Blog 2 Columns

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

We wrote in the latest Weekly Update that the Moody’s downgrade of US sovereign debt probably wouldn’t have any effect beyond a knee-jerk reaction, because the downgrade wasn’t significant new information. Prompted by the big deal that was made in the press over this virtual non-event, we thought that it was worth outlining what does and does not matter for the long end of the US Treasury market. We’ll start by listing some of the things that do NOT matter.

First, the so-called “debt wall” does not matter. When you look at a chart showing the amount of US government debt that will have to be refinanced every month or every quarter for the next several years, there always will appear to be a ‘wall’ of debt that has to be refinanced over the coming 12 months. This simply is a function of the fact that 25%-35% of the total debt constitutes T-Bills (debt securities that mature within a year). It is not significantly different today than it was at any time over the past 10 years and it most likely won’t be significantly different at any time over the next few years. On a related matter, almost everyone with a substantial T-Bills holding automatically rolls the position when the old bills mature, so it’s not like the US government constantly is having to find new buyers for its debt.

Second, the Fed staying tighter for longer does not matter, or at least is not bearish, for the long end of the Treasury market, because the Fed staying tighter for longer reduces both the actual and the perceived risk of “inflation”. In fact, at a time when inflation fears are elevated due to what has happened in recent years, it could be more of a plus than a minus.

Third, large-scale selling of Treasury securities by foreign governments is not a serious threat. Foreign governments (via their central banks) buy and sell US government debt securities primarily to manipulate the exchange rates of their own currencies. This involves selling US treasuries when the US$ is strong, with the aim of propping-up the local currency, and buying US treasuries when the US$ is weak, with the aim of preventing the local currency from becoming excessively strong. We see no reason to expect that the trade war initiated by the US will change this method of managing FX reserves.

We’ll now mention some of the things that do matter, that is, some of the legitimate concerns if you happen to own long-dated treasuries.

The main concern is the fiscal deficit. This is not only because a large fiscal deficit results in a large increase in the supply of new government debt securities, but also because a large fiscal deficit generally will lead to higher “inflation” by diverting savings from the relatively efficient private sector to the relatively wasteful public sector. The worst-case scenario is a fiscal deficit that is both large and increasing as a percentage of the economy.

With reference to the following chart, if we ignore the Covid-related extremes of 2020-2021 we can see that the US federal deficit is large and steadily increasing as a percentage of nominal GDP (the downward trend on the chart reflects a rising deficit/GDP ratio). Moreover, the budget bill that currently is making its way through the US parliament would all but guarantee the continuation of the adverse trend, because this bill front-loads tax cuts and back-loads spending cuts. This is a good reason to expect lower T-Bond prices and higher T-Bond yields over the years ahead.

Another valid concern is the inflationary effects of tariffs. The tariffs that Trump seems determined to impose could lead to an upward ‘blip’ in the popular measures of inflation within the next several months, but the more important longer-term effect is that they will reduce the dollar’s purchasing power by making the economy less efficient. This is a secondary reason to expect higher bond yields over the years ahead.

A third valid concern doesn’t apply right now, but it’s likely that when coincident and lagging economic data clearly signal “recession” the Fed will again take actions designed to rapidly boost the money supply. There’s a high probability that this will happen at a time when the government’s deficit is growing rapidly due to the combination of declining tax revenue and rising costs associated with government support and stimulus programs, leading to an inflation surge.

Summing up, some of the reasons to be bearish on the T-Bond that often get mentioned are not valid, but there are some very good reasons to be bearish, at least beyond the short-term. In particular, currently there appears to be no political will to end the deficit spending or even to cap the deficit’s growth rate, which means that any limits will have to be imposed by the bond market. This would be done via higher bond yields.

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

The US CPI numbers reported on Tuesday 13th May extended the downward trend that began in mid-2022. As illustrated by the following chart, the year-over-year growth rate of the US CPI has just made a new cycle low. The Core CPI’s growth rate is significantly higher and was reported to be unchanged at 2.8%, but its annualised growth rate over the past three months is only 2.1%. Therefore, the Core CPI also is moving in the right direction. However, the implications and the outlook are not clear.

