Register for a CI Markets account for FREE! No credit card required: https://completeintel.com/markets

In this episode of The Week Ahead, we’re joined by Dr. Anas Alhajji, Michael Belkin, and Tracy Shuchart. Dr. Anas starts by tackling the intriguing question of oil prices. Despite ongoing supply constraints, including OPEC’s cuts, Dr. Anas argues that there’s currently no compelling case for $100/b oil. He’ll walk us through his reasoning.

Next, we turn to Michael Belkin who shares his perspective on the equity market. Michael believes that we’ve reached the peak of the current cycle, and recent market turbulence seems to support his view. He also provides insights into energy trends and discusses his thoughts on sector rotation, particularly as it pertains to defensive sectors.

Finally, Tracy Shuchart takes the stage to explore LNG and electric vehicles in Asia. Her analysis highlights Asia’s growing dependence on LNG as the largest energy-importing region, with projections indicating a potential doubling by 2050. Tracy also gets into how gas may outperform green technologies like wind, solar, and batteries, shedding light on the future of electric vehicles in Asia.

Key themes:

1. No case for $100 oil

2. Equities have peaked

3. LNG & EVs in Asia

This is the 79th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.

Follow The Week Ahead panel on Twitter:

Tony: https://twitter.com/TonyNashNerd

Anas: https://twitter.com/anasalhajji

Michael: https://twitter.com/BelkinReport

Tracy: https://twitter.com/chigrl

Transcript

Tony Nash

Hi, and welcome to the week ahead. I’m Tony Nash. Today, we are joined by Dr. Anas Alhajji, for the first time. We’re really glad to have you here, Dr. Anas. We’re also joined by Michael Belkin and Tracy Shuchart. There’s a lot to cover today. First, we’re going to talk to Dr. Anas about $100 oil. We’re then going to talk to Michael about equities and sector rotations that are happening in markets. And then we’re going to talk to Tracey about LNG in Asia, which has been a story building over probably a decade, but it’s really starting to break out.

Tony Nash

So before we get started, I want to let you know about a new free tier we have within CI Markets, our Global Market Forecasting Platform. We want to share the power of CI Markets with everyone. So we’ve made a few things free. First, economics. We share all of our global economics forecasts for the top 50 economies. We also share our major currency forecasts, as well as Nikkei 100 stocks. So you can get a look at what do our stock forecast look like. There is no credit card required. You can just sign up on our website and get started right away. So check it out. CI Markets Free. Look at the link below and get started ASAP. Thank you.

Tony Nash

Guys, thanks so much for joining us at the end of this week. I know there’s been a lot happening this week, and I’m really, really grateful whenever you take your time here. Dr. Anas, let’s start talking about the case for $100 oil. Obviously, we’ve seen a lot of movement in crude prices over the last couple of months. There are supply constraints, of course, with Saudi and OPEC supply cuts and the extension of those cuts. But you put in a tweet earlier this week saying that there is no case for $100 oil, which sounds surprising a little bit. I’d really like to hear your reasoning through that if you can walk us through that. I’m sure there are a lot of items that go into that calculation. If you don’t mind, can you walk us through that, please?

Dr. Anas Alhajji

Sure. When we worked on our 2023 oil market outlook in December, and we published it on the third of January, we made 23 predictions in that outlook. It is available on the web for those who would like to check it out. We made those predictions, basically, most of them were against the grain. The title of it was, 2023 is going to be the tail of two-halves. That’s what the title. And the title tells the whole story about the two-halves. The increase in oil prices, etc, all was predicted. We were very bullish on the fourth quarter of 2023. We expected the Chinese economy to be very weak. You and I exchanged few tweets on this throughout the previous month. We expected that. We expected Russia in order to continue to go to the market. But what we did not expect, despite the 23 successes of those predictions, we failed to see that Chinese are going to increase their oil inventories, and they increased this substantially. We failed to see that. And given their history that we studied over the years, it was very clear that they are going to use this bill when prices go up, and they already started doing this.

Dr. Anas Alhajji

That’s messed up our very bullish fourth quarter. We are no longer very bullish, we are just bullish. If you look at all the factors that determine supply and demand in the market at this stage, and I repeat here because some people take this word and in 2025, you said no 100 in 2025. I did not say that at this stage. I think, Tracey got burnt several times with the same matter that I was burnt with. When you say something and people put it in a different time frame. At this stage, there is no case for 100 simply because if you look at supply and demand and the fact that the Chinese are releasing a lot of oil from their inventories, they already released about 35 million and we expect them to release another 45 million in the next few weeks. That’s one issue. There are many other issues that people do not know about. Now, I understand what speculators do and algorithms and all that stuff, but they need a trigger. One of the things, just to give you an idea how much people do not know those who are especially very bullish, the Russians promised the Saudi to cut production by 300,000 barrels a day.

Dr. Anas Alhajji

The Russians are cutting and people see the numbers. What people do not see is that the Russians are playing the game of what is crude because they shifted to NGLs and they reclassified the crude as NGLs. Their NGLs exports went up by 300,000, the same number they decided to cut.

Tony Nash

It’s all a statistical game, right?

Dr. Anas Alhajji

Absolutely. When we look at crude, absolutely. When we look at OPEC and people show, Look, Saudi production is declining, UAE production is declining. Look, OPEC production is declining, OPEC Plus production is declining. We’ve been saying for a long time that production does not matter, exports do, because supplies are what matter to the market. But after they build those massive refineries, what matters right now is the net exports, not the exports. Once you count the net exports, the decline is way lower. Therefore, of course, I mentioned 23 prediction, there are many things to talk about. We don’t have enough time. But the idea here is you start looking at those details, people saying, What if Iran does not deliver? Well, no one counted Iran in the first place.

Dr. Anas Alhajji

No one counted Venezuela in the first place. Why you guys are counting them when you want to?

Tony Nash

Just a very quick clarification. When you talk about exports versus net exports, for people who aren’t energy market experts, why does that matter?

Dr. Anas Alhajji

There are countries that have massive refineries that they take the oil from Russia or they take their own oil and they export it as products. If you don’t count that in the equation, you are missing something from the equation.

Dr. Anas Alhajji

Because they are exporting both. I’m just making up numbers. Let’s say if a country exports 1 million barrels of crude and their product exports go from 100-300, their exports went up. Although if you look at the crude alone, it did not change.

Tony Nash

Right.

Dr. Anas Alhajji

So you have to count that. The other issue that we fail to see, because we have two failures in our forecast. The first one is we did not see the build in the Chinese inventories. Although we know the Chinese story about releasing oil, but we did not realize that in 2023 they will build. The other related issue is we did predict that other OPEC members will buy Russian crude and Russian products. What we felt to see is the increase was fourfold our forecast.

Tony Nash

Okay.

Dr. Anas Alhajji

That changed the whole dynamics because the country can cut production, but they can still consume the oil anyway.

Tony Nash

Right. Okay. Has Russia been hurt by any of these cuts? By any of the energy cuts? It seems like it’s just train diversion more than really harm from these cuts.

Dr. Anas Alhajji

Let me put it differently. Are they being affected by what’s happening? Are they getting less money, etc, Yes, there is no doubt they are hurting. But definitely it’s not what Janet is saying. Okay, they keep talking about… Let me give the audience just one example about this. The price cab and the sanctions were imposed on December fifth, 2022. Two weeks later, Janet Yellen’s office was talking about the price cab is working and it’s reducing Russian exports, although the impact has not been done yet. Between the time the companies sell the oil, get the money, pay their taxes, the government collect the taxes, and reach the level of revenues, it take 6-9 months. Those guys were talking about it two weeks later.

Tony Nash

Right. Statistically, theoretically, it made an impact, but in fact, it hadn’t made an impact yet.

Dr. Anas Alhajji

The price cap never had an impact at all. We have a history of sanctions for the last 200 years, let’s say 120, because most of the studies are done for the last 120 years. Every single study on sanctions in the last 120 years concluded that sanctions do not work and there are always ways for the product to find its way to the market.

Dr. Anas Alhajji

This is a fact of life. The Russians were lucky because the Iranians were on their side and the top expert in the world on this are the Iranians. They took a page from the Iranian book and they made a thousand books out of it. They perfected the game on their own.

Tony Nash

I’m really relieved to see your statement about no $100 oil in 2023. Our CI Markets Forecast product does not have $100 oil in 2023. We see things peaking in October and then slightly deteriorating into the end of the year. That may or may not happen. But what you’re saying very much agrees with what we’ve forecast for months. As we go into 2024, what are the dynamics that you’re looking at? And do you see pressure for higher crude prices going into 2024?

Dr. Anas Alhajji

We published a report on 2024, and then we updated that we are still bullish. But we have a serious problem that we are still struggling with. We have the worst data, quality or records. We never had… I mean, the quality of the data deteriorated substantially to the level that we are really… I mean, we have to work extra hard trying to sort it out. We never had this problem before. It’s coming from all over. Today, we published a report on the EIA adjustment and crude quality and shale. The last statement, the conclusion was the US, with its might, it can send a rocket across the world and hit its target and cannot fix the adjustment in the data. That’s how bad it is. And what happened is, supposedly on the first of August, the EIA published a warning or a press release saying that we fixed the problem, we found the blending things, and we are adding the NGLs, etc. We were happy to see the decline, and the adjustment just declined to the usual 200,000 a day a week later, it multiplied by five. A week later. That shows you that we do have a serious problem in the United States.

Dr. Anas Alhajji

Now imagine with the dark Russian fleet, with the dark Russian, with the dark, Iranian fleet, with the Syrians, the Sudanese, the the Venezuelans, etc, how bad the data is. Then China basically is playing a game where one day the Iranian oil is coming to China from Malaysia and the other day is coming directly and the third day is coming from the UAE. I mean, it takes a lot of effort even to do that, and it’s becoming too expensive for any analysts even to do the analysis right now.

AI

Heads up for a short break.

AI

Are you using the potential of AI in your portfolio management strategies?With an impressive 94.7% forecast accuracy on average, you can confidently integrate AI into your approach with CI Markets. Visualize the potential volatility of your portfolio over the next 12 months and gain insights into specific assets that might experience fluctuations. This empowers you to make informed decisions on when to buy, sell, or hold. CI Markets covers a wide range of over 1,600 assets, including stocks, commodities, forex, indices, and economic indicators. Imagine running limitless portfolio scenarios to optimize your gains. Curious about the outcome of removing or adding certain assets? Wondering how your portfolio might evolve in the next 3, 6, or 12 months? CI Markets equips you with answers to these crucial questions. Whether you seek a streamlined portfolio analysis, wish to explore diverse scenarios, or aspire to track your investments with precision, CI markets is the ultimate tool for you. Ready to learn more? Visit us at completeintel.com/markets.

AI

Thank you and now back to the show.

Tony Nash

Okay, so there’s a lot of great data. For people who are looking at that data, is there a decent proxy data to look at to understand what’s going on? Or is it just a guess at this point?

Dr. Anas Alhajji

This is mostly when it comes right now to the Russian crew, because whatever I say about Russian crew, and I’m convinced of anyone can come in and say another number, and both of us are correct.

Tony Nash

Right.

Dr. Anas Alhajji

Okay, both of us are correct. But one point about the data quality here. Just to show you how bad the situation is, we are coming to the situation. For example, yesterday there was a major report published, I’m not going to name the agency, talking about the CO2 emissions between Europe and India and saying that India permanently now outpaces Europe. It’s a complete nonsense because Europe is in a recession, and in a recession, you use more renewable energy and less fossil fuel. Just show you how data deteriorates. The other data deterioration is related to the fact I know you are going to talk about EV, so I will mention it, and then we talk about it later. About how they report the EV growth in percentages, not the numbers.

Tony Nash

Right. Tell me what that means. You’re saying… Sorry, let me interpret that and make sure that’s what… You’re saying the EV installed base is pretty low. Because it’s pretty low, they’re telling you about percentage growth to make it seem more important when, in fact, the installed base of EVs is just pretty low. If they just told you the numbers, it would be a yawner.

Dr. Anas Alhajji

Is that fair to say? Correct. For example, this is a true case where the number of trucks sold jumped from 400 to 900. Around those numbers, but the report was, Oh, the sales of this truck increased by 154%.

Tony Nash

Right.

Dr. Anas Alhajji

But they did not mention the numbers.

Tony Nash

Right. Okay, that makes sense. Our observation is that macroeconomic data quality has deteriorated pretty bad in the past few years. It makes sense to me also that oil, crude trade and crude quality data has deteriorated as well. There’s just some fuzziness in the past few years, and I just can’t quite put my finger on it. Anas, before we move on to the next topic, can you help us understand the supply-side dynamics? We’ve seen Saudi Arabia continue their supply cuts into October. Do you think we’ll continue to see OPEC pull supply off the market? Let’s say if Europe continues to deteriorate, if Europe’s economy deteriorates, if let’s say, US consumers deteriorate and the US economy deteriorates, do you think we could see OPEC extend their supply cuts and even grow the supply cuts into ’24 if we see economies continue to deteriorate?

Dr. Anas Alhajji

There is one fact that we have to realize here that for Saudi Arabia in particular, they’ve been proven to be true on the demand side. Opec was wrong. If you look at OPEC forecast, you look at the IAEA was wrong. And so what? Because the Saudi are adopting a policy of two legs. The policy is every month they ask Aramco and they say, Look, tell me about what people are asking you for. They have their own clients. So what are the amounts that your clients are asking you for? And they tell them. I am convinced that they have a contract with a company. It’s an artificial intelligence company that measures sentiment. They take the sentiment from the market from the AI company and they take the data from Aramco and decide what to do. They get the first orders before you and I. And if any trader knows anything about the market, they have field before anyone else. The data for the forecast for OPEC and IA and everyone else, it comes later. They have a field of market before anyone else. Therefore, they really nailed it when it comes to the demand. The demand is not as strong as people predicted earlier this year.

Dr. Anas Alhajji

Because we already have this cut and we see where we are right now. They have a few. This is the first fact. The second fact is what do Saudi’s want? Because people really need to understand what they say, Well, they need to balance the budget. Look, this is just one tiny objective among many. There are many objectives. The budget and the money is just one part of it. It is extremely important for the Saudi to control the narrative. It is extremely important for the Saudi to be in the driver’s seat. That’s why they get angry when the speculators after the banking crisis in the US, the recent one, the speculators basically took over and then the media start publishing those weird, some of them fake news. Tracey and I basically are familiar with those news that becoming really annoying from time to time where it’s either fake news or, for example, it is part of corporate planning to study all scenarios. It’s natural. If they are discussing seven issues and one of them mentioned we discussed this issue, does not mean they are going to adopt that issue. But all of a sudden it’s a headline news and the market is reacting to it.

Dr. Anas Alhajji

But the fact is they want to control the narrative. They want to, yes, they want more money, yes, they want some political gains out of it. Yes, they want some strategic gains out of it, yes. But one important element this year that did not exist before that they are going to be a super active participant in COP28. Cop28 is going to start at the end of November for about 12 days in December, and it is in Dubai. This is in their backyard. They want to go there and be a hero. The reason why they want to be a hero, because they cannot be… Remember that this is the first time the oil companies are part of those meetings. They were barred before. They are going with the rest of the old industry, trying to convince the other side to change the narrative.

Dr. Anas Alhajji

And you cannot change the narrative unless you are active participant and you are ahead of everyone. You lowered CO2, you build those big mega wind farms, and you build those solar, and you are using hydrogen, and you are planting trees. They are going to come in full force to show all those good things that I am as good as any European country. Now you listen to me. This is part of it too, because a reduction in output for three months bring us to COP28. Reduction output means a reduction in CO2. At the same time, they are changing the narrative on the consumption side because for over 40 years, the data from VP and NA and all the others, now if you go to the web and search for the top 10 consumers of oil, Saudi Arabia is always there. But that’s a mistake because they did not count the export, the product’s exports. They count them as consumption. Saudi Arabia is not among the top 10 consumers, and therefore they count them as big emitter because they are consuming that oil while they are not consuming it.

Tony Nash

Well, it’s like looking at Singapore as a consumer, right? I mean, Singapore has massive refineries. They couldn’t possibly use all the oil they import.

Dr. Anas Alhajji

Absolutely.

Tony Nash

They import it, process it, re-export it. All these things make a lot of sense. They’re going to get involved in COP28 really to have more control over the narrative going forward. The vilification of oil and gas and the vilification of fossil fuel.

Dr. Anas Alhajji

With the cooperation of others. This is very important. They are going in with the rest of OPEC, China, India, the African nations with the oil majors, especially the Europeans. They are going there, armed with all the facts of 2022, where they show that you, Europeans, you reenact on everything you promised.

Tony Nash

That’ll be very interesting to watch. I can’t wait. Perfect. Anas, this is great. Just conclusions. No $100 oil in 2023. You’re still bullish going into 2024, but you’re not super bullish. The Saudi and OPEC will get more involved in COP28. Over time, we’ll say maybe a more friendly narrative to some of these traditionally fossil fuel-producing nations. Is that fair to say?

Dr. Anas Alhajji

Yes. On 2024, basically, the major issue we are facing is I mentioned one, but I’m going to mention something else since you are going to talk about LNG and EV and Tracy is going to talk about that, so this is a segue to it. One of the big lessons that we learned in 2022 is that we’ve seen substitution among energy sources in a way that we never seen in history, where wind stops, natural gas prices go up, people cannot afford them. Now they want LNG, LNG goes up, and now they go back to coal. It rains, there is no coal. It goes back to wood, and then from wood goes back to oil. We never seen this before, and it’s really quick. This is missing up our efforts to sort things out because we need to know the degree of substitution between all of those. This is a big problem right now in the analysis of the future.

