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Virtual Strategic Investment Conference 2020: Notes from Felix Zulauf Interview

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Virtual Strategic Investment Conference 2020

Discussion of Felix Zulauf (Zulauf Asset Management AG) and Grant Williams (author of Things That Make You Go Hmmm…)

Please note: Please forgive any typographic or grammatical errors.

Following are my high-level bullet point notes from Felix Zulauf’s discussion with Grant Williams, author of Things That Make You Go Hmmm… at the 2020 SIC.

Felix is a global macro investor with over 40 years of experience in the markets. As a side note, I’m a subscriber of his institutional research letter. It’s excellent.

I have learned so much from Felix. He is sharp, and straight to the point. I believe you’ll walk away with a much clearer understanding of how markets, currencies, trade and debt impact investments.

Grant does an excellent job leading Felix to answer today’s most pressing issues. Felix talks about the equity markets (a trading range within the structure of a cyclical bear market with the potential to retest the bottoms with a 30% to 40% potential downside before the bear market is over), he favors the U.S. dollar, sees the EU as a flawed structure with potential for bail in’s and capital controls, sees deflation now and risk of inflation a few years away and talks about hyperinflation (specifically the country’s most at risk), he remains bullish on U.S. Treasurys (though late in the game) and he is bullish on gold. Towards the end of the interview he shares how he manages his own wealth.

I believe you’ll walk away with a much better understanding of the most pressing issues of the day. COVID, world trade, debt, demographics and how you may think about navigating the period ahead. I hope you enjoy the notes as much as I enjoyed both listening to the presentation (several times) and then organizing the notes into bullet point format. (Bold emphasis is mine.)

Thanks for reading and please feel free to reach out to me with any questions.

Best regards,

Steve

GRANT: Felix, I’ve been back and reading some of the—some of your pieces over the last few months in preparation for this conversation. And, you know, it’s uncanny, actually, how spot-on you’ve been about everything. I mean, reading your work again is like reading a history book. I mean, it’s amazing. And you’ve talked about all the stuff that’s going on and we’ll get into that today. You’ve focused on the dollar. You’ve focused on Europe. You’ve focused on the post-pandemic disconnect between the facts and the seemingly distorted reality of equity markets, all of which are fascinating. But I just wanted for me to commend you upfront for the phenomenal work you’ve done and the prescience of your insights.

FELIX: Thank you, very much, Grant. I can reciprocate because you do a great job with your publication as well. It’s too much praise, actually. I did a few things right, and I’m usually happy when my bottom line is positive, and it has been. So, I’m relaxed.

GRANT: Well, this is one of the reasons I love you, is the fact that you think that’s too much praise. We’ll agree to disagree on that for now. But what I want to get into right away is the term depression, and you put a piece out today, in fact, which I eagerly read when it dropped into my box this morning. Talking about this idea of a new Great Depression, because it’s something that there’s been an awful lot of talk about, and I think people have a great deal of trouble framing what that means in long term, so I thought you did a great job in that piece this morning talking about why a depression is absolutely the right term to use, but how it might be different. So, could we start with your thoughts on this Great Depression of the 2020s.

FELIX: Well, a recession is the part of the business cycle that cleans the system from the excesses of the previous expansion. And a recession usually lasts only two to three quarters or less than a year, and it does not really change the thinking and behavior of economic subjects (like the corporate sector, managers, and the individuals/consumers).

