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[This blog post is an excerpt from a recent TSI commentary, with updated charts and minor modifications]

As is the case with the natural gas price, the price of the S&P Agricultural Index (GKX) appears to have made a cycle low via a double bottom in April and June of this year. At this stage the rebound from the Q2-2020 bottom doesn’t look more significant than any of the other rebounds of the past five years (see chart below), but the combination of rampant monetary inflation, rising inflation expectations and increasingly-volatile weather due to natural climate cycles is the recipe for a much longer and larger rally.

For at least the past 12 months we have argued that owning the stocks of fertiliser producers such as Mosaic (MOS) and Nutrien (NTR) is the best way for most people to participate in the agricultural (‘ag’) commodities bull market that potentially will unfold during 2020-2022. That continues to be our view. Although the fertiliser producers only provide indirect exposure to rising prices for ag commodities, obtaining direct exposure via the stock market involves owning ETFs that usually suffer substantial value leakage due to the “futures roll”.

The following daily charts show that the aforementioned stocks have rebounded strongly from their March-2020 lows but remain well below their highs of the past 12 months.

Not evident on the above daily charts is the fact that MOS and NTR are trading at small fractions of their 2008 peaks. The following weekly charts provide some additional perspective.

We think that the risk/reward ratios of these stocks are roughly equivalent, with NTR being less risky and MOS offering greater leverage. Both companies were very profitable in the June-2020 quarter and should become even more profitable over the quarters/years ahead.

[This blog post is an excerpt from a TSI commentary published within the past two weeks]

Many analysts downplay the Fed’s influence on bond yields, but we don’t think it’s possible to explain the following chart without reference to the massive yield-suppressing boot of the Fed. The chart compares the 10-year T-Note yield with the 10-Year Breakeven Rate, a measure of the market’s inflation (CPI) expectations. The Breakeven Rate is calculated by subtracting the Treasury Inflation Protected Security (TIPS) yield from the associated nominal yield.

The chart reveals that the 10-year T-Note yield generally moves in the same direction as the 10-Year Breakeven Rate. This is hardly surprising, given that the expected “inflation” rate is usually the most important determinant of the long-term interest rate. In particular, a higher expected “inflation” rate usually will result in a higher long-term interest rate. However, something very strange has happened since March of 2020. Since that time there has been a large rise in the expected CPI while the nominal 10-year yield has drifted sideways near its all-time low.

As far as we can tell, there are only two ways that the sort of divergence witnessed over the past five months between inflation expectations and nominal bond yields could come about.

One way is capital flight from outside the US to the perceived safety of the US Treasury market that overrides other effects on bond prices/yields. This is what happened during 2011-2012, which is the only other time that a substantial rise in inflation expectations coincided with flat or declining nominal US bond yields. In 2011-2012, capital flight to the US was prompted by the euro-zone’s sovereign debt crisis.

Manipulation by the Fed is the other way that the divergence could arise.

Over the past five months there has been no evidence of capital flight to the US. Therefore, it’s clear that the Fed has maintained sufficient pressure to prevent the nominal 10-year bond yield from responding in the normal way to a large rise in the bond market’s inflation expectations. Not without ramifications, though.

A large rise in the expected “inflation” rate in parallel with a flat nominal interest rate equates to a large decline in the ‘real’ interest rate. In this case, it equates to the ‘real’ US 10-year interest rate moving well into negative territory. This has put irresistible downward pressure on the US$ and irresistible upward pressure on the prices of most things that are priced in dollars, including gold, equities, commodities and houses. It has even put upward pressure on the price of labour, despite the highest unemployment rate since the 1930s.

At the moment the Fed undoubtedly is pleased with its handiwork. The rise in the gold price to new all-time highs could be viewed as a rebuke, but these days no-one in the world of central banking cares about the gold price. Central bankers do, however, care about the stock market, and the Fed’s governors will be patting themselves on the back for having helped the S&P500 Index fully retrace its February-March crash. They also will be pleased that the CPI is rising in spite of the deflationary pressures resulting from the lockdowns. After all, the concerns they have expressed over the years about insufficient “inflation” make it clear that the last thing they want is for your cost of living to go down*.