Tony Nash

Yeah, I wouldn’t have expected to see wood as a substitutional feedstock in 2022. that’s really-

Dr. Anas Alhajji

Our regional basis, it is.

Tony Nash

Yeah.

Dr. Anas Alhajji

Or local, if you want to. But on a regional basis, we’ve seen that change.

Tony Nash

Very interesting. This is perfect. Thank you so much. You’re welcome. Let’s go from energy to energy with Michael. A little bit of energy. Michael Belkin, thanks for coming back this week. You mentioned last month when you were on the show that you thought equities had hit the cycle peak, and we’ve seen headwinds in equity markets ever since. Your view is that equities have peaked, which is great. And we’ve got a screenshot of your newsletter. You also thought energy would start picking up, and you covered that a bit in your newsletter as well. Can you talk us through the cycle peak and energy, as you’ve outlined in your newsletter?

Michael Belkin

Sure. Thanks for having me, Tony. Just to review what I do. The Belkin Report is a forecasting service. I was a graduate of UC Berkeley Business School in the staff department. I study time series analysis. What I do is forecasting based on time series analysis. I developed my own proprietary model. It’s similar to what I studied in Fourier analysis in Box-Jenkins on a regressive integrated moving averages, but I came up with my own way. My model gives direction, position, and intensity in a 12-period forward forecast. It works particularly well on sector rotation. We used it in proprietary trading. I was the quant strategist in equity trading back in the early 90s at Solomon Brothers. Anyway, that’s what I do. My clients are big hedge funds, private-family offices, big asset managers all over the world. Basically, I’m looking for what’s going to happen next. Again, direction, position, intensity. Is something going to go up, down? That’s first thing, direction. Second is position. Where are we? Beginning middle and how strong is the signal? With that in mind, let me give you a forward look. Sometimes my forecast sound very contrarian because the model basically likes to buy low and sell high.

Michael Belkin

It’s basically trying to pick bottoms and tops and things. Not just in markets, but in ratios, the way sector rotation works. Okay, so having said that, let’s just say where are we? July 31st, that was the peak for the S&P, Dow Jones, Russell 2000, and DAX. The NICA peaked a little bit earlier, actually July third. So we’re not down a lot from there. We’re down like 3 % for the US indexes, 8 % for the Russell 2000 from their peaks, DAX down 5 %. The stuff that people like the most actually peaked earlier and is down more. So New York-Fang, which is the best measure of all these Magic Seven stocks or whatever, it’s an index you can follow. It’s the top 10 large cap stocks in the US. That’s down 5%, peak July 18th. So we’re good six, seven weeks past the peak in the stuff. But has that changed the appetite among buyers? Not a bit. It’s funny. I was thinking before I came on here, I think I’d dubbed this the Hunter Biden market. It feels so good at first. You know the pictures of Hunter Biden in his underwear, with a cigarette in his mouth, and then a prostitute in the background, and he’s smoking crack.

Michael Belkin

So that’s my facetious view of the people who are addicted to buying these AI stocks and tech stocks which have already peaked. So it feels good at first. And I’m not a permabar, while I was on this stuff, my model turned very bullish last October. It’s almost a year ago. Anyways, but these peaked the first beginning of the third quarter into the end of the second quarter. Just one little side, one little digression on that. If you look at the flows, Deutsche Bank puts out this cumulative flows chart and it shows over the last year, tech is off the top of the chart. That’s all that people are buying and energy is off the bottom of the chart. But that hasn’t been working right. So tech is underperforming now, energy is going up. So, for instance, energy sectors were the only positive gains in the US and in Europe last month, August. Again, this week. So the S&P is down 1 %, the XLE is up 2 %, 3 % positive alpha. And is anybody getting this? I mean, a little bit, maybe, but this is not a consensus popular trade by energy. This is not something that’s wildly popular by any stretch of the time.

Tony Nash

On us and Tracy would have told us the same months ago, just like you. I mean, it’s really interesting to hear you say this, Michael, because this on energy is what Tracy has been telling us to wait for several months. So it’s great to hear this.

Michael Belkin

So it’s working. Again, the model forecast, it looks like a sine wave where the left tail is the beginning of something, the middle is the beginning, the middle is the middle, and the right tail is the end of something, time is on the bottom axis. So where are we in the oil? I might differ a little bit from your previous speaker. I’d say we’re about half to two thirds of the way through this move. So where are we? About $90 a barrel on Brent crude, a little bit below that for US crude. I could think it could go for another month or so. And energy stocks have not really become wildly popular yet. So basically, SEC in the fifth, sixth, dealing. If you think of a baseball game, nine innings, that’s where we are. We’re halfway, we’re not to the seventh-inning stretch yet. So it could keep going. So now what is this doing to the economy? So the market is peak. The market is the best leading forward indicator, economic indicator. So I was driving down the… I live on this island outside of Seattle. Gas is now five dollars a gallon here.

Michael Belkin

That’s probably more around here than it is in other parts of the country. So what is this doing? I think the higher oil price is applying the coup de gross to the US economic expansion. So think about it. Where are we? We had all that stimulus. The COVID hit, they freaked out in Y2K back in 2000. The Fed printed trillions of dollars of money. The US government spent trillions of dollars in all this fiscal stimulus. Then they pulled the plug on that a while back. Not fiscal so much, but the Fed has been doing QT. It’s been draining raised interest rates by 550 basis points, I believe. I think we’re dealing with the lagged effects of all this monetary tiding and pulling the plug on stimulus. I think the oil price typically going into a recession, the oil, not always, but typically you get a rise in the oil price while the recession is already starting and the stock market’s going down. Then the oil price peaks after a few months into it and starts going down when everything goes down together, commodities. That’s where I think we are. I think the oil price is squeezing the economy.

Michael Belkin

It’s squeezing the US consumer for sure. Let me just go through some of the sector rotation stuff. I do a stronger and weaker US industry group forecast. It’s longs and shorts basically, page six of the Belcom report. Until about a month or two ago, I had autos, airlines, all that stuff as out-perform prospects. It was working. Consumer groups, restaurants, retailers, they were all working as longs. That completely changed about the last time you had me on. Now I have for out-perform, I have energy service, oil and gas, energy MLPs, which yield a huge amount, seven %, these pipeline operators. I think they’re still a nice conservative way to play the energy thing. Coal. But after that, what is flipped into the sector rotation is flipped into defensive outperform. So that’s consumer staples, utilities, which nobody likes. These are the most hated. But these are risk off sectors and groups. And when big portfolio managers get nervous about the market, they basically sell all their tech and cyclicals, and they rotate into consumer staples, utilities, health care, and maybe REITs. That’s maybe bottom for list. So that’s what I’m starting to get. And so what is the sell?

Michael Belkin

The market is like the top of my sell list is New York-Fang. So Tesla, Meta, AMD, and NVIDIA. By the way, NVIDIA is down 5% this week. Anybody noticed that? I mean, the favorite AI stock. So to me, this AI boom is… Yeah, it’s real, of course, but it will amount to something, but not the way people expect now. Free market economy, everything changes. The competitors come out of left field. So anyways, the video is down 5% this week. Semiconductors, these are my shorts, software. Also, by the way, software stocks, the same stocks that were in the bubble that Tiger Global was long, everybody has jammed back into these things. These are now my top shorts. So Broadcom, NVIDIA, AMD, ASML. You go down the list… Wait a minute, those are semiconductors, Data Dog, TTD, I mean, Monster, Shopify, Coin, Hubs. These are the tickers. These are the stocks that blew up Tiger Global. And here we are back again. These people are loaded up to the gills in these things. There’s an old saying, a dog who turns to his vomit, I hate to be too-

Tracy Shuchart

Have loves dogs.

Tony Nash

Yeah.

Michael Belkin

So these are my shorts. This is not like me thinking some… This is not a subjective thing. This is what the model is coming up with, internet stocks.

Tony Nash

The sense I get, Michael, is that for a lot of these portfolio investors, they can’t not be in these things right now. They have to. They’re limited and their investors are asking them why they’re not in these things because the perception is that they’re doing so well on the tech side.

Michael Belkin

Sadly. Yeah. So I won’t mention any names, but even one of my clients whose household name, Hedge Fund Manager, I saw his letter saying, Oh, yeah, we covered all our shorts and now we’re long and all these fang stocks because it’s the only game in town. This was like right at the top six weeks ago. So, sadly, that’s how sentiment is the market is like this big vice. It tightens, squeeze you in the vice and makes you capitulate. So sentiment is a big part. One of my smartest other clients is a big sentiment fan, and they always want to know when sentiment is leaning too far one way or the other. And so does anybody like defensive stuff now? No. Do people like energy? Maybe a little, not so much. And there’s no big flows into it or anything. And do people love tap? Absolutely. So I think that’s basically what’s going to… There’s going to be this big squeeze out of this stuff. If I could just go a little bit further globally. So in the context of a global top for equity markets and the economic cycle, there were huge inflows into EM, right?

Michael Belkin

And one of the biggest was Mexico. So Mexico, for some reason, the Japanese retail investors, maybe no more or somebody, pushed these things into the Mexican cash, so Mexican bonds. If you look at charts of Mexico, the Peso got incredibly strong and the Mexican stock market went to the moon. It’s been falling apart. So it’s down four % this week. Same thing with Brazil. So we’re getting this flush, global flush. And if you’ve been around as long as I have, been through a few cycles. When EM starts getting cold feet, basically the currency start weakening, the bonds interest rates start going up, there’s capital outflows, the stock market starts going down. It’s all part of the same risk of global move. So I see this big risk-off global move just starting. So where are we? Beginning of September. The three-month view for the US market points down. So I would be short. A couple of things that are nice trades, VIX. The VIX looks incredibly depressed to me right now. So VIX call options. There’s a big game. There are big vol sellers. Don’t ask me who they are. I don’t know if it’s a conspiracy or what.

Michael Belkin

I mean, it’s part of the zero-day-option thing. People just sell options and it depresses volatility. But if we start getting big moves… Right now, volatility has been depressed, realized the vol is low. It’s like you barely get 1% moves in the market. That’s a big move. But if we start getting 2, 3% moves, those can be up and down by the way, in a bear market. It’s treacherous. So the danger is to sell them in the hall, get bearish, Oh, it’s breaking down. Sell them, get squeezed. You buy it, you short them in the hall, then it goes up four % in your face, you buy them back at the top. So that’s not the way to operate. Sell the rallies. So that’s why I’m telling clients we’re going into a higher volatility market, like the intraday rallies. Like today we’re up a little bit, sell them, short them. Buy VIX when it’s down, when they’re crushing it. Look out for tech. And there’s this big… Retail investors, it’s hard for… They might not be aware of some of these trades, but there’s… For instance, one of my clients is an Alpha Capture Fund. They’ve got almost 200 contributors, sell-side, buy-side brokers, independent guys like me.

Michael Belkin

I’m ranked number one in that. I was ranked number one in the first quarter. I’m up about 16%. That’s market neutral. So the point I’m not boasting. Boasting tends…

Tony Nash

To- Boast. That’s good.

Michael Belkin

Look out when you boast, something comes out of left field and destroys you. But the point is it’s long, short. There’s opportunity to be things like long energy, short tech. And I’m even buying things in their American AT&T, Telephone, Verizon, these are really depressed stocks, defensive, high yielding stocks, out of favor. Maybe not huge absolute gains, but huge outperformance possible, and even gold stocks. So gold stocks are almost there in the forecast. I’m just about ready to push the button on gold stocks, which is a defensive group which outperforms. That’s it.

Tony Nash

No, that’s not it, Michael. There’s one other thing. You mentioned the EMs, you mentioned some of the previous discussions. I want to ask you quickly about China. When we spoke last time, you were a little bit positive about China, and it hasn’t seemed to go well. Is there a chance that we see a resurgence in China or is the opportunity passed?

Michael Belkin

Good question. Yeah, that one I’ve been wrong on. I think I attribute it to their reluctance to go full-bazooka on stimulus. If ever there was a time and a place where it’s appropriate for huge monetary and fiscal stimulus, it’s now. But I am… He’s saying he’s afraid to do fiscal stimulus because it’s going to make the consumers, Chinese consumers, weak. I think they’ll be forced into massive stimulus eventually by how bad things are. But I’m standing aside there now in the Apple news, this is really economic warfare. So everybody knows this by now. They’re not allowing anybody in the government or even state-owned enterprises to use Apple phones at work. So that’s a response to the restrictions the US has put on semiconductors. So there’s this tip for tap thing that makes me really nervous. And it could be that China is completely uninvestible. Right now, I just don’t know. If they go full tilt, bogey on stimulus at some point, then that market could start to go up just on money creation. We’re not there yet, so I’m standing aside for now.

Tony Nash

Great. Okay. Michael, thanks. That was very comprehensive. Really appreciate that.

Tracy Shuchart

I had a question for Michael really quickly. Actually, it’s about based on industrial metals, given this green transition, do you think that… Are we just waiting on China, demanding that they’re the world’s largest commodity buyer for this take-off? We have LME inventories at Lowe’s, but yet we’re seeing prices at Lowe’s as well. I don’t know if you had any thoughts on that sector.

Michael Belkin

Yeah. So base metals, neutral. I agree with you. They’re very low and they’re enticing. If you just look, you want to buy low, they look interesting and you think nickel is going to be in batteries and everything. I’m not getting a signal on those at all right now. So I think the economy is going to head down. And a lot of these EV stocks, the things, the battery makers and things, I just think if the economy goes down, the whole rationale for owning these things is going to get pulled. And so, for instance, in Europe, autos are one of my biggest shorts there. So it’s towards the middle. The top short is tech. So Mercedes, BMW, Porsche, all these VW, all these companies. I just think the economy goes down, auto sales are going to go down and there’s going to be… The demand scenario might not be as strong as people are anticipating for now, for a down cycle in the economy. So no, I’m not bullish on base metals at the moment.

Tony Nash

Okay. I also, on your auto comment, I think is that the volume or is that the pricing power? Do you see fewer cars being purchased or do you see those automakers losing the pricing power they’ve had over the past few years because of supply shortages, or is it both?

Michael Belkin

Both.

Tony Nash

Okay.

Michael Belkin

The economy tanks… Basically, Germany is a big auto manufacturing plant and export. That’s what they do. The stocks are extremely popular with international investors. They’ve been dogs and they’re just starting down. So direction, position, intensity, we’re only second, third, and down. Basically, the model doesn’t say, it doesn’t answer your question precisely, but it gives the implication that car sales are going to… The economy is going to go down, people are going to have less money to spend. They’re not going to be buying new cars so much. They’re too expensive anyways at the moment. You know how that works in an economic cycle? That’s what causes a recession. So the sales fall, companies start cutting production, they start laying people off, canceling orders, suppliers orders go down, et cetera, et cetera, inventories go up. That’s what we’re headed into, I think, inventory correction of classic economic recession.

Tony Nash

Very interesting. It’ll be interesting to see. Thanks for that, Michael. Tracy, let’s move on to some of your comments about LNG and EVs this week. Everyone’s mentioned EVs so far, so I can’t wait to dig into that a little bit. You made this post about LNG in Asia this week talking about Asia’s growing dependence on LNG being the largest importing region and doubling by 2050. Being from Texas, that’s great for us. You also mentioned how gas is likely to outperform wind, solar, batteries, which is interesting to me given that China is pushing green tech so heavily. Can you talk us through the importance of global gas demand as well as the adoption of things like electric vehicles in Asia?

Tracy Shuchart

Well, I think first of all, if you’re talking about Asian markets and we can lump Africa into this as well, even though it’s not Asia. We’re looking at the LNG market. It makes sense that you would make the transition from coal to LNG and then perhaps to renewables because they still need cheap energy. It’s clean energy. It makes sense for that jump to happen. You’re not going to jump from coal to wind. It’s just not a natural technology evolution. It makes sense that the LNG market would grow specifically in those areas. We’re seeing that it actually grow in Europe as well too. Or if you look at Germany, they’re going backwards and investing in coal again. But aside from that, so it’s a natural transition. There was just a big gas tech symposium in Singapore this week. It was everybody from the LNG industry. If you look at really the supply demands and what those orders are looking like for some of those larger LNG companies, particularly many in the US, that just makes sense. As we in the West are talking about cutting off, we want to end fossil fuels by 2050. Whether or not you can actually do that or not, it’s a totally different question, but that is the stated goal at this point.

Tracy Shuchart

We’re really going to see, especially in these emerging markets, fossil fuels grow as they move out of coal and into things like LNG, just as here in the West, how that naturally happened.

Tony Nash

Okay. As they raise their dependence on gas, so India, China particularly have huge dependence on coal right now. Not a small portion of their economy is focused on mining coal. Indian coal miners, Chinese coal miners, that thing. But as they transition to more LNG, are there gas sources in Asia outside of, say, Indonesia, Malaysia, a little bit of say, Myanmar and so on. But are there large gas sources and gas fields in Asia?

Tracy Shuchart

I mean, there are some, and a lot of that is coming from Russia as well. They have the Siberia-1 pipeline, they’re building the Siberian-2 pipeline. You also have large gas sources in Africa, so to speak. There’s a lot of natural resources that are still stuck in the ground at this point. If we’re talking about gas, it’s very abundant in the West as well. Obviously, Europe doesn’t tract, and so we don’t see that coming out of European markets, but certainly in the US, it’s a big abundant energy source.

Tony Nash

Okay, so let’s also talk through EVs because you mentioned that in this tweet as well, and we’ve talked about it with Anas and Michael. With the transition to gas, will those grids have the, say, feedstock and capacity to power the EVs that are expected to come online across Asia in the next, say, decade, two, three decades?