  • A depression is different. A depression goes deeper, and it lasts longer.
  • I think this is not your grandfather’s depression of the 1930s. This is very different. There are a few similarities, but there are very important differences.
  • This depression, I think, will last at least two years. It could last much longer. We have had a decline so far, what we know from all the numbers that we are off about 10 percent. GDP is down about 10 percent, more or less.
  • So, we go from 100 to 90. And as we recover, as we open up, as we loosen the restrictions, et cetera, we may go back to 94, something like that.
  • And then, the most important difference to a normal recession, you get into the second-round effects.
  • It’s very important how you enter such a decline. When you enter the decline with very strong balance sheets, et cetera, and very strong cash flow–positive corporate sector, then it’s no problem. You do not go into a depression; you stay in a recession and you come out of it quickly.
  • But this time, we entered this decline with the corporate sector that has more debt than ever around the world, a corporate sector that was running large financial deficits, which means they had to borrow to pay all the expenditures, including dividends and buybacks, et cetera. The deficit in the U.S. was about $500 billion last year.
  • In Germany and France, it was about $100 billion euros, in the UK, about $45 billion.
  • And now we have, at the present time, the last two months, we have approximately $100 billion net cash flow in the U.S. corporate sector per month. That means we have such tremendous pressure on managements to really cut costs.
  • And that’s the next step (that we will see), and this is what is very different from recessions. Corporations now they have to repair the balance sheet, and this is what Richard Koo really made famous when Japan entered the Big Depression in 1990—he called it the balance sheet recession.
  • That means that you have to repair balance sheets. You have to bring your equity capital up. You have to cut costs to the bone, et cetera, et cetera.
  • You cannot do that in two or three quarters. This is a multi-year process that is on the way. And that means (when) you cut costs and you cut somebody’s income at the same time. So that means a lot of the jobs that have been lost will not come back.
  • And this turns the sentiment of the private households much more conservative. It also turns the sentiment of the corporate sector because there are many subcontractors, much more conservative.
  • And that is the difference from a normal recession. It’s a much longer process at the lower level because you stay below previous break-evens for much longer than used to be the case in previous recessions. That’s the main difference.

GRANT: You know, I think we all—when we visualize a depression, we think of unemployment and food kitchens and long lines and that kind of… those black and white grainy photos that most of us, that’s the only memory we have of the Great Depression. So just talk a little bit about how this will be different on the ground and the difference that the various tools that central banks have today make, considering the absence of a gold standard.

FELIX: You know, in the 1930s, we had no social welfare. It was virtually zero. It started to build and grow since then. I could show you a chart of how it has grown. It’s a growth industry.

  • Social welfare is a growth industry. It is now maybe at 30 or 40 percent of GDP in social welfare in many countries. We didn’t have that. We also had a 20 percent deflation.
  • We might have mild deflation of maybe two percent or so, very mild deflation in coming quarters or coming two years or so, but we won’t have 20 percent. (SB Here: Dr. Lacy Hunt sees inflation going from near 2% to -2% so call it -4% deflation.)
  • That means our GDP will not be cut in half, as was the case in the 1930s.
  • We also have a completely different framework to work with in central banking and in fiscal policies. Think about, most of our fiscal authorities have run deficits, before this crisis hit, that were bigger than at the deepest point in the U.S. depression (1930’s).
  • The S. government ran about 2½% fiscal deficit in 1934. That was about the most they had during that period. So this is very, very different.
  • They had the gold standard, so they could not create liquidity unlimited as they can today. So it’s a completely different frame work.
  • Today it’s much more comparable to what happened in Japan when Japan started to support the system. And they have been supporting their system ever since, over the last 30 years.
  • They put on a yield curve around zero percent, they basically socialized the bond market. It’s a nationalized bond market. It has no use anymore for savers. That’s what it is.
  • There is no growth in an economy like that.
  • The other factor that is on the bearish side is demographics. We should not forget that. I have been pointing to the demographic challenge for years in my publication, because, you know, from the early 50s to the early 90s, the world population between zero and 65 years old grew by about 25 million per year.
  • We declined to zero in 2018. Now we are negative and it will be shrinking down to 12 million negative growth into the early 2030’s.
  • This creates a much different background for economic growth than what we had previously. So, this is the challenge that we are facing, and we cannot change demographics overnight with a little bit of money throwing at the system. You cannot change that.

GRANT: So, you know, it’s interesting because what I’m hearing is that the tools they have available to them today which they didn’t have in the late 20s, early 30s, are around the kind of restrictions that the gold standard put on. So, yes, they can print. They can run up huge deficits now, which hopefully will alleviate the pressures caused by the main problem in a depression, which was unemployment from a societal point of view. But there will be other unintended consequences. So just walk us through your thought process if they throw everything at this, which they seem to be committed to doing already. How does that come back to bite them? What are the things that we need to look out for in terms of the negative side effects of this policy that we’re seeing?

