Trumpflation: The Narrative Is Deflating

Trumpflation: The Narrative Is Deflating

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“I can feel it coming in the air tonight, oh Lord”

~ In The Air Tonight by Phil Collins

“Father tell me, we get what we deserve
Oh we get what we deserve

And way down we go
Way down we go
Say way down we go
Way down we go”

~ Way Down We Go by Kaleo

“The closest thing to eternity on earth is a government program.”

~Ronald Reagan

You would think Reagan fanboys like Donald Trump and Paul Ryan would heed their idol’s words of wisdom, but no. This week, the world’s worst healthcare bill was pulled effectively putting the Trumpflation narrative on notice. To be clear, tax reform is not impossible, just a lot less likely than the market had originally priced. We should see those diminished odds be reflected across the Trumpflation trade over the next few weeks.

I could not agree more with Jawad’s assessment. All the legs of the Trumpflation narrative came under fire this week. First up, long term bond yields are showing no signs of higher expectations of growth. Possible double top forming in the 10 year.

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The 30 year is has fallen back to 3% as well.

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Of course falling interest rates, and a flatter yield curve bode quite poorly for one of the largest beneficiaries of Trumpflation, US financials.

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In this new era of Trump, banks were set to be deregulated allowing them to make more loans. A steepening yield curve means that banks would make more money per loan. On top of making more loans, banks would make more money per loan, a bank bull’s dream. Not only were Trump’s plans of deregulation dealt a sizable a blow and the yield curve flattened to post crisis lows but to make matters even worse, bank lending has been slowing like the US economy is about to enter a recession. In short, this euphoric fever dream has quickly turned into a bad mushroom trip.

From the article:

“We find three key channels that are inhibiting demand growth: 1) political uncertainty, 2) elevated corporate leverage, and 3) Fed policy, both through past tightening and expected tightening going forward. We see little evidence that the slowdown in lending is due to tighter bank or non-bank lending standards.”

Given the embarrassing defeat of the Republicans and Trump administration this week, it appears political uncertainty is far from resolved. Elevated corporate leverage is not going away anytime soon. And the Fed continues to talk a big game despite a lack of data to support their hawkish stance.

It’s not “hard” to see where I’m going with this. It’s 2011 (Déjà vu) all over again.

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The Fed may think it can pull its foot off the pedal but the market knows better.

Which brings me to the dollar or what many consider to be the most crowded trade. If the Fed is reached peak 2017 hawkishness, this crowded traded could be in big trouble.

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Those betting on higher growth, higher US interest rates, a resurgent financial sector and tax reform are also betting on a stronger dollar. Although I think the case for a stronger dollar over the long term continues to build, the short term forces are only pointed in one direction and that is down.

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Lastly, oil closed under the 50 week moving average this week for the first time since last July.

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I don’t think speculators realized US shale could grow production as fast as it did.

Either that or they really did believe US economic growth was accelerating. Which brings me to the rising role that US shale has played in US economic growth over the past year.

 

The trucking and sand industries have been huge beneficiaries of the US shale resurgence. To increase the effectiveness of their wells, companies have been using more and more sand per well.

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“Tudor, Pickering, Holt & Co. estimates the sector will need 120 million tons of sand by next year, more than double the demand in 2014 at the height of the U.S. drilling boom.”

The increased demand for sand has flowed through to increased trucking demand as well.

“The expense is compounded by the logistics of moving sand from mines to well sites thousands of miles away. Drillers don’t use sand found on a beach. They prefer fine white silica, much of it found in northern Midwest states. Shipping 5 million tons of sand can require 200,000 truck loads, according to a 2013 study by the University of Wisconsin.”

In short, US economic growth is heavily reliant on US shale growth. Lower oil prices not only puts bond bears on notice but US economic bulls as well. The longer oil stays low, the more likely we’ll begin to see a further liquidation of the record long oil contracts.

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Given the fragility of the situation you might expect investors to be a bit more worried about a pick up in volatility, but you would be wrong. Despite the potential unwind of several large speculative trades, investors remain incredibly complacent.

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A lot of this may have to do with volatility being sold short. The fact that this week marked the first weekly close above 12 this year is simply incredible. Which leads me to believe that the sell off we saw this week is likely a prelude to a larger move.

 


DISCLAIMER: This blog is the diary of a twenty something millennial who has never stepped foot inside a wall street bank. He has not taken an economic or business course since high school (for which he is immensely proud of) and has been long gold since 2012 (which he is not so proud of). In short his opinions and experiences make him uniquely unqualified to give advice. This blog post is NOT advice to buy or sell securities. He may have positions in the aforementioned trades/securities. He may change his opinion the instant the post is published. In short, what follows is pure fiction based loosely in the reality of the ever shifting narrative of the markets. These posts are meant for enjoyment and self reflection and nothing else. So ENJOY and REFLECT!

