China’s stock market crash may lead to global ‘systemic sell-off’ – Tavi Costa (Pt. 2/2)

[vc_row][vc_column][vc_video link="https://www.youtube.com/watch?v=0-6wMOKuW90"][/vc_column][/vc_row][vc_row][vc_column][vc_column_text][/vc_column_text][/vc_column][/vc_row][vc_row][vc_column][vc_column_text][Music] so tavi in the second part of our discussion i want to focus on equities and then the miners i want to show this chart first and foremost this is a very interesting chart you're showing the relationship between u.s equities and chinese equities first of all can you describe why we've seen a correlation and i guess secondly why you think uh this divergence is likely to rectify itself and reconverge well i do think it's one of the the risks that we have here in the markets and it is a more deflationary risk than inflationary and that's given the levels of valuations we have in equity markets and this divergence is such an important one china really is a credit bubble in my opinion i remember back in 2018 we used to talk about it and the economy was about 40 trillion dollars worth of uh of assets in their banking system now we're about 52 trillion dollars and so it's a 314 percent of the of their gdp today and when we look at the banks in the chinese uh market uh you know industrial commercial bank it's it's about what a 5.2 trillion dollar assets alone which is about twice the size of jp morgan it's now about 40 since february 2018. so uh there are a lot of signs there you know if you look the required reserve ratio has been declining usually tends to uh lead to a little bit of the devaluation of the currency so i think the divergence that we're seeing right now it is signaling that the market could slow down you can also see the same issue if you look on a year over year uh basis of that of that line uh versus the the ice and pmi here in the us you can also see that that tends to slow down uh the growth here in the economy so i am i when you ask the stagflation question i think that that could lead to a stagflationary environment because uh for a brief moment i think inflation is going to be stickier than the the deceleration of growth and that's a big problem and so um i don't you know obviously ccp has the ccp has been proceeding on this crackdown over the domestic companies there's a lot of to think that that's you know that's just happening in china but you know let's you know this chart is to prove that china is not isolated the chinese economy is not isolated to the rest of the economy world economy at all and so be careful with that assumption in my opinion uh and and consider the fact that that may lead to a systemic sell-off in the global equity markets well tavi couldn't you couldn't one make the argument that uh the equities markets for the chinese side they've overreacted to the crackdown right and the tightening regulations happening from the ccp and in fact the yellow line showing the chinese equities that's been beaten down too much it's undervalued it's maybe the chinese side that will catch up to the blue line would you agree would disagree with that i would disagree but there's certainly a lot of folks that fall into the category of of looking at that chart and making that assumption that's a fine assumption i think that that's uh that's why there's a market for every buyer there's a seller and i think that the reason why i don't fall into the category is because i have study diligently uh what happens with credit bubbles and in my opinion this is a great example of one this is a a closed capital account economy i've never seen any economy like that build up a 52 trillion dollar banking system in that way and so i'm a little concerned that that leads to that that's not in the world it's just it tends to lead to a deceleration of growth that could be a total credit bust by the way uh but there is a there is definitely a lot of control from the pboc side and that's why i think that at some point it leads to the evaluation of the chinese u1 instead in order to recap those banks if you okay one more question on this chart and we'll move on if you take a look at your side note there you said that uh well divergence between chinese equities u.s equities in the chart player to crest gets advantage and you know bottom line is u.s markets have followed the chinese one down in the past so what wouldn't you say follow down what is the magnitude of this downward action because if you look at this yellow line these chinese stocks have corrected significantly from the tops of last year we're talking about we're talking about uh close 20 30 percent correction right yeah just the broad equities index and specific stocks have corrected even more i mean that hasn't happened in the s p 500 since uh well last march and then before that 2008 yeah and there's a reason why we saw this kind of weakness in the dollar as well because the level of the policies have been so extreme relative to other parts of the world and that's because of the dollar is the reserve currency of the world and allows the federal reserve rightly or wrongly to do what they have been doing more than other places and that definitely uh tends to uh to help on the growth side more than other places that are not supposedly capable of doing so much of