FELIX: Well, obviously, when you are in a balance sheet repair process, you do not take up new debt, and if you do not take up new debt in a credit-based economy, you cannot grow.

  • You know, it’s as simple as that. So the private sector won’t grow by much. It’s impossible in this sort of environment.
  • What you can do is the government sector can step in. And the government sector can replace part of the lagging demand from the private sector. But then you go into more government expenditures, work programs, et cetera, et cetera, and you finance all by printing money, and the central bank buys the debt, et cetera, et cetera. You can do that.
  • When you do that, you create a less efficient economy—you create more debt. More debt eventually reduces the productivity of debt. I think Lacy Hunt did a great job in showing that in his presentation and the velocity of debt continues to decline.
  • So that means the central bank can shovel as much money into the system as they want, but you do not get the private sector taking that money as a loan and do something in economic activity terms. For instance, in March and April, the Fed put a lot of—injected a lot of money into the banking system. It goes all through the banking system. The immediate consequence was that the banking system in the U.S. grew by about 12 percent immediately. That hit the point where the banks hit the border of the capital adequacy function. That means they cannot lend anymore because their asset base has ballooned. That means it curtails the lending process in a sense.
  • So these are unintended consequences that are happening in the very short-term, actually. In the long-term, zero interest rates, lead to a planning economy, a planning economic system. And you—I don’t have to tell you a communist system is not efficient.
  • It doesn’t create prosperity. It leads to political backlash. It leads to a revolution against the authorities, et cetera, et cetera. And that’s when gold comes in. Once the constituencies lose faith in the authorities and their governments, then they run away from the system and they run away from that money, and that’s when the gold market takes off.

GRANT: Well, I’m going to save any talk of gold to the end for very deliberate reasons, which I shall come to when we get there. But when I hear you talk about this stuff, the one word that just keeps popping into my head is inflation. Now, is that something that we need to be worried about? In the short-term, I feel probably not. Deflation is still going to be the prevailing force. But do you see inflation as being the problem that we really have to look at, and if so, in what sort of timeframe do you see that playing out?

FELIX: I think for the first one to two years, the problem is rather mild deflation, and mild deflation is a bigger problem.

  • Once, I talked about inflation with a central banker and I asked him why he wants two percent inflation as a target, because it doesn’t make sense to me. With two percent inflation, I lose half of my savings during my working period in life, so it doesn’t make sense.
  • He said, well, a little bit of inflation makes the wealth distribution process much easier politically, you know, and it’s true.
  • If you have mild deflation, it’s tougher, because you have to cut in some areas and cutting hurts much more than increasing less. So it’s a psychological thing.
  • I do not see inflation as the immediate threat. I could see it a few years down the road. If the economy stabilizes and the programs and the financing by central banks grows bigger and bigger, then of course, you will see certain scarcities.
  • You will see cost-push inflation. That is possible.
  • From there, it takes quite the bit of a quantum leap to hyperinflation.
    • We probably see hyperinflation right now in Argentina. Argentina is in a miserable economic situation. The people run away from the currency.
    • They do not trust the corrupt government. The currency in the black market rates at half the price that is the official price relative to the US dollar.
    • And they when such countries get into such a mess, they increase the money printing process. And then the currency collapses like you have seen in Venezuela and in Iran, et cetera, and then you go into hyperinflation.
  • Usually for hyperinflation, the precondition you need is economic misery. That means prosperity goes down. You get to certain social revolution, a distrust vis-a-vis the governments, the authorities, and then you need direct financing by the central banks of government expenditures, and so far only two central banks have announced that.
  • The first, interestingly, recently, was the Bank of England, which was sort of shocking.
  • And the other one that is more dangerous is Brazil. Brazil announced a few days ago that their central bank will finance directly the government. So Brazil is in a situation that has a very weak economy, weak structures, high corruption, and a weak currency that is beginning to collapse against the dollar. You see it in the charts very clearly.
  • And if they start financing directly, they run the risk of hyperinflation.
  • Two other countries come to mind that are in a similar boat, Turkey and South Africa. So I would be very concerned about those. They all run large current account deficits structurally, and that’s a big threat.
  • I think, for us, for the industrialized world, we are not there yet.
    • First, we have mild deflation for two years, then we might have mild inflation.
    • And if we then start to see the things I just mentioned, I will get worried about in the second half of the decade, not before.
  • So I don’t see that risk, immediately. I know a lot of people are talking about it. That’s a monetary thing that they believe, you know, money supply growth translates into inflation or hyperinflation.
    • I disagree with that because velocity declines because the real economy cannot use up that money and do something sensible with it.