However, the Fed is ‘playing with fire’. Putting aside the long-term negative economic consequences of the mal-investment caused by the Fed’s money pumping and interest-rate suppression, if the Fed continues to prevent bond yields from reflecting rising inflation expectations then the steady shift currently underway towards hard assets and anything else that offers protection against currency depreciation will become a stampede. And once that happens, the sort of central-bank action that would be required to restore confidence would crash both the stock market and the economy.

If the Fed continues along its current path then an out-of-control rise in prices won’t be an issue to be dealt with in the distant future. It possibly will become an issue before the end of this year and very likely will become an issue by the middle of next year.

*Nobody with common-sense can figure out why.

[This is an excerpt from a commentary published at TSI on 16th August 2020. The message remains applicable.]

The US$ commenced a cyclical decline in March of this year and probably will trade well below current levels during the first half of 2021. From the perspective of our investing and trading, the main consequences of this weakness in the senior currency are:

1) Broad-based strength in the commodity markets. As illustrated below, the S&P Spot Commodity Index (GNX) has been trending upward since shortly after the US$ peaked.

2) Strength in emerging market equities, especially the equities that are based in emerging economies that rely heavily on commodity exports. For example, Brazilian equities. Despite the debilitating effects on Brazil’s economy of virus-related lockdowns, the following chart shows that the iShares Brazil ETF (EWZ) has done well since the US$ began trending downward.

Note that it could make sense to buy EWZ if there’s a pullback to US$26-$28 within the next several weeks.

3) Rising US inflation expectations. As illustrated below, the US 5-Year Breakeven Rate (the annual CPI increase that the market expects the US government to report over the next few years) has been trending upward since the US$ peaked.

The above consequences have been apparent over the past few months and should become more pronounced within the next 12 months, especially during the first half of next year. However, we think that in the short-term the focus of investors/speculators should be on the potential for a US$ rebound.

It’s possible that the Dollar Index (DX) will become more stretched to the downside before it commences a meaningful countertrend rally, but once a US$ rebound begins in earnest the prices that have been elevated over the past few months by US$ weakness, which means the prices of almost everything, will fall.

It does not make sense to exit all anti-US$ trades in anticipation of a short-term US$ rally. Doing so would be risky because these trades would make large additional gains if the US$ rebound were to be postponed for a month or two. Also, making a complete exit would create the problem of having to time the re-entry. However, it would make sense to hedge against a short-term US$ recovery while maintaining core exposure in line with the dollar’s longer-term weakening trend.

Gold market sentiment is complicated at the moment. There are signs of speculative froth, but at the same time the total speculator net-long position in Comex gold futures is close to its low for the year despite the US$ gold price recently hitting an all-time high. A likely explanation is that large speculators are focusing more on gold ETFs than on gold futures.

The price of a gold ETF that holds physical gold will track the gold price automatically. Therefore, there never will be an increase in the amount of gold held by such an ETF unless bullish speculators become sufficiently enthusiastic to push the market price of the ETF above its net asset value (NAV). When this happens it creates an arbitrage opportunity for the ETF’s Authorised Participants (APs), which results in the addition of gold bullion to the ETF’s inventory.

The following charts from http://www.goldchartsrus.com/ show large gains in the amounts of physical gold held by GLD and IAU, the two most popular gold ETFs. Specifically, the charts show that about 400 tonnes (12M ounces) of gold was added to the combined GLD-IAU inventory over the past few months. This actually isn’t a huge amount within the context of the global gold market, but it points to aggressive buying of the ETFs.

In other words, the evidence of gold-related speculative froth is in the stock market rather than the futures market.

The next chart shows that the silver story is similar. Specifically, the chart shows that about 7,000 tonnes (220M ounces) of physical silver have been added to the inventory of the iShares Silver ETF (SLV) since the March-2020 price low, including about 1,900 tonnes (60M ounces) during the three-week period culminating at the early-August price high.

