Why This Recession May Be Different From Ones We've Seen

Ivan Martchev  |

Image: Marriner S. Eccles Federal Reserve Board Building. Source: iStockphoto, traveler1116

The Fed’s balance sheet went up by about $1 trillion in the month of March alone, reaching a record $5.25 trillion. As bond and repo markets began to malfunction due to the record scramble for cash (or liquidity at the institutional level), the Federal Reserve had to again become “the lender of last resort.”

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The Fed has always been the last place everyone turns to when the system is malfunctioning. Even though the parallels with 2008 are easy to make, there is a very big difference. In 2008, the banking system was sick with bad mortgage loans and leverage, where mortgage collateral was shrinking at an alarming rate.

Today, the banking system is very healthy. The big difference with 2008 is that this is a government-mandated recession. The government has stopped the economy in order to stop the coronavirus. It’s like turning off the circuit breakers in a house with the emergency backup power for essential services only.

Second-quarter GDP growth in the U.S. could be down double digits. GDP numbers are reported on an annualized basis, so if U.S. GDP is down 10% from the prior quarter, it would be reported down by 40% on an annualized basis. By the same token, third-quarter GDP in the U.S. could be up in double digits because of the same calculation, if the U.S. government has managed to flatten the curve of the infection.

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This is the first government-mandated recession. It did not show up in any economic indicators ahead of time because it was not driven by a deteriorating economy. It will be over soon if the stock market sees a “flattening of the curve” of infections or a clear slowdown in new cases that would indicate light at the end of the tunnel. Because the Fed has thrown so much money at the problem, on top of the $2.2 trillion deficit spending bill signed into law Friday, this could be the shortest and sharpest recession in history.

Before this viral panic started, unemployment was at 3.5%, yet initial jobless claims in the last week of March soared to 3,283,000, which is an all-time record. I wonder what the unemployment rate will be by election time. I think it will be in double digits. I do not believe it will stay in double digits for long, if the government handles this pandemic the right way and we see a peak in infections in the month of April.

I think it is possible for the stock market to be rallying right into the November election, if the pandemic is contained and if the novel treatments that show so much promise produce tangible results. The odds are not insignificant that the stock market come Election Day could be exactly where it was in November 2019, when one looks at the S&P 500, with one huge swing up to 3400, then down to 2200 and up back to 2900.

Wouldn’t that be something?

The Midas metal shows rapidly rising relative performance against the CRB Commodity Index, as industrial commodities are crashing due to the coronavirus government-mandated global recession while gold bullion is staying firm, close to a multi-year absolute high. This dynamic has caused gold bullion to register a relative all-time high compared to the CRB index.

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What happened to gold after it registered its previous all-time high relative to the CRB in 2008? It doubled in absolute terms to a peak above $1,900 in 2011. We have a similar environment at the moment. Short-term interest rates have dropped to zero and the federal deficit will be larger than 10% of GDP.

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The other major precious metals – namely, silver, platinum, and palladium – went down a lot more than gold bullion in the past month, even though they have rebounded some. This is because they are primarily used for industrial purposes; only gold bullion has the majority of its demand associated with precious metals purposes, like jewelry or coins used for a store of value. If the coronavirus government-mandated global recession is not over soon, the industrial precious metals should continue to underperform.

Of the industrial precious metals, silver is the most interesting, as there is about a 60/40 split between industrial and precious uses. Silver is also at a record discount to gold bullion, as the famous gold-silver ratio went to 125 at the March extreme, which is an all-time high. That means one ounce of gold could buy you 125 ounces of silver, although we have retreated some on that indicator as silver has rebounded.

Because silver is more industrial than precious, if the coronavirus recession lasts longer, it will take longer to rebound. Be that as it may, it probably offers an opportunity to investors with a two-year time horizon. The silver miners exchange-traded fund, Global X Silver Miners, looks interesting on pullbacks, as does the iShares Silver Trust.

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Equities Contributor: Ivan Martchev

Source: Equities News


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