The End of Monetary Policy Divergence: RIP US Equity Outperformance?

The End of Monetary Policy Divergence: RIP US Equity Outperformance?

The past several months I’ve been pointing out that speculators have been increasingly shifting to one side of the boat, long reflation. And then this week, central banks finally joined the party, tightening monetary policy only after these inflationary base effects had peaked.

I think this development is very bad over the medium term for global liquidity conditions. As noted by Johnathan Tepper in his recent Macrovoices interview, higher inflation and economic growth will pull excess liquidity out of financial assets and into the real economy. Throw in the hawkish shift of the world’s four largest central banks, and global liquidity conditions in the second half of the year should not be nearly as elevated as they are today.

With that said, global liquidity will not be the main topic of this week’s blog post (but I’ll touch on it later). Instead, I am choosing to focus again on yet another wobbly pillar of not just the reflation trade but US equity market’s outperformance these past +3 years as well.

In light of the hawkish shift of foreign central banks, the Fed finds that it is no longer the only game in town. Since 2013, the Fed’s relatively hawkish stance was super charged by the incredibly dovish policies that foreign central banks embarked on. During that time the ECB and BOJ increased their asset purchase programs and adopted negative interest rate policies. The combination of these central banking policies pushed capital into the US and strengthened the dollar.

As the dollar is a major source of emerging market funding, the stronger dollar tightened financial conditions in these countries, and hurt their economies which led to a prolonged period of capital outflows and equity market underperformance (vs the US). During this time, the phrase, “the cleanest shirt in the dirty hamper” was commonly applied to the US dollar, economy and stock market, but is that still true?

From a technical standpoint these trends seem to be waning and on the verge of a reversal. SPY / Europe (IEV):

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Despite the parabolic move higher, US equities have gone nowhere against emerging markets for over 18 months and counting. This week, we saw a break below the 50 week moving average as well as the +3 year trendline. SPY / Emerging Markets (EEM):

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SPY / World (VT):

 

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With the central banking divergence set to converge, we could even see the Fed hold steady or shift to a more dovish policy while the ECB and BOJ further tighten monetary policy. Given that the BOJ and ECB are still experimenting with NIRP there is plenty of room for them to tighten their monetary policy. Could you imagine the rally we would see in European financials if the ECB reduced its NIRP tax on the banks?

The Fed on the other hand may have overplayed its hand. If we look at inflation where it seems everyone (except those holding record treasury short positions) is now aware of the falling base effects associated with energy prices.

But in the US, little ink has been spilt over one of the largest contributors to inflation, rental prices.

In short, the inflationary pressures that the Fed has tried to get ahead of are unlikely to develop before the June meeting. Meanwhile, economic growth is also likely to disappoint or at least not accelerate to the upside as lending growth continues to fall.

Corporations have also put their debt issuance on hold as they wait for Trump’s regulatory cuts and stimulus package to form up.

If Trump and Congress cannot get their act together, look for the Fed to lower expectations of a future rate hikes.

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Which would mean that the Fed is unlikely to defend the dollar, and we could see it fall below the 99.5 level, completing this H&S pattern that I’ve been calling for these past few weeks. More importantly, by not defending the dollar, the Fed is essentially giving the green light for capital to leave the US.

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Lastly, any narrative about capital flight would not be complete without the country who has suffered from capital flight the most these past few years, China. And if there is a country that would benefit more from a falling dollar and falling US treasury yields than China I would not know it.

Previously I noted that the central authorities in China were hard at work to blow another stock bubble, Bitcoin: The Rising Tide Pressures The Biggest Leak:

“The stock market which everyone believes left for dead, may rise from its shallow grave and roar like never before. Pension funds will begin allocating additional holdings to the stock market as soon as this week. This is a pretty serious development. The last thing Beijing wants to do, is torpedo the pensions of millions of workers. On the back of this move, Chinese authorities have cut equity margin requirements from 40% to 20%.”

Just last week, the PBOC hiked interest rates. The reason: to apply more pressure on the nation’s out of control housing bubble.

It is likely that the authorities are trying to funnel China’s big ball of money back into other asset classes such as precious metals and equities. The inverse H&S pattern is quite obvious, throw in a weaker dollar and falling treasury rates and a new bull market could in fact be in the cards.

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It’s worth pointing out, that being bullish Chinese equities does not mean I am necessarily bullish on China’s economy, or global growth for that matter. There’s still plenty of warning signals out there.