The fundamental backdrop remains supportive for gold and silver, but sentiment suggests that a multi-month price top was put in place in early-August or will be put in place via a final spike within the next three weeks.

Many things have happened in 2020 that have never happened before, so in some respects it certainly is different this time. The most important of these differences, four of which are discussed below, revolve around the policy responses to the COVID-19 pandemic.

In the context of human history and in terms of the amount of death that it has caused, the COVID-19 pandemic is not particularly unusual. On average, there have been about two major pandemics every hundred years going back several centuries. Over the past hundred or so years, for example, there was the “Spanish Flu” in 1918 and the “Asian Flu” in 1958. Almost everyone has heard about the Spanish Flu and its horrific death toll, but the Asian Flu is less well known. Suffice to say that the death toll per million of global population resulting from the Asian Flu was about four times the current death toll per million of global population resulting from COVID-19.

The big difference this time is not the disease itself but the reaction to the disease. In particular, never before have large sections of the economy been shuttered by the government in an effort to limit the spread of the disease. Now, however, it has become accepted practice that as soon as the number of COVID-19 cases in an area moves beyond an unspecified low level, the orders go out for many businesses to close and for the public to stay home.

If locking down large sections of the economy is the optimal response to a pandemic, why wasn’t it tried before? Why did it take until 2020 to figure this out?

The answer is associated with the fact that COVID-19 is the first major pandemic to strike under the monetary system that came into being in the early-1970s. Under this system there is no limit, except perhaps an arbitrary level of increase in an arbitrary indicator of “inflation”, to the amount of money that can be created out of nothing. Previously there were limits to money creation imposed by some form of gold standard.

If there were rigid limits to the supply of money, the sort of economic lockdown implemented by many governments this year would cause immediate and extreme hardship to the majority of people. Therefore, it wouldn’t be an option. It is an option today because the ability to create an unlimited amount of money out of nothing presents the opportunity for the government to alleviate, or even to completely eliminate, any short-term pain for the majority of people. It should be obvious that this is an exchange of short-term pain for greater pain in the long-term, but hardly anyone is thinking about the long-term. In fact, the short-term fix that involves showering the populace with money is being advocated as if it didn’t have huge long-term costs.

Another difference between the current pandemic and earlier pandemics is the availability of information. For the first time ever during a major pandemic, almost everyone has up-to-the-minute data regarding the number of cases, hospitalisations and deaths. The widespread fixation on the cases/deaths data has fostered the general belief that getting the numbers down takes precedence over everything, long-term consequences be damned.

The third difference is linked to the first difference, that is, to the ability to create an unlimited amount of money out of nothing. This ability has existed for almost half a century, but 2020 is the first time it has been used by the government to provide money directly to the public. Prior to this year it was used exclusively by the central bank to manipulate interest rates and prop-up prices in financial markets. A consequence WILL be much more traditional “inflation” next year than has occurred at any time over the past decade.

The fourth and final difference that I’ll mention today is also linked to the money-creation power. It is that in 2020 some developed-world governments, most notably the US government, have stopped pretending to be concerned about their own indebtedness. Previously they made noises about prudently managing deficits and debts, as if the debt eventually would have to be repaid. However, this year they have tacitly acknowledged the reality that there has never been any intention to pay off the debt, and, therefore, that the debt can expand ad infinitum.

2020 certainly has been a watershed year.

[This blog post is an excerpt from a TSI commentary published on 19th July]

Sometimes, financial market relationships that have applied for a very long time stop working. This usually happens because the monetary system undergoes a major change or because the economy is altered in a permanent way by government and/or central bank intervention. It also can happen due to a major technological change that, for example, permanently reduces the demand for a commodity.

As a result of increasing central bank manipulation of money and interest rates, for the past 12 years gold has been getting more expensive relative to commodities that are consumed*. This is because the manipulation has been a) making it more difficult to earn a satisfactory return on investment and b) reducing the appeal of saving in terms of the official money. As central banks reduce the returns available from investing in productive enterprises and punish anyone who chooses to save cash, the demand for a store of value that central banks can’t depreciate naturally rises.

