My background for about the last 12 years or so is I have been a full-time macro trader; a global macro strategy trader. I ran a hedge fund for a few years. So what I’m pretty good at is learning about situations from people, who really are experts in figuring out how to translate these things to financial markets. So what I can offer to listeners is I’ve talked to people, who really are experts on this. I’ve read a lot of their work. I’m learning as fast as I can about a subject I don’t know very much about. And I want to be very clear in admitting I don’t know very much about all of this epidemiology stuff. But hopefully I can help to translate what it’s going to mean to markets, which is, I think, what your audience is most interested in.

Preston Pysh  02:44

So, Erik, like you I’m not an expert in any of those areas either. But where I like to spend my time is in mathematics, particularly in finance. And when I’m looking at this from a number standpoint, and then you’re looking at the videos that are slipping up under the firewall out of China, things are not adding up for me from a mathematical sense. I get the impression that you’re seeing it from a similar point of view. So, in general, what are your thoughts from a macro standpoint on what in the world is happening here?

Erik Townsend  03:16

Well, I tweeted last week that I think it’s entirely possible that this could be the most mispriced risk in the history of financial markets. And that’s probably an exaggeration, you know? If you think the big short story comes to mind. Do you member Mark Bomb, who was the fictional character who was based on the real hedge fund manager, Steve Eisman. You know, he’s pulling his hair out. He’s meeting strippers that own eight houses in Florida that they’re flipping over, and maybe it was in Las Vegas. I don’t remember. And, you know, he’s like, “How can it be that we can still buy credit default swaps on this completely worthless paper for a few basis points?” And it took months, and months, and months before reality hit the market. It’s not going to take months, and months, and months this time, but I feel like reality has not hit the market yet.

Erik Townsend  03:59

What you hear in the mainstream media and what you hear particularly in the financial press is, “Hey, it’s a bad flu. It’s not a big deal. It’s going to blow over. Don’t worry about it.” You look at what’s coming out of China as you say, and just so our listeners know how I approach this, there’s a lot of information that seems like it’s credible data. There’s also a lot of conspiracy theories, and possibilities, and so forth. Conspiracy theories have a funny way of eventually turning into conspiracy fact, so I wouldn’t be surprised if some of that stuff turns out to be true.

But the way I’ve been approaching this situation is when I hear something like somebody says that China secretly engineered a biological weapon, and it snuck out of the laboratory, and that’s the real story here. Look, I have no way of knowing whether something like that could be true. I think it’s important that we investigate all of these theories after the fact. But what’s important right now is what’s actually happening. So I tend to fade all of those nefarious, “What if somebody did this intentionally as a weapon?” All that stuff. It’s possible. It’s plausible, I suppose. I just fade all of that. And I assume that this is just a really bad viral outbreak. And I try to figure out what impact is it going to have on the world.

Erik Townsend  05:14

And if you look at what’s happened in China, it is completely, totally out of control. And we’re continuing for some reason, the World Health Organization, I think, is really dropped the ball on this. We’re sending airplanes full of people in and out of China every day, and we’re moving them all over the world.

There have been finally just in the last week or so, several mainstream epidemiologists; very highly credentialed guys saying, “Look, the cats out of the bag. It’s too late. You can’t stop this. It’s coming to the rest of the world.” Now, we can get into a couple of reasons later on why maybe it won’t be as bad as it was in China, but something’s coming. And it’s not just the seasonal flu. It’s a whole lot more than that. And I think markets are not discounting it. So there’s a lot coming and I feel like Mark Bomb in that movie, you know? He’s pulling his hair out saying, “I can’t believe they haven’t figured this out yet.” And at some point, I think the rubber is going to hit the road, and the markets going to say, “Oh, this is real. And it’s not just real in China. It’s something that’s going to affect the rest of the world.”

Preston Pysh  06:15

So whenever I’m looking at this, the thing that strikes me is just being totally unheard of is the supply chain. I know you’re familiar with project management and how many things run downstream to create a complex product.

Let’s just take the iPhone, for example. How many parts and pieces are impacted in China? And we’re not talking about just one town here that has been quarantined. We’re talking literally, the numbers that I’m hearing right now, and you tell me what numbers you’re hearing, but I’m hearing 400 million people. That’s more people than you have in the entire United States that are on lockdown inside of their cities right now. So from a supply chain management situation, the products that are coming out of China that are then impacted, not just in the US but all over the world. Talk to us about what you’re seeing here. Like, to me, it seems like it’s insane. But I’m kind of curious what you’re thinking.

Erik Townsend  07:11

There are reports of 400 million people on lockdown. Now, I don’t know where exactly that 400 million figure came from. I think it’s mostly the cities that are actually being locked down. And I think people may be adding together the population of the entire provinces to get that number. But let’s suppose that the 400 million is wrong. And it’s really just the sum total of population of the major cities in those provinces. Okay, now, we’re only talking about 150 to 200 million like two thirds of the number of people in the entire United States. If the 400 million figure is accurate, then it’s more people than the entire population of the United States.