And as I noted earlier, the Chinese authorities are actively working to deflate their booming real estate bubble. If successful in their efforts, the deflationary effects, will reverberate across not just emerging markets but the globe. And this in my view would likely mark a great opportunity to be long the dollar. As global liquidity begins to dry up around the world approximately 3-6 months from now, the dollar should bottom and begin to build up a head of steam for all the wrong reasons, There Is No Alternative (TINA).

 


DISCLAIMER: This blog is the diary of a twenty something millennial who has never stepped foot inside a wall street bank. He has not taken an economic or business course since high school (for which he is immensely proud of) and has been long gold since 2012 (which he is not so proud of). In short his opinions and experiences make him uniquely unqualified to give advice. This blog post is NOT advice to buy or sell securities. He may have positions in the aforementioned trades/securities. He may change his opinion the instant the post is published. In short, what follows is pure fiction based loosely in the reality of the ever shifting narrative of the markets. These posts are meant for enjoyment and self reflection and nothing else. So ENJOY and REFLECT! 

Mirror Mirror On The Wall: Is The Reflation Trade About To Fall?

Mirror Mirror On The Wall: Is The Reflation Trade About To Fall?

 

On Friday, Grant Williams announced he was working on a new presentation and asked the twitter-verse what they thought the craziest chart in the world was.

If you haven’t read the responses, I highly recommend that you do. There are a lot of really great charts (although Bitcoin is not one of them, give it a few more years folks). Of course, being somewhat of a reflation trade fanatic, I threw out a rather expected response.

I also forgot to add one very important component to this trade which is for speculators and hedge funds to be very long US stocks and short volatility, but we’ll get to this bit later.

 

Arguably the most overextended, and most talked about leg of this trade is the speculative long oil position. In 2017, we’ve seen speculators add to their net long position by about 200,000 contracts.

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With oil below its 200d ma (dark blue line) and at its lowest point this year, even without counting the cost of rolling these positions over, AT LEAST 40% of these contracts are in the red.

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Students of history will recall that the last time speculative positioning was this extreme oil tumbled over 70% in the following year. During this time (2014), Hedge Funds and speculators operated under the false assumption that OPEC had their back.

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Once again, OPEC has warned the US shale and more importantly the speculators that OPEC does not have their back.

The poor fundamentals supporting higher oil prices only gets worse from here. US oil inventory is at a post WWII record high.

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Meanwhile, US gasoline demand has also been “unexpectedly” soft.

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At the same time, US shale producers currently holding an extreme short futures position making them well prepared for a downturn in oil prices.

 

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On top of being well positioned for a downturn, US shale breakeven prices have collapsed in the last two years.

In order to cripple the growth of the US shale industry we’ll need to see oil prices below $40 for a prolonged period of time. That’s not exactly music to the ears of these record long speculators…

Which brings me to the crux of my argument: If the price of oil continues to fall, hedge funds and speculators will take incredible losses. These losses will begin to weigh on their other positions which they also have levered themselves to the hilt on and force them to unwind these positions as well. Taking into account that the fundamentals supporting their extreme positioning have continued to deteriorate, any potential unwind could become incredibly violent as the markets return to reality.

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In the past month I’ve written counter arguments for two of the reflation trade positions (long US dollar and long US stock market) and given that oil base effects have played a key role in driving inflation higher I believe we are about to see a tremendous amount of pressure applied to yet another one of these speculative positions, short bonds.

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Recall that oil prices bottomed in February 2016. With base effects firmly behind us, and the price of oil set to head lower, we could see oil quickly go from an inflationary pressure to a deflationary one.

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And if we give the recent rise in rates a historical perspective, we find that we are at the top of a 30+ year channel… and people make fun of me for betting against an 8 year trend.

I couldn’t have said the following better myself.

AND YET this is the exact opposite positioning that we see from hedge funds and speculators, who are not only short bonds but extremely long stocks!

Since my bearish post on US equities, the technical deterioration of the US stock market has only gotten worse.

Investor appetite for junk bonds appears to be waning.

At a very key juncture I might add.

Insiders are running in terror from the market.

But don’t worry, hedge funds aren’t alone in their foxholes, retail investors have finally joined the party.

So much for the most hated bull market in history. Retail have responded to higher prices and Donald’s rhetoric. They’ve heard that Donald Trump is going to enact some super stimulus and tax cuts that would transform the US economy into a soaring eagle that shoots laser beams out of its eye sockets.

