[This blog post is an excerpt from a recent commentary published at TSI]

It would be difficult for our opinion of Powell and Co. to be any lower, and yet we still manage to overestimate them.

Having correctly anticipated that the Fed had paved the way for a major inflation problem — a problem that would become evident in commodity, goods and services prices rather than just asset prices — during the first half of 2020, we were surprised that the Fed continued to stimulate after such a problem became blatantly obvious in 2021. And over the past few months we have been surprised that the Fed remained on an aggressive monetary tightening path after it became clear that the equity bubble had burst, the US economy had entered or was about to enter recession territory, commodity prices had set intermediate-term peaks and forward-looking indicators of the CPI were in downward trends.

With regard to forward-looking CPI indicators, one of the most useful is the difference between the 10-year T-Note yield and the 10-year TIPS yield, a.k.a. the 10-year Breakeven Rate, which is a measure of the future annual percentage growth of the CPI factored into the bond market. The following chart shows that over the past two weeks this indicator made an 18-month low.

Chart source: https://research.stlouisfed.org/

Another forward-looking CPI indicator is the ISM Manufacturing Prices Paid Index, an index based on a survey of purchasing managers at US manufacturing companies. As illustrated below, this index has plunged over the past six months to its lowest level in more than two years.

Chart source: https://tradingeconomics.com/

A popular view at the moment is that inflation will prove to be sticky. Well, if the Fed continues along its current path then many people are going to be surprised at just how non-sticky inflation proves to be. We think that if the Fed stays with its current balance-sheet reduction plan until early next year, then by this time next year the year-over-year growth rate of the headline CPI will be less than 2%. It could even be negative.

One of the reasons that the Fed may continue along its current path for a few more months is that policymakers are focusing on the headline CPI growth numbers, and these numbers will remain at very high levels for at least a few more months due to the large price rises that occurred during the first half of this year. Putting it another way, there won’t be a substantial decline in the CPI’s year-over-year growth rate until the large gains that occurred during the first half of this year start dropping out of the calculation. Until then, it’s possible that the Fed will be under political pressure to persist with its “inflation fighting”, and Powell has demonstrated that he is very susceptible to political pressure.

[This blog post is an excerpt from a recent TSI commentary]

Last year US President Biden was telling oil companies that they should be producing less. Then, during the first few months of this year he berated oil companies for not rapidly increasing their production in response to higher prices. Who knows what he will be telling oil companies to do next year or even next week? In this political environment, why would high-profile, publicly-listed oil companies make large investments in long-term oil production growth?

The answer is that they wouldn’t. Even if the next US president understands the need to increase fossil fuel production for at least another 10-15 years and is prepared to stand up to the crowd of misguided environmentalists who seem to believe that renewable energy systems can be created out of nothing, the person that gets the job four years later could have no such understanding and/or no backbone. Therefore, even if the political landscape were to become temporarily supportive, it would be too risky to invest in anything other than small projects with rapid paybacks.

Consequently, we probably have reached “Peak Oil”. This is not the Peak Oil that became a popular story during 2004-2008, because there is no doubt that oil production could be increased with the appropriate investment. It is Peak Oil caused by Regime Uncertainty. As defined HERE, Regime Uncertainty is a pervasive lack of confidence among investors in their ability to foresee the extent to which future government actions will alter their private-property rights.

Due to Regime Uncertainty, we expect that two things will happen over the next few years. The first is that the oil price will make a sustained move above this year’s high (US$130/barrel), because demand will grow (following the 2022-2023 recession) and the oil industry will not respond with large-scale investments in new production. The second is that there will be substantial growth in the amount of wealth returned by oil producers to their shareholders via dividends and share buybacks.

As is the case with NG [natural gas] stocks, short-term weakness in the commodity market combined with downward pressure exerted by the general equity bear market could create excellent opportunities to increase exposure to the oil sector within the next few months.

[This blog post is an excerpt from a TSI commentary published last week]

The financial markets were shocked — shocked, we tell ya! — by the US CPI for August. We know they were shocked because on the day of the CPI release the US stock market gave back almost all of the gain achieved during the preceding strong 4-day rebound and there was a big up-move in the Dollar Index. Before we take a look at the CPI report that caused the mini panic, it’s worth repeating the following comments from the 15th August Weekly Update:

“Over the past few weeks the financial markets have celebrated the signs of declining “inflation”, the thinking being that the evidence of an inflation reversal will lead to a Fed pivot in the short-term. This line of thinking is wrong in two critical ways.

The first way it is wrong is that the Fed’s leadership appears to have its eyes firmly fixed on the rear-view mirror. Although there is now a CPI downtick in the rear-view mirror, base effects (the CPI increases that will remain in the year-over-year calculations for months to come) ensure that the headline CPI growth numbers will remain elevated for at least the remainder of this year. For example, even though inflation most likely has peaked on an intermediate-term basis, the numbers that will stay in and drop out of the year-over-year calculations each month mean that there is almost no chance of the year-over-year CPI growth rate dropping below 6% sooner than the first quarter of next year. In fact, the year-over-year CPI growth rate reported for each of the next three months probably will still have an ‘8 handle’.

Therefore, for months to come the Fed is going to be seeing annual CPI growth rates near multi-decade highs, which will encourage it to continue tightening.

The second way it is wrong is that even after the Fed’s leadership starts to feel confident that inflation is heading towards a level that it deems acceptable, there won’t be an immediate policy reversal.”

The evidence continues to accumulate that inflation is now in a downward trend, but due to the price increases that have already occurred it is reasonable to expect that the year-over-year CPI growth numbers will be near multi-decade highs for at least a few more months. Nobody should expect anything else. Certainly, nobody should have been shocked by the 8.3% year-over-year CPI growth number reported for August.

The 8.3% growth rate reported for August followed 8.5% in July and 9.1% in June. This is probably the start of a downward trend that won’t bottom until Q2-Q3 of next year. More significantly, we point out that the percentage change in the CPI over the past two months was approximately zero — the result of a large decline in the gasoline price offset by price gains elsewhere (e.g. in rent and food).

However, the monthly chart displayed below shows that the numbers remain very high relative to everything over the past twenty years prior to the past few months. This is the issue, given the tendency of the Fed’s leadership to fixate on the rear-view mirror.