Erik Townsend  07:55

And Preston, there was, to give you a sense of how bad it is there. There was a video that was circulating on social media on Sunday morning, the day that we’re speaking, showing this woman in China. She’s on a balcony of a high-rise building screaming at the top of her lungs saying, “My husband is dying,” you know? “The emergency services don’t answer the phone. We’re not allowed to leave the building. I don’t know what to do. Can somebody help me?”

And it’s obvious, you know, nobody’s going to climb up the side of the building to help her. She’s just needing to cope with her own stress of watching her husband die in a completely helpless situation locked into her home; not allowed to leave. And the reports that we’re hearing is, even if they were allowed to leave, they would probably be turned away from the hospital, anyway. she’s just coping with her stress event by screaming at the top of her lungs on a balcony hoping somebody will hear her, and there’s nothing that can be done to help her. So it is a humanitarian crisis long before we even think about the economic implications, but just look at how much the world depends on China for everything.

Erik Townsend  09:00

And even if you somehow could solve the supply chain; if China goes back to work tomorrow, and you know, they can keep making stuff, and so forth. How are you going to ship it, when everybody is concerned? There was just a report coming out of Germany in the last few days, saying that this virus can live on surfaces for as long as 12 days. So it’s not just you can catch it from somebody sneezing on you. The worker in the manufacturing plant in China can sneeze on the part that they’re making. It gets shipped to another country. Two weeks later, somebody opens the box up, and they get infected just from touching the part that somebody sneezed on a week or 10 days earlier. It may or may not be true that that really is a realistic scenario, but it almost doesn’t matter because if people are afraid that it might be real. Then, obviously, you know, I already know people that are throwing away packages they ordered from Amazon because they appear to have come from China, and they just don’t want to take the risk. So what’s going to happen?

Erik Townsend  10:02

And the same thing with airline travel. What happens when this thing is moving all over the world? Now, maybe it’s not as bad as some people fear. Maybe some of the fears are a little bit hyped up and unrealistic. It doesn’t matter. If people are afraid to fly, then that has a crippling effect on the entire travel industry. It completely annihilates demand for jet fuel, you know, collapses the crude oil market. We’re already seeing crude oil, copper, and iron ore as the big commodity indicators of what’s going on here. And they’re telling a very, very ugly story.

Preston Pysh  10:36

When I think that that’s the point for me that’s so crazy is this point that you’re bringing up in that you’re really talking about the reflexivity of fear, and how the fear itself can actually create the whether it’s true or not, can drive the the market reality. So let’s talk about I’ve heard you mentioned, perfect storm, and we’re at a point in this market cycle where I think, man, you start throwing some of these crazy scenarios into the mix, things start getting really wild. So talk to us about your perfect storm narrative there, Erik.

Erik Townsend  11:11

The reason I see this as a perfect storm scenario, Preston, is three key factors that have come together to make me conclude that it’s going to be very, very hard to contain this and prevent it from becoming a global pandemic. And those three factors are as follows.

First of all, asymptomatic transmission. The way the SARS virus worked is people, who were infected with it got the fever before they became contagious to other people around them. So, and the Hong Kong authorities really deserve an incredible amount of credit for acting swiftly. They very, very quickly implemented procedures all over the city, where they’re using these little infrared thermometer devices, taking everybody’s temperature at checkpoints and anytime you go into a building. and so forth. And they’re identifying people with a fever and quarantining them and testing them for SARS. The reason that worked is because you got the symptoms that were measurable with a simple thermometer device before you became contagious. The information that we see so far about this nCoV virus is that it can be contagious before you develop any symptoms for as much as five to seven days.

Erik Townsend  12:18

Now, I want to be clear, this is a point that’s been debated back and forth. First, they said, “Okay, asymptomatic transmission it’s a really big problem then.” Somebody said, “No, wait. That’s wrong. It’s not really asymptomatic transmission. That’s not what’s in play here.” The epidemiologists are still arguing this point. Some people have said, “Well, there’s no conclusive proof that there’s asymptomatic transmission.” The way I look at this is, look, is there any conclusive proof that there isn’t? And as long as there’s no such conclusive proof, which there’s definitely not, then we have to assume it’s at least a possibility.

A lot of people think it’s a certainty. What this means is the whole business about using the thermometers at the airport, it doesn’t do any good because people are contagious and can give them infection to other people before you can detect any symptoms. That means that containment through the mechanisms that were used for the SARS virus is totally completely impossible. Those techniques are ineffective against this virus.

Erik Townsend  13:14

Number two, high transmissivity. Now, there’s this number called R naught or R0. That very simply what that means is, if a person is infected with this, how many other people are they going to give it to before it’s over. If you have an R naught value of one, that means on average, a person who’s infected is going to give it to one other person, and that sort of sustains the same number of infected people because one person gives it on to one other person. An R naught of two means one person gives it to two people, and each one of those two people gives it to two people, so it becomes a geometric progression. An R naught of three starts to get really scary because now you’re going not to squared numbers, but to cube numbers. One person gives it to three people. Each one of those three gives it to three more, so you go from 3 to 9 to 81 to whatever comes next in that progression.