Tracy Shuchart

Well, expected is the key word here at this point, which you mentioned because we’ve seen a lot of these very aggressive goals from, say, the IEA, which puts out what they think this is going to be. But in reality, we have to understand that right now, as far as energy is a concern, we’re in higher for longer. We have energy scarcity right now instead of energy abundance. I think it’s going to be higher for longer. Does that mean it’s going to be $100 oil from here on out? No, I’m not saying that. But it’s certainly not going to be… We’re probably… We’re not going to see $20 oil for any length of time, probably well within our lifetimes. I just think it’s higher for longer. It’s scarcity is concerned. I think this is going to be a very big problem when it comes to EV and EV production, which requires a lot of fossil fuels. You have to mine for all these metals. You have to charge these cars. Most grids are still based on some fossil fuels, and renewable energy mix is still a very small portion of that, and not to mention the problems with interminence.

Tony Nash

Isn’t it strange, though? I don’t mean this to sound as cynical as it’s going to come off. But we’ve had a push for alternative energy for the last, say, 20 years. I mean, trillions of dollars of subsidies with solar and wind and other stuff. But we still have supply constraints. We still have a deficit of energy and fossil fuel. There’s been this massive push to have more of the feedstock as these alternative feedstocks, but we still don’t have enough fossil fuels. Why is that?

Tracy Shuchart

Well, I mean, because we have these green transition goals. The West is really pushing for this. Whether they’re realistic or not, that’s up to debates. But at this juncture, when you’re telling oil and gas companies, We want to phase you out in the next 10, 15, 20 years. How much CaPEx are you going to throw at that? You’re just not. We’re seeing that. We’ve seen the same lack of CaPEx in the metals industry. This includes mining for cobalt, nickel, and all the things that you need for EV batteries, which is also going to be a challenge. I think combining this scarcity factor in metals and mining and in oil mining, we’re going to have a big problem as far as how much EVs cost. When you’re talking about these emerging markets and you’re talking about EVs that are suddenly 40, 50, 60, these people can’t afford those vehicles. It’s just completely unrealistic at this point. I think although these goals seem idealistic, they’re just in practice are not, and we’re going to suffer the consequences of this over the next 20 years because of the scarcity this is creating and the things that we need to make these changes.

Tony Nash

Right. With EVs and both you and I know Anas has written a lot about EVs. We have a subsidy for the EV manufacturer. We have a subsidy for the battery manufacturer. We have a subsidy for the consumer purchaser. What is the true cost of an EV? That’s what I don’t understand because there are subsidies at every… It seems to me at every step in that value chain. Absolutely. What am I missing? I’ve got those three subsidies. What other subsidies am I missing?

Tracy Shuchart

I think that if you look at the Inflation Reduction Act, it’s where do you source your materials? There’s a lot of embedded subsidies within green infrastructure or green transition renewables, not just EVs, but also wind and solar, depending on where are you sourcing this? Are you using American made parts? There’s a lot of embedded subsidies, which a lot of the babies don’t even actually can even capitalize on because a lot of those materials are not sourced within the United States. Those were incentives to get people to drill for those materials here in the United States. But then you look at our permitting process, which takes 10 years, and so that adds a whole other problem.

Dr. Anas Alhajji

Sorry. Add to that that the Department of Energy, the Biden administration is giving GM $12 billion for it to build its factory. That’s something on the side. The other related issues is all the research that’s been done free for them at the Department of Energy.

Tony Nash

Yeah. I’m not anti EV. I just want to be clear. I don’t have an issue with EVs as just an object. I just want to understand what is the true cost of that? Because if we’re supposed to see this EV adoption in Asia, particularly, which is largely in emerging markets, who’s going to pay for that? Because the countries themselves, let’s say in Indonesia, they can’t necessarily pay for all these subsidies. Are we necessarily going to see the grid impacts that we’ve seen in places, say in Europe and the US and other places, not in a place like Indonesia?

Tracy Shuchart

No. That doesn’t even include the cost of the overhaul of the grids. You have to completely overhaul your grid for this. Electricity, people think electricity comes from your socket. No. Electricity comes from burning fossil fuels generally in those countries, whether they be coal or natural gas or crude oil. There are a lot of things that are very altruistic about it. What I think, especially if you’re looking in, and I’m just going to throw this out there, especially if you’re looking in DM markets with the United States and all these people that want to go to these EVs, really, I think hybrid vehicles are a missed and overlooked niche market here. Nobody’s really talking about hybrids, but that solves a lot of the in-term problem. Again, they’re not inexpensive, so I’m talking for DM markets, but it’s incredible to me that people really are looking at hybrids more, especially because we don’t have charging infrastructure in the United States. You know that. You can’t drive across the country probably and make it on an EV alone.

Tony Nash

Yeah. Hybrids aren’t cool anymore, Tracy. They were cool in 2005. They’re just not cool anymore. It’s not cool anymore. Okay, guys, this has been a great show. Thank you so much for all that you’ve contributed, all the amazing thoughts you have. I appreciate all of that. Have a great weekend and have a great week ahead. Thank you so much.

Dr. Anas Alhajji

You too. Thank you.

Tracy Shuchart

Thank you.

Dr. Anas Alhajji

Thanks, Michael. Tracey, bye.

AI

That’s it for this week’s episode of The Week Ahead. Please don’t forget to rate us and review on whatever platform you are watching or listening to this. Thank you.

In this episode of The Week Ahead, Tony Nash hosts a discussion with Tony Greer, Albert Marko, and Tracy Shuchart, covering various market events and trends.

Tony Greer explains the concept of a bear steepener, which is causing a necessary rotation in the market, with tech stocks and the AI bubble deflating while natural resources and energy hold their ground.

The panel discusses the current market pullback, viewing it as orderly and temporary. They mention the spike in the VIX, indicating increased fear, but not impending doom. Tony Greer expresses bullishness in the oil market, citing tightening gasoline spreads and the strength of the physical oil market.

Tracy Shuchart agrees with Tony Greer’s assessment of the oil market, emphasizing extreme backwardation and market tightness. Tony Greer expects a continuation of the rotation out of tech stocks and a potential further pullback before finding a comfortable bottom for the S&P 500.

Tony Greer discusses his bullish view on the equity market, expecting a pullback in the tech sector due to bubble sentiment. Albert agrees and believes China will act decisively to address the current situation. They mention China’s potential sale of treasuries and discuss various developments in China, including domestic weakness, deflation, and Evergrande’s bankruptcy filing.

The episode also touches on the potential impact of selling Chinese treasuries and the belief that other countries, including the US, would buy them. They discuss China’s potential sale of overseas assets and domestic political dynamics. The conversation briefly mentions the depreciated Japanese yen and its impact on China’s export competitiveness.

The discussion then shifts to crack spreads and refinery capacity, with Tracy explaining their significance and the underlying issues caused by underinvestment. Tony Greer expresses bullishness on energy due to strong gas demand and potential disruptions in refining capacity. Tracy mentions the potential impact of companies requiring employees to return to the office on gasoline demand. Albert adds that a potential slowdown in China could temporarily bring oil prices down.

Key themes:
1. Bear Steepener
2. China death spiral
3. Your crack(spread) is showing

This is the 76th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.

Follow The Week Ahead panel on Twitter:
Tony: https://twitter.com/TonyNashNerd
Tony Greer: https://twitter.com/TgMacro
Albert: https://twitter.com/amlivemon
Tracy: https://twitter.com/chigrl

Transcript

Tony Nash

Hi everyone, and welcome to The Week Ahead. I’m Tony Nash. Today, we’re joined by Tony Greer, Albert Marko, and Tracy Shuchart. We’re going to talk through a bunch. There’s been so much happening in markets this week with China, with US markets, with bonds, all sorts of things. We’re going to talk through the Bear Steepener with Tony Greer. He’s going to take us through that. Then we’re going to talk about the China death spiral with Albert, which sounds really bad. Then we’re going to talk about refining and crack spreads with Tracy Shuchart.

Tony Nash

Before we get started, I’d like to cover a couple of items regarding CI Markets, our forecasting platform for stocks, ETFs, commodities, currencies, and economics. On September first, we’re raising our prices from $25 a month to $50 a month. Subscribe to that product before the end of August before we have to raise those prices. The second announcement is we have released portfolios for CI Markets. This allows you to see your stocks and ETFs and commodities and other things in a portfolio configuration where you can see the forecast for all of those assets on an individual and combined basis together over a 12-month horizon. You can see the return by month, the expected return by month, the expected total value, the individual stock and ETF and commodity price in each month. It’s really, really interesting. I hope you guys can check it out. If you subscribe before the end of August, you get that with your CI Market subscription. Thanks very much.

Tony Nash

Guys, thank you so much for joining us. It’s been a pretty crazy week, and I can’t wait to sort through this stuff and really understand what this means for really next week and the week after. Tony, when I was talking to you about this earlier this week, you started talking about a bear steepener. We’ve seen equities fall 5% since their peak on July 31.

Tony Nash

Two weeks ago, all the bears were hiding. The last bear said, “Oh, no, we’re not going to see a recession anymore” or whatever. Today, the bulls are slightly less vocal. Things have changed just a little bit in terms of, I think, the sentiment. Earnings this quarter were okay, I mean, depending on the sector, but they weren’t stellar. We’ve seen margins collapse a little bit. We’ve seen our compress a little bit. We’ve seen earnings a little bit harder to get. Rates are rising, of course. CPI is slowing, but it’s not really where the Fed wants it. Employment is still tight. Atlanta GDP now says we’re going to go at 6% this quarter, which I don’t know of a single person who believes that, but everyone likes to point to that number. You’re telling me that we have a bear stepener. Can you walk us through that? What exactly is a bear stepener and why are we here?

Tony Greer

Yeah. Now, I’m not an expert on the bond market tone, but I’m just saying- That’s okay. Yeah, this is what I see as affecting the equity market. The bear stepener in bonds is very simply the fact treasuries are trading off, that’s the bear part. Rates are going up, treasuries are going down. Steepener is the fact that the curve is steepening. The two’s tens curve has traded from about -85, 90 basis points back to about -65 or so basis points. That’s a sharp increase. Remember, we had it buried at -100 basis points for a lot of the year. This steepener is what woke up the VIX. The volatility picked up as the curve steepened and rates rose. In my opinion, that was direct response to the Fitch downgrade, which every analyst out there is saying, No, the downgrade doesn’t mean anything. I can point to markets that are moving in direct response to the ratings downgrade. I feel like we are experiencing an extremely violent rotation. I shouldn’t say that. A fairly violent rotation in equity is not as much a curl-over-sell-off. What the Bear-steepener is doing is just adjusting to what the markets are looking at inflation now, the way the markets are looking at inflation now and looking at the economy.

Tony Greer

While I’m not an economist, I think it’s fair to say that the recession fears have been put off for another day, and inflation, like you said, is not exactly going back in the bottle, certainly. We just got the first uptick in CPI in several months. This is the stuff that’s shaken up the bond market. When the bond market gets shaken up, especially in the long end, portfolio managers are going to react. That’s what I see as going on now. It makes total sense to me that some of the air should come out of the AI bubble that we’ve just blown and tech should back off. It makes perfect sense to me that some of the natural resources, names, and energy are actually holding ground during the sell-off, not backing off much. It makes sense to me that home builders finally backed off their highs with rates in the long end, rallying sharply. To me, this is a necessary rotation. Maybe the market was off sides in a couple of different places, but I think that that’s what the market is reacting to. I think that we probably have a little bit more to go before we find a comfortable bottom, again, the S&P that we can trade off of.

Tony Nash

You’re not a bonds expert and you’re not an economics expert, but you sure sound like it.

Tony Greer

I have a strong opinion on some of it, though.

Tony Nash

Yeah, you do. That’s good. In this pullback, would you say this pullback is fairly orderly in the way it’s happening?

Tony Greer

Yeah, I would, Tony. Until this week, we didn’t get any large downside extremes in the Tick Index, or at least they were scattered. That usually means agnostic selling when we are hitting bids across the board in the stock market. The last four days, we’ve finally seen some downside extremes wider than -1500 in the Tick Index. We finally got the VIX to wake up and approach 20. I think it got to a high of around 19 today.

Tony Nash

That’s crazy.

Tony Greer

Yeah, exactly. Vix at 19 isn’t generally an end-of-the-world trade. That’s why I’m looking at it as a fairly orderly pullback. It feels and looks and feels like it’s backing off at the same pace that it was going up, which is really odd in equities because we know them very well to take the stairs up and the elevator down. Now we could be in the middle of a little bit of a steeper sell-off. I just get a little bit more comfortable with the pulling into moving average support. We’re seeing a little bit of panic finally. Today we finally have a chance at a red to green day today, which often marks the bottom of tradable pullbacks. That’s how I’m approaching it. It’s not Armageddon, it’s not Doomsday. It’s just market dynamics adjusting to some interest rate changes and that’s it.

Tony Nash

Go ahead. Sorry.

Albert

It seems oddly similar to the bank crisis that we had last time around. It’s very order to sell off and then get set to relaunch back up to the stratosphere.

Tony Greer

Yeah, there are pockets that are definitely getting hit. This week, gold miners are off 6 or seven %. A couple of social media is off 5% or so. A couple of sectors of tech are getting put back to where they came from. It was a sharp rally. Yeah, exactly. With rates rising, you would have to think that growth is going to get hit a little bit, right? A little bit. It only makes sense. I’m pretty comfortable with what’s going on here.

Tony Nash

Okay, so, Tony, just a technical point. I want to make sure that we understand some of the technical things you’re talking about. The VIX, there are a lot of preconceptions and a lot of misunderstandings of what the VIX measures. Can you tell us, from a technical perspective, what the VIX actually measures?

Tony Greer

Yeah. It’s obviously a measure of options volatility at some level—I look at it as I read it a little bit as a sentiment gage, as a tactical traitor, like a live fear and greed index type of thing. When the VIX gets buried where it has been in the low teens, you have low volatility in the stock market. It usually means rallying S&P. When you see the VIX volatility index pick up and spike into the 20s and 30s, that’s usually what happens when we see steep sell-offs. Everybody is scrambling to protect their entire S&P portfolio by buying downside protection on it, volatility picks up. What happens at the end of that is it’s always one of those exhaustion trades, right? When the last guy stops himself out, sells his stocks on the low, they buy volatility at the highs, and then the market normalizes again and gets back to its range trade. That’s how I look at the VIX.

Tony Nash

Yeah. It’s volatility and options for the S&P 500 for the next 30 days. That’s all the VIXs. It’s not the next 24 hours, it’s not the next six months. It’s the next 30 days. This is something that I, on a very basic level, I’ll try to drive home with people because there’s this expectation that the VIX is something that measures volatility in this trading session or in tomorrow’s trading session, but it’s the next 30 days. That’s why we don’t see as much spike in the VIX as we think we’ll see sometimes because it’s over the next role. Okay, great. Can you also—and this is bleeding over into Tracy’s territory a little bit, but you talk about oil bullorns. Can you tell us what you mean by that? Then, Tracy, can you jump in and tell us where Tony’s wrong?

Tony Greer

Yeah. I don’t want to steal the oil floor from Tracy at all. I just want to state that I’ve gotten a little bit bullish. Luckily, I was early because I’m sitting here waiting for this oil consolidation to end. There’s a big back and forth going on between the Biden SPR selling and OPEC output cuts. That’s the narrative that’s gone on. What just happened recently, gasoline spreads tightened up the entire physical crude oil calendar, tightened up into backwardation. We got a little rally in price that finally did something meaningful technically for me. We broke above the moving averages. We traded up to the range top. Now the market’s got potential crack spreads. I know Tracy is going to talk about have got the refiners on a run. There’s a lot of signs of strength in the physical oil market, and I’ll leave it at that.

Tony Nash

Great. Tracy, what do you got on that?

Tracy

I cannot disagree with them.

Tony Nash

Of course.

Tracy

Obviously. I mean, if you look at the curve, and I was just talking about this yesterday on Twitter, X, whatever we’re calling it these days, I was just talking about the strength of the curve and the fact that if you look at the curve, it’s still an extreme back gradation, even though we had that dip yesterday or prior to yesterday, to ’78. Usually, we see this hook on the front of the curve as you’re moving into the next month. We are not seeing that at all. To me, that says this market is very tight and this market remains very bullish, even though we saw a few dollars sell-off before options are free.

Tony Nash

Okay. Tony, what do you expect for markets in the near term generally? Just covering equity markets first? I mean, S&P 500 is back to June 27th levels, so ancient history all the way back to six weeks ago. What do you expect to see over the next week or two in equity markets generally? Is it continue the rotation out of tech, potentially lower level, these sorts of things?

Tony Greer

I’m looking for this pull, but I wake up bullish in the equity market, right, Tone? With that view, I’ve been expecting tech to pull back because obviously we’ve got bubble sentiment type of thing. I think that’s the heart of what’s going on, is that we’re letting air out of technology. I have a big tech index that I monitor that’s seven or eight of the largest cap tech stocks. It’s been off over two % for three weeks in a row now. That is what was leading the market in total fairness. We know that. Nobody would probably argue too hard about that. We’re seeing a serious pullback there that directly coincides with the rise in yields. Now, I don’t see it as a thing that’s terminally bearish for the stock market because remember we just said we had to pump the recession fears down the road a little bit, or at least the recession bros on Fin2it have got to be a little disappointed because we’re not there yet.

Tony Nash

Everyone’s disappointed. Bulls, bears, recession bros, everyone.