It’s worth mentioning that there continues to be a wide gap between the current CPI growth rate and the expected future CPI growth rate.

The following daily chart shows that the 10-Year Breakeven Rate, a measure of what the bond market expects the CPI to be in years to come, peaked on 21st April this year at 3.02%, made a short-term bottom at 2.29% on 6th July and currently is much closer to a 12-month low than a 12-month high. There’s a good chance that the expected CPI will drop to 2.0% or lower during the stock market’s next large multi-month decline.

The problem for the stock market bulls who take every hint of declining “inflation” as a reason to anticipate a shift from monetary tightening to monetary easing is that such a shift won’t happen within the next six months unless there is a lot more economic and stock market weakness. We think that the aforementioned monetary shift will happen during the first quarter of next year, but that’s only because we are expecting a lot more weakness in the stock market and the economy.

[This blog post is an excerpt from a recent TSI commentary]

In most countries/regions around the world, monetary inflation rates peaked at extraordinary heights in early 2021 and have since crashed. Furthermore, the declines are set to continue over the next several months as central bankers attempt to make up for their mistake of being far too ‘easy’ during 2020-2021 by being far too ‘tight’ during 2022-2023, thus revealing a fondness for irony given that part of the official justification for central banks is to smooth-out the business cycle. Here are monthly money-supply charts showing where we are and where we’ve been.

G2 True Money Supply (TMS), a concoction of ours that combines the money supplies of the US and the euro-zone, is the primary driver of the global boom-bust cycle. The following chart shows that in July-2022 the year-over-year G2 TMS growth rate dropped below the boom-bust threshold. With both the Fed and the ECB intent on contracting their balance sheets over the months ahead, it’s a virtual certainty that the line on this chart will continue to move downward. This will worsen the global recession that is already underway.

At a little over 10%, Australia’s monetary inflation rate remains high. However, it has come down a lot from its level of 18 months ago and looks set to drop to 5% or lower over the next several months as the Reserve Bank of Australia ‘tightens the screws’. This is bearish for Australia’s real estate market, where valuations generally remain extremely high.

Over the past 18 months Canada’s monetary inflation rate has collapsed from an all-time high to near a multi-decade low. This has very bearish implications for Canada’s real estate market.

The UK’s monetary inflation rate also has collapsed from an all-time high to near a multi-decade low.

Japan has been a monetary inflation enigma for a long time, in that despite the appearance of aggressive Bank of Japan (BOJ) money pumping the year-over-year growth rate of Japan’s M2 money supply spent the bulk of the past 25 years in the 0%-4% range. In response to the COVID crisis the M2 growth rate surged to almost 10% in 2020-2021, but it has since fallen back to its low/narrow multi-decade range.

With regard to money-supply growth, China has been the ‘odd man out’ over the past three years. In China the monetary response to the COVID crisis was relatively minor and by January of this year the year-over-year growth rate of M1 money supply had dropped below zero. It has since rebounded to around 7%.

The following chart shows that China’s monetary inflation rate has been making lower highs and lower lows (trending downward, that is) since 2010. It probably isn’t a fluke that this downward trend coincides with Xi Jinping’s leadership, because Xi does not like financial speculation.

China’s relatively slow rate of monetary inflation over the past few years is a long-term plus for that country’s economy, but it is being counteracted by many negatives including the severe damage that has been wrought by the “Dynamic Zero COVID” policy.

Once central banks have created a bubble the best they can do is step aside and let the markets sort out the mess. Stepping aside would involve not creating any more money and not destroying any existing money. The worst they can do is take money out of the economy, because that causes additional price distortions and because simply ending the pumping-in of new money would be sufficient on its own to burst the bubble. Currently, central banks are doing the worst they can do in an effort to address price rises resulting from supply constraints, as if reducing the availability of money and credit will promote the investment needed to bring about additional supply. These actions will have dire consequences.

[This blog post is an excerpt from a commentary published at TSI last week]

We have referred to the 6% level for the year-over-year US True Money Supply (TMS) growth rate (the US monetary inflation rate) as the boom-bust threshold, because transitions from economic boom to economic bust generally don’t begin until after the TMS growth rate has made a sustained move below this level. It was different this time, however, because according to other indicators the US economy entered the bust phase of the monetary-inflation-driven boom-bust cycle during the first quarter of this year with the TMS growth rate still above 6%. Why was it different this time and what’s the current situation?

We outlined the most likely reasons why it was different this time in previous commentaries, most recently in the 27th July Interim Update. Here’s the relevant excerpt from our 27th July commentary:

“We think that the current bust began at a higher rate of monetary inflation than in the past for two main reasons. The first is that the Fed was still in monetary-loosening mode at the peak of the economic boom. This had never happened before and resulted in even greater wastage of real savings/resources than in previous booms. The second reason is that due to decades of increasing central bank manipulation of money and interest rates, the economy has become structurally weaker and therefore the collapse of a boom now requires less relative monetary tightening than in the past.”

The main new point we want to make today is that the US money-supply data for July-2022, which were published on Tuesday of this week, reveal that the monetary inflation rate has now confirmed the bust by moving well below the 6% boom-bust threshold. This is illustrated by the first of the two monthly charts displayed below. Furthermore, the second of the following charts shows that the year-over-year TMS growth rate minus the year-over-year percentage change in the Median CPI*, an indicator of the real (inflation-adjusted) change in the US monetary inflation rate, has plunged to near a multi-decade low.

As an aside, from the end of last year to the end of July this year the US True Money Supply increased by $580B. This figure comprises the change in currency in circulation, the change in commercial bank demand and savings deposits, and the change in the amount of money held by the US government in the Treasury General Account (TGA) at the Fed. It is very roughly equal to the increase in commercial bank credit plus the increase in Federal Reserve credit minus the increase in the Fed’s Reverse Repo program. Over the aforementioned period the Fed’s direct actions REDUCED the US money supply by about $210B, but the Fed’s actions were more than offset by the money-creating actions of the commercial banking industry.

With the Fed still on the tightening path, it’s unlikely that the lines on the above charts have bottomed. One implication is that the yield curve probably will become more inverted over the next few months. Another implication is that it would be difficult to be too bearish with regard to the US stock market’s 6-12 month prospects.