GRANT: Yeah, it’s interesting. When I hear you describe Argentina there, you know, there have probably been half a dozen times in my lifetime that you could be talking about that same country, right? And yet they managed to get away two years ago, a 100-year bond at a very low interest rate. So what does that tell you about the state of maybe pension funds or bond portfolios? Does that send a message to you about how potentially fragile they might be? Or is that just an anomaly?

FELIX: Well, obviously, we live in a world where we all run fiat currency systems. We have a fiat-based economic system and monetary system. And eventually you run the risk of high inflation.

  • By definition, when you can print money and you can print yourself out of, you know, immediate problems, eventually you add up those problems over time and you end up in an inflationary world.
  • That will also come to the industrialized world eventually, I believe.
  • So, bonds, when they trade as low as they trade right now, that’s a very unattractive proposal for investors, you know. That’s actually a certificate of confiscation. And that’s what they used in the late 1970s when they became slowly attractive for a 30- or 35- year bull run, you know, a 40-year bull run bond.
  • So I think bonds are in danger. It’s a guaranteed loss in many countries.
  • In the Eurozone and in Switzerland and in Japan, it’s a guaranteed loss in nominal terms and it is a guaranteed loss in real terms for many others. That means that pension funds that are obliged to have a certain percentage in the fixed-income area are at risk because they have guaranteed losses in the future.
  • And I think this is going to be one of the next big crises—the pension fund crisis in many countries—because pension funds are paying out pensions that they cannot earn anymore, and they are actually soaking up capital from the young and distributing to the older generation, which is unfair.
  • So I think eventually there is going to be a major problem and the shortfalls are tremendous. In the U.S. alone, public pension funds are down to 60 percent of what they should be to cover their future liabilities. And it’s very similar in many other countries.
  • The private pension funds are a little bit better or are quite a bit better, but they are not covered in full these days anymore.
  • So I think this is a problem for the future. And it all means that in a broad sense, we will get poorer in real terms eventually.

GRANT: So the one thing that this pandemic has done is in some bizarre ways, it’s kind of leveled the playing field because everybody around the world seems to be now facing the same problem. And for someone who looks at the world through a macro lens like you do, that in some ways must be an advantage because trying to figure out winners and losers and where to allocate capital becomes perhaps a little easier in terms of trying to work out who can deal with this problem the best. I want to jump to a few regions and get your thoughts on whether they come out of this stronger or weaker under various pressures, and I want to start in Europe. I watched your panel with the Gavekal guys the other day, and I wanted to get some more of your thoughts on Europe, maybe the Union itself, the pressures it might be under, and what might happen from a political standpoint. And also the currency, because you’ve written a lot about the euro and again, you’ve been spot on with your forecast. So talk a little bit about Europe as you see it under COVID.

FELIX: Europe has a bloody history, and because of that bloody history, after World War II, France and Germany, the two arch-enemies came together and said, “We have to do something about it.” So they founded the Common Market.