Tony Greer

Yeah, for sure.

Tony Nash

Everyone’s disappointed.

Tony Greer

Yeah. Because everyone’s disappointed, I still look at it as sentiment to me is fairly balanced in the stock market. I feel like I could find as many bulls as I can bears. I even feel like that I can find more bears than bulls, to be quite honest with you. With that a balanced backdrop, when you have the economy that if it’s not going into a recession, we’re going to say that it’s growing. If you have an economy that’s growing a little bit, the stock market can tolerate higher yields. We’ve seen periods like that in history. We saw it in 2011, 2012. We saw it in 2016, 2017, and we saw it in 2021, 2022. Stocks rallying with higher interest rates. If the economy is not rolling over into a ditch, the stock market can bear it. That’s how I look at it, and I feel like we have a recipe for a slow moving bull market. While tech has to pull back, I certainly am not a fader of the AI craze and the AI investment theme. That is going to be with us for a long time. Thank you. What?

Tony Nash

Thank you. As an AI company, I love what you just said.

Tony Greer

Yeah. I feel like we’re in the first inning of this discussion. That’s why it’s gotten so exciting. Now you see a pullback. While I’m more interested in staying with my natural resources length, I’m getting to points on some of the tech charts where I’m like, Well, this is interesting at this price now. I think that the tech can actually get back to a level where if rates stop rising and stop rising at such quick pace that we just saw, tech can get back on its feet again. As Tracy pointed out, we’ve got a pretty tight energy market. If energy can lift some of the other commodities out of the whole bear market that they’ve been in, I don’t see why the S&P has to curl over. I’m not a double-horn bull in stock market. I’m not too bearish at all, but I don’t see a reason for it to curl over right now. This is a tradable dip to me.

Tony Nash

Albert, what do you think about that, specifically with regard to tech and some of the other transitions to other sectors?

Albert

Tony’s right. It’s definitely a tradable dip. The Fed has talked about soft landing for God knows how long now, and everything points to it. Whether they script the manufactured bank crisis and script this new Chinese crisis, it’s simply to get this market to a level where it’s somewhat normal and go right back up. I mean, it’s just what they’ve talked about it. That’s nothing new.

Tony Nash

Albert, it’s been pretty lazy for the feds to invest in fangs to goose the market whenever it’s convenient. Do you think they move away from that?

Albert

No. Why would you move away from something that works? I’ve been embarrassed since 4300 because it’s just I just saw this market being stupid bubble-like and I knew that it was going to start relaunching inflation. But I was to give myself credit, I had to do tech calls to hedge because that’s just what they keep doing. It’s just silly. It’s silly not to. You have to be insane not to look at tech at certain levels to play at knowing what the Fed does and knowing what the market’s been doing.

Tony Nash

Yeah. Okay, while we’re here on markets generally, before we get to China, can we talk a little bit about TLT, guys? There’s been a lot of talk about TLT, hitting lows. A lot of people saying, Get out of the way, or it’s time to get in, or whatever. Can we talk a little bit about TLT and just see what your general thoughts are there?

Albert

Oh, boy.

Tracy

I’m like, I have nothing to say about TLT.

Albert

It’s TLT. TLT for me is probably a buy 93. You have a bunch of players selling TLT, and you have definitely Yellens putting out a bid to swallow them up to keep things somewhat normal. So there’s obviously, again, soft landing scenario, but there’s definitely a place in the 94, 93 area where TLT is very attractive.

Tony Nash

Okay. Tony, any thoughts on that?

Tony Greer

Yeah. I don’t trade. I don’t have any risk on in the bond market, so I want to preface this conversation with that. I don’t have any money where my mouth is, but I have to say that I’m trading from the bias that I’m accepting rates can go higher. I feel like we’re at the point in headline inflation where we went from 2%-9%, to a 50% pullback now to four % or so or three and a half, four, and I feel like it’s going to hold here and rally. If I’m expecting inflation to creep back into the picture, I can expect rates to go a little higher. While I’m not on the… I think yields can go higher while I’m a bond bear. I’m not like a terminal bond bear. I’m just on guard for downside dislocations because that’s the risk to my equity bull scenario, is that the bond market really has a big downside move, rates jacked higher in a super fast move or something like that. That is something that would derail the S&P. That’s how I’m looking at that. Perfect, guys.

Tony Nash

This is perfect. Thank you for that. Thanks very much.

AI

Get ready to supercharge your investments and trades with CI Market’s latest game-changing feature. Now you can create your very own investment portfolios in CI markets. With an impressive 94.7% forecast accuracy, you will be empowered to make smarter investment moves. Visualize your portfolio’s performance with easy-to-understand graphs and charts, giving you a clear picture of your investments. Make data-driven investment decisions with in-depth insights and transparent error rates for greater confidence in your trades. Create multiple portfolios to plan ahead for various investment strategies and seize opportunities as they arise. Our forecasts let you know the best times to buy, sell, or hold assets, ensuring you stay ahead of market trends. Maximize your returns and achieve your investment goals with CI Markets Investment Portfolio feature. Don’t miss out on this powerful tool for your investment success. Subscribe for as low as $20 per month at completeintel.com/markets. Thank you.

Tony Nash

Let’s move on to China. Albert, we saw a lot happening in North Asia this week from Japan’s GDP print that broke out on an export boom and an import collapse. The China macro prints that showed domestic weakness and deflation, rapidly valuing CNY, property developers like Country Garden stating they won’t be able to service some domestic bonds and the US bankruptcy filing that chapter 15, I think, bankruptcy filing in the US of Evergrande, there’s a lot going on. We saw CNY fall to 7.3, and we saw CNH, the offshore currency, fall a little bit further. Just for a little bit of context, this is boring on the weakest point since 2007, which is a big deal.

From a CNY as national strength projector really makes the Chinese leadership look messy. The only slightly weaker value was in November 2022, but they defended that very aggressively. In response, of course, the central government is supposedly planning all sorts of stimulus. The PBOC, the central bank there says they’ll be precise and forceful in their response.

I guess first, Albert, do we believe that? Do we believe they’ll be precise and forceful? Will they do it anytime soon?

Tony Nash

That’s my first starting question. But also I want to understand the Chinese government told their banks to defend the currency aggressively over the past couple of days. I’m curious how much you think they’ve spent defending a 7.3 CNY over the past couple of days?

Albert

For your first part, do I think they’re going to act decisive and forceful? I do. I think they’re absolutely coordinating with Yellen on the issue. China is a big inflationary player, so having China play ball is paramount to whatever Yellen and the Fed have in mind. I think they’re absolutely coordinating and they will be decisive. To how much have they spent? Defending the Juan, probably about 400 billion at the moment. I know that they just hit from… People I’ve talked to, I know that they just hit the treasury market for about 100 billion a few days ago, maybe a week ago. They are the…

Tony Nash

What? The Chinese are buying treasuries?

Albert

No, they’re selling.

Tony Nash

Oh, they’re selling.

Albert

Okay. Yeah, they’re selling. I think they’re using Kman entities, whatever proxy. It doesn’t look off, but they’re arguing. They’ve been defending the one here for the CNY for months. We’ve been talking about it for months doing this. They’ve been staggering their way down. They’re really keen on not collapsing the currency. G can’t look like an idiot, can’t lose power or face. That’s just the way Chinese work. They don’t really have to devalue. As much as people want to say, as much as we’ve even said that they’re probably going to have to, they don’t really have to as long as they’re staggering and playing ball with the feds. But they have maybe 600 billion left in treasuries that they can use to defend the CNY. That’ll probably get them through the next three months if they want to unload it.

Tony Nash

I’m going to ask a really somewhat cynical question here. If the Chinese sell their treasuries, does that mean the end of the dollar? I’m going to try to say that without laughing.

Albert

I mean, end of the dollar thing is just silly and just click-baity stuff. Yeah.

Tony Nash

Chinese sell their treasuries. Who’s going to buy them?

Albert

The reality is-

Tony Nash

Everyone?

Albert

Everyone will. Absolutely everyone will. I think Yellen prepared to buy back 1.5 trillion in the treasury. He has to. They certainly have the account for it. I mean, the Chinese, they killed animal spirits on a 400% leveraged economy, where unaffordable real estate was the core asset. What do people think was going to happen with Evergrand? It’s just been in trouble for years.

Tony Nash

Right. Right.

Albert

Again, this is a staggered way down. It helps the inflation fight. They probably scripted it out a while back. The bank crisis, now China crisis, and God knows what the next crisis is going to be in the spring to bring back the market to some normal level so they can launch it again. I’m a big believer in systemic protection. Whenever there’s a system, whether it be the US or Europe or Asia, that they’re at critical levels where the system could break down, they’re absolutely going to jump in and the world works together in that respect.

Tony Nash

Will this result in China selling off any overseas assets? Maybe some of the infrastructure they built overseas that they own, not really, but they own that thing?

Albert

I’m thinking they’re going to have to. You don’t want to get to critical levels on their dollar reserves or their gold reserves or whatever else they’re leveraging to keep the CNY up. You don’t want to get that far down. Yeah, I’m pretty sure they’ll probably let go of something. I don’t know. I can sit there, speculate they’ll let go a third or fourth of what they have overseas, but probably they will.

Tony Nash

Yeah. Like, Chinese data and entities that own, say, power generators in Portugal and ports in Greece and all this stuff.

Tony Nash

They really need that? Is that a way for them to get cash? Can they sell that to some Middle Eastern entity and that’ll be fine and it’ll build those relationships for crude sale, all that stuff, right?

Albert

Yeah, of course. Qatar or Dubai or one of the Saudi’s or someone will jump in and buy something in Turkey or God knows where else, just to give them some cash.

Tony Nash

Okay. There was some news out, I think, Thursday or Friday talk about how Xi Jinping will not take responsibility for the current economic difficulties. He’s going to pawn that off on Lee Chang, his deputy. Nobody overseas believes that, but do you think that will sell in a domestic audience?

Albert

Yeah, when you control the media and you rule by fear, of course, whatever the ruler says is going to go whether people believe it or not privately. That’s what the narrative is going to be. When do national leaders take responsibility for things that go wrong? You find scapegoat. Just like the US, the Europeans, the Chinese, they’re just going to find scapegoat.

Tony Nash

Is the clock ticking for denunciation of Lee-Chong? We have two years. Set the Timer in two years, he’s going to be found guilty of some corruption or something?

Albert

I could definitely see it. Internal Chinese politics within the PLA and the CCP are so muddy.

Tony Nash

It’s tediously predictable, right? I mean, these things are tediously predictable. I want to also talk a little bit about the Japanese, Chinese dynamic in terms of the depreciated JPY and the currency dynamics with CNY is that a factor? Japan just reported stellar GDP numbers on an export boom with a very cheap JPY. China is having difficulties with the exports and with imports on a not as depreciated on a relative basis, CNY. I know you say that China doesn’t have to depreciate CNY, but are those regional dynamics not forcing the PBOC to look at the CNY value and maybe push it for export competitiveness or something? Especially in light of the regionalization and the FDI numbers, the terrible FDI numbers that China has seen so far in 2023?

Albert

Normally, I would say yes, but the problem that Japan has at the moment is they actually have inflation creeping up higher and higher. They’ve really done probably better than anybody else in the world up until now. But wage inflation is taking hold there. Their currency, they’ve devalued it as much as they possibly can without causing issues. But I don’t think… Well, Japan is getting a lot of help from the treasure and the Fed in that respect to push China to cooperate. But I don’t think that it’s as vital for the Chinese to look at the Japanese Yen at the moment. Not yet. I wouldn’t say yet. Give it 3-6 months to see where we’re at to see if Japan can actually tame inflation, then we’ll probably have to readdress that question.

Tony Nash

Okay. I just want everyone to know we’re not even talking about the European GDP number that came out this week that was horrific, except for Ireland, all that stuff.

Albert

They’re back from vacation yet? What’s the date.

Tony Nash

Of the year? Exactly. They’ve been on vacation since April, right?

Albert

2020.

Tony Nash

Right, exactly. Okay, Albert, that’s great. Thank you very much. Tracy, let’s talk about crack spreads. Crude prices are rising. I mean, given the day over the past month or so, they’ve been rising. Gasoline prices are on the rise. Crack spreads are rising. We’re seeing record oil demand and I believe record refinery throughput. Can you talk us through some of those numbers about refinery, throughput, and crack spreads? First of all, just for a definition, what is a crack spread for people who aren’t really sure what that is, is. What are the factors that are contributing to that?

Tracy

Crack spread is basically, the easiest way to explain it is, what can you refine a barrel of crude oil into? There are many different ratios for crack spreads that trade, but it’s really what can you refine from a barrel of crude oil, depending on whether that’s going to be gasoline or heavier visco. But the ratio is very different. There’s many different ratios. Three to one crack spread is the most popular. But anyway, it’s really what can you refine in a barrel through the oil?

Tony Nash

Okay, so on the screen, we’ve got the RBOB, gasoline, crack spread, and CL price.

Why are these important? Is it important to look at these together?

Tracy

Yeah, well, it is important to look at these together, depending on how you would look at it, really. If you see, say, oil prices getting softer, but you have product demand still higher, obviously, that’s very good news for refiners. That’s where you see a divergence, sometimes where you see lower oil prices, but higher refining prices or crack spread prices. However, I think that’s just looking at one portion of the big picture. I think we need to look at the macro view of this because I think the underlying issue in refining that remains still unresolved is lack of capacity. We’ve had a lot of capacity come off over the last seven years. There’s a lot of underinvestment with the onslaught of this EV narrative, many refiners aren’t really interested in expanding capacity at this point. We’ve also had significant disruptions due to not COVID and due to the fact that we’re running our refineries at a very high utilization rate, which leads me into another section of this.

Tony Nash

But Let’s talk about that. What’s the utilization rate around if-ish?

Tracy

Well, last week EIA was 94.7%. Now, the problem comes is that if we’re looking at the US, for example, we have a lot of older refineries and we haven’t had a significant greenfield project in decades. Greenfield project meaning that we’re starting a whole new refinery. We’ve had a lot of brownfield projects, which means we’re expanding existing refinery capabilities, but no new green book in decades, literally decades. What happens is that these refineries are older. When you start running them over 90%, they consistently, which we have had to do, things tended to break, thus causing more disruptions, which we have more breakdowns, which we have seen this summer.

Tony Nash

Okay. I’m sitting in Houston, Texas, and I’m hearing that by Wednesday we could have a tropical storm in the Gulf and that there are potentially two hurricanes out in the Atlantic that could come toward us. So given the almost 95% capacity utilization of refineries, if we start seeing that in some of these ancient refineries, when they get hit in Louisiana or on the Texas Coast or whatever, and they get shut down for say, four or five days, and then it takes them how long to get them back up? Ten days or something? If they shut down for five days. They’re out for like 15, right? Minimum, yes. General. Let’s say some refinery in Baytown or Louisiana gets put out. That marginal refinery on average, would that increase margins for the other refiners pretty dramatically pretty quickly?

Tracy

Absolutely. Because you’re taking capacity from offline in general, and that’s going to be better for other refiners. The problem is you also have to factor in is how much production is being taken offline. Now, generally, production is easier, especially if you’re talking about a hurricane in the Gulf or something like that and offshore. Usually, that production comes back very quickly. We generally see production come back much more quickly than we would see the mining capacity come back online. But in general, if we’re just talking about a tropical storm or something like that, that’s probably not going to affect actual production capability. You have to keep an eye out for both.

Tony Nash

Right. But in terms of refineries, this hurricane season so far has been equivalent to the warm winter in Europe for natgas.

Tracy

It’s the knock on wood.

Tony Nash

It’s almost been perfect, right? We’ve had no refinery outages due to storms, due to hurricanes, all that stuff so far. We have almost a zero risk environment for refining. Any of this stuff comes, for a refiner utilization that’s at 95%, it could potentially be a real shock for refiners, right?

Tracy

Well, absolutely. If we look at the actual EIA numbers, and we’ve been at 92%-94.7% for the last few weeks, and we’re still seeing product draws. We’re still seeing gas lead draws throughout excessive utilization rates. That’s something that I think about as well, is that we’re consuming as much as they can put out.

Tony Nash

Yeah. Does this conversation make you even more bullish on energy?

Tony Greer

Yeah. Tracy makes a lot of really good points about refinery capacity, etc, when you consider that gas demand globally has been record-strong, regardless of what the economy has done. That’s one thing you got to keep in mind. Even when people were expecting the recession, the economy didn’t look so good, we were still setting records for gas demand locally and globally. If the consumer has got to get their gas from somewhere, God forbid there’s an outage, what will happen is the crack spreads will widen out even further. Refiners will rally even further until that’s buttoned up because the same thing is going to happen. There’s only so much capacity. If there’s only so much capacity and one less refiner, the spreads are probably going to widen out. We’re in a situation now where last year we had a lot of diesel tightness. This year we’ve got a lot of gasoline tightness. As Tracy said, that has propped up the prices of the products more towards the price of crude oil. Now that’s why the crack spreads are so wide and the refiners are doing so well. Yeah, it is a pretty sensitive cocktail right now in oil where disruption should be bullish in price.

Tony Nash

I’m also hearing, and maybe this is a minor consideration, but I know of a handful of publicly traded companies that are starting to require their employees to be back in office four days a week as of September first. We’re already at record demand, but as we start having larger companies require their employees to be back in office, that pulls the demand along even further, right?

Tracy

Well, absolutely. You’re talking about this going into refinery, maintenance season, where you’re going to have capacity even down the floor because the fall is refinery, maintenance season. If we see these companies asking people to come back for more and say they’re not in a city that has public transportation to get them there, then we’ll probably see increased demand going into refinery, maintenance season could make for a vicious cocktail then.