There is currently a study that is concluding that the R naught for this virus is approximately 4.08, which is extremely high. It’s higher than the SARS virus, and it’s way higher…there’s a benchmark. There’s about a 1.28 R naught on the normal seasonal flu. So it’s…and four is not just four times worse than one. This is an exponential relationship. So it’s many, many times worse. And it looks like the R naught value for this virus is over four. That means super duper contagious, and it’s contagious, when you cannot detect that the person, who’s contagious is contagious, so there’s no way of testing against it or knowing, who is infecting other people.

Erik Townsend  14:51

Number three, the very high serious complication rate may actually be more important than the case fatality rate. What a lot of people are focusing on right now is they’re saying, “Look, okay, so maybe it’s a really big deal. Maybe it’s super contagious, but it’s not as deadly as SARS in terms of the case fatality rate, so it’s not going to be as bad.”

First of all, they don’t know that the case fatality rate is not as bad as SARS. We can come back to that later. But for now, the point is even if the case fatality rate is low, what we do know about this virus is that it has a high serious complication rate. About 20% of the people who get it, need serious medical attention. Well, if millions of people are going to get this around the world, and 20% of them need to be hospitalized. You very, very quickly overwhelm the medical facilities of even developed countries, and in the emerging world, it’s even more challenging because you could…they really don’t have any spare capacity to deal with something like this.

Erik Townsend  15:54

Medical facilities will be completely overwhelmed. And you have a major, major crisis around the world, even if the case fatality rate turns out not to be nearly as high as SARS, just because of all of these complications. So that’s the perfect storm is these three factors come together to say this thing is super duper contagious, and it’s spreading quickly. And you look at what’s going on in China already with 400 million people locked down. We’ll come back to a study a little bit later on that explains exactly why they locked all those people down, which is really important to understand. But you know, everybody assumes “Well, that’s all terrible. But you know, that’s happening over there in China. That’s, you know, that could never ever happened in the United States.”

Look, there’s already experts who are saying, “There’s no way to keep it out of the United States. It’s already here. It’s already spreading. It’s in the very early stages of spreading.” The good news from a seasonal standpoint is we’re getting into mid-February now. So if it takes another month before this really gets going, we’re into March. The weather’s turning better. And one of the things that at least in the case of other Coronaviruses is known about these things is hot weather tends to kill them. So it may be that we get saved by the weather to some extent, but I don’t think we can count on that.

Preston Pysh  17:15

So a lot of people that would be hearing everything that you’re talking about, which in my humble opinion, is 100% valid at this point, but people hear that, and they really kind of want to believe what’s convenient as opposed to what reality or that circumstances are. So when you describe that, and we’re specifically looking at this from a financial investing kind of standpoint, where should a person be concerned as far as their pocketbook or their trading account? As we look through this, like, what is the impact to that?

Erik Townsend  17:48

I’ll be really honest, I think that this point, what I’m focused the most on is trying to get my head around how big it’s really going to be, and you’ve got a case for it to become super huge, which is if the same thing that’s already happened in China were to happen across the whole world. We’re talking about just the biggest financial event of our entire lifetimes. Ten times worse than the 2008 financial crisis; major civil shutdown; crazy, crazy stuff that could shut the global economy down completely. Now, there’s plenty of reasons to think that it’s not going to be that bad.

So why don’t we go over what some of those reasons are that it’s maybe not going to be so bad. First of all, this, believe it or not, is a racist virus. It targets something called ACE2 receptors, and I have absolutely no idea what that means. It’s way beyond my paygrade. But the net of it is Asian people and Asian men particularly are at the greatest risk, so that’s not good news for the rest of Asia. This could easily spread across Asia, but it appears that the contagion rate and the infection rate is lower with non-Asian races.

Erik Townsend  19:01

And one of the things that we saw at the worst of the Hubei case count increase. And of course, we have to remember that these numbers coming from China are extremely suspect. We don’t know if the data is any good at all. But at one point, the case count was growing at about 40% per day. That’s just a super scary exponential growth path. So far, what we’re seeing in the X China data, which I think is much more reliable in terms of being believable numbers. It’s about a 10% per day, exponential increase in case count. Now, 10% per day is nothing to shake a stick out. Imagine if you had an investment that returned 10% per day of compound interest. Needless to say, you know, it’s multiplying itself many thousands of times over very, very quickly, but at least it’s 10% and not 40%.

