[This blog post is an excerpt for a commentary published last week at www.speculative-investor.com]

The following chart shows that over the past five years the US$ copper price (the brown line) and the S&P500 Index (the green line) generally trended in the same direction. Why, then, have they moved in opposite directions over the past two months?

The relationship between the copper price and the S&P500 Index (SPX) can be described as one of generally positive correlation with divergent movements at times. The copper price acts as an economic bellwether due to its extensive industrial usage, while the SPX represents general equity market sentiment. They are influenced by similar macroeconomic factors, but short-term performance differences occasionally arise due to shifts in commodity-specific factors, inflation expectations and risk preferences.

The performance difference since early-April, with the copper price moving downward to a new low for the year while the SPX moved upward to a new high for the year, is most likely due to shifting risk preferences within the stock market. To be more specific, the copper price has declined in sympathy with a global manufacturing recession (the US, European and Chinese manufacturing PMIs are all in recession territory) and the high probability of reduced metal demand over the months ahead as the on-going monetary tightening takes its inevitable economic toll, while the SPX has risen on the back of speculation that technology in general and AI in particular will generate good returns almost regardless of what happens to the economy.

One way or the other, it’s likely that the divergence will close within the next three months.

From our perspective, copper is performing exactly the way it should be performing considering the macroeconomic landscape. It is short-term oversold and could rebound at any time (a routine countertrend rebound would take the copper price back to the US$3.80s), but we suspect that it will trade at least 10% below its current price before completing its downward trend. Consequently, we expect that the divergence will close via weakness in the stock market rather than strength in the copper market.

[This blog post is an excerpt from a recent commentary at https://speculative-investor.com/]

Last week there was a big drop in the US federal government’s account at the Fed (the Treasury General Account, or TGA for short). The latest figures show a TGA balance of only US$57B, which probably means that the government will run out of money within the next three weeks unless a deal is done to raise or suspend the Debt Ceiling. Given the lack of fear recently evident in the financial markets, with risk-off assets such as gold doing relatively poorly and signs of aggressive bullish speculation in parts of the stock market, it appears that most market participants expect a deal to be done very soon. While that’s definitely possible, it’s far from a foregone conclusion. Moreover, what comes after a Debt Ceiling deal will not favour the stock market.

What comes after a Debt Ceiling deal will be a flood of new government debt issuance to replenish the TGA and make the payments that were postponed during the preceding months. To be more specific, based on information provided by the Treasury there will be net new debt issuance of more than US$700B during the three months following a deal. This will drain liquidity from the financial markets unless it is accompanied by money leaving the Fed’s Reverse Repo (RRP) program. For instance, if the government were to increase its total debt by $750B after a deal and $500B of the new debt were purchased by MMFs using funds presently held in the RRP program, then the net liquidity drain would only amount to $250B.

Currently, therefore, there are two big unknowns. The first is the timing of a political deal to raise the Debt Ceiling and the second is the proportion of the ensuing flood of new debt that will be offset — in terms of effect on financial market liquidity — by money coming out of RRPs.

With regard to the timing question, there are two main scenarios.

The first is that a deal will be done within the next three weeks, thus avoiding a partial shutdown of the government. As mentioned above, this currently appears to be the general expectation. We suspect that if it comes to pass it will lead to short-lived (1 week maximum) moves to the upside in the stock market and downside in the gold and T-Bond markets, followed by reversals as other issues, including an imminent recession and the coming flood of new government debt, move to centre-stage.

The second scenario is that the political negotiations will drag on until a deal is forced upon the two negotiating parties by extreme weakness in the stock market. Under this scenario, a deal could be 2-3 months away. Even though the TGA balance probably will drop to almost zero within three weeks, this sort of delay in striking a deal is possible because of the corporate tax payments that are due on 15th June and the additional special measures that could become available to the Treasury at the end of June. In addition to substantial stock market weakness and a partial government shutdown, likely ramifications of this scenario include a large rise in the gold price.

What happens with the US government’s Debt Ceiling will have a big influence on the paths taken by the major financial markets over the next three months, but our short-term assessments of risk and reward do not hinge on when/how the Debt Ceiling issue is resolved. Regardless of whether we get the first scenario or the second scenario or something in between, the outlook for the next three months is bearish for the S&P500 Index, bullish for gold and bullish for the T-Bond.