this i mean if the the chinese u1 is is is a is a bad currency uh and and for whatever reason their m2 is today at about 36 trillion dollars with a smaller economy than the us the usm2 is somewhere close to 21 trillion dollars when we talk about money printing in the u.s i think a lot of folks have not looked at the credit growth in china as being astonishing and i think it's uh it's one of the issues that we're seeing there's a lot of signs in the in the chinese markets that tend to lead to issues in the overall economy and that's something i pay a lot of attention to one of them is the implied volatility of asian currencies we're seeing that picking up recently especially in three months and six-month horizons and that tends to lead to uh actually an increase in the vix and so i am paying attention to those things it's just one small part of our a significant but a small part of our portfolio uh because i deal as an insurance uh in other words i'm referring to a put option that we have in the chinese u1 relative to the dollar and that has been worked very well over the years for us and some other years it didn't and it doesn't cost us the whole year as a performance it's just an insurance at the way i view in in our portfolio but someone tell me sometime i look at this chart and say well that's a scary chart because that implies that what you're implying with downward arrow is that the blue line is going to fall to the same extent as the yellow line uh i mean is that is that is that more or less what you're implying or do you think that maybe the correction for the s p 500 would be a little less dramatic unless uh and the time span may not be so short well look it's uh it the the point of the chart is not to be uh dramatic even though i agree with you it's definitely very dramatic when you look at and uh it certainly suggests that we should be a lot lower than where we are today it wouldn't surprise me but look at the multiples that we are trading today in equity markets you look at median multiples segregated multiples average multiples everything looks expensive uh from from the tech sector to the only thing that is cheap today in the markets really if i'm not going to go down to the nitty-gritty really is just the commodity size the natural resource industries are actually really cheap but the other parts of the market extremely expensive and so i think there's a lot of issues and yeah in the past we've seen some brutal declines in equity markets am i suggesting that that has to happen though it does not have to happen it goes back to that commodities to equity ratio i don't know which one's going to work the commodities are going to go up a lot or is it the equity markets they're going to go fall a lot but it's a spread trade and that spread trade the beauty is if you find two asymmetric bats in both sides it's what becomes very compelling that leads to the mining site of the conversation now starting with this chart real free cash flow yield by sector and you're showing that the gold and silver miners are the only sector that are sh that is showing positive free cash flow right now that is natural change yet at the same time as you know the miners have been considerably beaten down from their all-time highs last year so talk us talk to us about this sort of uh divergence and fundamentals here we've got great great great cash flow but really poor stock price performance what's going on well it is incredible how they're really building up this cash balance right now and paying down debt improving their balance sheets in a way that we haven't seen in the past i mean we saw other times in history or where the comp those companies were making money but they're actually not prudently uh financially speaking right now there is a sense of conservatism and skepticism by investors forcing those companies to be conservative and that is the key part of it which i'm seeing there's another chart that i have that shows uh that we haven't even seen the m a uh you know the cycle start which is quite interesting now we that is the one of the the elite innings indicators of of of the precious metal cycle we haven't seen that yet and i think that what's happening is that there's a lot of fundamental growth happening in in the mining space along with a lot of embedded uh growth itself i mean we're seeing for cash flow growth in in numbers that we haven't seen in the past uh and those companies are actually improving their margins uh and their cost is not increasing as much as other industries just yet i would say that even even relative to other commodities even the base metals or agricultural commodities the precious metals companies look extremely attractive right now i don't know necessarily why um i i would say i have a few uh theories for why the capital allocators are not seeing this as an opportunity one of them is the fact of that skepticism in the industry we've been through 25 years of capital of being capital destroyers that those companies didn't make any money they were just losing money and misallocating capital everywhere uh and so right now we're seeing lack of exploration uh capex budgets are not increasing to the levels that you would expect to the levels that we are with gold prices and folks are sung up looking