*A price index calculated by the Cleveland Fed

[This blog post is a brief excerpt from a recent TSI commentary]

Over the past few weeks the financial markets have celebrated the signs of declining “inflation”, the thinking being that the evidence of an inflation reversal will lead to a Fed pivot in the short-term. This line of thinking is wrong in two critical ways.

The first way it is wrong is that the Fed’s leadership appears to have its eyes firmly fixed on the rear-view mirror. Although there is now a CPI downtick in the rear-view mirror, base effects (the CPI increases that will remain in the year-over-year calculations for months to come) ensure that the headline CPI growth numbers will remain elevated for at least the remainder of this year. For example, even though inflation most likely has peaked on an intermediate-term basis, the numbers that will stay in and drop out of the year-over-year calculations each month mean that there is almost no chance of the year-over-year CPI growth rate dropping below 6% sooner than the first quarter of next year. In fact, the year-over-year CPI growth rate reported for each of the next three months probably will still have an ‘8 handle’.

Therefore, for months to come the Fed is going to be seeing annual CPI growth rates near multi-decade highs, which will encourage it to continue tightening.

The second way it is wrong is that even after the Fed’s leadership starts to feel confident that inflation is heading towards a level that it deems acceptable, there won’t be an immediate policy reversal. Instead, the following sequence is likely:

1) The pace of rate hiking will slow

2) The rate hiking will stop

3) The balance sheet contraction (QT) will stop

4) Rate cutting will begin

5) Balance sheet expansion (QE) will begin

At the moment Step 5 is probably at least eight months into the future. In the 2007-2009 bear market and recession, the bear market didn’t end until about six months AFTER step 5.

This suggests to us that asset prices in general and the stock market in particular will face monetary headwinds until at least the first quarter of next year, and that monetary conditions will not be ripe for a new equity bull market any sooner than the second half of next year. In the meantime there will be rebounds to lower highs followed by declines to lower lows.

[This blog post is an excerpt from a recent commentary published at TSI]

It is claimed that government indebtedness can be reduced via something called “financial repression”, which is the combination of “price inflation” and interest rate suppression. The idea is that the government debt burden can be made smaller in real terms in a relatively painless way by depreciating the currency in which the debt is denominated while the central bank prevents a large rise in the cost of servicing the debt. At a superficial level it seems plausible and may well be attempted over the years ahead by some governments, including the US government. However, aside from it having never worked as advertised in the past, the problem with financial repression is that when viewed through the lens of good economic theory it is not plausible. On the contrary, good economic theory indicates that the financial repression path leads to the destruction of the currency and economic collapse.

To support their argument, advocates of the idea that financial repression can achieve its intended goal (a reduction in the real government debt burden without dramatically adverse economic consequences) point to the US experience during the decade following the end of the Second World War. During this period there was significant “inflation”, a large reduction in federal government indebtedness and a successful effort by the Fed to prevent the yield on US government bonds from rising to reflect the inflation. However, this is an example of the logical error of observing that ‘B’ followed ‘A’ and concluding that ‘A’ must therefore have caused ‘B’.

In economics there are always many potential influences on an outcome. As a result, to avoid coming up with nonsensical cause-effect relationships you must be armed with prior knowledge in the form of good theory. For example, an observation that over the past twenty years the US unemployment rate has tended to move inversely, with a lag, to the price of beer in Iceland, should not lead to the conclusion that the rate of US unemployment could be reduced by increasing the price of beer in Iceland.

With regard to the US post-War experience, the key to success was not “financial repression”. The keys were the dismantling of New Deal programs, the general freeing-up of the economy, a reduction in government spending (government spending collapsed in the two years immediately after the War and then essentially flat-lined for a few years), and a currency linked to the world’s largest gold reserve. It was the combination of economic strength and restrained government spending, not the combination of inflation and interest-rate suppression, that enabled the US government to greatly reduce its debt burden.

In today’s world, we can safely assume that a general freeing-up of the economy leading to strong real growth is not on the cards.

To envisage what would happen in response to financial repression over the years ahead, bear in mind that if the central bank stops one pressure valve from working then the pressure will blow out somewhere else. For example, by monetising enough government debt the Fed could create a situation involving high price inflation and a low interest expense for the US government, but even in the unlikely event that the US government tried to its rein-in its spending the non-interest-related cost of running the government would surge due to price inflation. As a result, the total amount of government debt would rise rapidly and the Fed would be forced to ramp-up its bond monetisation to keep a lid on government bond yields, causing more “inflation” and giving another substantial boost to the cost of running the government, and so on.

Summing up, in a high-inflation low-growth environment, financial repression would lead to a downward spiral in currency purchasing power and an upward spiral in government indebtedness.

[This blog post is an excerpt from a recent TSI commentary]

A basic and very important fact of which hardly anyone is aware is that a general rise in asset prices has nothing to do with economic progress. It is, instead, driven totally by an increase in the supply of money. To put it another way, the general appreciation of asset prices is driven totally by the depreciation of money.

For example, there is no reason other than an increase in the money supply for broad stock market indices to rise over the long-term. The prices of some stocks would rise due to certain companies gaining an advantage and becoming more valuable relative to other companies, but the overall market would not rise in the absence of monetary inflation. An implication is that if the money supply were stable then dividends would constitute 100% of the long-term returns on investment achieved by the owners of broad index funds.

For another example, there is no reason other than an increase in the money supply that residential property prices should rise over the long-term. The prices of some houses would rise due to renovations or zoning changes or some locations increasing in relative popularity, but the median house price would not increase over the long-term in the absence of monetary inflation. In other words, the increase in the median house price is solely due to monetary inflation. This means that if the market value of your house gained 25% over a period and the median house price gained 20% over the same period, then 80% of the increase in the market value of your house was due to the depreciation of money.

A source of confusion is that over the past 50 years asset prices have tended to rise much faster than the prices of goods and services, creating the impression that the price increases are mostly real (that is, not driven by the depreciation of money). This has happened due to the nature of monetary inflation and policies designed to boost the prices of assets.