Erik Townsend  19:54

The other thing that we’ve got going for us, maybe is, although, it’s not really known for this particular virus research on other Coronaviruses has said that it tends to get killed by hot weather. A lot of people think that what really ended the SARS outbreak was warm weather. And there have been some studies that say the amount of time that the contagious virus can live on surfaces is dramatically longer at four degrees Celsius, as opposed to 30 degrees Celsius, or 25 degrees Celsius, which is like 75-80 degrees Fahrenheit. Now, there’s also unfortunately a counter argument to that, which is right now, the X China data, where is it growing the fastest, Thailand, Indonesia, and Philippines, which are all places where the weather is quite warm right now. So we’ve already got warm weather in those places, and the outbreak is starting to occur there.

We’ve still got very small numbers outside of China, so we don’t know yet how fast it’s going to grow. So there is some data that suggests the case growth rate in China has already peaked. Frankly, I don’t believe that. I think what’s going on is medical facilities have become completely overwhelmed in China. And they can’t test or report any more data because they just can’t do anything. So I think that we can’t really trust the accuracy of data. We know from the fact that they’re locking down most of the major cities in the country that something is very, very badly wrong there.

Preston Pysh  21:29

So, Erik, to date, I mean, I guess I’m just looking at the past two weeks. Central bank’s solution for this is to print and add even more liquidity in environment, where they were already adding crazy amounts of liquidity through the repo market and all the other fixed income vehicles that they’ve been exercising. So I guess my question for you: Do you think that the central banks can continue to just provide liquidity and let this thing, I guess, counteract the reflexivity effect of this? Is that something that’s in the cards, or do you think that it’s just getting over the brink at this point?

Erik Townsend  22:04

I think there’s a huge amount of central bank accommodation coming in response to this. The thing that we don’t know is whether it occurs preemptively. If the authorities are smart enough to see what’s coming, and they do a whole bunch of extra stimulus.

I think that that really is what has fueled this stock market rally. You know, what we’re seeing right now is copper, crude oil, and iron ore are all showing very, very ugly looking charts. They are not pretty at all. But we’re at all time highs in the stock market. How the heck is that possible? I think the answer is because central bank liquidity has fueled these markets. So far, so long, everybody’s used to it, and the attitude of everybody on Wall Street is, “Hey, every time we’ve gotten bad news in the past, and central banks respond by creating money out of thin air, the ultimate result ends up being higher asset prices.” And I think people are speculating that that’s where this is heading.

Erik Townsend  23:00

Now, I think that that logic is going to break down and break down hard, when they realize just how bad this could be if it gets to its worst case, again. But if we get something that even begins to look like what’s happening inside of China across the rest of the world, it’s so big. And it is such a huge burden on global growth, that it’s going to be much bigger than anything that central banks can overcome through stimulus. On the other hand, with some point, this will play out. It’ll be over, and you can expect just massive stimulus. And I think that’s eventually going to fuel a V-shaped recovery. No matter how bad it gets, you know central banks are going to be there to drive the recovery back to wherever it needs to be. So I think this is going to get really ugly, and I don’t know whether the money printing is going to happen before, during, or after, or all of the above.

Preston Pysh  23:52

As you look at these policies, and you look at how they just continue to throw so much liquidity in your comment about them. You know, if it has a V shape, let’s just say that this continues to accelerate, and then it kind of, it gets stopped in a month or two from now. And central banks respond in force with a ton of liquidity. What is the mechanism that’s eventually going to make that stop? Or is there a mechanism that’s going to eventually make that stop? Does it turn into this political social unrest that actually causes the undoing, and you get, you know, helicopter money that actually brings inflation in. Is that what actually causes this to change the direction that we’ve been seeing for the last decade?

Erik Townsend  24:30

Well, you’ve been reading my mind once again. Our great minds think alike. I’m not sure which, but something that I’ve predicted for years, Preston, as you know, as I’ve said, “Look, everybody has it in their head,” right? When I say everybody, I mean, investors and financial markets, have it in their heads that quantitative easing is good for asset prices because the way quantitative easing as we know it works is they buy bonds with the money that they conjure out of thin air. Where’s the money come from? It comes from institutional investors that were holding those bonds that puts a whole bunch of money in their pockets. What do they do with it? They use it to buy other risk assets, whether it be stocks or what have you. And that’s what’s driven asset prices. Everybody’s assuming that it’s going to keep working that way indefinitely.

Erik Townsend  24:51

And what I’ve predicted, and I thought it would be, maybe the political cycle as we get into later in this election year. I’ve said, I think at some point, politicians, particularly left leaning politicians are going to say, “Look, it’s time…central banks have proven that you can conjure trillions of dollars out of thin air without taxing anybody. That’s great news. It’s time to stop giving that money to rich people and start using it to bail out Main Street, not Wall Street.” And there’s some fallacy to that argument that they’re giving money to rich people because it’s not really giving money to rich people per se. But you know that political rhetoric is going to sell, and it’s going to sell well.

Erik Townsend  25:55

And I think that what you could get to, and maybe the virus response is what gets you there is where people say, “Look! Yeah, we need to have central banks conjure money out of thin air, and we need to do a lot of it. But we need to use all of that money to respond to the virus.” We’re not going to buy any bonds from primary dealers. We’re not going to give any money to institutional investors. We’re going to directly monetize an emergency response to a pandemic outbreak. And that potentially sets a new precedent, where future quantitative easing becomes more of a helicopter money kind of event, and it starts going to social programs.

