, we could get this cascade effect just like we saw in early January, all through January, and early February where the U.S. stock market actually fell over 10%. So again, this is all speculation, but that's all anybody else can do at this point. And I'm just astonished here, two days after the election, at the level of people that are utterly confident now that they can see the future. The dominoes, as they fall, and the unknown unknowns should prohibit anyone from making guesses when they really don't know what's going to happen.

Mike Gleason: Certainly one of the big things about a Trump campaign was that he was a real wild card and nobody really knew what to expect. I guess furthering the speculation here, what are we to make of a Fed and monetary policy under a Trump presidency? If we can make a guess, is there any chance we could see some fiscal restraint in Washington all of a sudden, or do we see inflation really take hold if Trump does deliver on all these plans to borrow money to rebuild our nation's infrastructure… basically, what are you expecting when it comes to monetary and economic policy under Trump?

Craig Hemke: Exactly. Everybody's talking about fiscal stimulus and debt packages and the Fed was actually even talking about that. If you read some of the minutes of the last couple of meetings, that they want some fiscal policy to come out of Washington that's going to drive more debt because that gives them another reason to print more money and fight deflation. There's a lot going on there, and to think that, again, we know what Trump will do I think is a fool's errand for anybody that's going to say right here, two days after the election, that they're going to do this and which is going to mean that.

I don't know what Trump's policy will be, but I do know that specific to interest rates, it is almost impossible, and I've claimed for years that it's almost impossible for rates to go back up and normalize. If anything, because of what it will do to the U.S. budget deficit, which is already being vastly under-reported. It's reported to be $600 billion, but the total amount of debt last year went up by $1.4 trillion. Never did see anybody try to figure that one out. Nonetheless, if interest rates go up and the interest that is paid on the accumulated debt then is forced to rise, the whole debt spiral begins to spin that much faster.

If you look at the line item on the U.S. budget for interest on the national debt, it's held pretty steady, under $400 billion for the last five or six years, even though the debt has risen. Well, why is that? Because the Treasury Department has shortened the average maturity of this debt as far as they can down to something like four years. And why do they do that? Because interest rates on the short end of the curve is where they're the lowest, and so they keep shortening maturities to get lower and lower rates so they can keep that line item on the budget under control. But the problem is, those short maturities come due sooner and have to be rolled and refunded, right?

Well, now what if all of that accumulated $19, almost $20 trillion in debt suddenly starts to roll over, instead of at 3%, starts to roll over at six? Well, then now all of a sudden, instead of $400 billion in interest on that line item expense in the budget, it's $800 billion or $1.2 trillion. And the budget begins to move that much out of control that much faster. This idea that some of the rates are going back up ...

And I’ll take it one step further, Mike. How about all the folks out there, and again, derivatives aren't necessarily my area of expertise, but how about all the folks out there that discuss, and I think rightly so, the idea of all the banks and the hedge funds and everybody else… insurance companies, pension funds, that have been buying up all of this global debt, even junk bonds, down here just desperately searching for yield? Well, now with rates rising the value of those bonds as they're marked to market every day is plunging dramatically. What if you've taken those bonds and you've levered them up 10, 20 times? We're going to start seeing some dramatic headlines of hedge funds that are suddenly under stress.

Again, you just don't know how these dominoes are going to tumble into each other. The term I'll use again is unknown unknowns. So all these folks are out there trying to make a buck now, trying to assure their clients or assure their newsletter readers that they know exactly what's going to happen now that Trump's been elected. Well, they didn't even know Trump was going to be elected. I would advise everybody to be extremely cautious here and just to watch and let's just see if we can make some sense of things over the next few months before they take any dramatic action.

Mike Gleason: Now, Trump has planned to "drain the swamp". Do you think he'll actually do anything meaningful on that front, including when it comes to Wall Street? Because there seems to be a culture of cheating, fraud, and market rigging, something you cover often there at the TF Metals Report.

Craig Hemke: I wouldn't expect anything in terms of a change of the culture of Wall Street. Remember, Trump's kind of a creature of that. He's a banker in his own right. He's worked with the banks his whole life. I don't think he's ever really promised anything about finally going after the bankers and doing a perp walk and all that kind of stuff. I wouldn't expect Trump's justice department to be any different from the (Eric) Holder, Loretta Lynch scam that we've seen for the last eight years.

Now, I do think, though, the promises he’s made regarding changing in Washington, maybe we'll get something there. Number one on his contract with America that he put out a couple weeks ago was the institution of term limits. If he can get something like that done, oh boy. I'd be all for it. Obviously, no president or politician's ever going to get everything done that they say they're going to do. But if he can even just drain the swamp in that regard, make some changes as to how the political structure of the U.S. operates, well then that would really be a significant improvement and I'd be all for it. But these folks that think that suddenly he's going to really upset the apple cart and change the system, boy, count me as shocked if he actually does go off in that direction.

Mike Gleason: Yeah, we definitely tend to agree on that front. Well, as we begin to wrap up here, Craig, what are you looking for over the remainder of the year in the metals and, more importantly, into next year as Trump finally takes over the White House? Is this going to be a good environment for precious metals prices, and are the reasons we all wanted to own this stuff under an Obama presidency still going to be relevant in the years to come?