An important characteristic of monetary inflation is that the new money does not get injected uniformly throughout the economy and therefore does not affect prices in a uniform manner. As explained in a TSI commentary in 2019, this is one of the three reasons that the Quantity Theory of Money (QTM), which holds that the change in the “general price level” is proportional to the change in the money supply, doesn’t work.

Instead of a uniform rise in prices in response to monetary inflation, different prices get affected in different ways at different times depending on who the first receivers of the new money happen to be. In the case where the new money is created by the central bank as part of a QE program, which has happened a lot since 2008, the first receivers of the new money are bond speculators. This makes the owners of financial assets the initial and main beneficiaries of the money creation. In the case where the new money is loaned into existence by commercial banks, the main beneficiaries are the owners of assets that are purchased with the borrowed money. Over the past few decades a sizable portion of the borrowing from commercial banks has been related to the purchase of real estate (most buyers of houses are able to borrow a high percentage of the purchase price), causing the owners of houses to be among the main beneficiaries.

As an aside, monetary inflation is responsible for the widening of the “wealth gap” that has occurred over the past 40 years, because it benefits the asset rich at the expense of the asset poor. The expanding wealth gap is now being touted as the justification for greater government intervention and/or taxation, almost always by people with no understanding of the underlying cause.

As another aside, the big inflation-related change that happened during 2020-2021 is that a large increase in the money supply was accompanied by government actions that simultaneously destroyed supply chains and super-charged consumer spending.

Monetary inflation’s pivotal role in boosting/distorting asset prices is why we pay so much attention to it and so little attention to the more popular ‘fundamentals’. In some cases the more popular fundamentals, market-wide corporate earnings being a good example, are themselves just functions of the monetary inflation rate.

[This blog post is an excerpt from a recent commentary published at TSI]

This is a follow-up to our 25th April piece titled “Inconvenient Facts” in which we summarised some of the issues that are ignored or brushed over by many proponents of a fast transition to a world dominated by renewable energy sources. The follow-up was prompted by a recent RealVision.com interview of Wil VanLoh, the CEO of Quantum Energy Partners, by Kyle Bass. The charts displayed below were taken from this interview.

To summarise the summary included in our earlier piece, it takes a lot of energy and minerals to build renewable energy systems and it takes years for a renewable energy system to ‘pay back’ the energy that was used to build it. Consequently, achieving the energy transition goals set by many governments will require increasing production of fossil fuels for at least the next ten years, which, in turn, will require substantially increased investment in fossil fuel production and distribution (pipelines, terminals, storage facilities and ships). In addition, achieving today’s energy transition goals will necessitate substantially increased production of certain minerals, meaning that it will require more mining.

With regard to the need for more mining to bring about the Sustainable Energy Transition (SET), the top section of the following chart compares the quantities of minerals required to build a conventional car with the quantities required to build an electric car. The bottom section of the same chart does a similar comparison of fossil-fuel (natural gas and coal) power generation and renewable (solar, on-shore wind and off-shore wind) power generation.

The next chart illustrates the increase in the production of several minerals that will have to happen by 2030 to achieve the current energy transition goals. Of particular interest to us, it shows that over the next eight years copper and zinc production will have to double, manganese production will have to increase by 5-times, nickel production will have to increase by 11-times and lithium production will have to increase by 18-times.

On a related matter, mining is an energy-intensive process. Moreover, the bulk of the increased mining required to meet the current SET goals will occur in places where the only economically-viable sources of energy will be fossil-fuelled power stations or local diesel-fuelled generation. This means that the increase in mining required for the energy transition will, itself, require increased production of coal, natural gas and diesel.

Soaring prices of oil, natural gas, coal and oil-based products (gasoline and diesel) have focused the attention of senior Western politicians on the urgent need for more oil and natural gas production. However, today’s supply shortages are due to a decade of under-investment in hydrocarbon production, which, in turn, is a) the result of political and social pressure NOT to invest in such production, b) a problem that even in a best-case scenario will take many years to resolve, and c) a problem that will be exacerbated by chastising oil companies and threatening government intervention to cap prices.

If it were possible to do so, ‘greedy’ oil and oil-refining companies would be very happy to flip a switch and increase production to take advantage of current high prices. The reality is that it isn’t possible and that increasing production to a meaningful extent will require large, long-term investments. But why should these companies take the risks associated with major investments to boost long-term supply when they continue to be pressured by both governments and their own shareholders to prioritise reduced carbon emissions above all other considerations and when there is enormous uncertainty regarding future government energy policy?

[This blog post is a excerpt from a recent TSI commentary]

In terms of effect on the money supply, reverse repurchase agreements (reverse repos) are the opposite of quantitative easing (QE). Whereas every dollar of QE adds one dollar to the money supply plus one dollar to bank reserves at the Fed (bank reserves are not counted in the money supply), every dollar of reverse repos subtracts one dollar from the money supply plus one dollar from bank reserves at the Fed. Consequently, although reverse repos are not done with the primary aim of tightening monetary conditions, they effectively are a form of quantitative tightening (QT).

Unlike QE, reverse repos are temporary. To be more specific, the money removed from the banking system via a reverse repo will be returned within 24 hours unless a new reverse repo is created to replace the expiring one. However, the following chart shows that since April of last year the Fed has not only been rolling over or replacing expired reverse repos, but also has been adding to the outstanding pile by creating new reverse repos. As a result, the outstanding pile of reverse repos now amounts to $2.16 trillion. This means that the Fed’s reverse repo program has removed $2.16 trillion from the US economy since the beginning of April-2021.

From April-2021 until March-2022 the Fed was adding money to the economy via QE and simultaneously removing money from the economy via reverse repos. The amount of money being added via QE was greater than or equal to the amount being subtracted via reverse repos until early-December of last year, at which time the Fed became a net subtractor from the US money supply and US bank reserves.

One implication is that even though the Fed officially won’t start QT until this month, for all intents and purposes QT has been happening for about six months. Another implication is that the Fed now has more than two trillion dollars that it could inject into the economy simply by allowing existing reverse repos to expire. This could enable the Fed to boost the money supply over the months ahead while pretending to do QT.