And all of a sudden, you’ve got universal basic income and health care for everybody, and forgiveness of college debt, and free tuition, and so on, and so forth; all coming out of central bank money printing, as opposed to taxes, and it’s some time in the future. I think we could be headed there. Maybe the response to the virus will be the pivotal event that gets us out of the old style of quantitative easing and into a new helicopter money style. I’m not sure, but I think it’s a distinct possibility.

Preston Pysh  27:03

And I mean, if they go to that route what this really comes down to, as far as I’m concerned, and I’m curious to hear your thoughts; for me, it all comes down to the inflation rate. As long as you’re doing QE, we’ve demonstrated that QE does not create inflation inside the economy. But I would imagine if you start putting all this liquidity into the hands of mainstream, now, all of a sudden you start getting inflation on all of those items that we have in the basket that we’re measuring inflation with, and then, the risk premiums, the interest rate premiums are all a premium above that inflation rate. And now all of a sudden, everything gets repriced. You’re seeing it the same way. I’m assuming Erik. Is that correct?

Erik Townsend  27:42

Well, once again, great minds think alike, I guess. I think that I’ll take it one step further than what you just described, which is: What happens when we get inflation, and the inflation starts to get to be too much? Well, the historical approach to solving that from a policy standpoint has always been raise interest rates. *Paul Volcker himself before he died has publicly said, you can’t do what he did back in the 80s to fight inflation next time around because that was only possible due to a relatively small amount of outstanding national debt. With the amount of debt that we now have, you can’t raise interest rates substantially, especially not during a crisis because you would bankrupt the federal government and make it impossible for them to roll their debt forward.

Erik Townsend  28:31

So if you can’t increase interest rates to fight inflation, what do you do? I’m not sure what you do. I guess you let the inflation run away, and you get into maybe a supercharged version of financial repression that brings about an inflationary Great Depression. I’m not sure. We’re in uncharted territory. So I don’t know what happens when we get there. But I do think that ultimately we get to a situation, where inflation is what really brings about the end game, you know?

As long as we have a deflationary backdrop, you can solve almost any problem by conjuring money out of thin air. A trick that central banks have gotten pretty good at in the last 10 years. And hey, it feels good, and it works initially. Eventually, it’s when it causes inflation that you have a problem. When that inflation comes around, I don’t know when that’s going to be. When it does occur, especially if it starts to get out of hand and turns into runaway inflation, I don’t know what you would do to fight it.

Preston Pysh  29:25

Let me reference this 29th of January, China Academy of Sciences report. They had a specific portion of this regarding what might lie ahead in the future. Talk to us about some of these ideas that were found in this report.

Erik Townsend  29:40

That report in particular is the one where it all came together in my mind. I had the “Aha!” moment there, and the way to think about this is start with what the heck is going on in China. We’re hearing that this thing according to a lot of people is just a really bad seasonal flu. It’s not as deadly as SARS. Why the heck are they locking down entire cities, so that more people than the entire population of the United States are on lockdown? What the heck is going on in China if this is just the seasonal flu? Well, this report on January 29 from the Chinese Academy of Sciences, it’s not yet peer-reviewed because things are happening very quickly here. This is a crisis situation. We don’t have time for a peer review cycle, but it is, you know, a credible academic paper written by credible academics, who have been published before in peer-reviewed journals.

What they say is first of all, the R naught value they estimated 4.08 that I described earlier, the combination of that high R naught value, plus a symptomatic transmission means that it is just freakishly scary in terms of how transmissive this is; how quickly it spreads; and how impossible it is to contain it. See say, okay, it’s spreading very, very quickly. You can’t use the thermometers and stuff. It doesn’t help to contain it. That doesn’t work.

Erik Townsend  31:03

They also said in this report that they thought it might have a similar case fatality rate to SARS. And the good news on this particular point, Dr. Eric Ding, who’s an epidemiologist at Harvard University, did a whole Twitter thread, where he commented on this report from the China Academy of Sciences. And what he said is, “They are R naught at 4.08 looks like very credible analysis.” He agrees with their analysis. He says, “That’s super scary. Be very worried about it.” He said the 6.5% case fatality rate, he sees some flaws in their analysis. Now, obviously, this is way over my head, so I don’t know what the flaws are. Read Dr. Eric Ding’s analysis if you’re knowledgeable about these things, and you want to know.

Erik Townsend  31:45

But the really, really important part of this report to understand is they said, “The only way to manage this is you can get the R naught, which is 4.08 down to about one if you can contain the incubation period. In other words, if you can prevent people from having exposure to other people for, it’s only about 2.7 days, I think was the number in the report. But remember, just shutting down or locking down a city for 2.7 days isn’t enough because you’ve got to cover, you know, when people got it, and how long they’re contagious for, and so forth. So you got to lock things down, so that whoever has it goes through the process of either getting sick from it, or not getting sick from it, or what have you. And then, 2.7 days go by. If you can keep people from coming into contact with other people for a certain period of time, you can contain it.