A knock-on effect is that some gold/commodity ratios appear to have been permanently elevated to higher ranges. There still will be periods when gold falls in value relative to these commodities, but the former ceilings no longer apply. In fact, in some cases it may be appropriate to view the former ceilings as the new floors. The two long-term monthly charts displayed below are cases in point.

The first chart shows the gold/platinum ratio. From the early-1970s through to 2015, gold was always near a long-term peak relative to platinum whenever the ratio moved up to 1. However, in 2015 the ratio broke above 1 and continued to trend upward.

A few years ago we speculated that gold/platinum’s former ceiling near 1 had become the new floor, that is, that the gold price would never again make a sustained move below the platinum price. The probability that this is so has since increased, although it’s likely that gold/platinum made an important high in March-2020 and is in the early stages of a 1-2 year decline.

The second chart shows the gold/oil ratio. From 1970 through to the start of 2020, gold was always near a long-term peak relative to oil whenever the ratio moved up to 30. However, during March-April of this year the gold/oil ratio reached a multiple of its previous long-term peak.

As is the situation with the gold/platinum ratio, it’s likely that the gold/oil ratio is in the process of establishing a higher long-term range that involves the former ceiling (30) being the new floor. As is also the situation with the gold/platinum ratio, it’s a good bet that the gold/oil ratio made an important high in April-2020 and is in the early stages of a 1-2 year decline.

It could be a similar story for the gold/silver ratio, although to a lesser degree. It’s likely that the gold/silver ratio has been permanently elevated, but not to the extent where the former ceiling (80-100) is the new floor. Our guess is gold/silver’s new floor is 50-60.

*That’s right, central banks are inadvertently manipulating the gold price upward, not deliberately manipulating it downward.

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

Gold is more money-like and silver is more commodity-like. Consequently, the relationships that we follow involving the gold/GNX ratio (the gold price relative to the price of a basket of commodities) also apply to the gold/silver ratio. In particular, gold, being more money-like, tends to do better than silver when inflation expectations are falling (deflation fear is rising) and economic confidence is on the decline.

Anyone armed with this knowledge would not have been surprised that the collapse in economic confidence and the surge in deflation fear that occurred during February-March of this year was accompanied by a veritable moon-shot in the gold/silver ratio*. Nor would they have been surprised that the subsequent rebounds in economic confidence and inflation expectations have been accompanied by strength in silver relative to gold, leading to a pullback in the gold/silver ratio. The following charts illustrate these relationships.

The first chart compares the gold/silver ratio with the IEF/HYG ratio, an indicator of US credit spreads. It makes the point that during periods when economic confidence plunges, the gold/silver ratio acts like a credit spread (credit spreads rise (widen) when economic confidence falls).

The second chart compares the silver/gold ratio (as opposed to the gold/silver ratio) with the Inflation Expectations ETF (RINF). It makes the point that silver tends to outperform gold when inflation expectations are rising and underperform gold when inflation expectations are falling.

We are expecting a modest recovery in economic confidence and a big increase in inflation expectations over the next 12 months, meaning that we are expecting the fundamental backdrop to shift in silver’s favour. As a result, we are intermediate-term bullish on silver relative to gold. We don’t have a specific target in mind, but, as mentioned in the 16th March Weekly Update when the gold/silver ratio was 105 and in upside blow-off mode, it isn’t a stretch to forecast that at some point over the next three years the gold/silver ratio will trade in the 60s.

Be aware that before silver commences a big up-move in dollar terms and relative to gold there could be another deflation scare. If this is going to happen it probably will do so within the next three months, although we hasten to add that any deflation scare over the remainder of this year will be far less severe than what took place in March.

*The gold/silver ratio hit an all-time intra-day high of 133 and daily-closing high of 126 in March of this year. This was one of the many unprecedented market/economic events of 2020.