[This blog post is an excerpt from a TSI commentary published on 5th June 2022]

A point we’ve made many times in the past* is that gold and the world’s most important equity index (the S&P500 Index – SPX) are at opposite ends of a virtual investment seesaw. Due to their respective natures, if one is in a long-term bull market then the other must be in a long-term bear market. In multi-year periods when they are both trending upward in dollar terms it means that the dollar is in a powerful bear market, not that gold and the SPX are simultaneously in bull markets (the one that is actually in a bull market will be determined by the performance of the gold/SPX ratio). Recently, our ‘investment seesaw’ concept was part of the inspiration for the Synchronous Equity and Gold Price Model (SEGPM) created by Dietmar Knoll. This model is a quantitative relationship between the SPX, the US$ gold price and the US money supply (the model uses the M2 monetary aggregate), and is explained on pages 251-266 of Incrementum’s latest “In Gold We Trust” report.

Before delving into how the SEGPM works, it’s worth pointing out that there have been previous attempts to link changes in the stock market and the gold price to changes in the money supply. These attempts failed. With regard to the stock market they failed because a strong positive correlation between the senior equity index and the money supply only exists during equity bull markets, that is, the money supply in isolation fails to account for the major swings in the stock market. For example, during the 9-year period from March-2000 to March-2009 there was huge growth in the US money supply, but the SPX was 50% lower at the end than it was at the start of this period.

With regard to the gold market the aforementioned attempts failed first and foremost because the underlying premise is wrong, in that there is no good reason for the gold price to track the US money supply. Also, we know from the historical record that valuations for gold that are based solely on the US money supply can deviate hugely from the real world for DECADES at a time, which means that they have no practical value.

The sorts of models mentioned above have never worked over complete cycles because they consider the SPX and the money supply or gold and the money supply, as opposed to an SPX-gold combination (both ends of the ‘investment seesaw’) and the money supply.

The SEGPM is based on the idea that there are periods when an increase in the money supply will boost the SPX more than it will boost the gold price and other periods when an increase in the money supply will boost the gold price more than it will boost the SPX, with the general level of trust/confidence** in money, the financial system and government determining whether the SPX or gold is the primary beneficiary of monetary inflation. During long periods when trust/confidence is high or trending upward, increases in the money supply will tend to do a lot for the SPX and very little for gold. The opposite is the case during long periods when trust/confidence is low or falling.

Dietmar Knoll found that adding the SPX to 1.5-times the US$ gold price (and applying a scaling factor) resulted in a number that has done a good job of tracking the M2 money supply over many decades. The correlation is illustrated by charts included in the above-linked Incrementum report, but we have created our own charts using True Money Supply (TMS) instead of M2. Our charts are displayed below.

Each of the following two monthly charts compares the US TMS with the sum of the S&P500 Index and 1.5-times the US$ gold price. The only difference between these charts is the scaling of the Y-axis. The first chart uses a linear scale and the second chart uses a log scale.

The log-scaled chart displayed above indicates that since 1959 there have been only three multi-year periods during which the SEGPM deviated by a substantial amount from the money supply. The first was during 1969-1971 due to the extreme under-valuation of gold (the gold price was fixed at the time and unable to respond to the monetary inflation and declining confidence of the time). The second was during 1979-1980 due to a gold market bubble. The third was during the second half of the 1990s due to a stock market bubble.

Interestingly, both charts indicate that the current SPX+gold level is low relative to the money supply. If we are right to think that an economic bust (a 1-3 year period of declining confidence) has begun, then this suggests that there is a lot of scope for the gold price to increase over the next couple of years even if the pace of money-supply growth is slow. To be more specific, it suggests the potential for the US$ gold price to double over the next two years with TMS growth of only 5% per year.

*For example, in the May-2017 blog post linked HERE

**The general level of trust/confidence is quantified by our Gold True Fundamentals Model (GTFM)

[This blog post is an excerpt from a commentary published at TSI last week]

One of the few commonly-believed things about gold that is actually true is that gold tends to become more valuable when the real interest rate is trending downward and less valuable when the real interest rate is trending upward. Furthermore, although the real interest rate trend is just one of seven inputs to our Gold True Fundamentals Model (GTFM) and usually doesn’t have a greater effect than the other inputs, over the past three months it clearly has been the dominant fundamental influence on the US$ gold price. This prompted us to ask: Have there been times in the past when the change in the real interest rate trumped all other considerations?

Before we answer the above question we’ll reiterate a point we’ve made numerous times in the past, which is that the only way to get an accurate read on the real US interest rate trend is via the yields on Treasury Inflation Protected Securities (TIPS). Unfortunately, the TIPS market did not exist prior to 2003, so there is no way of measuring the performance of real interest rates during earlier periods. In particular, it would be extremely useful to know the performance of real interest rates during the 1970s (the last time that “inflation” was widely viewed as “Public Enemy No. 1”), but the information simply isn’t available. It is tempting to calculate the real interest rate that prevailed in earlier periods by using what is available, for example, by subtracting the year-over-year change in the CPI from the nominal interest rate. However, you can’t make up for the lack of a legitimate number by using a bogus one.

As far as we can tell, during the 19.5 years since the TIPS market came into being there has been only one other multi-month period when the real interest-rate trend caused a sizable move in the gold price that was counter to the overall fundamental backdrop. That period was March-October of 2008, which is the first of the three real interest rate (10-year TIPS yield) surges labelled on the following chart. During March-October of 2008 the overall fundamental backdrop was supportive for gold, but the real interest rate rise was large enough and fast enough to trump the bullish influences on the US$ gold price.

By the way, the second of the three real interest rate surges labelled on the chart occurred during April-September of 2013. This one doesn’t qualify because it occurred when economic growth expectations were rising and the overall fundamental backdrop was bearish for gold.

Like the real interest rate surge during March-October of 2008, the one that began on 8th March of this year has occurred in parallel with collapsing economic growth expectations. The difference is that whereas the 2008 surge in the TIPS yield was driven by plunging inflation expectations, the 2022 surge has been driven by rising nominal interest rates.

Despite the overall gold-bullish fundamentals, in 2008 the US$ gold price remained in a downward trend until the TIPS yield peaked. Gold then quickly retraced its decline and gold mining stocks sprang back like beachballs that had been held underwater. Based on the way things are going it is likely that something similar will happen this year.