Erik Townsend  32:38

So the point is, this report perfectly explains the actions of the Chinese government. The only way to contain it when it starts to get out of hand is to shut things down, so that people just don’t interact with other people. And that’s the only way to contain it. And that explains why they’re shutting down other cities. Now, again, it’s not in this reports and other reports, where they’ve talked about how this is a racist virus. It picks on Asian people. Well, we don’t know whether or not we’re going to see the kind of R0 value in the spread of this virus in western countries like the United States. But if it’s anything close to that, then we’re going to have to use the same tactic of completely shutting things down and quarantining people, potentially entire cities in order to stop it from spreading.

Preston Pysh  33:31

So, Erik, you’re really good at anticipating turns in the market perception story. Any we should know about here, and how you’re looking at this?

Erik Townsend  33:41

Oh, yeah, there’s definitely one that I really want our listeners to understand because it’s not even a possibility. I think it’s a prediction. Imagine this, the worst thing that can happen to you as a podcaster, Preston, is we publish this podcast, and boy, this is some gloomy stuff that we’re talking about. Two hours later, the Chinese government sounds the “all clear” and announces that the quarantines are being lifted, and workers can go back to work. Well, don’t we look like a couple of knuckleheads. Everybody would be, you know, all over your Twitter feed ridiculing you: “I can’t believe you two idiots,” you know? “You don’t know what you’re talking about. Why are you doing a podcast?”

Erik Townsend  34:16

Look, here’s the deeper level that you need to understand what’s going on right now in China. And if you look at my Twitter feed, I just posted the minutes of a meeting from China. Google translated it into English that provides a lot of insight into this. There’s a really big debate going on, where one side is saying from this report that came on the 29th. We got to shut things down until this virus dies out or else we could kill off our entire population. We don’t have any choice. It’s the only thing you can do.

Erik Townsend  34:46

There’s another side of that argument. Think of that as the left side. The right side is coming in, and saying, “Wait a minute. Our entire nation is dependent in its economy on being the biggest exporter of all kinds of stuff to the rest of the world. We cannot afford to shut down our economy; shut down our factories for six months, no matter how bad it is. We can’t do it. And if we even started to do it, the rest of the world would be forced to find alternative sources, and we would lose that business permanently. And we would be economically screwed for the next 50 years. We cannot let that happen. We have to send our workers back to work. We have to open our factories. There’s no choice.”

Erik Townsend  35:28

At this point, they’re still debating this back and forth. What I predict will happen, and I have no idea what the timing is whether it happens before you’ve even edited and released this podcast, or an hour after you did, or a week after you did it. At some point, China is going back to work. They’re opening the factories back up. That news is going to come out, and I predict that when it comes out, both commodity markets and particularly equity markets are going to rock it higher. “Okay, it’s over. It’s all better now!” It’s not all better.

The analogy here is: think of the D-Day invasion in Normandy. That didn’t happen because a bunch of analysts said, “Hey, we think we can go in and do this with a very low loss rate in terms of how many of our own soldiers were going to get killed.” No, they knew exactly what they were getting into. They knew it was a suicide mission, and that they were going to lose. Thousands of soldiers would be killed, but they knew that the alternative was so unthinkable that they had to make this incredibly difficult decision to go ahead and basically send a lot of good people to their certain death, in order to achieve their objective.

Erik Townsend  36:20

What’s going to happen in China is they’re going to get to the point, where they just have to keep the factories going because they cannot allow the loss of their position in the global economy. And they’re going to send people back to work, even though the virus has not been contained. I don’t know when that’s going to happen. It’s something that’s being debated in China right now. There was Foxconn, who had already tried to compose getting their factories back online. I’ve read a couple of reports this weekend. One said that that was vetoed, and the government said, “No way.” I saw another one that said, maybe they’re now considering allowing that to happen, so it might already be happening.

Erik Townsend  37:29

The point is, when you hear Chinese workers are going back to work, they’re no longer quarantined. It doesn’t mean the virus is all better. It means they were not willing to let their economy go, no matter what the cost was. And don’t misinterpret that data. But my prediction is, the entire world is going to misinterpret that data. And I think we’ll see commodities and stocks go shooting up, when that news comes out, even though it’s not really the good news that it appears to be. I’ll use that opportunity to double down on my short exposure because I think it’s going to get a lot worse after that.

Preston Pysh  37:49

And so, you think that that’s a much higher probability as well based on the way you’re describing this, that you think that they’re going to go back to work?