The last time the CPI’s growth rate was as low as it was in April of this year was February-2021, at which time the Fed was inflating the money supply aggressively via its QE program and maintaining a target interest rate of around zero. Now, the Fed is still draining money via QT and expects to keep its targeted interest rate at 4.25%-4.50% in the short-term. Why?

The principal problem is that the Fed has no way of knowing what its monetary policy should be, because the correct interest rates and monetary conditions are those that would exist in the absence of the Fed. The Fed is the equivalent of a giant spanner that has been thrown permanently into the monetary works. The best that anyone reasonably can hope for is that the damage it does is counteracted partly by private industry.

A secondary issue is that having exacerbated the inflation problem by being so blatantly late in stopping its monetary easing and starting its monetary tightening during 2020-2022, the Fed is now being overly cautious with regard to any actions that would ease monetary conditions.

A related secondary issue is that the constantly shifting tariff situation is causing uncertainty at the Fed just like it is causing uncertainty everywhere else. The news that the US and China governments have agreed to slash tariffs by 115% — from 145% to 30% in the case of the US and from 125% to 10% in the case of China — is positive, but at this stage the reduced rates are for 90 days only and still leave the average tariff rate for US imports at around 18%, which is the highest since 1934.

The tariffs will be more negative for economic growth than positive for inflation, but they could cause an upward ‘blip’ in the official inflation numbers over the next few months if the economy doesn’t tank in the meantime. The decisionmakers at the Fed are concerned about this possibility and therefore are reticent at the moment to make any moves in the easing direction.

Due to the uncertainty regarding the effects of tariffs, it’s possible that the US economy will have to become very obviously weak before the Fed makes its next decisive move to loosen monetary conditions. If so, this will magnify the severity of the recession that probably has started or will start soon, although the Fed’s slowness to loosen won’t be the primary cause of the recession. The recession will be the result of several years of malinvestment, with a final push coming from the “policy uncertainty” of the past few months.

[This blog post is an excerpt from a recent commentary published at www.speculative-investor.com]

We expect that a 1-2 year or perhaps even longer upward trend in commodity prices will begin this year. Although we will refer to this upward trend as a bull market, strictly speaking it shouldn’t be labelled as such. This is because there actually is no such thing as a commodity bull market, meaning a bull market in a broad index of commodities such as the GSCI Spot Commodity Index (GNX) or the CRB Index. There are only gold bull markets that eventually expand to encompass most commodities. In other words, what we are anticipating is an expansion of the gold bull market to encompass most other commodities.

Gold bull markets begin and are sustained by monetary and governance factors. In short, there is a decline in confidence in the official money and/or the banking system and/or the government that causes an increase in the demand for gold, meaning an increase in the desire to hold gold bullion. These bull markets have nothing to do with gold supply, since for all intents and purposes the supply of gold is constant over a normal investment timeframe*.

Eventually, the issues that have been discounted by the gold market lead to higher prices for many other commodities, but, for all commodities other than gold and to a lesser extent silver, supply can be a major price driver. In fact, the non-monetary commodities that have the most severe supply restrictions tend to be the ones that rise in price the most after monetary/governance factors set in motion a broad upward trend.

Every cycle is different in some way and this time around one of the major differences has been the extent to which price trends have been elongated by the concerted attempts, during 2023-2024, to counteract the Fed’s monetary tightening by pre-emptive recession-like deficit spending on the part of the US government and actions by both the Fed and the Treasury that sustained ‘liquidity’ in the financial markets. These actions postponed the start of a US recession by 1-2 years and also, we think, substantially widened the gap between the start of a gold bull market and the start of a broad upward trend in commodity prices (a gold bull market began in Q4-2022 and a general commodity bull market is yet to begin).

Just as the performance of the gold price telegraphed weakness in the US dollar, it is telegraphing a large, broad upward trend in commodity prices. Furthermore, the upward price trend will be exacerbated by artificial shortages caused by Trump’s trade war. Like the Covid lockdowns, the tariffs and the uncertainty regarding future tariffs have disrupted and will continue to disrupt supply chains.