at gold prices while those companies who cares if gold prices stay where they are those companies are extremely profitable and so that is the whole point of it it will create at some point a huge liquidity floodgate that will come into the the very exploration projects there are very high quality uh which will be uh those companies are gonna have to replete uh uh replenish those reserves of those those uh those major producers they have been really depleting those reserves for so long that does lead to a very good point so hypothetically let's create a hypothetical scenario as a gold mining investor what i would like to see is my investment in a senior or junior doesn't matter whatever the case may be outperform gold even during a gold bear market which is what we've seen in other words i like it to diverge away from a bear run when gold declines that obviously wasn't the case because we've seen them both fall together but hypothetically if i were to see my mining investments go up during a bear cycle for gold what does the miner need to do what does the sector need to do to bring that kind of optimism to just the equity side well it's going to happen slowly the first thing that's going to happen in my opinion is the attractiveness of those gold miners and silver miners and even copper miners that will start becoming more fundamentally attractive in other sectors let's put it as an example techie industry or tech sector uh today is the first quarter or so that we've seen brick asheville yield for the gold miners to be above the the cashflow yield for the tax sector and so those are the the beginning of the changes for a lot of quant investors that tend to create those screens looking at uh fundamental data uh those guys are starting to see those show up uh another thing is uh we're seeing this this real improvement in the balance sheet side it's going to lead to my in my opinion to dividends uh we may see companies starting to pay down dividend which is something we haven't seen in a while in a large degree uh we're seeing that happening a lot of the energy companies already and so it's a matter of time they they have the money they will do that in my opinion and that's going to track capital two so those are the types of moves that they should be uh doing uh soon and and that's in my opinion gonna be the thing that will uh increase i mean if you look at pension funds and large capital look at they don't have any allocation towards minors today and so i think that that's a real asymmetric opportunity in my opinion i'm very focused on those minors and i think that it's time to own a lot of the explorers where there's a lot of high quality projects that have been bidding up in the last years or so and like i said as those companies become fundamentally strong they're going to be more likely to to uh to start an m a cycle so i think that that's uh that's going to lead to a lot of appreciation in those smaller names too one final chart i want to show this is really interesting commodities versus mining labor market a classic early sign you right of a commodity cycle mining industry non-farm payrolls near historical lows labor and capital constraints are the amplifiers of bull market in resource stocks so in the red line you're showing the u.s employees and non-farm payrolls in the mining industry in the yellow sorry the white line rather you've got the equal weight commodity index so what we're seeing right now is again a divergence what does this chart tell you oh so many things first of all this chart almost speaks for itself but at the same time if you look at those bottoms in the red line where we've seen the difficulty of of of finding labor in general certainly leads to a large appreciation uh in in or at least a bottom in this in this in these levels i mean we've seen this happen uh for some time now with capex really diverging from uh from the actual price of the metals uh in the last uh you know 24 months and 36 months or so and those those are important parts i mean if you are in the mining industry you know that has been it has been incredibly difficult to find skilled labor now on top of that uh the infrastructure in place has been also very difficult to find uh we've been struggling finding drill pads uh even the right uh drillers to do the job that we need to in the exploration side of uh some of the the projects we've been funding at kraske capital and so i think there's a quite a lot of very interesting signs that this is not a a usual thing that happens at the peak of the market certainly and so uh you know the amount of geologists that we're seeing right there's there's a lack of geologists worldwide it's uh and so uh i think that those those those problems which started really with the esg issues and the green revolution that uh you know in a counterintuitively way uh really began to uh to to make those companies not uh spend money and spend capital towards those industries and those industries are now starting to get very attractive not only the energy sector but the precious metals sector an entire commodity space looks really attractive i have another chart looking at the energy related labor market as well it looks very similar it's it's difficult to find labor market in the energy sector too