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

MMT (Modern Monetary Theory) revolves around the idea that governments with the ability to create money are not limited in the way that individuals and corporations are limited. Whereas private entities can only spend the money they have or the money that another private entity is willing to lend to them, a government with the ability to create money is only limited in its spending by the availability of real resources. As long as there is ‘slack’ (what the Keynesians refer to as “idle resources”) in the economy, the government can spend whatever amount of money is necessary to bring to fruition whatever projects/programs the majority of voters desire. MMT’s appeal to the political class is therefore obvious. The only problem is that MMT is based on misunderstandings about money, debt, and how the economy actually works.

If you read the explanations put forward by MMT advocates you could come away with the impression that the ‘theory’ is a discovery or original insight, but nothing could be further from the truth. What MMT actually does is employ accounting tautologies and a very superficial view of how monetary inflation affects the economy to justify theft on a grand scale.

Expanding on the above, when the government creates money out of nothing and then exchanges that money for real resources, it is exchanging nothing for something. In effect, it is diverting resources to itself without paying for them. This is a form of theft, but it is surreptitious because the seller of the resources does not incur the cost of the theft. Instead, the cost is spread across all users of money via an eventual reduction in the purchasing power of money.

According to the MMT advocates, the surreptitious theft that involves diverting resources from the private sector to the government is not a problem until/unless the CPI or some other price index calculated by the government rises above an arbitrary level. In other words, surreptitious government theft on a grand scale is deemed to be perfectly fine as long as it doesn’t result in problematic “price inflation”.

Further to the above, there is a major ethical problem with MMT. However, there are also economic problems and practical issues.

The main economic problem is that the damage that can be caused by monetary inflation isn’t limited to “price inflation”. In fact, “price inflation” is the least harmful effect of monetary inflation. The most harmful is mal-investment, which stems from the reality that newly-created money is not spread evenly through the economy and therefore has a non-uniform effect on prices. That is, monetary inflation doesn’t only increase the “general price level”, it also distorts relative prices. This distortion of the price signals upon which decisions are based hampers the economy.

Another economic problem is that the programs/projects that are financed by the creation of money out of nothing will not consume only the “idle resources”. Instead, the government will bid away resources that otherwise would have been used in private ventures. The private ventures that are prevented from happening will be part of the unseen cost of the increased government spending.

A practical issue is that the government’s ability to spend would be limited only by numbers that are calculated and set by the government. There is no good reason to expect that this limitation would be any more effective than the limitation imposed by the “debt ceiling”. The “debt ceiling” was raised more than 70 times over the past 60 years and now has been suspended.

A second practical issue is that it often takes years for the effects of monetary inflation to become evident in the CPI. Therefore, even if there were an honest attempt by the government to determine a general price index and strictly limit money creation to prevent this index from increasing by more than a modest amount, the long delays between monetary inflation and price inflation would render the whole exercise impossible. By the time it became clear that too much money had been created, a major inflation problem would be baked into the cake.

It’s often the case that what should be is very different to what is, so MMT being bad from both ethical and economics perspectives probably won’t get in the way of its implementation. After all and as mentioned above, it has great appeal to the political class. Also, it could be made to seem reasonable to the average person.

In fact, even though it hasn’t been officially introduced, for all intents and purposes MMT is already being put into practice in the US. We say this because the US federal government recently ramped up its spending by trillions of dollars, safe in the knowledge that “inflation” is not an immediate problem and that the Fed is prepared to monetise debt ‘until the cows come home’. Furthermore, another trillion dollar ‘stimulus’ program is in the works and there is a high probability that a multi-trillion-dollar infrastructure-spending program will be approved early next year. Clearly, there is no longer any concern within the government about budget deficits or debt levels. They aren’t even pretending to be concerned anymore.

The good news is that the implementation of MMT should accelerate the demise of the current monetary system. It means that there is now a high probability of systemic collapse during this decade. The bad news is that what comes next could be worse, with a one-world fiat currency, or perhaps a few regional fiat currencies, replacing today’s system of national currencies.