[This blog post is an excerpt from a recent commentary at https://speculative-investor.com/]

Short-term moves can create opportunities to scale in or scale out, but the big picture always should be kept in mind. For the gold mining sector, this means keeping in mind the high probability that a cyclical bull market is underway. This cyclical trend should result in large additional gains by gold mining stocks in nominal terms and relative to most other stocks. With regard to relative performance, the following two weekly charts give some idea as to the amount by which gold mining stocks could outperform other commodity-related stocks over the next 6-12 months.

The first chart shows that gold mining stocks (represented by GDX) doubled-bottomed relative to general mining stocks (represented by XME) between August of last year and February of this year. Significant gains in the GDX/XME ratio have occurred already, but based on the historical record the ratio could double from here prior to making its next major peak. As mentioned in previous TSI commentaries, the cyclicality of this ratio points to the gold sector’s next major relative-strength peak occurring between late-2023 and mid-2024.

The second chart shows that the gold sector reversed upward relative to the oil sector (represented by XLE) during the final quarter of last year. This chart suggests that the new trend involving strength in gold stocks relative to oil stocks is still in its infancy.

In case what we’ve written above and in many previous commentaries is not clear, the focus of most investing/speculating should be on gold and the related assets (silver and the gold/silver mining stocks). This has been the case for the past six months, it is the case now and it likely will be the case for the next six months.

For equity traders, this means that the gold mining sector should be prioritised when planning portfolio additions. However, it doesn’t mean that everything else should be ignored and that your entire portfolio should consist of gold/silver stocks. With regard to “everything else”, we note that the fundamentals for the oil tanker sector remain very bullish, the cannabis sector is starting to shows signs of life, it is important to have exposure to energy (oil, coal, uranium and natural gas) and it would make sense to have some exposure to commodities such as lithium and the REEs.

Some economists/analysts argue that the government creates wealth in the private sector via deficit-spending. From an accounting perspective they are right, in that when the government borrows and then spends X$ the private sector is left with the same amount of dollars plus an asset in the form of government debt securities worth X$. This implies that every dollar of government deficit-spending immediately adds a dollar to the private sector’s wealth, regardless of whether or not the spending contributes to the pool of real resources. This is counterintuitive. After all, given that every government is very good at deficit spending, there would be no poverty in the world if it really were possible for the government to create wealth in the private sector simply by putting itself further into debt. So, what’s the problem with the aforementioned accounting?

There are multiple problems, the first of which I’ll explain via a hypothetical case. Fred Smith is operating a basic Ponzi scheme. He is issuing $1,000 bonds that have a very attractive yield and using money from new investors to pay the interest on existing bonds and to finance a lavish lifestyle for himself. Using the same accounting that was used above to ‘explain’ how government deficit-spending creates wealth, every time Fred issues a new bond and spends the proceeds the total amount of wealth in the economy ex-Fred increases by $1,000.

The government is like Fred. For all intents and purposes, the government is running a Ponzi scheme because a) the interest and principal payments to existing investors are financed by issuing new debt, and b) there is no intent to ever pay-off the debt (the total debt increases every year). As was the case in the Fred example, every time the government issues a new bond and spends the proceeds the total amount of wealth in the economy ex-government increases by the amount paid for the bond.

Just as it would not make sense to view a dollar invested in Fred’s Ponzi scheme as having the equivalent effect on actual wealth as a dollar invested productively, it does not make sense to equate investment in government bonds with investment in productive assets.

That’s not the only problem, because if government bonds are purchased with existing money then an increase in government indebtedness must result in reduced investment in private sector debt or equity. In this case, therefore, government deficit-spending ‘crowds out’ private-sector investment, which is a problem in that politically-motivated spending by the government is likely to contribute less to the total pool of real wealth than economically-motivated spending by the private sector.

But what if government debt is purchased by the central bank or commercial banks with newly-created money, as occurs when the central bank implements a Quantitative Easing (QE) program? In this case there is no ‘crowding out’ of private sector investment.

According to MMT (Modern Monetary Theory) proponents as well as most Keynesians and Monetarists, the money supply increase that occurs when government debt is purchased using newly-created money is not a problem until/unless it leads to a large rise in the “general price level” as indicated by statistics such as the CPI. However, a rise in the general price level is not the only problem that can be caused by creating money out of nothing. It’s not even the main problem. The main problem is the distortions to interest rates and other price signals that the new money brings about. These distortions can lead to mal-investment on a grand scale.

In conclusion, sometimes a concept can be counterintuitive primarily because it is wrong. In accounting terms it can seem as if the government can ‘magically’ create wealth via deficit-spending, but only if you treat investment in government debt as equivalent to investment in productive endeavours and ignore the fact that creating money out of nothing tends to cause mal-investment.