SCI Felix Zulauf 2 - imports.exports - CMG

Virtual Strategic Investment Conference 2020: Notes from Felix Zulauf Interview - CMG

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.

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.

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
• 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.