  • Eventually that grew into the European Union, and that was a good idea, actually. The Common Market was a very good idea.
  • And then they introduced the Monetary Union. It came about due to the wall coming down in Berlin, and the French feared the too-powerful Germany, and they said, “We have to integrate you more into Europe.” So they agreed on a monetary union, and that’s when the problems really started because it is a complete misconstruction.
  • It forces centralization because the different economies are completely different structurally and have different productivities, et cetera, et cetera.
  • Having the same monetary interest rate, currency, policy, and this means that the differences become bigger, so you create more and more imbalances. The weaker get weaker and the stronger get stronger, et cetera, et cetera.
  • So you have to rebalance that through a center. And that’s where the whole process turned into a centralization effort, and you know what that means?
    • When you try to centralize large regions, you lose productivity and your competitiveness goes down, et cetera, et cetera.
  • And that’s the mess in Europe. Now, we are at the point where that rigid structure of the euro is going to be tested.
  • The euro is a dogma. It’s a political dogma. You cannot discuss it. It’s a bad thing, does a lot of damage and harm, but it’s there and we don’t talk about it. We don’t discuss it. It stays there.
  • So as it stays there, when there is downward pressure in the economies, it needs a rigid system. You have to compare it to like fixed-exchange rates between the member nations of that European Monetary Union, and you lose the ability to adjust because you’ve lost your currency as an adjustment tool.
    • For instance, if a weak economy would suffer badly, the currency would drop and they would import less and they would become competitive in exports, and so it would be self-correcting. You lose all that.
  • Therefore, the weaker ones are demanding help from the stronger ones. So they want to mutualize the debts because the weaker ones are building up more and more debt all the time, whereas the stronger ones finance them.
  • And obviously, this creates anger between the two. And what they came up with today was a sort of a eurobond. The Germans didn’t want to go into a eurobond because it’s a debt mutualization. So they decided instead of a one trillion eurobond, they decided we have one half trillion or 500 billion of an increase in the budget, and the northern states pay for it.
  • In the EU, all 27 member nations must agree to get it through. Austria already said, “We reject it. We don’t agree with that, et cetera, et cetera.
  • So it’s going to be a long process. And in the meantime, the pressure on the weaker nations and economies continues and intensifies. And that’s a big problem because the banking systems in those countries are hardly in a condition that they could absorb all the loan losses that are coming over the next few quarters.
  • Therefore, because we have the bail-in clause in Europe (put in place since the last crisis), that means that depositors could lose their deposits and get, in return, shares of the bank, so they could increase the equity capital of the bank by using depositors’ money. When depositors realize that that risk is increasing, they run away with their money and they run away—not just from that bank, but they run away from that country.
  • And I think the risk is that some of the southern countries have to introduce capital controls. That means they have to lock in the capital in their countries and in their banking system because otherwise it would weaken their banking system in addition to the weakness of the loan losses.
  • And if you have that, capital controls inside a monetary union, it’s basically the end of it.
  • I mean, it loses all confidence among investors, and investors in the world will turn away from the euro. And the euro would then probably have a decline of 15, 20 percent, or whatever.
  • So I think the euro over the next 12 months is really at risk of breaking down. If you look at the chart, it has a long-term uptrend line and it comes through at about 108, 107. We are right there. We are now jumping off. Actually, yesterday I went tactically long some euros just for a short-term trade. But my strategic position through options is to be short the euro against the dollar. And, you know, it could decline to 98.5 or something like that against the dollar. That’s a tremendous move for the foreign exchange market. And that’s why I would recommend using the option market to place such short positions.
  • So it’s coming to—it’s coming to a decision, you know. And I think it’s going to happen this year.

GRANT: You brought up the dollar there, and obviously the dollar’s been such a hot topic for a couple of years now and everybody, like everything else in society today, everyone’s picked a side and they’ve just gone as hard against that wall as they possibly can. You know, I understand the side—you’re on the side of a stronger dollar, but your reasoning behind it has been a lot less hyperbolic—has been a lot more reasoned than a lot of the people that I’ve read. So I’ll just let you talk about the path you see for the dollar both in the short- and medium- to long-term, and also the rationale behind it, because I think people could take a lot from that.

FELIX: Usually in the currency markets, investors look at and compare, you know, monetary policy, fiscal policy, current accounts, inflation rates, interest rates, nominal and real, et cetera, et cetera. And then they come up with which one of the two currencies of the pair they like better. That’s how it usually works.