Albert

The only thing I see that’s I don’t want to use the word bearish for oil at the moment, but a little bit of a dip is China slowing down. I think they’re hinting at it at the moment, but I think it’s another week or so until September WTI closes and then you’ll really see what the market is doing in terms of Chinese demand. But I think a slowdown in China would hopefully bring it down to the mid-70s so I can buy.

Tracy

What’s really interesting is that for November delivery into Asia, and I think we had that week, but we have 40 million barrels for November delivery to Asia. Now that is not all by any stretch of the imagination and in fact, less from China. But it’s very interesting that we’re seeing increased demand for other PAC-Asian nations where we haven’t seen before. That’s almost at an all-time high.

Albert

What about Canada, Tracy? Should they be like a litmus test of what’s going on with demand and production?

Tracy

And they’re doing really well, too. It’s hard to use Canada only because they don’t were their main import. They don’t really export anywhere else but the United States. But we’re pretty much gobbling up everything that they have to give us at this point in the day. Okay.

Tony Nash

One thing since you mentioned China, Albert, they do have mid-autumn festival and National Day Festival coming up in China, which means the last week of September, first week of October is dead. Not fully dead, but dead. They will have a little bit of a respite there in terms of, say, crew demand. Well, at least they’ll have jet fuel and that thing. But in terms of normal activity, they’ll have a little bit of a respite there.

Albert

Okay. Great. Yeah, just curious.

Tony Nash

Guys, thank you so much. This is really interesting. I love weeks like this where we can talk to guys like you, Tony, who just have this massively broad view on things, and you boil it down to precise views. And that’s really, really amazing. So we’re really grateful to have you here. Albert, Tracy, as always, you guys are invaluable. Thank you so much. So have a great weekend, and have a great weekend. Thank you.

Tony Greer

Thanks for having us, Tony. Thank you. Great job.

In this episode of The Week Ahead, we have Joseph Wang, Tracy Shuchart, and Ralph Shoellhammer.

Joseph kicks off by talking about inflation, the Fed, and banks. He looks at the recent CPI numbers and asks whether they suggest inflation or not. The conversation revolves around the Fed’s plans and a survey indicating two more interest rate hikes this year. We’re also examining changes in the money supply and whether it’s going back to normal levels.

Tracy gives us an OPEC update. The latest report forecasts oil demand growth for this year and the next. She gets into the impact of OPEC’s supply cuts, particularly Saudi Arabia’s extended cuts, and how they shape the supply situation this quarter.

Lastly, Ralph presents the case for why Europe needs nuclear energy. He shares insights from his report on the topic. Ralph explains the importance of energy density and its link to nuclear power. Safety concerns about nuclear energy and European perspectives on restarting nuclear plants are also discussed. We’re also looking at Germany’s energy mix and recent shifts in energy prices.

Key themes:
1. CPI. Fed. Banks.
2. OPEC Supply Deficit
3. Why Europe Needs Nuclear

This is the 75th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.

Follow The Week Ahead panel on Twitter:
Tony: https://twitter.com/TonyNashNerd
Joseph: https://twitter.com/fedguy12
Tracy: https://twitter.com/chigrl
Ralph: https://twitter.com/Raphfel

https://open.spotify.com/episode/2ZnDx1jYnODX7nfCAw4dGf?si=52f5044bfc4740fe

Transcript

AI

Plan and forecast the performance of your investment portfolios with an impressive accuracy rate of 94.7%, all thanks to the power of AI. Get ready for this exciting new feature, exclusively available on CI Markets. Coming very soon.

Tony

Hi, everyone, and welcome to The Week Ahead. I’m Tony Nash. Today, we’re joined by Joseph Wang, by Tracy Schuchart, and by Ralph Shoellhammer. I’m really excited to have the view on Central Banks and some of the macro stuff that we’re looking at with Joseph. He’ll help us look at CPI, PPI, Fed, banks, and the health of what’s happening in the US banking system. Tracy is going to help us look at OPEC. We’ve had some really interesting monthly report come through from OPEC, and we’ll look at the impact on crude prices. Then Ralph is going to help us look at nuclear in Europe. There’s some history there since Fukushima and nuclear plants closed down. We’re just going to look at some of the economics and impacts of why Europe needs nuclear now based on a report that Ralph just published.

Tony

Guys, thanks for joining. I really appreciate it. I know this has been a super busy week, and I always appreciate you guys coming to talk to us on Friday. Joseph, if you don’t mind, let’s start with you. We just had a CPI print and, of course, PPI this week. Obviously, everyone sees it. We’re in that phase where everyone sees it through their own prism.

Tony

Some people are saying it’s great, inflation is over. Some people are saying, We’re going to see a resurgence of inflation, and Core doesn’t reflect a weakening of inflation, all this other stuff. Do you see these prints as inflationary or disinflationary or neutral? How do you see these prints?

Joseph

Well, first off, thanks for inviting me. It’s a pleasure to be here. Thank you. Yeah, it’s great to meet everyone. This week’s CPR print, as we know, was unambiguously pretty good. We’ve had two good CPI prints over consecutively, and that very much shows that inflation is decelerating. Right now you can think of it in two ways. If you’re a team, and inflation is over, you can look at this, and then you can look at some model of where shelter inflation will be for the coming months. You can think, Well, there’s probably going to be more disinflation coming down the pipeline. Maybe inflation is really over. We’ll go back to the world wherethe world the way it was before. There are other people, of course, who would point to what happened in the 1970s. In the 1970s, you saw inflation rocket higher and then go back down. When it looked like it was going to go back down and stay down, it just did a 180 and rocketed higher. Those people would point towards things like, well, you have commodity prices rising, again, oil has been steadily rising over the past few weeks, and you also have wages that seem to be stuck at around, say, 4 or 5%, which is not consistent with 2% inflation.

Joseph

You have these two caps right now, and that actually is being mirrored in the Fed as well. This past weekend, Governor Bowman gave a speech where she basically strongly suggested that she’s not just open to another hike, but more than one hike since they used the term hikes, so in plural. That’s one faction. I suspect that let’s say, Governor Waller, and maybe Chair Powell would be partial to that. But on the other hand, you also have, let’s say, John Williams, who is President of the New York Fed, one of the top three people in the Fed, give an interview within New York Times where he’s setting up the groundwork for rate cuts next year. I actually think that overall, if you look at the evidence, I think it makes sense for there to be rate cuts going forward next year, but definitely not going back to, let’s say, zero, probably just going back a little bit with an acknowledgment that inflation is definitely decelerating, but probably going to decelerate towards a rate that’s going to be higher than pre-pandemic. In a sense, what I’m trying to say that there’s some truth to both those camps.

Joseph

Now, we could have a situation where inflation slows down but doesn’t go back to where it was before, and that’s still consistent with a higher for longer framework. The Fed looks at interest rates through the lens of real interest rates. So real interest rates are nominal interest rates minus inflation. If you look back over the past several months, inflation peaked at about 9% year-over-year rates. Now it’s come down to about, say, four-something %. That’s normal. At the same time, Fed raised interest rates from zero to over 5%, and maybe they’ll go a little bit more. As inflation has come down, if you want to keep real interest rates constant, it makes sense to cut nominal interest rates a bit. I think that’s what they’re setting up to do next year. It doesn’t mean that we’re just going to go back to a low interest rate world. I suspect that we probably hold around 4%, 4.5% if we cut rates there for some time. I think that’s the… I think that that’s how I read this inflation print, showing deceleration, but not towards a world that it was before.

Tony

Yeah, it’s weird that we had been at low interest rates for so long. In the US and Europe and obviously Japan. There is this expectation, I think, that we’re going to snap back at something. We’re going to wake up from this dream, and it’s all going to be over with, and we’re going to be back at very, very low interest rates, very, very low mortgage rates. I think on some level, we’re arguing about the details about whether we are inflationary or disinflationary or whatever, because I think what you said about hire for longer is true regardless. We are at least for a period of time, it seems like we’re at a higher level. Now, we took a survey last week and my Twitter followers are fairly educated people. Most of them view, I think, I can’t remember the percentage, I’ll put it up on the screen when we publish this, but the majority had two or more hikes before the end of 2023.

That was before this week’s CPI print. What’s your view of that? Do you think it’s possible that there are two hikes before the end of 2023?

Joseph

Two sounds like a lot to me. When I think back to the last dot plot, Fed FOMC members overwhelmingly suggested two more hikes this year. The data has broadly come in line with their expectations. I think if we have another hike, we could have one more hike. But two, that doesn’t seem reasonable to me in line with the data and in line with what the FOMC members guided towards last time they released their dot plot. I think we could have one more. But right now, not next meeting, we’d really have to see, again, inflation reaccelerate, maybe wages go higher again. Basically, we’d have to see stronger than expected data. Right now, I think the doves on the committee have more political power simply because we’ve had two pretty benign inflation prints.

Tony

Okay.

AI

Heads up. It’s time for a Week Ahead break.

AI

With CI Markets, you can access AI-powered market forecasting for as low as $20 a month. Get 94.7% market forecast accuracy for over 1,200 assets across stocks, commodities, currencies, equity indices, and economics. With weekly updates and one-month and three-month error rates, you can rely on CI Markets to help you make informed decisions. Join a growing number of satisfied users who already transformed the way they invest and trade with CI Markets. Don’t miss on another opportunity. Start forecasting with confidence today for as low as $20 a month. Visit completeintel.com/markets to learn more.

AI

Thank you. Now back to the show.

Tony

Great. I want to talk a minute about money supply and potential for QT. I’ve got a chart on the M2 money supply.

This is month-on-month growth rates for M2. Now, I did some work, I think it was last week, looking at the trend growth rate for M2. If we had kept the trajectory we had been on in 2019, we’re still about $2.1 trillion above that. I know in ’22 and in the first, say, four months of ’23, we actually saw M2 contraction, and then we saw a little bit of expansion in May and June. What’s your expectation in light of where rate hikes are going? Do you think the Fed will continue to gradually rein in the money supply, or do you think we’ll resume on this incremental, slow growth of M2?

Joseph

I’d be cautious when trying to map M2 to other economic variables. In the past, there was a school of thought, monetarism, that placed a high emphasis on money supply, so much so that the Fed, actually for a period of time, actually tried to implement monetary policy by changing the money supply. That experiment was not successful. If you look at what happened over the past decade, say, Japan, must have really increased their money supply, but did not seem to get inflation upwards. I don’t really focus on money supply when I think about the world. I think in the past, you could have made an argument where banks are making loans, creating credit, increasing money supply, and so we want to focus on that. But post financial crises, money supply is strongly influenced by Fed actions. When the Fed does QE, for example, that increases M2, and when the Fed does QT, that decreases M2. What you’re seeing right now, I think, is largely just the impact of quantitative tightening. The Fed is shrinking their balance sheet, and that mechanically has been shrinking M2. At the same time, we’ve been having very good growth, and financial assets have been going to the moon.

Joseph

I’m cautious when I think about money supply in the modern economy. Going forward, as the Fed continues to tie in their balance sheet, I would expect M2 to continue to decline, especially since the banks have significantly cut back on their lending. When you look at loans and leases from banks, you know that they’ve basically been relatively static for about since the end of last year.

Tony

Okay. You think we’ll see incremental QT on the Fed balance sheet?

Joseph

Incremental time? Absolutely. In fact, I think it’s going to go on for a couple of years. There is a discussion. There is some thought as to what would happen with QT when the Fed eventually cut rates. Like I mentioned before, Fed is laying down the groundwork to cut rates sometime next year. Now, traditionally, when you look at the Fed, the thinking is that you don’t want to step on the brakes and the acceleration at the same time, so it would not make sense to both be cutting rates and to shrieking your balance sheet. But Chair Powell, at his recent press conference, was pointedly asked about that, and he seemed open to be letting QT continue even if they were to cut rates next year. I think that that’s just a strong suggestion that the Fed really wants to get back to a smaller balance sheet. I think they have everything in place to make that happen over the, let’s say, another two years.

Tony

Okay. Now, you said they may cut next year or they’re likely to cut next year. Just because they say next year, I think there’s this belief that it’s going to happen, boom, it’s going to happen in January, it’s going to happen in February. We’re going to see rate cuts right away. That’s not what you’re saying, right? You’re saying sometime next year.

Joseph

Absolutely not. I think the common thinking is that the Fed is hiking, there’s going to be a recession, everything’s going to implode, and so they’re going to have to do emergency cuts to save the economy. What I’m seeing, what I’m thinking is that we actually just gradually, inflation comes down, growth slows a bit, or maybe not, I don’t know, but definitely inflation is going to be lower than, let’s say, the 9% annual rate we had in the past. In order to keep real interest rates in line at where the Fed feels is restraining, they’re just going to cut nominal rates a bit. Maybe just a little bit of an adjustment next year as inflation comes down. Now, inflation, I don’t think it’s going to come down to 2%, but it’s going to be lower than it was in the past. But then it was in the past several months. Yeah, sorry.

Tony

Right, past, say, 18 months or whatever, right? Yeah. That would be a nice, fresh relief for a lot of people. Hey, let’s move on to bank health, Joseph, because I know since March, there’s been a lot of interest with the BTFP, the Program for Regional Banks to borrow from. I know that that’s really a lot of your expertise is there. We saw the BTFP hit $106 billion, I think, last week. I’ve got the chart up on the screen.

It seems like banks are going more and more to bar from the BTFP. Can you help us understand what is going on with regional banks and what is the health of regional banks look like given the continued expansion of the BTFP?

Joseph

Yeah, the BTFP is an emergency lending facility that the Fed offered around March when we had a panic in the regional banking sector. The BTFP is really a sweetheart deal because you’re able to borrow basically borrow at one very advantageous rates, but you’re also being able to borrow at par value rather than market value. For example, if you had a treasury security and because the rates went up, it was now trading at $0.80 to the dollar. You can actually take that treasury and borrow $0.100 of the dollar against it from the BTFP facility. It’s a sweetheart deal, and I think it’s expected that banks would take advantage of that. I wouldn’t read that as stress in the banking system. What I think is more telling about liquidity stress in the banking system is federal home loan bank borrowing. When banks have stress, what they usually do is not go to the Fed discount window because there’s a stigma there. What they do is they go to the lender of second to last resort, which are the federal home loan banks, and they did that in size in March and April. When we look at federal home loan bank data, we’ll see that their loans are actually shrinking significantly.

Joseph

Banks are not borrowing as much from the federal home loan banks. They’ve cutbacks significantly, and that tells me that the liquidity situation is improving significantly. Now, I’ve also been following bank earnings reports over the past couple of months, and by and large, banks are doing fine. What I think is happening now is that a lot of the regional banks are having their profit margins, their net interest margins squeezed a little bit because they’re having to pay a little bit more to retain depositors. Even as interest rates go higher on their assets, they’re also going higher on their deposit liabilities, and that’s causing their net interest rate margins to contract a bit. They still remain historically healthy. They’re just not as fat as they used to be. I don’t think that’s a reason for concern, especially, again, we don’t expect the Fed to just keep hiking rates or whatever. Eventually, the Fed is going to cut rates even by a little bit and maybe not to the low levels before, but they’re going to cut rates a little bit and that’s going to give these banks a bit of a breathing room. Now, I would also take a step back and look at what happened with the regional banking sector over the past few months.

Joseph

Now, back then in March, it would seem like the system was imploding. There’s a lot of doom and gloom, but that was never my view. Another way to look at it, which is how I look at it, is at the end of the day, Fed hiked rates. A lot of the more speculative industries in tech imploded, and all the banks that built their business models around those sectors also went down. You saw Silicon Valley Bank, obviously, First Republic, obviously, you have the Crypto Banks. Crypto Banks also got taken down as well. I really think of that as more of an idiosyncratic thing rather than a sector thing. I’m not really worried about the bank system.

Tony

Great. Okay, so that’s good. From your perspective, the US banking system seems okay, if not good. Yes. Inflation seems to be okay if not it’s trending in the right direction. It seems to me from that perspective, the Fed banking system perspective, the US seems to be okay. That’s what you’re telling us.

Joseph

I think the US is doing well. I mean, if you look at, let’s say, first quarter GDP, it was growing above trend. If you look at second quarter GDP, it actually accelerated. If you look at GDP now, which is the forecast for this current quarter, which is very volatile and will get revised, it actually points towards further acceleration. What we’re seeing is that inflation coming down, wages continue to be strong, and of course, credit conditions that everything seems to be not very concerning. Now, if you look at credit spreads, for example, they’re very benign. They’ve gone up from their lows, but they’re still within historical ranges. From my read, the US economy is doing well.

Tony

Great. Fantastic. That’s so good to hear because, again, we see all these polarized views, everyone trying to make their market, and so it’s really good to hear that refreshing perspective. Thank you, Joseph. Thank you very much. Hey, Tracy, let’s talk about oil and gas markets a little bit. You were telling me this week about the OPEC update that came out, and the report says that demand will grow by 2.4 million barrels per day this year and 2.2 million next year.

With OPEC supply cuts that are still underway in Saudi Arabia just extended—we talked about this last week—how big do you expect the supply deficit to be this quarter?

Tracy

Well, I personally think that it’s going to be about 2.1 million barrels a day. We did have IAEA come out. They think it’s going to be about 1.7, which is actually huge for them because they become the anti-oil and gas group. They’ve been on that trajectory of we only need renewables. To them say that they expect a deficit as well as they also are expecting an increase in demand is quite impressive for that particular organization. But if we look, we have demand at 103 million barrels a day. That’s literally all time highs well above 2019. We’re not seeing demand diminishing at any time and both groups because the IAA report just came out this morning. Both groups expect an increase in demand at 2024, although IAEA has pared back their initial estimation from the last report that came out. It does come in a bit lower than the OPEC report, but that generally is the case. They’ve been very conservative on their demand estimates.