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

Financial market discussions and analyses often focus on fundamental issues that don’t matter, or at least don’t provide useful clues regarding the likely future performance of the market in question. A good example is the so-called “global US$ short position”, which is regularly cited in support of a bullish outlook for the US$.

The argument is that the roughly $12 trillion of US$-denominated debt outside the US constitutes a short position that will create massive demand for dollars and thus put irresistible upward pressure on the Dollar Index (DX). There is an element of truth to the argument, but the “global US$ short position” always exists. It exists during US$ bull markets and it exists during US$ bear markets, because it is simply an effect of the US$ being the currency of choice for the majority of international transactions. Furthermore, the shaded area on the following chart shows that the quantity of dollar-denominated debt outside the US steadily increases over time and that even the 2008-2009 Global Financial Crisis resulted in only a minor interruption to the long-term trend. Consequently, the existence of this debt isn’t a major intermediate-term or long-term driver of the US dollar’s exchange rate.

Source: https://www.bis.org/statistics/gli2004.pdf

The element of truth to the “global US$ short position” argument is that a significant strengthening of the US currency relative to the currencies of other countries will increase the cost of servicing dollar-denominated debt in those countries. This lessens the ability to borrow additional US dollars and puts pressure on existing borrowers to reduce their US$ obligations. In effect, it leads to some short covering that magnifies the upward trend in the US dollar’s exchange rate. This means that while the “global US$ short position” won’t be the cause of a strengthening trend in the US$, it can exacerbate such a trend.

We mentioned above that there is no empirical evidence that the “global US$ short position” drives trends in the US dollar’s exchange rate, but that doesn’t guarantee that the pile of US$-denominated debt outside the US won’t become an important exchange-rate driver in the future. The reason it won’t become important in the future is that prices are driven by CHANGES in supply and demand. The US$12T+ of foreign dollar-denominated debt represents part of the existing demand for dollars, meaning that the demand-related effects of this debt on the dollar’s exchange rate are ‘in’ the market already. At the same time, the total supply of dollars is growing rapidly.

At this point it’s worth addressing the idea that the Fed would be powerless to stop the US$ from appreciating if a major ‘debt deflation’ got underway. This is nonsense. Until the law of supply and demand is repealed, someone with the unlimited ability to increase the supply of something WILL have the power to reduce the price of that thing.

The Fed’s power to reduce the relative value of the US dollar was very much on display over the past few months. The financial-market panic and economic collapse of March-2020 predictably resulted in a desperate scramble for US dollars, leading to a fast rise in the Dollar Index. However, it took the Fed only two weeks to overwhelm the surging demand for dollars with a deluge of new dollar supply.

The upshot is that the so-called global US$ short position is not a valid reason to be a US$ bull.

With regard to performance over intermediate-term (3-18 month) time periods, the fundamentals that matter for the US$ are relative equity-market strength and interest rate differentials. This combination of drivers has been neutral for more than a year but soon could turn bearish for the US$.

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

The year-over-year rate of growth in US True Money Supply (TMS), a.k.a. the US monetary inflation rate, has continued its journey “to da moon.” Based on the monthly monetary data for May-2020, it is now at 27% and still rising rapidly. The following chart shows that the money-supply growth surge engineered by “Mississippi Jay” Powell* now dwarfs the earlier efforts of “Easy Al” Greenspan and “Helicopter Ben” Bernanke.

Anyone who thinks that this year’s monetary inflation moon-shot won’t lead to much higher prices for many things is kidding themselves. It has already fuelled the fastest 40% rise in the S&P500 Index in history, but unlike the other money-supply growth surges of the past 20 years the current episode also should lead to substantial gains in what most people think of as “inflation”. Not so much this year, because in the short-term there are counter-balancing forces such as an increasing desire to hold cash, but during 2021-2022.