  • I think what they are neglecting—and there is a lot of bearishness out there for the US dollar—I think what they are misunderstanding is that the world is in a shrinking process. Globalization is running backwards. World trade is weakening.
  • When that happens, it’s usually in favor of the currency that usually performs best in declining or weak economic environments. And the dollar has always performed best in a shrinking world economy.
  • And that has some reasons. You have to understand that the global financial system is dominated by the U.S. dollar. And there is a lot of money outside of the U.S. that is U.S. dollar–denominated.
  • Just in the last 10 years, the emerging markets have increased their U.S.-denominated debt from $6.8 trillion to $13 trillion. So there is a lot of debt owed that is denominated in US dollars.
  • Now, if the banking system begins to tighten because we are in a difficult economic environment—and that’s what usually happens when the economy goes down—then, of course, the intermediaries in the system tighten and the end-borrower has to pay back his loan.
  • Usually in an expansive phase, the loans get rolled-over all the time. That’s the normal process, and as they get rolled-over they get increased from time to time, so that’s the process. Now, all of a sudden, the intermediary says we want the dollar back at maturity. They say, “Pay back, please.” And the borrower says, “I cannot. I don’t have those dollars.”
  • Then what do they have to do? They have to go out in the market and buy dollars. And basically, the huge U.S. dollar–denominated debt sector that is short-term out there in the world outside of the U.S. is really a huge short position in U.S. dollars, and that’s what the people are missing.
  • And the other thing that people do not understand or do not think about it—or I haven’t read it anywhere else–is when the world economy shrinks, the big losers are the big exporter economies, the Germanys and the Chinas of this world because they import and export less in a shrinking or weakening economy. That means from their GDP growth, they deduct the net figure. You know, when they export less, the net exports, the trade surplus shrinks, that’s a deduction from what it used to be. The biggest importer in the world is the U.S.
  • It runs a huge trade deficit with the rest of the world. Obviously, when they import less because they consume less, the deficit shrinks. That means it gets added to GDP. So the big net importer of the world is a relative beneficiary, while the net exports are relative losers.
  • Nobody wins in a shrinking world economy, but you have relative winners and you have relative losers. And the relative winner is the U.S.
  • And that’s why you have a tremendous flow of capital into the US dollar. And that keeps the dollar high and will probably keep the dollar strong on a major trend basis until this recessionary/depressionary period begins to normalize.
  • I think then the dollar, with all the flaws it has, structurally, could decline for cyclical reasons in the next upswing. Usually the dollar weakens in a cyclical economic upswing and it strengthens in a cyclical economic downswing.

GRANT: So you—a couple times you touched upon trade flows, globalization. Have we reached the end of globalization, and if so, what does that mean in terms of the restructuring of supply chains, potential stress points? Mexico is one that, there are potential stress points there as global supply chains change. Talk about that whole infrastructure of global trade and how you see that evolving from it.

FELIX: Well, for the last few years, I have been beating the drums and telling people that globalization is over and the movie will run backwards in the next 10 to 15 years or so. And it has started, and this is not only because of President Trump.