Of course, the reason retail investors are in the stock market has nothing to do with the underlying fundamentals of the actual reflation trade or US economic health for that matter. I hate to sound like a broken record but here is a quote from The Reflation Trade:

“But investors have become so accustomed to the US driving the global credit cycle that they have missed the origin of the reflation trade. The dollar, commodities and inflation have all risen together for the first time in over a decade which has left investors scrambling for a narrative to explain this paradox. Fortunately, the recent US presidential election has provided just that. Despite the “coincidence” of commodities bottoming with China’s economy in February of last year, investors have latched on whole heartily to the “Trumpflation” narrative. Or to use another analogy, investors have entered the Jade City, but they have become distracted by the Giant Green Floating Head.”

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If we examine the underlying health of the US economy, we find it is quite weak. Despite this Trumpflation narrative, loan growth over the past two months has actually been negative.

Consumer lending standards are tightening.

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3-month LIBOR continues to hit post crisis highs.

And even with the tremendous growth we’ve seen in US shale, the US economy has continued to slow. Going from 1.9% in Q4 to just 1.3% in Q1.

The accelerating growth in employment we’ve seen, although enough to spook the Fed into hiking, has diverged dramatically from the underlying fundamentals of GDP growth.

And yes, let’s not forget the Fed is prepared to hike interest rates for the 2nd time in just 3 months. This dramatic tightening has put a great deal of pressure on China’s slowing economy.

 

And to top off this cluster fuck of speculative positioning, it is important to note that the VIX has been sold shorter than Tyrion Lannister.

Fortunately as we all know, a Lannister always pays his debts.

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Or just watch and wait for oil volatility to spread to other asset classes.

So while hedge funds and speculators are watching Trump for false bull signals, they are missing the underlying weakness. To make matters worse, investors and speculators have not been this positioned for a move in the global economy since the world was supposed to end in 2009.

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666 becomes 999 which some how becomes 1999 but wait the year zero didn’t actually start till the year 10, which makes the year of the devil 2009!

OK bad Arnold Schwarzenegger movie references aside (I’m optimistic to think that 3 people will get that reference), my point is that investors are levered to the hilt in almost all the wrong places: Long dollar, long commodities, long US equities, short volatility and short US bonds.

Until now, these levered positions were a powder keg in search of a spark. If the price of oil continues to fall we could witness a forced unwind of these extremely levered speculative positions which would come at a time when the market is incredibly fragile and the Fed has been uncharacteristically hawkish.

 


DISCLAIMER: This blog is the diary of a twenty something millennial who has never stepped foot inside a wall street bank. He has not taken an economic or business course since high school (for which he is immensely proud of) and has been long gold since 2012 (which he is not so proud of). In short his opinions and experiences make him uniquely unqualified to give advice. This blog post is NOT advice to buy or sell securities. He may have positions in the aforementioned trades/securities. He may change his opinion the instant the post is published. In short, what follows is pure fiction based loosely in the reality of the ever shifting narrative of the markets. These posts are meant for enjoyment and self reflection and nothing else. So ENJOY and REFLECT! 

Toro: Dollar Bulls Charging At The Fed’s Red Cape

Toro: Dollar Bulls Charging At The Fed’s Red Cape

The dollar story is a very interesting one. As the global monetary system’s reserve currency the dollar does not behave like any other fiat currency. The history of other monetary systems typically lasts around 40 years. At 46 years, our current post-Bretton Woods system (beginning in 1971), is old, rickety and fraught with danger. These instabilities have created powerful structural forces that have propelled the dollar higher. The most recent episode was the 2014 rising dollar story that crushed oil and other commodities as well as the Emerging Markets that depend on them.

These forces are still at work. They haven’t gone away, and neither have the bulls who are aware of their presence, no matter how far in the background they may be. I consider myself in this camp, but at the same time, as I indicated in the previous sentence, I believe these forces to be mostly hidden in the background, waiting to be thrust again into the light.

On the other hand, I see a confluence of bearish dollar forces at work. Despite the amazing soybean quarter of 2016 which almost puts TSLA’s Q3 “positive cash flow” to shame, US GDP growth has been sub 2%. Q1 2017 is likely to come in under 2% as well.

It is important to note that these two quarters will have taken place before the effects of rising interest rates and the stronger dollar will be fully felt. These sub par GDP numbers also include the incredible growth we’ve seen from the US shale industry. Is some other US industry going to magically contribute to GDP going forward? It is hard to imagine a scenario where US economic growth will surprise to the upside.

And yet the Fed still finds reasons to hike interest rates. Janet Yellen, looking through her rearview mirror points to the fantastic economic strength we’ve seen in the larger foreign economies.