[This blog post is a brief excerpt from a TSI report published last week]

Central banks and governments rarely, if ever, take responsibility for obvious inflation problems. They never have to, because by the time an inflation problem becomes obvious a lot of time will have transpired since the implementation of the policies that caused it. Furthermore, due to the aforementioned time between cause and effect it generally will be possible for policymakers to point the finger of blame at external influences from the more recent past. A great example is the Biden Administration’s references to the current US inflation problem as “Putin’s price hike”.

The foundation for today’s inflation was laid many years ago by a central bank that reacted to every bout of serious economic and/or stock market weakness by pumping up the money supply, but it was in 2020 that ‘the rubber hit the road’ so to speak. Beginning in March of 2020, this is what happened:

1) The government shut down large sections of the economy in reaction to a pandemic. This was a heavy-handed, low-tech and short-sighted political decision that gave scant consideration to the collateral damage it would cause to both the economy and public health. Unfortunately, an economy isn’t like an engine that can be stopped and then restarted with no ill effects. On the contrary, many supply chains will be permanently broken when large sections of the economy are shut down. Establishing new supply chains often will take time (at least several months and perhaps even years), and in the interim there will be shortages.

2) The government-driven economic collapse prompted the Fed to create several trillion new dollars out of nothing, thus expanding the total US money supply by 40% in one year. This is the single most important contributor to the current inflation problem, and yet the Fed generally is portrayed as the solution to the problem rather than the primary cause of it.

3) To mitigate the extreme short-term hardship caused by its own actions, the government distributed to individuals and businesses a substantial portion of the new money created by the Fed. In effect, the government showered the population with money, and as a result the 2020 recession coincided with a rapid increase in personal income. Nothing like this had ever happened before.

Summing up the above, as part of a reaction to COVID-19 the government caused the supply of many goods to shrink, and at the same time the government teamed up with the Fed to engineer a large increase in the monetary demand for goods. This created an obvious “inflation” problem well before Russia invaded Ukraine.

The major inflation problem that existed prior to Russia’s invasion of Ukraine has since become worse, but not due to the invasion itself. Russia’s invasion of Ukraine could not have made a significant difference to inflation in the US or in most other parts of the world if not for the economic sanctions imposed against Russia. The sanctions have added to the problem.

The anti-Russia sanctions have done new damage to supply chains and deprived the world of critical resources, but to what end? Economic sanctions have never worked in the past and there is no reason to expect that this time will be different. In fact, the evidence to date indicates that the sanctions have not only done nothing to help innocent Ukrainians or discourage the perpetrators of the war (in Russia, Putin is now more popular than ever), but also caused hardship for innocent people throughout the world.

In conclusion, the current US inflation problem was caused by the combination of a huge increase in the US money supply, US government programs that effectively showered the population with money, supply disruptions caused by COVID-related lockdowns and additional supply disruptions caused by a raft of anti-Russia sanctions that have no chance of achieving anything positive. That is, the “inflation” that has become the primary focus of US policymakers is the result of domestic US policy choices. Therefore, calling it “Putin’s price hike” is disingenuous to put it mildly.

[This blog post is an excerpt from a TSI commentary published last week]

The phenomenal rise in the US monetary inflation rate from early-2020 to early-2021 set in motion an economic boom. There remains some doubt as to whether the boom is over, but the weight of evidence indicates that it probably is.

Booms contain the seeds of their own destruction, meaning that a painful economic bust becomes inevitable after there has been sufficient monetary inflation to foster a boom. Usually, the boom begins to unravel after the pace at which new money is being created (loaned into existence by commercial banks and/or electronically ‘printed’ by the central bank) drops below a critical level, but note that the bust phase cannot be postponed indefinitely by maintaining a rapid level of money-supply growth. On the contrary, an attempt to keep the boom going via an ever-increasing pace of money creation will cause the eventual bust to be the hyper-inflationary kind, which is the worst kind because it crushes the prudent along with the imprudent.

Over the past few decades a boom-to-bust transition for the US economy didn’t begin until after the monetary inflation rate (the year-over-year True Money Supply (TMS) growth rate) dropped below 6%. However, due to the structural damage to the economy resulting from the Fed’s manipulations of money and interest rates over many decades and especially over the past decade, it’s possible that this time around a bust will begin with the monetary inflation rate at a higher level than in the past. That is, even though the latest money-supply figures* reveal that the year-over-year TMS growth rate remains slightly above the 6% boom-bust threshold (refer to the monthly chart below), it’s possible that the US economy has entered the bust phase of the cycle.

Actually, it’s LIKELY that the US economy has entered the bust phase. This is because even though the monetary inflation rate has not yet dropped below our boom-bust threshold, it has dropped far enough to bring about a significant widening of credit spreads and cause the 10Y-2Y yield-spread to become inverted briefly in early-April.

The most important boom-bust timing indicator that is yet to signal an end to the boom is the gold price relative to the prices of industrial metals such as copper. As illustrated by the following chart, since peaking last October the copper/gold ratio has chopped around at a high level. It must make a sustained break below its March-2022 low to signal the sort of relative strength in gold that would be consistent with the bust phase of the cycle.

*The Fed published the money-supply data for March-2022 on Tuesday 26th April.

My Gold True Fundamentals Model (GTFM) takes into account the seven most important fundamental drivers of the US$ gold price (the real interest rate, the yield curve, credit spreads, the relative strength of the banking sector, the strength of growth stocks relative to defensive stocks (an indicator of whether the financial world is tilting towards growth or safety), the general trend in commodity prices and the bond/dollar ratio) to arrive at a number between 0 and 100 that indicates the extent to which the fundamental backdrop is gold-bullish. 100 signifies maximum bullishness and 0 signifies minimum bullishness (maximum bearishness).

Although it can be helpful in figuring out when to buy/sell gold-related investments, the GTFM is not designed to be a market timing indicator. Instead, it indicates the direction of the pressure on the gold price being exerted by the fundamentals that matter.

The most recent significant shift in the GTFM (the blue line on the following weekly chart) was from bearish to bullish during the second half of February this year. Four of the seven inputs to the GTFM are bullish at this time, so the Model’s output remains in bullish territory.

I expect that the GTFM will move a little further into bullish territory within the coming month due to the Yield Curve input (one of the three currently-bearish inputs) flipping to bullish.