Tony

Where is that demand coming from?

Tracy

Well, particularly in Asia. We’re seeing a lot of flows in Asia. Obviously, we’re not really seeing a lot of that demand come from Europe as we see manufacturing slowing down. But we are seeing demand growth in the United States. It’s coming in month after month. We’ve had upward revisions from the EIA. Demand continues to be very strong and to increase every month in the United States. Really, the areas that we’re looking at where we’re seeing the softness in demand is really just coming from Europe at this point.

Tracy

I think that going forward, I just wanted to bring China into this a little bit because we just had China’s seaborne import numbers come in. They slump below 10 million barrels a day, which is down toward July, which is down about 13%, month-over-month from June three-year highs, which is very high. Meanwhile, their onshore crude stocks have climbed at a rate of about a million barrels per day for three straight months. Not surprising, China likes cheap oil and gas. That means that-.

Tony

I do too.

Tracy

They also had refinery throughputs were very low during the spring turnaround season. We’ve also seen a slow recovery in domestic demand, particularly from the manufacturing sector. I think that we should be prepared to see a little bit of slowdown going into the fall of Chinese imports as prices rise because they’ve already built up that socket. Although I don’t think their teapot refineries and their state-owned refineries still have quotas that they have to keep up with and export quotas are coming out in a couple of weeks here. We’ll find out how much if their export quotas for diesel increase, that means they’re going to likely have to buy more crude. Now that depends and where are they going to get it. Because right now what we’re seeing with lower Russian crude supplies, the tea pot refiners are basically leaning deeply into discounted gray market, uranium oil right now. Just that’s the general picture of what’s going on in China right now. Again, I would expect to see imports from China soften for the rest of H2.

Tony

Okay. The demand is coming from the US and from Asia. Is China back to 2019 levels? They’ve exceeded it?

Tracy

No, not yet.

Tony

Okay. How far are they? Are they still a long way or?

Tracy

No, they’re not a long way, but they’re definitely a couple of million barrels a day below what we’re seeing. Again, because the manufacturing sector, again, because we’re not really seeing that recovery, they’re doing a lot to stimulate some demand. They just took off the airport, the airline travel restrictions for international flights and things of that nature. But you know what’s going on with China right now with the property sector still in the shambles.

Tony

We’re at 103 million barrels and China is not up to… That’s a record and China is not up to 2019 yet. Is most of that growth the US?

Tracy

A lot of it is going to the US and a lot of it is coming from other PACAC Asia nations.

Tony

India, other places?

Tracy

India, Vietnam, Thailand, Malaysia. We’re all seeing growth in those areas.

Tony

Very good. Okay. With this growth, how do you expect that to impact… With the supply deficit, how do you expect that to impact crude prices? Of course, there will be upward pressure, but how much upward pressure are you expecting?

Tracy

It depends. Again, I think we talked about this last week. Nobody wants oil prices to spike over 100. It’s bad for everybody. It’s a bad for economy. Price, and it’s bad for OPEC because nobody wants their product and can’t afford it. I think they’re going to do their best to regulate the market. But I think that we’re in a era of higher for longer right now. I would not be surprised if we stayed again in that $80, $90 range for Brent, which OPEC is very comfortable there.

Tony

Okay, great. Can I ask you a question about EIA report? Because you put stuff out on this every week and it looks like US production is rising. Why is that happening?

Tracy

It’s not.

Tony

Oh, it’s not.

Tracy

Okay. It’s the weekly reports. It has been rising. It has been rising for the first half of this year. But I would pay attention to the monthly reports and not the weekly reports, even though they’re lagging by two months because it’s pretty much just a guesstimate. What we are seeing right now, and from what I’m hearing within the industry, is that all those rigs that have been coming offline all of this year are starting to impact production. That is not surprising. I think that we’ll probably see decline starting in August.

Tony

Okay.

Tracy

Headed into the fall as far as US production is concerned.

Tony

So less US crude output.

Tracy

I believe so for the second half of this year.

Tony

Second half of this year. Okay, very interesting. Thank you for that. Thanks very much for that.

Tony

Stay on energy, Ralph. You put out a report, I think it was this week, looking at why Europe needs nuclear. We’re really interested. You did it through this organization, MCC Brussels. It’s an amazing read, very interesting. I’d like you to make the case for us of why Europe needs nuclear. I’ve got a couple of charts to look at.

The first one is looking at energy density of nuclear versus other stuff. Why is energy density important? I know maybe that sounds a bit stupid, but what does it mean and why is that important?

Ralph

Actually, it’s a fantastic question to start this conversation. Just to give you a number that I think really highlights this. If we take uranium as the most commonly used main resource for nuclear power plants, pound by pound, they produce 16,000 times more electricity than, for example, coal does. I think this just gives you a little bit of an impression of the tremendous energy that is contained in the potentially nuclear power plants. There’s a famous letter that Niel Sboar wrote to Winston Churchill in 1944 where he informed him about the Manhattan project. He basically talks in the entire letter about the energy content that can be released via nuclear fission. This is, on the one hand, which many critics correctly point out, a fairly, quote-unquote, old technology, the first fission took place in Germany in Berlin in 1938, and only seven years later, devastatingly. But the time frame, it was actually very tense. We had the first two detonations of nuclear bombs, of course, in Japan by the US military. But that shows you that we had the technology for a significant amount of time. The reason why I’m mentioning this is because very often that is used as an argument against nuclear.

Ralph

It’s like yesterday’s technology. I think it’s actually making the case for nuclear because the point is we actually know how to do it and we have been pretty good at it. Just to give you two examples. The Canadians in the 1970s, they basically built a new reactor every year. The French in the ’70s did the same thing. The French had one of the least carbonized or one of the most decarbonized electricity grids in the world that really was a nuclear success story. We see the same now in the province of Ontario. I don’t know how many of you viewers and listeners are following Canadian politics. Usually, that doesn’t sound super exciting. I guess for Americans, the idea of Canadian revolutionaries is something like an oxymoron. But there was something…

Tony

They see like a Canadian expert.

Ralph

Well, there you go. At least we have won on our side. In Ontario, that basically was something like a small energy revolution with the new government by the, in my opinion, hilariously named progressive Conservatives of Doug Ford now pretty much abandoning, actually deliberately repealing the so-called Green Energy Act the province has adopted. In 2009, they have now repealed it and they want to go back all into nuclear. Sweden has now announced they want to build 10 new additional reactors. Pretty much the only outlier here is always Germany. But of course, since Germany is Europe’s most important economy, it matters what they do. But just very quickly, for one second, go back to the tech logic part. I’m a political scientist. I’m not a nuclear physicist. People say, Oh, how can you talk about this? That’s a fair criticism. This was my biggest fear when I wrote and when the report was published and when I was reaching out to get input that I will get huge pushback from people who really know the technicalities of it. But they pretty much all agree. You will not find a nuclear physicist who will tell you that, for example, producing electricity via nuclear power is a bad thing.

Ralph

They will say there is regulation that makes it uneconomical. They will say that the political conditions are against it. But nobody will say, Oh, no, we actually have better means of producing electricity because we really don’t. When it comes to this one thing, it is the best available. Yes.

Tony

No, that’s the case, Ralph. I know Germany and Italy and other places closed nuclear plants after Fukushima in Japan. Why did they do that? Was it just such a bad investment or return? Or was it just political sentiment? Why did they do that?

Ralph

Now, I usually refrain from hyperbolic statements because I think it embodies the debates. But if we take Fukushima and Chornobyl, those are the two examples. Fukushima, and this is factual, this is from the Japanese authorities. One person allegedly, supposedly died seven years after the incident after cancer that developed potentially because of radiation. They really had to get to a huge stretch to find one casualty of after what happened in Fukushima, which really was a once-in-a-millennium tsunami. Again, you could say Fukushima tells you stop nuclear, but I think you can make the opposite case, that nuclear power plants, their quality has gotten so good that they pretty much survived a tsunami with barely anybody dying. Just to give another example, in the 1970s, I can’t speak Chinese, so I’m not saying the name of the dam because I’m probably going to ruin it, but a dam broke in China that killed between 26,000 and 240,000 people. Again, the numbers were let’s take the lower end. Let’s try to be very conservative in our estimates. Twenty-six thousand people died. We have millions of people today living in areas close to hydroelectric plants to dams. Nobody is terrified of it, but they are theoretically, or by body count, if we want to use that crude measure, they are much more dangerous than a nuclear power plant. What I’m trying to say is…

Ralph

Let’s take a look at that.

Tony

Yeah, let’s take a look at that, actually. You had a good chart looking at the death rates per unit of electricity production. It seems a little bit grim, but it’s very interesting looking at coal, oil, biomass, gas, hydropower, and so on. And so… Obviously, nuclear is very, very low. There are more deaths by wind than there is through nuclear.

And so I asked the question about why did Europe, or at least Germany, Italy, and some other places closed down some nuclear plants? It looks like polling is showing that people in Europe are more open to reopening or restarting nuclear plants.

Ralph

Yes, that’s true. I think the main reason is that this was a hyperbolic part because people were, for lack of a better term, I would say they have been lied to or they have been brainwashed. Let me give you another example just recently. All of you American listeners probably know Tulsae Gebert, the one—and I don’t know, she’s still a Democrat, she’s not a Republican—but the little bit of a firebrand and she’s very entertaining. But she had this massive tweet where she said, President Biden must do something because Japan is releasing former cooling water in Fukushima back into the Pacific Ocean and this will have a huge impact on the food supply in the Pacific is going to be radiated and everybody is going to die. The one good thing that Elon Musk did with X, formerly Twitter, are the community notes because the water that the Japanese are releasing is better than the drinking water quality in most European cities. A banana and a beer, if this is your diet of choice, will expose you to more radiation and that water. But people are just saying it. It’s just this comment, days, nuclear was involved, it must be deadly.

Ralph

This is really the mentality that most Europeans have imbibed. But what last year, of course, did with the energy crisis is that all of a sudden people realized, Wait, give me a moment, if my electricity bill, my heating bill doubles or triples, if all of a sudden I cannot simply rely on a plug in my gimmicks and they work? Then you take a second look at this and you say, Well, but okay, like microbial, which by the way, just as a quick add-on, was a fact of mostly producing plutonium for the Russian military. It was a sidekick, was the electricity production, at least in the reactor in question. People say, But does that really also apply to German reactors? Does that apply to Swedish reactors? Does this apply to French or Canadian reactors? And people, good for them, they are taking a second look and just as a last point. It’s good that they do because we need, and I think also what Tracy said, really dovetails with this or actually precedes this, the world remains hungry for energy. The International Energy Agency pretty much, I think what did they say? They said peak is going to be in 2019, and by 2030 it’s going to be at 75 million barrels a day or something.

Ralph

Now it’s like, “Oh, it’s probably going to be 105 million barrels per day. I’m sure that in four years they’re going to say it’s going to be 120,000,000 barrels per day.” The world needs that energy. The last point, the argument that, Oh, forget about nuclear, wind and solar can do it. I’m an agnostic when it comes to energy. If we get the solar energy to really harness the power of sun, radiation, I’m all for it. But currently the capacity factor, basically the factor that says what is the percentage of the ideal conditions under which an electricity producer produces electricity? For wind, onshore and offshore, depending where you are, it can be up to 30% to 40% and the ideal conditions. But for example, solar in Europe is 11 or 12%.

Tony

Let’s talk about that. While you’re on that, let’s talk about the German energy mix. Since Germany is the manufacturing driver of Europe, you have some charts in on the German energy mix and energy prices. It was really great to have those side by side.

Can you talk a little bit about how renewables came in in Germany and then what happened to energy prices in Germany?

Ralph

Yeah, this is another one of those stories. I think Tracy recently posted a picture of, I think, a new Ford electric vehicle that cost $150,000. The reason why I mentioned this is because what they do, for example, in the EV sector is very often they never tell you how many EVs they sell. They only tell you their percentage change. They sell one EV this year, they sell two next year, and the headline is EV sales increased by 100%. This is the same thing they did in the German electricity market. Everybody now says, Ralph, what you’re talking about nuclear? Look at it. Now, 65% of electricity in Germany is produced by wind and solar. Yes, of course it is. If you take everything else that’s not wind and solar, you’re going to end up with 100% wind and solar. It’s just going to be hugely expensive. This is the other trick they say, they only look at electricity produced. They don’t look at electricity consumed because they don’t tell you that Germany is now buying energy or electricity, to be precise, from the Czech Republic, from French, and from other states. This is a game with numbers in defense of particularly wind and solar, which I believe, and as I said, I’m an agnostic.

Ralph

If they improve these technologies or if we finally get these miraculous batteries that we’ve been promised now for 20 years, that’s the game changer. If the technology changes, I’m the first one to say let’s look at this again. But at the moment, it’s statistical tricks that try to basically justify one inferior form of electricity production to a superior one. It’s the same thing. I always get down these emails that says, Well, we modeled. We have this model that says that Germany can run 100% on renewables. But I think they are running the experiment right now. I don’t need your model. They are trying it while we speak and it’s not working. It’s the same. You have some guy who is in reality and then the other one waves to study at him and says, But your reality is wrong. It’s very Hegelian, it’s very German in a sense. This idea that reality has to adapt to theory and not the other way around. This is a little bit. Yeah.

Tony

Do you know how much governments in Europe have put toward renewable energy in the last 20 years? I’m just curious if you know that number. It’s got to be hundreds of billions or trillions, I would think.

Ralph

There are different estimates. In the last 12 years, I think overall we’ve spent worldwide four trillion. The bulk of this was spent in Europe and China. I can’t give you the precise numbers. Again, because a lot of this is done, let’s say, directly and indirect financing than the whole subsidy scheme. It’s very tricky to get the real numbers. I think they are much higher than we think. It shows you another thing. I know that you know much more about China than I do, so I hope that we can have a conversation about this one day as well. But this is another thing. I say, Look at China. Look how massively they expand their renewables. Which is true. But if you look at the numbers, I think Dr. Anesh, recently in a podcast said that I have very much faith in the things that he says—he says if the Chinese would keep up expanding their renewables as they do at the moment, and if we assume that they don’t have to be replaced, which is of course a huge assumption that is unrealistic, as he himself says, it would take them 211 years to go fully renewable.

Ralph

Even the world’s leading spender on renewables, and they know this, this is why the Chinese still invest in coal and still invest in nuclear. Europe is a little bit in the energy sector. The shift is happening. It’s like an ocean minor that tries to turn around. But as a concluding remark, without energy, de-industrialisation is a fact. Again, we can turn and twist the numbers. We have the statistics, we have the numbers, we know what the companies are doing. We know where BASF is going, we know where other companies are going. This is a very harsh reality. So far, again, if this is possible one day, I’m the first one to be for it. But so far, the favored sources of electricity and energy have not delivered what they were promised to be capable of.

Tony

It looks to me, based on your charts, that as renewables have taken over more of the fuel source in Germany, prices have risen by 70, 80%, something like that. Given the subsidy that’s gone in from European governments, it just seems odd that that’s the return. The 90% rise in energy prices.

Ralph

Just as a quick thing on this. As I always say, I’m an agnostic on this, but it’s frustrating in the sense, particularly for consumers. We constantly hear with this border fraudulent way of calculating it, the so-called level cost of energy. We are constantly taught that wind is the cheapest of all forms, followed by solar. But every statistic we look at, Germany, Denmark, Great Britain, everywhere, cost of electricity increased proportionately with the share of renewable. Again, as an agnostic here, but somebody needs to explain this to people. They see the large electricity bills and people on TVs, they’ll tell them, Oh, this is also cheap. It’s amazing. Well, okay, then where is the cheap electricity? This is, I think, the frustrating thing.

Tony

I live in Texas, so I’m shamelessly pro-oil and gas, but we have, I think, the largest wind energy field in the US. That started, I think, in 1995 under a guy, an obscure guy we used to have as governor called George Bush. He started that program for the Texas government. We have one of the largest wind fields in the US, but we still struggle every year to get it to take over an increasing proportion of the grid here. Increasingly, natural gas is becoming the no-brainer solution for us, although we spend more on alternatives here in Texas, but the reliability is in things like net gas. Look, my bias is out there on the table. If something’s better, I’ll take it. But it sounds like Europe’s gone to the point where alternatives have hit a wall for now and they really need to do look at a different energy mix. I think your report, I’d encourage everyone to check it out. I think it’s very, very interesting. I think every nuclear investor, which I know there are a ton of really aggressive nuclear investors out there, they should read your report and they should just throw it out to everyone that they know so they can all read it.

Tony

So very good. Guys, this has been fantastic. Thank you so much for taking your time. I know we’ve covered a lot, and I really appreciate your time, guys. Have a great weekend and have a great weekend. Thank you so much.

AI-powered market forecasts with CI Markets: https://completeintel.com/markets

In this Week Ahead episode, Tony Nash, Michael Belkin, Tracy Shuchart, and Albert Marko discuss various investment opportunities and market trends.

Michael emphasizes the importance of sentiment and positioning in the market, predicting a sentiment reversal and a potential liquidation squeeze out of tech stocks and into energy, financials, and China. He also highlights the under-owned nature of the energy sector and suggests investment opportunities in energy stocks, particularly at the point of maximum pessimism.