Apart from its larger scale, there are three reasons that the money-supply growth surge engineered by “Mississippi Jay” should lead to much higher “price inflation”** than the money-supply growth surges engineered by his predecessors. The first is that although the Fed is still buying US government debt via Primary Dealers as opposed to directly from the government, it is crystal clear that the Fed is monetising the US government’s deficit. That’s why the Federal government is no longer even pretending to be concerned about the level of its spending and indebtedness. In effect, MMT (Modern Monetary Theory) is now being implemented in the US.

MMT is based on the ridiculous idea that there should be no upper limit on government spending/borrowing, facilitated via the creation of new money, as long as the CPI’s growth rate is below a certain level. It completely ignores all effects of monetary inflation apart from the most superficial. It also ignores the reality that government spending tends to be counterproductive because it is driven by political considerations and not market forces.

The good thing about MMT is that it should short-circuit the boom-bust cycle, in effect almost skipping the boom and going directly to an inflationary bust. This is because it lays bare the crudeness of the central bank’s monetary machinations. No longer is the central bank (incorrectly) perceived as finely tuning interest rates to keep the economy on an even keel. Under MMT it is seen to be pumping out whatever amount of new money the government demands.

The boom associated with this year’s monetary inflation moon-shot began in April and probably will end within the next six months. Actually, it might have ended already.

The second reason to think that this year’s money-supply growth surge will be followed by substantial “price inflation” is that the lockdowns of the past few months have damaged supply chains. This, combined with the shift away from globalisation, will lead to reduced supply and/or less efficient production of goods.

The third reason is supply constraints on important commodities. Firstly, this year’s lockdowns caused the mining industry to delay expansion plans and cancel new developments. Secondly, in labour-intensive mining countries such as South Africa, the requirement to implement social distancing following the return to work has made and will continue to make the mines less efficient. Thirdly, many small-scale commodity producers that together account for a significant portion of total supply have been put out of business by the lockdowns. Fourthly, the “El Nino” weather event of 2020-2021 and the Grand Solar Minimum that should start becoming influential in 2021-2022 probably will result in extreme weather volatility, which potentially will disrupt the supply of important agricultural commodities during 2021-2022. Lastly, due to the virus-related lockdowns and associated economic pressures there is heightened risk of war in the Middle East, implying heightened risk of an oil supply shock.

In summary, the latest flood of new money created by central banks will be more widely perceived to be “inflationary” than the other ‘money floods’ of the past 20 years. In addition, the latest money flood has occurred near the start of a multi-year period during which the production of many commodities and manufactured goods will be hampered. A likely result is substantial “price inflation” during 2021-2022.

*“Mississippi Jay” is the nickname we’ve given to current Fed Chair Jerome (Jay) Powell. The name links Powell with John Law, the roguish Scotsman (is there any other kind?) who, while residing in France in the early-1700s, engineered the Mississippi Bubble via a scheme that involved creating an extraordinary amount of new currency.

**We don’t like the term “price inflation”, because there is no such thing as an economy-wide average price level and because at any given time some prices will be rising while others are falling. However, we use the term because it is generally understood to mean a rising cost of living for most people.

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

In most countries/regions, the money-supply growth rate bottomed in 2019 and by the beginning of this year was in a clear-cut upward trend. Then came the “coronacrisis”, involving widespread economic lockdowns and unprecedented central bank money/credit creation designed to counteract the effects of the lockdowns. A result was a veritable explosion in monetary inflation rates around the world during March and April (April being the latest month for which there is complete money-supply information). Here are some examples:

1) The combination of US and euro-zone money supply that we call G2 True Money Supply (TMS) was at a 10-year low in the middle of last year. It is now at an all-time high. This is by far the most bullish force currently acting on equity and commodity prices.

2) Early last year Australia was in danger of experiencing monetary deflation, but this country’s monetary inflation rate has since rocketed to an all-time high of 24%. This is not bearish for the A$ relative to other currencies and especially not relative to the US$ (we suspect that the A$ will trade at parity with the US$ within two years), because the A$’s exchange rate is influenced to a far greater extent by the commodity markets than by the local monetary inflation rate. However, it suggests that in Australia the prices of goods, services and assets will go up a lot over the next few years.