  • The problem started before, and one of the problems is that the Chinese system and the Western system, the two systems are not compatible. The Chinese system is like the Japanese and the Korean system was when they developed their economies.
  • What they basically did was they created full employment and overproduced and the overproduction was dumped in the world markets and they went for market share in the world markets and they didn’t make a profit.
  • The World Trade Organization was really set up that the members of the World Trade Organization run their economies to make a profit, that the corporations participating run for a profit.
  • Now, with all the state-owned enterprises, all that, and guaranteed and financed in a hidden way, companies in China, you know, they do not run for a profit. They run for employment. They run for market share, et cetera.
  • And the two systems are incompatible. And that’s why I said a few years ago before the trade war started, “This is incompatible, and this will lead to frictions.” And, obviously, President Trump instinctively realized that there is a problem, and he spoke up. He addressed it and he said, “You are behaving in an unfair way.” And he is right. I think he is right.
  • Well, it could have been done better than how he handled the situation. He was very aggressive. And obviously, we have the problem of two leaders who want to present themselves in their own nations as powerful leaders of the number—one and they want to be number one, you know.
  • And this creates additional friction because the two cannot talk to each other friendly and pragmatically. So I think this situation could escalate.
  • If it does escalate, and it turns into a full trade war, then we have another whammy on the world economy, of course.
  • Because what happened actually with the lockdown was very similar to what happened initially with Smoot-Hawley. All of a sudden you shut down a big part of the economies. So we have to watch that very carefully. The trade situation is problematic.
  • I think corporations are rethinking their supply chains. I do not believe that overnight, all the supply chains will change. I think first they will introduce dual supply chains that are closer to home and in their regional markets so that in case there is a risk elsewhere, we have another supply chain. I think that will happen, but eventually the big loser will be China.
  • I think they will lose part of the business and the business will move elsewhere. And it makes sense for the US companies to have the suppliers and subcontractors in Mexico rather than in China. It’s close—or its right over the border. They are neighbors, you know each other, et cetera, et cetera. So there is going to be a lot of change, but it’s a slow process over many, many years.

GRANT: Well, you know, given all this, I want to get into some of the questions. There’s a clear winner in the question stack, and that is given everything we just talked about, talk a little bit about your asset allocation over the next three-, five-, 10-year time period. There’s a lot of people who are interested in that.

FELIX: Oh, ten years is way too far out.

  • Well, I do believe that the equity markets are still in a bear cycle. But I do not see a ‘29, ‘32 type of bear market decline of 90 percent. I could see 30 to 40 percent or so declines because eventually the reality of a retarding economy and depressed profits for much longer than the reshaped crowd believes, will hit the market once again.
  • The stock markets are bifurcated. You have basically a continuation of the bull market in certain segments. That’s information technology and it’s healthcare—including biotechnology and some consumer staples.
  • And I think those are the old leaders that remain the new leaders. And that continues on a major trend basis. But they will have shakeouts. They will have serious shakeouts.
  • The cyclicals and value stocks are the real losers because they need economic growth to prosper and they won’t get that economic growth to prosper for the next one to two years. So I think they just sit and are dragged down, et cetera, et cetera.
  • So I’m more trading the markets than investing. I actually sold my long-term equity investments in early 2015 and since then I’m more trading than investing. I still own some Treasury bonds.
  • I’ve LOVED them forever. You know, I’ve been in Treasury bonds since ‘81. A lot of zero-coupon bonds, et cetera, so I still hold them, but I’m not bullish because the yield level is just too low.
  • I own a lot of gold, but I think gold is probably in for some temporary peak here in May, June. I dislike the hype that is going around.
  • I think most of the gold bugs are wrong in their reasoning. They are reasoning that there will be inflation and a dollar decline, et cetera, et cetera, and therefore you have to own gold. I think that’s the wrong reason.
  • I think the reason to own gold is because there are economic problems, dislocations. There is a growing mistrust in the governments, the authorities, and the whole legal fabric and framework of our system. And, therefore, you move part of your money outside of the system.
  • Gold has no liabilities, can sit outside of the system. So I love a lot of gold.
  • I own some private equity investments, of course. I have some private debt. I think private debt is a category if you do your homework, where you can get a decent return and you can get it—if you talk to the right people, you can get it all collateralized in a way. So if something goes wrong, you own collateral. So I own some of those.
  • I own art. I own commercial real estate.
  • So I have the whole variety. But the way I manage it is, basically, I have different pillars. I have the equity pillar, the gold pillar, the fixed income pillar, and the real estate pillar. Art is separate.
  • And then I have currency trading because I overlay my currency exposure and I do trade. Usually I go in my overlays (leverage) from +100 to +200 when I go long and I go -200 when I go short of what I’m long, so I hedge with 100 and go another 100 short. Those are the maximums of the overlays and I use that for all the asset classes I own.
  • And in real estate, I short real estate companies that are listed to hedge my commercial real estate exposure.

