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

Monetary inflation is the driver of the economic boom-bust cycle, with booms being set in motion by rapid monetary inflation and busts getting underway after the rate of new money creation drops below a critical level and/or it becomes impossible to complete projects due to resource shortages. The following chart shows that the US monetary inflation rate (the year-over-year growth rate of US True Money Supply) extended its decline in September-2022 and is now below 4%, down from a peak of almost 40% early last year.

Due to the economic damage done over multiple cycles by the manipulations of the central bank, the current US economic bust began at a higher rate of monetary inflation than previous busts. In addition, most things related to the current boom-to-bust transition have happened within a compressed timeframe.

In previous cycles over the past three decades, a decline in the monetary inflation rate to below 6% kicked off a sequence lasting 1-2 years encompassing an inversion of the yield curve, a substantial widening of credit spreads (the start of the credit-spreads widening trend combined with the start of an upward trend in the gold/commodity ratio marks the start of the bust phase) and a reversal of the yield curve from flattening/inverting to steepening — PRIOR to the start of an economic recession. This time around, however, all of the above except a steepening of the yield curve occurred within 7 months of a decline in the monetary inflation rate to below 8%.

There is yet to be a reversal in the yield curve from flattening/inverting to steepening, but that’s because this time around the Fed is continuing to tighten monetary conditions aggressively into the teeth of an economic recession. This is similar to what happened in 1973-1974.

To further explain the above comment, the monetary inflation rate (the blue line on the following monthly chart) drives the yield curve (the red line on the chart). Of particular relevance to this discussion, an inversion of the yield curve (the red line dropping below zero) is an EFFECT of a large decline in the monetary inflation rate, and in general a trend reversal in the yield curve from flattening/inverting to steepening requires an upward trend reversal in the monetary inflation rate.

With the downward trend in the US monetary inflation rate unlikely to end any sooner than the first quarter of next year, a trend reversal in the yield curve (to steepening) is probably still at least several months away. In the meantime, it’s reasonable to expect that the curve will move even further into inverted territory.

As mentioned in the 3rd October Weekly Update, if the Fed sticks with its current balance-sheet reduction plan for only a few more months then by February of next year the year-over-year rate of US money supply growth probably will turn negative, that is, the US will be experiencing monetary deflation. If this happens then the prices of most assets will go much lower than they are today.

As also previously mentioned, economic and stock market weakness eventually will put irresistible pressure on the Fed to commence a new monetary easing campaign, but there is nothing to be gained by trying to guess when that will be. This is because the initial attempts to ‘stimulate’ almost certainly won’t be sufficient to ignite a new boom, and because the stock market usually doesn’t bottom until well after the monetary inflation trend has reversed upward. At the moment we are a long way from such a reversal.

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

The root of Europe’s energy crisis is under-investment or outright dis-investment in nuclear energy and natural gas production/storage/transportation combined with over-reliance on intermittent and relatively inefficient forms of renewable energy. Russia’s invasion of Ukraine and the anti-Russia sanctions exacerbated the problem, but the problem was evident prior to this year. A policy course correction therefore would be appropriate (to put it mildly), but it won’t happen anytime soon.

When private companies go in the wrong direction they lose money and either change direction or go broke, but after it becomes clear that a government has gone in the wrong direction the typical response is to go faster in that direction. This is because doing otherwise would require an uncomfortable public admission that mistakes have been made or a practically impossible public admission that the political ideology underpinning the chosen direction is wrong. In the case of the shift towards increasing reliance on renewable energy, the latter (a public admission that the underlying political ideology is wrong) would be required, which is why we shouldn’t expect it. Instead, we should expect acceleration along the wrong path.

Signs of acceleration along the wrong path are not hard to find. Examples include the recent increase from 32% to 45% in the official European target for the renewable energy share of total energy, requiring a doubling of the renewable energy share within the next eight years, and the government of Victoria, Australia, recently announcing a goal to become 95% dependent on renewables by 2035.

It is not possible to achieve the renewable energy targets being set by governments, but nevertheless it’s reasonable to expect that great efforts will be made to achieve them. Here are some of the likely effects of these efforts:

1) There will be major shortages within the next few years of the minerals used in renewable energy systems, leading to vastly higher prices for these minerals and increased mining activity.

2) On a global basis there will be extensive environmental damage, and for at least the next ten years there will be increased carbon emissions, due to the additional mining and manufacturing activity associated with building the renewable energy systems.

3) There will be periodic major shortages of natural gas, oil, oil-based products (diesel and gasoline) and coal due to under-investment in the production of these commodities, leading to the existing producers of these commodities becoming far more valuable.

4) The cost of energy as a percentage of GDP will be much higher this decade than in the preceding decade, leading to a lower standard of living for the average person.

5) There will be a large rise in the price of uranium, because the expansion of nuclear energy will become politically attractive (meaning: a vote winner) in the face of periodic energy shortages and extremely high energy prices.

As investors/speculators, we can’t do anything about the adverse social and environmental consequences of the accelerating trend towards ‘renewables’. However, we can attempt to profit from points 1), 3) and 5).

[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.