Erik Townsend  37:56

Well, they have to. And I’ve been reading a few different pieces, including this one that I tweeted today. It’s the way they’re thinking about this is the entire nation’s economy is dependent on their export business. They can’t just shut it down. That’s not an option that they’re willing to consider. Well, what’s the other option? Take people, who are still contagious, and put them into an environment, where they can transmit the virus to other people. They’re two unacceptable options. And there is a political struggle, I perceive going on behind the scenes. Now, who’s in charge? Who’s winning that debate? You know, obviously, they can’t send everybody back to work and everybody infects each other, and they all die.

Erik Townsend  38:38

So at the end of the day, what’s going to happen? My best guess is the Communist Party will make whatever decisions they think are most likely to make sure that the Communist Party stays in power. That’s the most important thing. The importance of the country and its economic mission is paramount to them. And one of the things that’s different about Asian culture, and particularly Chinese culture from American culture is that they don’t really have the emphasis that we have on individual rights and making sure that, you know, every person always has their rights respected. They tend to make decisions in terms of what’s best for the whole. What’s best for society overall.

Erik Townsend  39:22

And if they had to make a decision, which was to sacrifice a bunch of people; let a whole bunch of people die, in order to keep the economic engine of the country going. I’m not going to say that’s what they would do. Because obviously, I mean, from a humanitarian standpoint, I would never make that accusation about the people or the leadership of China without knowing. But what I would say is culturally, making a difficult decision that involves sacrificing human life in the name of protecting the long term interests of the country, they’re much more inclined than Americans would be to think about what’s best for the whole, even if it completely violates the rights of a few individuals. And in this case, a lot of individuals.

Preston Pysh  40:07

So Erik, we talked a little bit about the stock market, the bond market, QE, and you lightly mentioned commodities. But I know this is your forte is commodities. Talk to us how you see commodities playing out in the next quarter.

Erik Townsend  40:22

Well, first of all, copper, crude oil, iron ore are all way down. And most analysts are now looking at this and saying, “Okay, these things are oversold on a technical basis. And maybe there’s been an overreaction to the Coronavirus, and this is your buy the dip opportunity.” I don’t think that that’s right. Now, one reason that could look right is the scenario we talked about a minute ago, which is if they do announce a go-back-to-work program because they want to keep the economy going. The markets are going to respond by saying, “Okay. It’s all over, you know? The worst is over. They fixed it now.” I don’t think that’s the right way to look at it, but you could see a big bounce here.

Erik Townsend  41:03

The way I look at it is we’ve gone through the first wave down. There’s a bounce that happened at the end of last week. Maybe that bounce is not over yet; kind of depends on the news flow. But I think there’s another really big wave down; a much bigger wave down, particularly in copper and crude oil. I don’t know that much about the iron ore market, so I don’t want to comment on it. But in the crude oil market, which is primarily what I trade, look, the crude oil market depends in many respects on transportation, the airline industry, shipping industry, and so forth. That’s where a lot of the energy gets burned. If you have to shut down airline travel, either by conscious decision of governments that they’re banning travel, or simply because people are afraid to travel because the virus gets worse, and I think it is going to turn into a global pandemic.

Erik Townsend  41:57

Now, a lot of people are saying, “Oh, wait a minute. It’s not as bad as you think. There’s a lot of evidence and this is true, there is evidence to say that the case fatality rate might be lower. We should probably come back to case fatality rate, but it might be considerably lower than SARS and other viruses. Okay. Okay. But if there is a pandemic that has a lot of serious complications where people have to be hospitalized, and the case fatality rates are not that high, so that people are not dying, but it’s requiring all these hospitalizations, it’s going to freak people out. So they don’t want to travel, and it’s going to completely annihilate airline travel.

Erik Townsend  42:34

Similarly, if the studies that we’re seeing that say that this virus can live on surfaces, and still be contagious, you know, by touching that surface for as much as 12 days later. It’s going to affect trade, you know? Who wants to buy parts from China if the parts might have germs on them? Now, those parts could be disinfected. There are ways to overcome these things. But remember, there’s a psychological factor here, you know? The part that I’m getting from China could have a virus on it that could kill me. And I’ve got to trust that somebody ran it under this ultraviolet light that they were supposed to run it under, in order to kill the virus, so it doesn’t kill me. Do I want to take the chance, or do I want to just avoid it, and not deal with it if I don’t have to? So even if the fears and hesitations are not based on rational, logical concern, they may still have a debilitating economic effect.

Erik Townsend  43:29

So the real question is: Does this turn into a global pandemic? And I think the answer to that is what we’ve seen in China says it’s on a path that it should, even if that global pandemic does not have a very high fatality rate, it’s still going to have a debilitating effect on the global economy that will result in massive money printing; massive stimulus. For that reason, I tend to be more bearish on commodities than I am in the stock market. Believe it or not, although I am in the interest of full disclosure. I’m holding puts on the S&P right now. At the 3200 strike, I think it’s very possible that we could get a panic that causes a big sell off. But I know central banks are going to come riding to the rescue with a huge amount of stimulus, and markets are conditioned for stocks to rally on that stimulus. I don’t think that the stimulus is going to save the copper and iron ore, and particularly, crude oil markets. So most of my positioning right now in terms of downside is puts on crude oil futures.

