Oct 6, 2022

We are in the middle of a giant short squeeze, and it is going to get even bigger.

The main reason is: the starting point of sentiment was zero. We were in the 0^th percentile of sentiment. In the last 50 years of markets, it has never been worse—not even during the financial crisis. You may find that hard to believe if you lived through the financial crisis, but it is true.

This year, I’ve seen calls for the S&P 500 to go to 3,000, or 2,600, or 2,400, or zero. I’ve seen calls for interest rates to go to 9%. For a bond market crash. For a stock market crash. For EUR/USD to go to 0.90. For gold to go to $1,350. That the housing market would crash. That we would descend into another Great Depression. A few weeks ago, I sat in the office of a prominent Wall Street strategist, and he looked me in the eye and told me this would happen.

It did not happen.

The fundamental assumptions were wrong, but that’s not why I disagreed. I disagreed because bearish sentiment can only get too far in one direction before it snaps back.

I am a sentiment analyst. My analysis is not very useful at the 50-yard line. My analysis is only useful at the extremes—what we just experienced and what happened in early 2021. In about 21 months, we have gone from one extreme to another.

Financial Armageddon

Now for the fundamentals. You probably heard that the Bank of England rushed in to cap long-term yields in Britain, or risk pension fund insolvency. They spent $65 billion GBP in the process. It’s not quantitative easing. It’s yield curve control—it’s capping interest rates because if they continued higher, they would blow up the country.

This was my thesis back in 2008 when quantitative easing started:

1. That we were printing lots of money

2. That it would cause inflation

3. Which would make interest rates go up

4. But at some point, we would be unable to withstand the pain of rising interest rates and have to monetize the debt

5. So, you monetize the debt

6. Inflation goes parabolic

7. Gold goes parabolic

8. Financial Armageddon

When I first came up with this idea, I was 34 years old. I was an inexperienced strategist. What I did not understand was that this process would take decades to play out, and there would be a lot of ups and downs in between. My solution was to be long gold—which worked until 2011, and then we had a long period of disinflation and falling interest rates and gold prices.

As you know, we’ve finally got inflation, interest rates finally started going up, and the Bank of England had to monetize the debt. Note: this is not a short-term measure. They will always have to do this. This is permanent. Interest rates are permanently capped in the UK, and they will be here one day, too. It has happened before, and it will happen again.

Then inflation will really go bonkers. Gold too. And you end up with Financial Armageddon. This will happen at some point in the next 15 years.

In the short term, inflation is coming down—we will see in the next CPI reading that it is coming down a lot—the bond market will rally, and interest rates will come down.

But we haven’t yet addressed the root causes of inflation. This Fed is not willing to take the economy to -6% GDP to get rid of it. They never had the constitution of Volcker. So, one day, inflation will be back. And interest rates will rise again. And at some point, the Fed will be forced to cap yields.

That’s the point at which all risk assets fly, but especially gold.

Hypothetical

Anyway, all of this is purely conjecture. It is hard to predict 15 years out. It is hard enough predicting one month out. And, admittedly, this is the sort of macro-BSing that happens on industry panels that makes me want to gag.

But I think there are a few conclusions. One central bank capped yields. Others could do it. This is a green light for risk. That was the catalyst for this whole rally. And people realized that the Fed went too far, too fast and blew up our closest ally. I’ve always said the Fed would hike until they broke something. They broke something, and now, the party’s over. We won’t be seeing multiple 75-basis-point hikes in the future.

This is a roundabout way of saying that everyone was limit short, and we’re in the midst of what might be the biggest squeeze I have ever seen in my career. There’s no resistance for miles. This could go a lot higher and longer than people think.

What happens after that—well, we’ll deal with that later.

Jared Dillian

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