3) The Bank of Canada has been a little more circumspect than most other central banks over the past few months, but in response to the recent crisis it has done enough to boost the country’s monetary inflation rate to near a 10-year high. A year ago it was near a 20-year low.

4) We occasionally read articles that attempt to make the case that central bank money pumping does not lead to higher prices, with the situation in Japan cited as evidence. Japan supposedly is relevant because the Bank of Japan (BOJ) has been aggressively monetising assets for a long time with minimal effect on prices.

As we’ve noted many times in the past, prices have been stable in Japan because Japan’s monetary inflation rate has oscillated at a relatively low level for decades. Whatever the BOJ has been doing, it has NOT been pumping money at a rapid rate. Even now, in the face of additional monetary stimulus, the year-over-year rate of growth in Japan’s M2 money supply is below 4%. This contrasts with a US money-supply growth rate of almost 20%.

Therefore, the low rate of price inflation in Japan is in no way mysterious. It’s exactly what would be expected from an economy with a low rate of monetary inflation and some productivity growth.

In summary, outside of Japan the supply of currency is increasing at such a fast pace that there WILL be substantial price increases over the next two years. However, the price increases won’t be uniform. For example, due to a high unemployment rate the price of labour probably will be a laggard, and due to their relative supply situations the price of oil probably won’t rise by as much as the prices of uranium, natural gas, copper, nickel and zinc.

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

The rebound from the H1-2020 plunge into recession probably will look like a ‘V’, at least initially. This is not because conditions will become positive as quickly as they became negative, but because conditions got so bad so quickly that charts of economic statistics such as industrial production and retail sales will appear to make a ‘V’ bottom in Q2-Q3 of this year. However, the ‘V’ won’t mark the start of a genuine recovery.

The following charts show what we mean by “got so bad so quickly”.

The first chart shows that within the space of three months the Small Business Optimism Index collapsed from a level that indicated a high level of optimism to one of the lowest levels in the 34-year history of the index. The only other decline of this magnitude occurred during the 2005-2008 period and took more than two years.

The second chart shows that Industrial Production has just registered its largest month-over-month decline in at least 101 years. By this measure, even the worst months of the Great Depression were not as bad as April-2020.

Source: dshort

Source: Hedgeye

There are thousands of people who have lost their businesses — in some cases, businesses that they spent the bulk of their adult lives building — over the past two months as a result of the lockdowns. These people probably are feeling angry and/or devastated. However, we get the impression that the vast majority of people have accepted the lockdowns with equanimity. They haven’t taken to the streets to protest the economic destruction that has been wrought by their political overlords. Instead, they have shrugged off the most rapid decline in industrial production in history and a sudden rise in the unemployment rate from below 4% to above 20%. How is this possible?

It’s possible only because the government and the Fed have showered the people with money. The money that has been created out of nothing is acting like pain-suppressing medication. In effect, the government and the Fed have administered anaesthetic so that the patient felt no pain as vital organs were removed. Without this anaesthetic, the populace would not have remained docile as its basic rights were cancelled and its economic prospects were greatly diminished.

Money, however, is just the medium of exchange. It facilitates the division of labour*, but it does not constitute real wealth. For example, if every current dollar were instantly replaced by ten dollars, there wouldn’t be any additional wealth. The point is that the government and the Fed cannot make up for the decline in real wealth caused by the lockdowns by providing more money. All they can do is change the prices of the wealth that remains.

There will be a ‘V’ shaped recovery, but due to the destruction of real wealth stemming from the lockdowns the rising part of the V is bound to be much shorter than the declining part of the V. This will lead to a general realisation that life for the majority of people will be far more difficult in the future than it was over the preceding few years.

Returning to our medical analogy, eventually the anaesthetic will wear off and the patient will have to start dealing with the consequences of having lost a kidney, a spleen, a lung and half a liver.

*In the absence of money, a tomato farmer who needed some dental work would have to locate a dentist who needed a few crates of tomatoes.