Preston Pysh  44:31

So, Erik, I’m kind of curious. I was talking with Luke Roman, who I’m sure you’re well familiar with. And Luke had the opinion that he doesn’t think central bankers would let the market fall more than 5% before they come to the rescue and add more stimulus and reflate it. Would you agree with such a small amount of tolerance in the volatility of the equity market?

Erik Townsend  44:53

Well, yes and no. I think that as soon as we get to 5% down, central bankers are doing their own version of panicking, and they’re going to come riding into the rescue. The question is whether the stimulus or the, you know, the good news from stimulus or the bad news from a global pandemic crippling the global economy. Which one is a bigger piece of news? And again, we don’t know if it’s going to be a global pandemic yet. That’s a very real risk that I don’t think people are adequately discounting. But it’s not a certainty by any stretch of the imagination, so we don’t know what’s going to happen. If it does happen, I think that whether or not the stock market really tanks and crashes or not, I’m not sure because it’s entirely possible that that central bank liquidity will save the day once again, but I don’t think they can stop the crude oil market from crashing if we have a global pandemic that just shuts down airline travel and a lot of international trade. And of course, OPEC will institute deeper cuts. There will be things that will be done, but it won’t be enough.

Preston Pysh  45:57

So, Erik, there’s reports that people can read that suggest that there’s already a cure for this. And that may be our discussion sounds very alarmist because we’re not addressing that idea. And this is specifically out of Gilead Pharmaceuticals, which is a major big pharma company that is already testing a drug that they’re having somewhat successful treatment on this. So is this a throw out? Is this a very important information? How are you viewing that development?

Erik Townsend  46:27

Well, Preston, I don’t know if I’m pronouncing it correctly, but the Gilead drug is called Ramdesivir or Rem…de…desiver, or something like that. The thing to understand first of all, this is a drug that has never been approved for use in any country anywhere on earth. It was originally developed to treat Ebola, and it didn’t really work. And there’s a lot of good reason to think that it will work with this virus. And curiously, China filed a patent way back on January 21st. That’s very early in this story for the use of this particular drug to fight the Novel Coronavirus. So it does appear to have lots of promise. It was used apparently, and I don’t know how this happened. Supposedly, it’s never been approved for use in any country. Found that statistic. But apparently it was used, I guess, on some kind of exception basis for this one patient in Snohomish, Washington who had Coronavirus, and it appears to have helped to cure them. Well, that’s wonderful news.

Erik Townsend  47:28

But the thing is, you know, stock market went racing up like, “Oh, they cured it! It’s no problem.” Look, the situation here if we have a global pandemic, and there’s this wonder drug for the sake of argument that it is fantastically effective, and it brings the case fatality rate from, you know, 12% down to 0.1%, which is about what the normal common flu is because we can cure it in most cases. Well, first of all, that’s unrealistic. It’s not going to help that much, but suppose it did. Okay, you’ve still got a global pandemic with a very high serious complication rate, where you’re going to have the risk of overwhelming hospital facilities in many countries around the world. You’ve still got a major global economic event.

Erik Townsend  48:12

Now, at risk of sounding like a greedy market guy, this drug could have a really profound positive impact on the humanitarian story. Maybe it saves a lot of lives, and that’s wonderful news. But I don’t think it really has that much of a positive impact on the economic story. Because we’re still going to have global trade screwed up. We’re going to have travels screwed up. We’re going to have the supply chain problems that we talked about. There’s a whole bunch of stuff that is going to completely screw up the global economy. And this drug is not going to make one iota of difference. So I don’t mean to minimize it and say it’s not good news. It’s definitely good news. But it’s good news in terms of saving lives. I don’t think it’s going to save us from the economic impact, which I believe is going to be much more worse than what markets are presently discounting.

Preston Pysh  49:02

Well, I’ll tell you what, Erik, I am just so thankful that you made time to come on our show and have this discussion. I’m sure most of the people, who listen to our show are well versed on Macro Voices. But if they’re not, and I’m sure they want to check out more of your stuff, give them a hand off, where they can find you and learn more about you.

Erik Townsend  49:21

Sure, Macro Voices is a weekly podcast that is specifically targeting professional finance and very sophisticated investors. It was created to fill a gap, when there’s just so many retail podcast teaching newbies about investing, but there wasn’t really something that was targeted at very experienced investors and finance professionals, so that’s what the podcast is about. It’s at macrovoices.com. The main podcast airs on Thursday evenings every week. We also have a short form format called All Stars, where we do a couple of extra smaller interviews every week as well. And it’s all at macrovoices.com, or you can find us on iTunes or other feed readers just by searching for Macro Voices.

Preston Pysh  50:02

And we’ll be sure to have a link in our show notes to your content there, Erik. Thank you so much for taking time out of your day to talk with us.

Erik Townsend  50:09

It’s my pleasure, Preston!

Extro  50:12

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