and so it this is happening it's a problem that is happening globally uh and i think that usually it's it's another early uh signs of of where we are in this secular bull market for precious metals it goes back to the mna cycle thing uh it goes back to usually companies that start to really lever up at the end of the cycle we're starting we're seeing the largest repayments of that in history uh we're seeing really large free cash flow numbers uh you know cost of uh of things as a whole have not begun to rise in a significant way operating expenses are still relatively low compared to other peak cycles that we've seen especially 2011 and so there's a lot of signs that we're still at the very bottom here i wouldn't say bottom but i should say early innings uh to mid-early innings of this fresh metals secular bull market let's put all this together now tavi for the audience we've got uh your bullish outlook and commodities your bullish and the miners obviously however you're cautious about the broad equities index in the u.s as a whole so given these uh i would say uh different uh almost contradicting outlooks would you be buying miners right now or would you wait a little bit before before getting in if you were somebody on the sidelines let's say well first of all i want to point out i don't have the crystal ball but i i would i would because i see all the the macro signs are uh writings are in the wall right now so it's pretty clear to me uh that the the financial you know if you're if you're not a believer that the fiscal stimulus will continue to be the case and that the economy will be able to grow organically without the need for fiscal monetary stimulus that there is no need to suppression of interest rates going forward if you're a believer of that do not touch this whole industry i don't believe in that i think that we have started a lack of discipline that started in the 70s we're now seeing uh the real problems of this and it's probably going to lead to inflation and those are the times when you have a difficulty of finding alternatives of investments that yield above inflation those are the times that you want to own commodities and when i look at precious metals there are the cheapest ones now relative to uh even overall commodities uh today especially silver and so i like the miners quite a lot i think that you can go down the list and take the explorers too and the developers uh if you want to take higher risk but also you know uh there's also higher risk embedded in those names too and so but i like i like that as an opportunity for the next few years i use the word contradicting because that assumes of course the word contradicting assumes that they both fall together it's possible that the s p 500 falls but the minors outperform right it's possible well we've seen that actually in the great depression uh in 1929 uh well home stake mining was going up at that time uh while we saw a major decline in equity markets we saw 1973-74 uh when there was a real estate inflationary kind of bus where inflation was rising still and the economy was turning lower what happened was miners diverged from the equity markets and in 2000s where we saw the tech bubble starting to bust and that the miners really began to uh were highly correlated to the equity markets at the time they declined together and then they started to diverge massively and so uh you know people tend to fight the last war because they remember what happened in a way and they remember what happened in march uh 2020 but that's not necessarily the case in history all the time i would say that most times especially in what we're seeing right now where folks would be very much aware of what the federal reserve would do if there is a 30 decline in equity markets what do you think they would do immediately would be a company in my opinion by large amounts of monetary stimulus in order to uh to fix the issue and fix i mean not necessarily really fixing the problem and so i think that that's what creates the the possibility of a divergence in the future but i don't need to be right on that i think that there's a lot of uh like i said before the convexity in this trade is quite interesting in my opinion and so the commodities to equity ratio spread should continue to lead a higher price and i don't know which one is going to lead which way but in my opinion commodities look extremely undervalued right now and still are poised to go much higher all right well fantastic thoughts we covered a lot of ground today thank you so much we'll catch up with you again soon thank you thank you for watching kikko news stay tuned for more [Music] [Music] you<br><!-- wp:image {"id":1776,"sizeSlug":"large","linkDestination":"none"} -->rn<figure class="wp-block-image size-large"><img class="wp-image-1776" src="https://en.videoencontexto.com/wp-content/uploads/2021/10/Chinas_stock_market_crash_may_lead_to_global_systemic_selloff__Tavi_Costa_Pt_22_0-6wMOKuW90.jpg" alt="China’s stock market crash may lead to global ‘systemic sell-off’ – Tavi Costa (Pt. 2/2)" /></figure>rn<!-- /wp:image 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China’s stock market crash may lead to global ‘systemic sell-off’ – Tavi Costa (Pt. 2/2)

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