Michael draws parallels to Sir John Templeton’s advice on buying at the point of maximum pessimism and selling at the point of maximum optimism. The conversation also touches on the Federal Reserve’s interest rate decisions and inflation concerns.

Albert agrees with Michael’s assessment on tech stocks being overvalued and predicts a potential resurgent US dollar, albeit remaining range-bound. He discusses the impact of a stronger dollar on Europe and emerging markets.

Albert also expects a trend of contraction in money supply for another month or two, followed by an expansion. The discussion further explores potential investment opportunities in China’s large-cap sector, driven by efforts to ignite optimism among Chinese investors, while acknowledging the risk of the Taiwan-China conflict.

The speakers also touch on the potential for a rally in small caps, driven by rotation and the consensus being long on large-cap tech stocks.

Additionally, the episode highlights the impact of the dollar on commodities, particularly crude oil. Albert predicts a range-bound crude oil price between 75 and 85, unless a geopolitical issue arises.

Tracy discusses refinery margins and the strength of crack spreads, noting the strengthening diesel prices and the focus on refining diesel for better margins. She also emphasizes the importance of considering fundamentals in commodity prices and highlights the current high demand for oil, surpassing pre-pandemic levels.

Lastly, the conversation mentions OPEC’s voluntary cuts and their preference for a stable market with a price range of $80 to $90 for Brent crude. The group is seen as cohesive and unlikely to deviate from the cuts. The episode also briefly touches on the impact of Rhine River levels on manufacturing in Northern Europe, noting a recent return to normal levels that will take time to alleviate the backlog of products.

Key themes:
1. Forget AI. Real Equity Opportunities
2. Inflation, Fed & Treasury
3. More Crude Supply Cuts

This is the 74th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.

Follow The Week Ahead panel on Twitter:
Tony: https://twitter.com/TonyNashNerd
Michael: https://twitter.com/BelkinReport
Albert: https://twitter.com/amlivemon
Tracy: https://twitter.com/chigrl

Transcript

Tony

Hi and welcome to the Week Ahead. I’m Tony Nash and today we’re joined by Michael Belkin. Michael runs the Belkin Report, which is the hedge fund advisory service. We’re also joined by Tracy Shuchart and Albert Marko. We’ve got a few key themes today. The first is a report that Michael just put out talking about forgetting AI and looking at some real equity opportunities. And we’ll go through some of those opportunities in detail. We’re also going to get some information from Albert on inflation, the Fed and treasury. So what direction are those going and what can we expect there? And finally, Tracy is going to round us out with some discussion about crude supply cuts and a few other issues there.

Tony

Before we get started, I’d like to let you know about a promotion we’re doing for CI Markets, our forecasting platform for stocks, ETFs, indices, commodities, currencies, Forex, and economics. For the next two weeks, we’ll buy the first month of CI Markets for you. Go to the link to find out more. At checkout, use the code 25OFF. That’s the number 2, the number two number 5, and the letters O, F, F. This will give you the first month free when you subscribe to our $20 or $25 a month plans. Get fresh market forecasts every week, accountable forecasts where CI discloses our error rates and a growing set of capabilities. We’ve just launched the top 50 US ETFs Nasdaq 100, Nikkei 100, FTSE 100, and so on. Check out CI Markets today and use the promo code 25off. Thank you.

Tony

Guys, thanks so much for joining us. I know you guys are busy all week long and I always appreciate this recap at the end of the week and the look forward. Michael, thanks for joining us for the first time. Last week you issued a report titled Forget AI, the Real Opportunity is in Energy and China. So as an AI company, I won’t take offense, that’s totally okay. But we’re going to dig into this. Before we get into some of your predictions, can you walk us through your set up? What are you seeing in recent months that have really brought you to some of these predictive conclusions?

Michael

Okay, thanks for having me. My background, I came out of UC Berkeley Business School and I studied statistics there. My main drive is forecasting. I use a form of time series analysis, proprietary algorithm that I developed based on my studies. It’s similar to foray or box Jenkins ARIMA models. I was in proprietary trading at Solomon Brothers and my model gives a 12 period forecast weekly data that’s the next three months. My time horizon is three months, most of the time, can be longer or shorter. But the model gives direction, position, intensity, direction, up, down, or neutral position, beginning, middle, end, and intensity or confidence interval. I’m looking for the strongest signals and try to get in at the beginning. And most of the time, the model will be buying stuff that’s down and selling stuff that’s up. Buy low, sell high is what you’re supposed to do, right? But that can be relative. That’s not just the market indexes. So the indexes are obviously high up here after this big rally. But okay, that’s what I do now. It’s really effective on sector rotation. And just to give you a little bit of background, I was really bullish on tech and the market starting last October, October 17th.

Michael

So October through March, really bullish on tech. I was totally wrong in Q2. It overshot to the upside. My favorite stocks were the FAang stocks, and then they overshot and went three months higher. But that didn’t change the forecast, so it’s really gotten stronger. So right now, the model forecast direction for tech down, direction for energy up. That’s relative in absolute terms. So just to flesh that out, in July, the USO crude oil ETF was up 15 %, OIH Energy Service was up 20 %. The model has a similar forecast for China, by the way. M y strongest long ideas are energy and China. In terms of the position, remember, the model gives direction, position. I think of it in terms of innings, we’re probably like second, third inning of a relative and absolute move up in energy and China, both relatively depressed. Turn that around on tech. Tech just looks terrible to me, really overowned. Direction down, intensity strong, position early, just starting. And to flesh that out, just to finish up on this little idea. This week, the tech sector is down 3 %, XLK, and the energy sector, XLE, is up 3 %.

Michael

So I ran that chart a few weeks ago in the report. Long energy, short tech, that’s the trade. That’s what hedge funds do. You’re supposed to be market neutral, have longs and shorts. That spread is up 6 % this week.

Tony

Fantastic. Very good. Can you walk us through, Michael, some specifics? Let’s look first at tech. You have this chart on the New York Fang to S&P 500 ratio.

I know you give us a little bit of background on what’s happened in July, but can you talk us through your forecast and what you’re expecting in the coming months there?

Michael

Okay. So as far as the black box forecasting thing, which I do, I also wear investment strategist hat. The investment strategist hat is how do the pieces of the puzzle fit together, what’s going on out there. And I’ve been doing the Bellcon Report. I left Solomon 1992, so I’ve been doing this for what, 31 years now? Egads. Anyways, sentiment is really important. Sentiment and positioning. And this is one of those times where people have just been squeezed into this stuff. One of one of my clients is a alpha capture fund. They run my stuff, have 50 positions. And I talked to the guy yesterday and he told me everybody has long fang stocks. I mean, that’s just anecdotal, but they have 180 contributors sell side by side. And he said something like, well, you got to tell your investors at the end of the quarter. If you’re not invested in the video, they’re going to want to know why. So all these people, there’s this huge squeeze. People are over positioned. They’ve been squeezed into this stuff because it’s work, but it’s yesterday’s story. I think we’re set up for a sentiment reversal. Nobody likes energy.

Michael

By the way, tech is 29 % of the S&P 500. Communication services, 9 %. So both tech. That’s 38 % of the index. I’m not particularly bullish on the indexes. S&p, Nasdaq, there’s too much tech in it. Energy sector is only 4 % of the index. Financials, I’m also bullish on financials. Financials are 12 %, so that only amounts to 16 % %. So you’ve got 38 % that wants to go down and only 16 % that wants to go up. So it’s not particularly bullish scenario, but mainly it’s sentiment. So I think there’s a huge pain trade ahead. People got squeezed into these stocks Now they’re rolling over. They’re not going up anymore. Look at Apple, it was down. I mean, it was only up 1 % in July. It’s down on the day. Amazon’s up. But these things are turning into a big pain trade, basically. So I think there’ll be liquidation squeeze out of tech, out of Fang, into this other stuff, energy and financials and China.

Tony

Michael, I’m hearing more about unannounced layoffs in tech coming. So what I’m hearing would me hear what you’re expecting. So it feels like there is some pain in those companies that really isn’t being talked about, or at least some expected pain.

Michael

Yeah, true. So you’ve got AI now. I’m not a Luddite, right? I use Kwan. I use this stuff. I mess around with these chat things, but they give me hallucinatory answers, some of these. But if you go down beyond Fung, a lot of tech stocks… So the Bellcon Report covers all the different groups, computers, software, communications services, cybersecurity, all these things. And I run the groups relative the index and the sector, and then the stocks relative to the groups. And there’s a lot of stocks that have been acting like crap, even while the Fung stocks have held up. So AMD is supposed to be one of the leaders, right? They came out with okay earnings, and then they opened up on the high and reverse sharply yesterday. So I think that’s a pattern. And as you suggest, a lot of the stocks that are not the headline super large cap ones, they’re not doing so great. And it’s not like a tech collapse yet, but again, second, third ending. It reminds me a little bit of the height of the TMT bubble, 2000, if you were around back then. A lot of stocks acted better after that.

Michael

In 2000, March 2000 was the top. Tech stocks started trading down big time. The internet was a thing then. It wasn’t going away. But a lot of the companies turned out to be not frauds, but they just didn’t last. The stocks went down 90 %, they just didn’t hang up.

Tony

They didn’t survive. Is a thing, but a lot of these companies are… We’ve talked about this before with Albert, a lot of these companies, AI may not necessarily be the main thing, but it’s a thing. It’s a real thing. Ai is not going away, like you said, the internet is not going away.

Michael

Right. Microsoft back then was the headline stock, and that certainly survived. But the stock went down 80 % or something over the next couple of three years from the high end. I’m not predicting anything that dramatic. I don’t know. I only look three months through here at the moment. But generally, it just makes me nervous on the market. I’m bullish. We’re going to talk in a minute about the Russell. Russell 2000, no tech stocks in it, no FAang. I mean, it’s got some smaller tech stocks, but it doesn’t have the weight of the FAQ stocks. So that looks like it wants to outperform, even though a lot of the companies there, they’re not doing so great. But just in terms of flows and what happens, it’s like there’s a squeeze out of big tech into other stuff.

AI

Great news, traders and investors. CI Markets has expanded its coverage to include stocks from the S&P 500, Nasdaq, Nike, FTSE 100, and the top 50 ETFs. With more than 1,500 forecasted assets, our AI-powered platform provides highly accurate forecasts. Join our community of successful investors who rely on CI Market’s insights to make informed decisions. Subscribe now for as low as $20 per month and unlock the power of comprehensive forecasting. To learn more or book a demo, visit completeintel.com markets.

Tony

Let’s speak about other stuff. Let’s talk about energy. You have a chart of XOP oil and gas ETF. Can we talk about that? Energy is pretty unloved or has been pretty unloved. Let’s talk through that a little bit here. I’ll look on XOP. Okay.

Michael

By the way, so I talked to my Alpha capture guy. By the way, I’m ranked number two in that out of 180. I’m up 15 % market neutral in Q3. So that’s after a month. And the point is, I talked to him and I said, Is anybody… He doesn’t tell you what other people are doing exactly, but he just gives you an overall view. So it’s a good picture of how people are positioned. I said, Is anybody long energy stocks? He said.

Michael

Long tech stocks. I think people are not in this ESG. You’re not supposed to own this thing. It’s not green. It’s carbon capture. It’s the end of the world. We know we’re all going to be living on windmills and solar. I’m into this. I have a geothermal heating system in my house. Again, I’m not a Luddite. But just in terms of investment opportunities, it’s underowned XOP. Again, second, third inning. It’s been definitely quiet on my end. I’ve been pushing this for a couple of months. It’s been working. Do I get calls about it? No. So I think people are still like… A lot of my clients have been with me for a long time. They don’t call me. I know they pay attention to what I say. But in general, I just think… Remember Sir John Templeton, right? He said the time to buy is at the point of maximum pessimism and the time to sell is at the point of maximum optimism. And that really holds true. I think energy point of maximum pessimism, maybe we’re a little bit past that. We’re only a couple of innings past that. Tech, if you get a point of maximum optimism. So from Sir John Templeton’s perspective, it’s time to buy energy and sell tech.

Tony

That’s great. I can hear. Yeah. Tracy has been saying this for a while, and we just continue to see headwinds there. But like you say, the performance over the past couple of months has been really good. Let’s also talk about another unloved sector is China large caps. For political reasons, for economic reasons, for failure to launch reasons after COVID, China equities remain unloved. So can you talk us through why do you see some upside in China?

Michael

Okay. Again, direction, position, intensity, the model just turned me on to China about a month or two ago. Really looked bottomy, had a few zigs and zags. Then it started to go up. It’s not up this week. It’s underperform. Fxi is the ETF down 2 % this week. But again, it looks very similar to energy in the forecast. Second, third ending up. And then investment strategist hat looking for a catalyst. What’s going to make… Let’s talk about catalyst for a second. One for China. So all of a sudden it’s stimulus, stimulus, stimulus, and they’re not running out the baz, right? It’s like little… But it’s something every day. The authorities in China are talking to the brokers saying, What do we need to do to make people more optimistic on the market? By the way, Chinese investors, the Chinese, the CSI 300 and Chinesex, they’ve been dogs. And the Chinese investors have lost hope in their market, which to me, from a sentiment perspective, is positive because then you get squeezed into it. So they’re trying to ignite optimism among Chinese investors. Foreign investors, Tiger Global blew up on Chinese stocks. Now they came out with a news story.

Michael

Tiger Global’s Long Apollo. They’ve turned away from Chinese tech stocks and they’re into financials, which is okay. But I’m just saying anecdotally, there’s room for people to get squeezed back into China. Of course, the risk there is the Taiwan Chinese conflict. I watch that very closely. You never know if something’s going to come out of left field. I’m sure that makes people little nervous. But by the way, I want to mention one other thing about catalyst for energy. The Biden administration Energy Department was selling the Strategic Petroleum Reserve, SPR. They’ve been draining it by like, forget how much, 20 million barrels a week, I think on average over the last three months. That ended about three or four weeks ago. They were using it for a cookie jar to depress gasoline prices for political reasons. I don’t want to go there, but that’s not what it’s for. If you go to the ESPR, it says it’s for severe disruptions in energy supply, of which there hasn’t been any. So anyways, they emptied the thing as far as they can take it. And now that was an artificial depressant on the crude oil price that kept crude oil.

Michael

The model was short previously earlier in the year, but that’s over. So there’s a catalyst now. So now they’re in an arm wrestle with OPEC, OPEX, and Russia’s cutting production. So I think there’s a a catalyst for energy in terms of the end of the SPR drain, and there’s a catalyst for China in terms of fiscal stimulus coming out of the Chinese Politburo. Everything over there.

Tony

Great. So all of this talk about fiscal stimulus that we saw in the first six months of the year post opening that was hollow, we’re starting to see some traction there from the NDRC in China, from the PBOC. What are your thoughts on a DVal? Do you look at C&Y? Do you have any thoughts on whether we’ll see a C&Y DVal?

Michael

Yeah. So I’m neutral on the dollar at the moment. The direction, position, intensity, remember, sometimes position, direction is neutral. So I don’t have a strong opinion on the dollar at the moment. So that could be coming up, but I don’t have a firm answer from the model for you. I’m just standing aside in the currencies. So that doesn’t factor into my China view at the moment.

Tony

Okay, good. Yeah, neither do we. We’re not seeing strong either way in the dollar. So I definitely agree with you there. Let’s close out with small caps.

You mentioned some things about the Russell 2000, but I want to go into that a little bit more detail. So you’re showing small caps out performing and forecasting a rally. And so help us understand why. Is that just on a relative rotation basis or what does that look like?

Michael

Yeah, it’s a rotation thing. So again, squeezed. So like I said, I’ve been doing this for 30 something years now, right? My original clients were what I call the hedge fund mafia, the tigers and steinhearts of the world. I have clients all over the world. And by the way, if you have international viewers, there’s nine innings in a US baseball game. I get questions about this when I say you’re in the second or third inning, they say, Well, how many innings are there? But anyways, I’ve seen over the years, I’ve seen this consensus get squeezed into stuff short at the bottom and long at the top. I’ve seen it over and over and over. And it’s them reversing that causes these major inflections in sector and index rotation. So right now, I think unequivocally, these guys are long, large cap tech stocks. I don’t want to mention any names, but I shudder some of my clients who are, again, just household names, big guys. I see them saying, Oh, yeah, we’re long fang stocks. We’re long in the video. And I just shudder because I know I’ve seen this before. I’ve seen this movie. It’s just like play the movie over again.

Michael

What happens, it turns into a dump. So it starts going down. They’re overloaded. Loaded on it. They have to sell and they say, What do I buy? So getting back to the Russell 2000, they’re not in that. You know what I mean? It’s not a thing for them. So just from a rotation perspective, again, I’m not a bubble person. I don’t think this lasts forever. So where are we now? Beginning of August, right? So I’ve got the indexes look like they’re a long hold, barely. S&p, again, they’ve got so much tech in them, going up into maybe late September, sometime September, October. That’s when I start getting nervous. The Russell looks fine. And by the way, one little observation on that. So I run all these groups and stocks. That’s why I spend my weekend doing 12 hours a day, Friday through Monday. And I still see a lot of stocks that want to go up. Cyclical stocks stocks, chemical stocks, basic resources stocks. In Europe, there’s a lot of China plays. So basic resource sector in Europe. I do sector rotation in Europe. It’s really depressed, it looks like. And these are stocks that are related to Chinese demand, base metals, things like that, want to rally based on the China recovery.

Michael

And it’s not like a complete… I wouldn’t say it’s not like one of the previous huge stimulus packages in China. It’s more like a mini bubble. But we’re setting up for China rally that could feed into energy small caps in the US for another couple of three months. That’s as far as my forecast runs right now.