There are three ways that the Yield Curve input to the GTFM could turn bullish within the next few weeks, one or two of which probably will happen. One way is for the 10Y-2Y yield spread to become more inverted than it was in late-March. A second way is for the 10Y-2Y yield spread to signal the start of a steepening trend, which at this point of the cycle also would be a recession warning. A third way is for the 2-year T-Note yield to generate preliminary evidence of a downward trend reversal, which it could do by moving below its 50-day MA.

The following chart of the 2-year T-Note yield shows that the 50-day MA is a long way below the current yield. However, it is rising rapidly and should be above 2% by the end of this month.

Given what’s happening in related markets, I expect that the GTFM’s February-2022 upward reversal and shift into bullish territory will prove to be sustainable, meaning that I expect the gold market to have a fundamental tailwind for at least several more months.

[This blog post is an excerpt from a recent TSI commentary]

For 36 years the yield on the 10-year T-Note moved lower within the channel drawn on the following chart. Depending on how the lines are drawn, an upside breakout from this channel may or may not have just occurred. If an upside breakout has occurred or occurs later this year following a pullback over the next few months, would this confirm the end of the secular downward trend in interest rates?

It’s not that simple. Obviously, an upside breakout from the long-term channel would be consistent with the trend having changed from down to up, but prices often generate misleading signals via failed breaks below chart-based support or above chart-based resistance. However, there are fundamental reasons to be confident that a long-term trend change has occurred.

The fundamental reasons revolve around the monetary and fiscal responses to the pandemic in 2020, which in combination created such a massive inflation problem that the forces putting downward pressure on interest rates have been overwhelmed. The official response to COVID wasn’t the straw that broke the camel’s back, it was the bazooka that blew the camel to pieces.

There were two parts to the official COVID response that set the stage for a directional change in the secular interest-rate trend. First, there was the imposition of widespread lockdowns that caused the prices of most commodities to collapse and prompted a panic into Treasury securities, leading to a blow-off move to the downside in Treasury yields. Second, there was the effort by the Fed and the government to mitigate the short-term pain stemming from the lockdowns, which involved expanding the total US money supply by 40% in less than a year and ‘showering’ the population with money. The effort was very successful at mitigating short-term pain, but at the expense of economic progress and living standards beyond the short-term. The adverse effects of the actions taken to reduce/eliminate short-term pain during 2020 and the first half of 2021 will be evident for many years to come.

We thought that the secular downward trend in interest rates had ended shortly after the blow-off move in Q1-2020, and this opinion has been subsequently supported by a lot of evidence. However, all secular trends have tradable countertrend moves. We are anticipating a tradable move to the downside in US government bond yields over the next several months.

[This blog post is an excerpt from a recent TSI commentary]

The phenomenal rise in the US monetary inflation rate from early-2020 to early-2021 fuelled a speculative mania in the stock market and set in motion an economic boom, while the subsequent plunge in the monetary inflation rate will lead to an equity bear market and an economic bust. A lot of speculation has been wrung-out of the stock market in parallel with the plunge in the pace of new money creation, but there remains some doubt as to whether or not the economic boom is over.

Just to recap, a boom is a surge in economic activity, involving both consumption and investing, in response to price signals caused by monetary inflation. It fosters the impression that great economic progress is being made, but most of the apparent gains achieved during the boom will prove to be ephemeral because the underlying price signals are false/misleading. It will turn out that there are insufficient resources (labour and materials) to complete projects and/or that resources cost a lot more than planned and/or that the consumption forecasts upon which business additions/expansions were based were far too optimistic. The realisation, stemming from rising costs and lower-than-forecast cash flows, that many of the investments made during the boom years were ill-conceived sets in motion the bust phase of the cycle. During the bust phase, boom-time investments get liquidated.

The economic bust will be ‘explained’ by Keynesians* as a collapse in aggregate demand stemming from a mysterious collapse in confidence (“animal spirits”) and will prompt policies aimed at creating a new boom (a new batch of false price signals upon which future investing mistakes will be based), thus perpetuating the cycle.

As mentioned above, there remains some doubt as to whether or not the latest US economic boom is over. Some indicators say it is, while others are yet to confirm. Also, although the monetary inflation rate has crashed from its February-2021 high, the following monthly chart shows that it is still slightly above the boom-bust threshold of 6%**.

We defined the threshold based on the historical record, in that over the past few decades a boom-to-bust transition for the US economy didn’t begin until after the monetary inflation rate dropped below 6%. However, due to the structural damage to the economy resulting from the Fed’s manipulations of money and interest rates over many decades and especially over the past decade, it’s possible that a bust will begin with the monetary inflation rate at a higher level than in the past.

In any case, the monetary inflation rate should never be used for timing purposes. There are other measures, such as credit spreads, that signal when the monetary inflation rate has risen far enough to set in motion a boom or fallen far enough to set in motion a bust. These measures suggest that the US economy is now in the early part of a bust, although the evidence is not yet conclusive.

*All senior central bankers and most politicians are Keynesians.

**Due to tough year-over-year comparisons, we thought that the US monetary inflation rate (the year-over-year rate of growth of the True Money Supply) would drop below 6% during the first two months of this year. The reason it didn’t is that more than $800B was added to the money supply over the course of those months. The 2-month money-supply surge to begin 2022 was due to a reduction in the Fed’s reverse repo program (this put about $300B back into circulation), an increase in commercial bank credit (this created about $240B of new money), Fed monetisation of securities (this created about $150B of new money) and, we suspect, the flight of some money to the US to escape the troubles in Europe.

[This blog post is an excerpt from a recent commentary published at TSI]

Gold is inherently a stronger currency than the US$. This is because the total supply of gold increases by about 1.5% every year, whereas the total supply of US dollars seldom grows at a rate of less than 4% per year and periodically experiences double-digit annual percentage growth. As a result, the US stock market should peak in gold terms well before it peaks in US$ terms, which is exactly what has happened in the past.

The following weekly chart shows the S&P500 Index in gold terms since 1980. With regard to the past 25 years, the two peaks that stand out on this chart occurred in September-2018 and July-1999. In the first case, the peak in the SPX/gold ratio preceded the SPX’s nominal dollar peak by about 16 months (the SPX didn’t peak in dollar terms until February-2020). In the second case, the peak in the SPX/gold ratio preceded the SPX’s nominal dollar peak by about 8 months (the SPX peaked in dollar terms in March-2000).