First off, China does not look as healthy as Janet Yellen’s rearview mirror suggests. The GDP growth target in China has fallen to 6.5% and, more importantly, M1 growth has rolled over which suggests China’s best days are now behind it.

Part of the readjustment in China’s growth is due to the unstable nature of the country’s real estate boom. Xi’s approach to a tighter monetary policy and more stable growth should slow the real estate boom and have far reaching effects for not just China’s economy but commodities and Emerging Markets as well.

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As for Europe and Japan, yes it is true their economies have responded positively to the reflation trade. Because these economies have been trapped in deflation the longest, it makes sense to see them be the largest beneficiaries of inflation (at least in the short term). Eurozone’s PMI is at its highest point in over 5 years.

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We haven’t seen a Japanese PMI this positive since Abenomics’ heyday in 2014.

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Meanwhile, warning signs have piled up in the US, and the ISM manufacturing survey despite being elevated could peak as early as this month.

But we know the real reason the Fed is prepared to hike. The global reflation trade has certainly given Janet and her ilk a false sense of comfort, but the odds of a fed rate hike were incredibly low until a week ago.

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That is, until The Donald gave his State of the Union address.

There was no US economic news between mid February and now to suggest such a rapid rise in March rate hike odds. Trump spoke, and the Fed panicked. If everything Donald said was in fact going to happen and at the pace he implied, the Fed would have undoubtedly fallen behind the curve. But is Trump really going to get the things he desires as soon as he suggests? From my November blog post, It’s A Trap!:

“In order to win the election, Donald Trump successfully united a diverse group of people and yet he didn’t win the majority vote. And although the republicans may have won congress, Donald is hardly a republican president. Donald Trump is akin to a battle commander who has charged too far ahead of his troops. He will need to wait to gather the army before he can launch an effective attack.”

However, eloquent and well spoken his State of the Union address may have been, it is of vital importance to realize that Trump does not write the bills. Trump does not pass the bills. The fractured and incompetent Congress does. A large portion of Democrats are still sore from “their” loss in November, and are opposing Trump on every issue imaginable. Meanwhile, the Republicans are split between a Border Adjusted Tax, repealing Obamacare, and a number of other issues. Republican Senator Rand Paul hasn’t even been allowed to see the current bill.

Trump’s stimulus is further out than the market and more importantly the Fed anticipates. It is more likely that the Fed is hiking into weakness than strength. Speaking further to probabilities, it is likely that the March rate hike will mark the peak in Fed’s hawkish stance for the year, and yet Hedge Funds are positioned for further US economic strength and inflation.

 

Somewhat paradoxically, funds are also incredibly long commodities.

The long dollar and long commodity trade is also known as the reflation trade. Rising global growth pushes up demand for commodities, which props up prices which in turn pushes up inflation thereby leading to a rise in bond yields. US bond yields rise higher than those in EU and Japan due the QE and NIRP policies further propelling the dollar higher.

But the reflation trade is not only old and well known but perhaps most importantly is likely turning. As I believe the origin of the reflation trade is found in China (not Trump), it should worry these reflation bulls that China’s economy is slowing not accelerating. It should be even more worrisome that the Fed is hiking not because of improving Chinese economic data but Trump’s rhetoric. From my post The Reflation Trade:

“But investors have become so accustomed to the US driving the global credit cycle that they have missed the origin of the reflation trade. The dollar, commodities and inflation have all risen together for the first time in over a decade which has left investors scrambling for a narrative to explain this paradox. Fortunately, the recent US presidential election has provided just that. Despite the “coincidence” of commodities bottoming with China’s economy in February of last year, investors have latched on whole heartily to the “Trumpflation” narrative. “

The base effects from reflation should peak this month (the data from February is released in March). The Fed with its well polished rearview mirror should fall hook line and sinker for the inflationary data just as it is peaking. Meanwhile growth from the EU (if the specter of Le Pen disappears) and Japan could surprise to the upside while the US lags. Going forward, we should expect Fed dovishness, not hawkishness and dollar weakness not strength.

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DISCLAIMER: This blog is the diary of a twenty something millennial who has never stepped foot inside a wall street bank. He has not taken an economic or business course since high school (for which he is immensely proud of) and has been long gold since 2012 (which he is not so proud of). In short his opinions and experiences make him uniquely unqualified to give advice. This blog post is NOT advice to buy or sell securities. He may have positions in the aforementioned trades/securities. He may change his opinion the instant the post is published. In short, what follows is pure fiction based loosely in the reality of the ever shifting narrative of the markets. These posts are meant for enjoyment and self reflection and nothing else. So ENJOY and REFLECT!