Craig Hemke: I'll take the back half of your question first. Absolutely. Trump has even had his advisors talk about gold exchange notes and stuff like that in the past. Again, you have no idea how the Chinese are going to react to all of this. I'm no fan of the Chinese, believe me, but they've got their own interests to tend to. They've been making progress over the last eight years to set up all these direct swaps to the yuan with all these other currencies around the world. They've been accumulating gold like mad, as have the Russians. Who knows how they're going to play their hand in the months and years ahead?

I have no doubt, nothing is changing my view about the physical metal that I hold and continue to stack. Now, in the short term, however, we talked again earlier about the control that these high frequency trading machines play in setting the gold price, as it were. Which, again, is not a physical price. That's the price of the paper derivative that gets traded back and forth. Yesterday, the COMEX set a new record in volume for COMEX trading. For just the front month December contract, they traded something like 800,000 contracts.

Do the math on that. It's like 2,500 metric tons of paper gold in just the front month contract for swaps yesterday. That's 80% of global mine supply. It was traded in derivative form on the COMEX. There's no actual gold trading hands. The only value of this discovery, the only price of discovery is the price of this derivative that nobody ever exchanges into physical metal. But yet, that's the price we quote. Okay, well whatever. In the short term, with the dominance of these high frequency trading machines that take their cues from the dollar-yen and from changes in interest rates, I think people need to be very alert and very wary of a short term drop in price.

Gold has held in there while we've seen this interest rate spike. We were 210 in the long bond in July. We're now 290. Yet, gold is only down about 10% in that time frame, giving back gains from earlier this year. I think we have to be very alert to a sharp drop, maybe closer to $1,210, $1,220 in the days ahead. Hopefully it won't happen. It's the last thing I want to have happen, but if interest rates keep moving higher these machines at some point are going to dump a bunch of their spec trading positions in gold and re-balance and re-calibrate versus a relative valuation of bonds.

You have to be alert for that. Silver has hung in there these last few days and it’s still in there $18.50, if only because copper is up almost for every day for the last three weeks in an extraordinary, almost parabolic, move. If suddenly gold starts to correct down in reaction to falling bond prices and higher interest rates, and if suddenly copper hits an air pocket back down, man, they're going to beat the living daylights out of silver as well. So in the short term, people need to be very cautious and aware of the risks that paper prices might fall and with it share prices as well.

In the long term, man, nothing has changed. Nothing. Man, it's the old Charlton Heston line, they're going to have to come pry my gold and silver out of my cold, dead hands, Mike. Nothing has changed, and people should be contacting your firm and using any drop in price to continue to accumulate the real thing because the price that you're seeing is just a price that's determined by derivative trading. The real metal is what you want, and it continues to be your only protection from all of these unforeseen events that are coming. And boy, nothing that has happened in the last couple days should change that.

Mike Gleason: Well, very well put. We'll leave it there. Wonderful insights as usual, Craig. We always enjoy hearing from you, and absolutely look forward to doing this again before long. Thanks for the time today. Now, before we let you go, please tell everyone more about the TF Metals Report and what they'll find if they visit your site.

Craig Hemke: It's a great community. It's folks who are all trying to get through this madness together. Like you said, we've been around now for, coming up, almost six years since the site went live. And we've seen a lot of stuff, obviously, in the last six years, but what we recommend is we're all in this together. We're all here to help each other through this madness. What I do, the commentary I give on a daily basis, the podcasts we do, the webinars we do, works out to about 40 cents a day, so it's not some exorbitant cost, 12 bucks a month. I think it's a pretty good value.

As we wrap up, I would just again really caution everybody. There's all this euphoria out there today that now the Dow, which is at an all-time high, is going to 20,000. I would offer a contrarian view. If the Chinese are, in fact, dumping treasuries, raising dollars, and they're now going to take those dollars and put them someplace else. The stress that's on all emerging market currencies could very well lead to a repeat of January. Just pull up a chart if anybody's forgotten. I realize we were talking 10 months ago and people have short attention spans, but go back and look at what was happening in January. We may very well be seeing that happen again, either later this month or next. People need to be alert to the risks, even just in the stock market, and not get complacent. Anyway, we talk about all that at TF Metals Report on a daily basis and I invite everybody to check us out.

Mike Gleason: Yeah, certainly interesting times ahead for sure. Going back to January and February there, those were, of course, very good months for precious metals, as they were the beneficiary of a lot of that trade that you're talking about there with the Chinese. So perhaps that repeats itself, we'll have to see. Well, excellent stuff. Once again, thanks so much, Craig, and I hope you enjoy your weekend. We'll talk to you again soon.

Craig Hemke: Mike, it was a pleasure. All the best.

Mike Gleason: Well, that will do for this week. Thanks again to Craig Hemke. The site is TFMetalsReport.com. Definitely a fantastic source for all things precious metals and a whole lot more. We urge everyone to check that out, and you'll want to check it out regularly for some of the best commentary on the metals market that you will find anywhere.