The most recent peak in the SPX/gold ratio occurred at the beginning of December-2021. Based on what’s happening on the monetary and economic fronts, we think that this will turn out to be a major top (a top that holds for at least 3 years). At this stage, however, what we have is a pullback to the 200-week MA, which would be consistent with either an intermediate-term correction within an on-going major upward trend or the first leg of a new major downward trend.

The point we want to make today is that even if the decline over the past three months of the SPX/gold ratio was the first leg of a new major downward trend (the most likely scenario, in our opinion), it would not be out of the ordinary for the SPX to make a new all-time high in dollar terms during the second half of this year or the first half of 2023.

[This blog post is an excerpt from a commentary published at TSI on 6th March 2022]

The latest leading economic data indicate that the US expansion is intact. This is the case even though the following monthly chart reveals that the ISM Manufacturing New Orders Index (NOI), one of our favourite leading economic indicators, has been working its way downward since hitting a cycle peak about 12 months ago. The reason is that it’s normal for the rate of improvement — which is what the NOI is measuring — to decline while the economy remains in the expansion phase. That being said, we’ve noted over the past two months that the pace of US economic activity is set to slow markedly during the first half of this year.

We wrote a month ago that due to “inflation” remaining near its cycle peak while the pace of economic activity slows, the ‘real’ GDP growth rate during the first quarter of this year could be close to zero. That was before Russia attacked Ukraine and the West imposed severe economic sanctions on Russia, causing additional large increases in commodity prices. As a result of these price increases, the official “inflation” statistics such as the CPI will be higher for longer and calculations of ‘real’ growth will be lower. This could well mean that the headline US GDP growth numbers will be negative in both Q1-2022 and Q2-2022.

Note that a sign of the downward pressure on economic activity resulting from high inflation is the decline in ‘real’ wages. The monthly US Employment Report issued on Friday 4th March contained an estimate that hourly earnings had increased by 5.1% year-over-year in nominal dollar terms. While this is high compared to the average of the past two decades, it’s likely that the cost of living increased by 8%-12% over the same period. This implies that real hourly earnings have fallen by at least a few percent over the past 12 months.

Will the Powell-led Fed make a series of rate hikes in the face of a shrinking economy in response to price rises that are due to supply disruptions? We don’t think so. A Volcker-led Fed would have begun hiking interest rates long ago, but “Mississippi Jay” is the most dovish Fed chairman ever. The Fed almost certainly will make a 0.25% rate hike this month, but we continue to suspect that it will then go on hold for the remainder of the year.

At this stage the leading recession indicators we follow do NOT point to a recession beginning within the next six months (two quarters of negative GDP growth can occur in the absence of a recession), but there’s now a high probability that a boom-to-bust transition will begin during the first half of this year. The recent widening of credit spreads is warning that this is the case, but to confirm a boom-to-bust transition the credit-spread widening will have to be joined by a downward trend reversal in the GYX/gold ratio (the Industrial Metals Index relative to the US$ gold price) and/or a downward trend reversal in the 2-year T-Note yield. The chart displayed below shows that the GYX/gold ratio ended last week at a multi-year high and near the level at which it peaked in 2014 and 2018.

As noted in previous TSI commentaries, the start of a boom-to-bust transition usually precedes the start of an official recession by at least a few quarters.

[This blog post is an excerpt from a commentary published at TSI about 1.5 weeks ago]

The latest leading economic data indicate that the US expansion is intact. This is the case even though the following monthly chart reveals that in January-2022 the ISM Manufacturing New Orders Index (NOI), one of our favourite leading economic indicators, dropped to its lowest level since June-2020. The reason is that it’s normal for the rate of improvement — which is what the NOI is measuring — to decline while the economy remains in the expansion phase. That being said, there are signs that the pace of economic activity will slow markedly during the first half of this year.

Note that the NOI would have to drop below 55 to stop being a positive influence on the US stock market and below 48 to warn of a recession. We won’t be surprised if it drops below 55 within the next two months, but a decline to below 48 is probably at least 2-3 quarters away.

Regarding the pace of US economic growth, in our previous four “US Recession/Expansion Watch” monthly discussions we wrote that we expected US economic activity to re-accelerate during the final months of 2021 and the early part of 2022 due to inventory building and millions of people returning to the workforce. That happened (for exactly the reasons expected*) and was confirmed by the preliminary estimate of annualised GDP growth coming in at 6.9% for Q4-2021. It was also confirmed by Real Gross Private Domestic Investment (RGPDI), a quarterly statistic that acts as a leading indicator of recession starts and a coincident indicator of recession ends. As illustrated below, RGPDI rose sharply to a new all-time high in the fourth quarter of last year.

Note that the vertical red lines on the following chart mark official recession start dates.

However, the financial markets don’t care what happened months ago; they care what’s going to happen over the months/quarters ahead and there is evidence that the GDP growth rates reported for the first two quarters of this year will be MUCH lower than the rate reported for the final quarter of last year. In fact, due to “inflation” remaining near its cycle peak while the pace of economic activity slows, the “real” GDP growth rate during the first quarter of this year could be close to zero.

The preponderance of evidence from leading economic indicators and confidence indicators points to the H1-2022 economic slowdown occurring within the context of an economic boom, although a pronounced slowdown within a boom and the early part of a boom-to-bust transition can be indistinguishable.

Money-supply trends warn that a boom-to-bust transition could begin as soon as the first half of this year, but the start of a boom-to-bust transition usually precedes the start of an official recession by at least a few quarters and leading economic indicators are a long way from issuing recession warnings. Therefore, the next US recession probably won’t begin any earlier than Q4-2022.

*We noted at the time they were announced that the initial BLS estimates for jobs growth in November and December of last year had massively understated the strength of the US labour market. The latest monthly employment report, which was issued on Friday 4th February, contained revisions to previous months that corrected the errors. The corrections resulted in a combined increase of 709K to the November-December jobs growth total. As a consequence, the employment data now show that the US economy added 1.83M jobs in Q4-2021 and 2.3M jobs over the past four months.