We expect that a broad upward trend in commodity prices will begin after it becomes sufficiently clear that the US economy is in recession to prompt monetary and fiscal measures designed to stimulate economic activity. This is likely to happen before the end of this year and could happen as soon as the next three months.

*Almost all the gold that has ever been mined remains available to satisfy demand today, with the global mining industry adding only about 1% to this existing stockpile every year.

[This blog post is an excerpt from a recent commentary posted at www.speculative-investor.com]

Due to everything we are seeing and expecting, including the performance of the gold price and shortages that potentially will stem from Trump’s trade war, we think there’s a very real possibility that an equity bear market could unfold in parallel with a commodity bull market. If so, it would be very different from anything that happened over the past three decades, a period during which the commodity markets generally weakened when the stock market was very weak, but very similar to what happened during the 1970s. As illustrated by the following monthly chart, a broad basket of commodity prices rose substantially during the equity bear market of 1973-1974.

By the way, the chart also shows the remarkable stability of commodity prices when the US$ was linked officially to gold.

We hasten to point out that right now there is only tentative evidence in the price action to support the above-mentioned scenario. In particular, the first of the following charts shows that equity prices (represented by the SPX and shown in green) and commodity prices (represented by the GNX and shown in black) plunged together in early April and have since rebounded together — price action that does NOT support the idea that commodity prices will be able to trend upward while equity prices trend downward. However, the second chart shows that commodity prices have been strengthening relative to equity prices since early-December of last year.

What we could see over the coming quarters is more of what happened since early-December of last year, with commodity prices generally strengthening relative to equity prices but getting hit during the brief periods when equity prices fall rapidly and there is a rush for liquidity.

[This blog post is a modified excerpt (for example, it contains updated charts) from a recent commentary published at www.speculative-investor.com]

Think back to how bullish almost everyone was about the US dollar’s prospects at the start of this year. Also recall that our view at the time was that the Dollar Index (DX) was set to make a very important peak in January-2025, after which it would trend downward for at least a year. Actually, our view going into this year was that the DX had commenced a cyclical decline in September-2022 and would resume its cyclical decline in January-2025. The fact that it recently made a new cycle low confirms that the DX has, indeed, been in a cyclical bear market since September of 2022 and that the strong rally from the September-2024 low was nothing more than a countertrend move. So, what now?

Before attempting to answer the above question, we present herewith a daily chart and a weekly chart of the DX. The daily chart shows the virtual crash of the past two weeks, while the weekly chart shows that the DX has broken below its July-2023 low and is at its lowest level since April of 2022. Both charts show that the DX is extremely oversold.

Due in part to the performance of the US$ gold price, we doubt that the DX’s cyclical decline is complete. This is because on an intermediate-term basis the gold market does not react to trends in the US dollar’s exchange rate, it projects them. For example, gold’s strength last year projected future US$ weakness against other currencies. The fact that the US$ gold price has just made a new all-time high projects future weakness in the DX.

The way that the DX’s true fundamentals are expected to evolve over the months ahead (they are expected to remain bearish) and the paths taken by the DX following comparable highs in September-2022 and January-2017 also point to additional downside.

However, thanks to the recent collapse it’s likely that the bulk of the decline is in the past.

We have had and continue to have the mid-90s in mind as a target for the DX’s ultimate cycle low. This target may have seemed unreasonably bearish a few months ago, but it is only a few points below the current level. At the same time, a countertrend rebound could result in the DX returning to the 104-105 range.

Further to the above, we are now short-term and intermediate-term neutral on the DX. The ultimate cycle low probably won’t be set until the final few months of this year, but the rebound potential is now at least as large as the remaining downside potential.

[This blog post is an excerpt from a commentary published at www.speculative-investor.com on 6th April 2024]

The effects on the financial markets of Trump’s 2nd April announcement were similar to, albeit not quite as extreme as, the effects of the COVID lockdowns in March of 2020. Like the COVID lockdowns, what was announced on 2nd April constituted a massive government intervention that will disrupt global commerce and that to some extent came as a shock. Markets obviously were expecting widespread tariffs to be announced, but it is clear by the reaction that many market participants were surprised by the magnitude of the tariffs and/or the arbitrary way in which the tariff rates were determined.