GRANT: Right. There’s a couple of thoughts I want to jump on there, but I want to make sure we get some, there’s a couple of other questions that plenty of people want to ask you, so I want to get to those quickly. Can you expand upon your concerns over the Bank of England being the first bank to come out and start monetizing the Treasury. Can you talk a little bit about your concerns—expand on that—and talk about your views on the British pound in the next short- to medium-term?

FELIX: Well, Great Britain is an interesting case because they are now, they have exited the EU, and if they do it right, they could become the most prosperous place in Europe because they could be home for all those who feel uncomfortable with the growing socialism on the continent.

  • So I would recommend to Boris Johnson that he sets in place an attractive framework for businesses to manufacture and do services out of the EU and also for wealthy individuals, that they feel home there, and when you get the prosperity, they move in with their capital, the economy will flourish and blossom. The EU doesn’t want that, of course, so they make the exit very difficult. And if the EU tries to punish the UK for exiting, I think that’s the biggest blunder they can do because that creates an example—oh, this is a club.
  • If you once belong to them, you cannot leave anymore. This is so wrong.
  • The European politicians are so wrong. They are so from a different planet, it’s just unbelievable. They are destroying their own continent. They all mean it well, but they operate with the wrong software.
  • So I think the pound could become an attractive alternative to the US dollar, certainly against the euro. I see the pound sterling over the next few years stronger, if the Bank of England, you know, returns to sound monetary policies. That’s the if. We have to monitor all that carefully.

GRANT: The now second most popular question is an interesting one, given the state of the world around us. There’s someone asking, if you weren’t lucky enough to be Swiss and you had to choose a country in which to be a taxpayer, which one would you choose? Where do you still see freedom and prosperity are still high?

FELIX: Well, Switzerland is still fine. It is not as good as it used to be, unfortunately. And the trends are going in the wrong direction, but inside Europe, it is probably the best place.

  • It is not only nice to live here and raise a family because the landscape is fantastic. You have everything close by. You have your lakes where you can swim. You have your mountains where you can ski and hike. You have a population that is not aggressive, but Switzerland is changing and we are part of Europe.
  • I like the diversity of the culture in Europe. I like that. And we have it inside our own little country. But unfortunately, the trend is influenced by the EU’s trend. It’s in the wrong direction, but I think, you know, the tax system in Switzerland really depends on where you are. I’m sitting in Zug, which is the most attractive place. Foreigners can have bargaining deals if they are big enough, which could be attractive, as it is in the UK. The UK has similar options. Right now, I am paying more than I should, more than in my other domiciles, on an island in the North Sea, and in Florida because we have a wealth tax in Switzerland. And while the wealth tax is only .2 percent here in Zug, it’s a lot. It’s a lot, and it really brings me up to 45, almost 50 percent of my income, because my income nowadays is low.
  • What I do with my letter is a nice little business, but I do it as a hobby. I, you know, I have retired from running hedge funds and aggressive money, et cetera, et cetera. Switzerland is still fine.

GRANT: Are there any other places that you would think people should look at?

FELIX: The UK. London. Absolutely, attractive, very metropolitan. But they have to do it right. They have to do it right. You know, pound sterling before World War I, when they entered World War I, pound sterling traded at 35 Swiss francs. One pound was worth 35 Swiss francs. When I went to school in the 60s, in the 60s, we calculated with 12 francs. So it went down from 35 to 12. Right now it is ~1.20, another 90 percent down. So that tells you which one to choose.

GRANT: Well, Felix, sadly, we’ve run out of time. I apologize for the questions we didn’t get to. I had a whole list of my own, I didn’t get to. So I’m going to bug you with those once we’re off the call, I suspect. But look, thank you so much for joining us. Again, you talked about your little hobby there, but for those of you watching, Felix’s little hobby is an extraordinary product that if you haven’t had a look at it, you really ought to do that. Felix, again, my thanks. Hopefully you and I can get together in person again soon, even if we have to stay six feet apart and whenever that may be, I really look forward to it.

FELIX: I hope so, too. Thank you very much for the great questions Grant, thank you.

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