Due to the adverse consequences for global economic growth, commodity prices plunged along with equity prices over the final two trading days of last week. For some industrial commodities the current price levels are not surprising to us in that we expected to see new cycle lows, but what we expected to unfold over the next few months occurred over the space of just two days.

For example, we expected that the rebound in the oil price from its early-March low would be followed by a decline to new cycle (multi-year) lows within the next few months, but the following weekly chart shows that last week the oil price plunged from a 1-month high to its lowest level in almost four years. In oil’s case, the negative reaction to the growth shock that potentially will stem from the tariffs was exacerbated by an OPEC announcement that the first three months of its planned production increases will be lumped together, meaning that OPEC oil production will increase by 411K barrels/day rather than the expected 135K barrels/day next month.

The oil price probably hasn’t bottomed, but by plunging to a new cycle low last week it has done as much as we thought it would do prior to the start of a cyclical upward trend.

For another example, a week ago we wrote that we perceived a lot of downside risk in the copper price, but we didn’t expect the downside risk to materialise immediately. Instead, the copper price fell 14% last week and removed any doubt that a multi-month price top was set via the spike up to US$5.40 during the preceding week.

The commodity and equity markets reversed course following their lockdown-related crashes in March-April of 2020 due to 1) the extent to which they were stretched to the downside and 2) the upward price pressure exerted by unprecedented monetary intervention. Based on Powell’s words late last week, the Fed is not close to doing anything supportive on the monetary front. Therefore, currently there is no reason to expect anything more bullish than a countertrend rebound.

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

We are revisiting a long-term cycle that we began tracking several years ago. This cycle, which is illustrated by the vertical red lines drawn on the weekly chart displayed below, has been elongated for the same reasons as other cycles/trends over the past couple of years. Before we get to the current situation, a recap is in order.

Over the past two decades, gold mining stocks as represented by GDX have set major peaks relative to general mining stocks as represented by XME approximately every four years, that is, the GDX/XME ratio has tended to make a multi-year peak approximately every four years. Furthermore, the major peaks in the GDX/XME ratio have coincided with major peaks in the gold/GYX ratio (the US$ gold price relative to the Industrial Metals Index), which, in turn, have coincided with the crescendo of an economic or debt crisis. To be specific, the Q1-2009 peak was linked to the Global Financial Crisis, the Q1-2012 peak was linked to the euro-zone sovereign debt crisis, the Q1-2016 peak was linked to the shale oil bust in the US and the general bust in industrial commodity-related investment, and the April-2020 peak was linked to the COVID lockdowns.

The continuation of the 4-year cycle would have led to major peaks in the GDX/XME ratio and the gold/GYX ratio last year. However, this didn’t happen. There was a substantial rise in the gold/GYX ratio, but the GDX/XME ratio did little more than ‘chop around’ near its cycle low.

This prompted us to conclude, in the 23rd September 2024 Weekly Update:

“Either the GDX/XME ratio is going to peak at a much lower level during the current cycle than it ever has in the past, or the current cycle has been elongated and is still a long way from its completion.

The latter possibility is the more plausible. The main reason is that the GDX/XME ratio is driven by the gold/GYX ratio, and as noted above past peaks in the gold/GYX ratio have coincided with the crescendo of an economic crisis or a debt crisis.

Mainly because of aggressive government deficit spending designed to postpone a recession, but also because of Fed/Treasury actions that have boosted financial market liquidity in the face of tightening monetary conditions, there has been nothing resembling an economic/debt crisis during the current cycle to date. The crisis has, we think, been shifted from 2024 to 2025 or perhaps even later. Consequently, the cycle top in the GDX/XME ratio that was ‘due’ to occur this year probably won’t occur any sooner than H2-2025.

An implication of the above is that it will make sense to favour gold mining stocks over other mining stocks for at least another 12 months.”

Turning to the current situation, since late last year there has been a significant increase in the GDX/XME ratio (shown in the top section of the following chart), while the gold/GYX ratio (shown in the bottom section of the following chart) has continued its strong upward trend. GDX/XME is now at its highest level since mid-2021.

Despite its meaningful increase over the past three months, the chart suggests that there is plenty of scope for additional relative strength by the gold sector. We are referring to the fact that over the past two decades the GDX/XME ratio has never made a cycle peak below 1.2, which is more than 50% above the current level.

We expect that both the GDX/XME ratio and the gold/GYX ratio will make their cycle peaks this year, but those peaks probably aren’t in place and in the case of GDX/XME the peak could be a long way above today’s level.

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

We generally don’t engage in unprovable/unfalsifiable conspiracy-linked speculation to explain market performance or government policy, but today we are making an exception because we are struggling to come up with a more straightforward explanation for Trump’s recent actions.

Tariffs would be negative for the US economy even if they were not large in percentage terms and were introduced in a measured way, but the haphazard way in which large tariffs have been imposed and changed over the past two months greatly magnifies the economic damage that will be done. Furthermore, another intervention under consideration could be even more damaging than the tariffs that have been threatened/implemented to date. We are referring to the port fee plan discussed in an article posted at lloydslist.com on 11th March. Here is an excerpt:

“The US Trade Representative announced on February 21 that it plans to levy exorbitant port fees — in some cases over a million dollars — for every US port call by Chinese transport operators, Chinese-built ships, all operators that have any ships on order at Chinese yards, and according to one interpretation of the proposal (based on a presidential draft order obtained by Lloyd’s List), all operators with any Chinese-built ships in their fleets.

The USTR plan would also mandate that a portion of US exports be carried on US-flagged and, eventually, US-built vessels.

Respondents had until Monday to submit comments to the USTR if they wanted to testify at the hearing on the proposal on March 24. They responded in droves, overwhelmingly negatively, with several predicting a disaster for importers, exporters and the US economy in general if the USTR did not kill the port fee plan.

Some executives also bluntly asserted that if the plan was approved as written, their companies would go out of business or leave the US.”

If the port fee plan is implemented it will inflict a devastating blow on the US economy, with no potential upside in either the short-term or the long-term. Why, then, is it even being considered?

The port fee plan and the reckless way in which tariffs are being imposed/threatened only make sense if the Trump Administration is trying to ensure that the US economy goes into recession soon. If this is the plan then there is already evidence of success, in that the High Yield Index Option Adjusted Spread (HYIOAS), an indicator of US credit spreads, generated a recession warning signal last week. The signal is the weekly close above the 65-week MA (the blue line on the following chart).

Why on earth would the Trump team want a recession to happen ASAP?

One reason is that a recession this year could be blamed on Biden. In a way this would be appropriate, because the US economy probably would have gone into recession 12-18 months ago if not for the Biden Administration’s use of aggressive deficit-spending and other tools (mainly, issuing a higher percentage of short-term debt as mentioned below) to delay the inevitable until after the November-2024 elections.

Another reason is that a recession would create a financial/economic backdrop in which there was much greater demand for Treasury securities, enabling the US Treasury to ‘term out’ the government’s debt at lower interest rates. By way of further explanation, during 2023-2024 the US Treasury under Janet Yellen substantially increased the use of short-term debt to finance the government’s deficit and in doing so reduced the average term of the total debt. The new Treasury Secretary (Scott Bessent) must now return the average term of the debt to where it should be, which only could be done by increasing the issuance of long-term debt relative to the issuance of short-term debt. This would put upward pressure on long-term interest rates, but if there were a recession then this pressure probably would be more than offset by an increase in the demand for the relative safety provided by long-dated Treasury securities.

A third reason is that if a recession occurs this year, then the economy probably will look fine by the time the mid-term elections roll around in late-2026.

There’s now a high probability that if a US recession is not already underway then it will begin within the next three months. Therefore, if this is happening according to a plan to get the inevitable recession out of the way in 2025, then the first part of the plan is coming together.