Tony

Great. That’s great, Michael. I appreciate your openness on, Hey, this is a rotation thing. It’s not necessarily a long term rotation. And to Russell, I appreciate your openness on that because I think that really helps people understand the basis of why you’re looking at these things. So thank you so much for that. Albert, can you help us look at a little bit more the macro situation? You’ve been saying for months that the Fed will likely raise to 6 %. So I put up a little survey this week to see what people thought. It’s interesting to see that 80 % of people see at least one more hike, and 50 % see at least two more hikes this year in 2023. So do you still think we’ll be at 6 %?

Albert

At 6 % or just below it. I mean, what does it matter at that point if we’re at 5.75 % or 6 %? And I would like to say that Michael is pretty much exactly right on the whole tech thing being overvalued at the moment. I’ve been saying that for quite a while now. As they pump this market using those magnificent seventh tech stocks that the liquidity just pours into commodities now and rallying the market just is an inflationary problem. And for the past few months, you can look at the headline of inflation at 4 % and 3 % handle. But you look at core, it’s not going anywhere but staying steady in the 5 % range. And I think that the next CPI report is probably going to surprise to the upside. I mean, we continue with the wage inflationary. We continue with the TGA being used by treasury for liquidity inflationary. I mean, we look at these policies going into an election year and all of it looks inflationary to me. I don’t see anything where the Fed or the treasury is acting where they really want to combat inflation. And I have to question why at the moment.

Albert

The only thing that we can look at is the US dollar at this point because they’re not going to go over 6, 7 %, 8 % or some people saying double digit rates right now. That’s just silly. I mean, that would be catastrophic for the US economy in the market overall. So from that point, I want to see what the US dollar is going to do in the next three months.

Tony

Okay. So in terms of inflation, we had the services PMI coming on Thursday. And I think a lot of people want to believe that we’ve defeated inflation. And we saw the ISM services prices paid at 56.8 %, which is relatively higher than it was in the previous month. So you’ve been on this persistent inflation message for over a year. So this doesn’t surprise you.

Will we see a resurgent US dollar, or are we in the ballpark rk? And what factors would play into that?

Albert

I think that the US dollar is probably going to be the range bound between 100 and 110 on the tick seat, only because starting to get over the 110 range into 115 is problematic for Europe. I mean, they’re already having problems as it is. I mean, you talk about a 115 dollar, 120 dollar and emerging markets, which Europe is in reality is going to be problematic.

Tony

Especially as they’re buying so much net gas from the US, right?

Albert

Yeah, of course. Course, because they’re not allowed to buy from Russia. We won’t talk about those tankers going in the Rotterdam, but that’s for a different conversation.

Tony

Right, exactly. What’s your view on money supply? I was doing some calculations earlier this week. We’re still $2.1 trillion dollars over what our, say, Feb 2020 money supply growth rate was. We grew at 5 % a month for, I think, four months in 2020, and then it’s ratcheted down bit by bit. But we’re still 2.1 trillion dollars over where we would have been had that not happened. So I know what’s happening with the TGA, but do you believe we’re going to see a continued drawdown of M2? Obviously, we’ve seen negative, we’ve seen a contraction of money supply for several months. We’ve had the odd positive month, but do you think we’re going to see a focus on M 2 contraction from the Fed as interest rates are, say, continue to be elevated?

Albert

No. I think it’ll trend down for another month or two. But coming into 2024, I think that they’ll just expand it once again.

Tony

Okay. So rather than lower rates, you think they’ll just continue expanding money supply?

Albert

Absolutely.

Tony

Okay.

Albert

And lower rates is a problem. Lower rates is going to be a problem for inflation, for their inflation fight. They start lowering rates and cutting rates back to 3 % or 2 %. You’re talking about CPIs again in the 7 8 9 handles.

Tony

Right. So this higher for longer narrative, you think rates will stay pretty consistent through ’24?

Albert

Oh, yes. It’s certainly gearing up for higher for longer. I think Andy Koston or Bob Woodward was talking about higher for longer forever now. The pivot and the pause crowd have been so loud over the past 12 months that it’s drowned out guys like that. But they’re absolutely right. It’s certainly higher for longer at the moment.

Tony

Okay. And so going back to Michael’s talk about outlook on tech, obviously, elevated rates, say, contracting money supply for the next few months, that definitely is not bullish tech. That’s not a bullish tech environment, right?

Albert

No, it’s not a bullish tech environment. We should even be here in the first place. It’s only because the S&P, like Michael pointed out, is heavy with tech names, and that’s what they’ve used to rally this market and rally the S&P. It’s absolutely silly that we’re even here. At some point, physics takes over and the numbers and fundamentals take over, and I think we’re close to that point at the moment.

Tony

Okay. Then with your dollar outlook, how do you think that impacts commodities? We ve seen commodities really up and down over the past couple of weeks as the dollars figured out where it wants to be. If we see the dollar trading in your range, do we see crude where it is now or what happens with things like crude and base metals?

Albert

Well, the crude, with the range that I pointed out of 100 to 110 on the Dixie, I think crude sticks in the 75 to 85, maybe 90 range at the moment. I don’t think that they even want… They won’t let it go up higher. They’ll just get into the futures market and start selling it down with brokers.

Tony

Okay. So we may be touching on 90.

Albert

In the next three months.

Albert

Maybe touching on 90. Obviously, it can’t count. Can’t sit there and speculate what geopolitical problem pops up out of the Middle East or the Black Sea or so on and so forth. But just on a numbers basis, I think we’re still going to stick between 75 and 85.

Tony

Okay. And that flows through Tracy to refiners and expiration companies and oil and gas companies along with Michael’s XOP thesis, right?

Tracy

Yeah, absolutely.

Tony

Okay. So do you expect refinery margins to start coming back more or are they good where they are? They just need some stability and higher base prices for a while.

Tracy

Is this question for me?

Tony

Yes, ma’am. Yeah.

Tracy

I mean, we are seeing those crack spreads start to gain strength once again. And so things are looking good for refiners. What I’m seeing is we’re seeing diesel prices strengthen not only in Asia, but in Europe and in the United States. So what I think will be happening is when we start to get to, say, the fall, where gasoline demand teters off as a seasonality thing, you’re going to have refiners go and start refining diesel because there’s just better margins on it.

Tony

Okay. And then what’s your view? If Albert’s dollar thesis remains and we see, say, over $100 between, say, 105 or so, how much does that impact dollar based crude prices and commodity’s prices? Well, it.

Tracy

Does and it doesn’t. I mean, everybody, there’s not a one to one correlation with crude oil and a dollar. If you look at it over the long term, it’s just not a one to one correlation. We have seen, for instance, last summer where we had USD prices completely divorced from crude prices, and they both went up together. And that’s happened often in the past before. And so it really depends on, for me, for the fundamentals. And then if we start to talk about the fundamentals, let’s talk about some demand numbers here for a little bit.

Tony

Let’s do that. And then let’s get into supply cuts as well.

Tracy

Right. So what we’ve seen, right, so we’ve had from China, India, and the United States, which are basically the biggest buyers this year. In H 1, we’ve seen about a 3 million barrel a day increase in demand from those three countries combined. Now, H 2 is forecast to see an additional 2 million barrels a day from just China and India alone. I think we’re over 20 million barrels a day. That’s pretty much I think where we’re going to stay for the rest of the year. And so although 2022 demand was not completely all the way up to 2019 demand, we have this year surpassed 2019 demand. Now, we’ve had a lot of negative sentiment on oil because everybody’s scared of this recession that’s just not here yet. And so there was a lot of negativity on that. That said, we haven’t seen demand can’t calm down at all. And I could argue also that demand is relatively inelastic. Even when you had, say, 2008, and 2020 is a different story because the whole global economy shut down. But you look at 2008, the last recession we had, global oil demand came back fairly quickly compared to everything else.

Tracy

But going back to where we’re at right now. So that’s where we’re at as far as demand numbers are. We’re over 2019 levels. We’re at literally all time highs in demand. And then you still have OPEC with their voluntary cuts. And as we just saw earlier this week that Saudi Arabia decided to extend their million dollar voluntary cut to September, which is not really a big surprise.

If you have studied Saudi Arabia, they like to do things in three months. So that’s their M. O. So going into the fall, we could have a serious problem with the market. Now, will OPEC react? Yeah, they can. But you have to realize that once they react, it takes a couple of months for that to actually filter into the market. In fact, we’re only just now seeing, as far as exports and things of that nature, the May cuts come in, not even the June and July cuts. Those haven’t even factored in. Even if they respond and we see oil prices kick up because the fundamentals actually kick in and people care about the market again and actually care about fundamentals, then they can react and I do think they will.

Tracy

They don’t want a spike in oil prices either. They would rather have oil prices steady and manage the market. They don’t really want to see the 130 spike that we saw February of 2022 after the invasion of Ukraine. That’s not really a stabilized market because then it becomes an issue for emerging markets and it hurts other economies. Then they stop buying your product. I think that $80 to $90 range for OPEC, for Brent is a good place for them to be right now.

Tony

Will we see other OPEC or OPEC countries follow suit with Saudi Arabia?

Tracy

It’s a very cohesive group. I’ve been saying this since the 2020 debacle that out of that catastrophe emerged a very strong cohesive group where we were used to seeing a lot of infighting, a lot of cheating, and things of that nature. And everybody just assumed that’s going to be the way that it’s going to be. But since 2020, we haven’t seen that.

Tony

Okay. So Saudi is the only one that will continue cutting. Everyone else will stay based.

Tracy

On the black and white. Yeah. There are cuts between… It’s not Saudi Arabia. Saudi Arabia is shouldering the burden of the cuts, but there are other six other countries that have the voluntary cuts to the end of the year. So we still have that 2.5 million cuts. And then this extra million was Saudi Arabia’s alone decision to do this. And it was just supposed to be for the month of July and August, and they now put that out for one more month. So it will include September as well.

Tony

Interesting. Okay, very good. Now, Tracy, I want to go back to something we talked about a couple of months ago, and I think we covered it again last month is Rhine River levels. And we talked about how there was drought in Northern Europe, and the Rhine River had fallen to levels where manufacturers upstream couldn’t receive the commodities they need to manufacture and so on. Can you walk us through some of the impact that’s had? And then you had this tweet earlier this week talking about how Rhine River levels are back to normal levels. Will we see an immediate impact or will that take some time for, say, German manufacturing to get back to normal?

Tracy

Yeah, that’ll definitely take some time just because of the backup that has happened because what was happening is what you have to do is you have to split your load because your vessel is too heavy to transverse the river. So you have to split your loads, which obviously takes a lot of time. So there’s a lot of product backed up still that needs to be shipped out. So it’s going to be a few weeks before I think we will really start seeing some allevi there. But it’s good, obviously, it’s very good news. And you can see the prices of some of these commodities that were very affected start to come down, particularly the softs and things of that nature.

Tony

Very good. So that’s good news for Northern Europe. So guys, thank you so much. This has been a great overview. Thank you, Michael, for your outlooks. Please check out the Belkin Report, guys. Michael’s got a lot more forecasting there and really solid. Michael, thank you. Albert, Tracy, thank you so much and have a great weekend.

Welcome to “The Week Ahead” with Tony Nash, where we discuss the latest market trends and forecasts for the upcoming week with a panel of experts including Blake Morrow, Tracy Shuchart, and Albert Marko.

They begin with Blake by examining the strength of the dollar in relation to the euro, Japanese yen, and the resurgence of commodities. The conversation highlights the Fed’s indication of keeping rates high, the dovish stance of the European Central Bank, and the inflationary environment in Europe and the United States.

The focus then shifts to the Bank of Japan and the potential changes in their yield curve control policy. The speakers discuss the challenges the BOJ faces in moving away from ultra-loose policy, and the impact it may have on the Japanese yen’s depreciation and potential future appreciation.

The episode also covers China’s economy and the challenges it faces in shifting towards a consumer-based model. The speakers mention the potential devaluation of the yuan to boost exports, as well as the appreciation of the Mexican peso and the rally in commodities driven by a weak US dollar and China’s stimulus.

Tracy touches on the energy sector and the United States’ oil demand. The conversation explores the implications of rising energy costs on inflation and the global economy, as well as the slowing growth in margins for S&P 500 companies. They discuss the impact on luxury brands and high-end consumers, as well as the current status of AI in the tech industry, mainly with Albert.

Lastly, the experts discuss the role of large language models in improving search efficiency and potentially replacing low-level analyst jobs. They acknowledge the transformative effect of AI advancements in search capabilities, but caution about the accuracy of information provided by AI, especially in legal contexts.

Key themes:

1. Dollah! (& EUR, JPY, CNY)
2. Commodity Resurgence
3. Earnings

This is the 73rd episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.

Follow The Week Ahead panel on Twitter:
Tony: https://twitter.com/TonyNashNerd
Blake: https://twitter.com/PipCzar
Albert: https://twitter.com/amlivemon
Tracy: https://twitter.com/chigrl

Transcript:

Tony

Hi. And welcome to the Week Ahead. I’m Tony Nash, and today we’re joined by Blake Morrow, Tracy Shuchart, and Albert Marko. Thanks, guys, for joining us. Today, we’ve got a few key themes. The first is the dollar, and we’re going to talk about the dollar in relation to the euro, Japanese Yen, CY. We’re also talking about commodity resurgence and earnings.

Tony

Before we get started, I’d like to let you know about a promotion we’re doing for CI Markets, our forecasting platform for stocks, ETFs, indices, commodities, currencies, forex, and economics. For the next two weeks, we’ll buy the first month of CI Markets for you. Go to the link to find out more. At checkout, use the code 25OFF. That’s the number two, the number five, and the letters O, F, F. This will give you the first month free when you subscribe to our $20 or $25 a month plans. Get fresh market forecasts every week, accountable forecasts where CI discloses our error rates, and a growing set of capabilities. We’ve just launched the top 50 US ETFs, Nasdaq 100, Nikkei 100, FTSE 100, and so on. Check out CI Markets today and use the promo code 25OFF. Thank you.

Tony

Guys, thanks so much for being here. I really appreciate the time as always. Blake, it’s your first time here. Thank you so much. I appreciate it. I’ve heard great things about you and I follow you on Twitter. I want to start by talking about the dollar. We do see another, of course, another 25 basis point move by the Fed and the ECB this week. And after a couple of months of hearing about the dollar’s demise, which Albert and Tracy and I have laughed at every time we hear it, yesterday on Wednesday, we’re looking for strength to return the dollar. And we saw that Thursday this morning after the ECB meeting. Can you walk us through your case for dollar strength?

Blake

Yeah, sure thing. And by the way, thanks for having me here. It’s first time and hopefully not the last time. It’s really an honor to be here with you guys. This week was a unique week because we had the Fed, ECB, and the B2B OJ is happening tonight. And we just had some headlines come out less than an hour ago that’s really moving the markets. But it’s rare when you can get these central banks, you have a good understanding from a macro micro point of view, fundamental point of view, what to expect. And in this case, we had the Fed that… I think we’re all coming to the realization that the Fed, even though they’ve said this many a time for months and months and months, rates are going to stay high for probably a long period of time. And something they said yesterday that really caught my eye or caught my ear, rather, was that their internal economists aren’t even forecasting a recession, which means that if you were thinking thinking when we get in a recession, the Fed is going to eventually cut rates, they’re not going to. So that automatically, I was assuming that they would message that they were going to keep rates higher for longer and try to drill that in.

Blake

I didn’t think it would come out in that way. However, I also figured the ECB, which came out this morning, and if you saw Christine Le Gard, I almost thought her shoulders were really slumped over. She looked really not so optimistic, and she was very dovish, more so than I’ve ever seen her in over the last 12 months. I figured that was going to be the case because the European data has been really deteriorating. And so I figured that she would be somewhat dovish and maybe not lead us down the path that we’re going to get another rate hike, which I think that was the case today. So it just so happened that it worked out the way that I anticipated. But let me be the first to say, Tony, that doesn’t always happen by no stretch of the means. It did really work out according to the way I planned it this week.

Tony

Hey, take the win.

Blake

I’ll take it this time. I take plenty of losses, so I’ll take the win.

Tony

With Powell yesterday, one of the things that I noted that he said is he said policy is not restrictive enough or for long enough to have its full intended effect. And so that the hire for longer is just all baked into that sentence, right? And surely after that, he said, we have a long way to go. And so I think there were some people who walked away from that press conference thinking it was Dovish, and I just didn’t hear that at all. Did you hear Dovish comments out of the press conference?

Blake

No, I think it was pretty well balanced, but the higher for longer, I think it’s starting to resonate with the markets. But between that and between the ECB and now the BOJ, I think the markets are starting to understand, and really you’re taking the Bank of Japan, which is the last G10 central bank that has ultra loose policy, that might actually get removed or start the other direction as of tonight or tomorrow morning in Asia. And I think the markets might be getting the hint now. And I think we’re starting to see signs of it actually today would be the first day that we are.

Tony

And then ECB made comments about end of cycle. So she really wanted wants to be at the end of her rate rise cycle, right?

Blake

She does. And I think she’s probably feeling a lot of pressure from Germany. If you’ve looked at the German, especially the manufacturing PMIs just earlier this week, they’re horrendous. And when Germany is the growth engine, if you will, of the Eurozone, if you will, and they have plenty of seats in the ECB Board of Governors, she’s probably feeling a lot of pressure from Germany specifically. And so, yeah, I think she wants this cycle to be over. I think everybody does. But the problem that we’re all facing, and I think the best case or I shouldn’t say the best case, the best example of a stagflationary environment is what’s happening in the UK with persistently high inflation. But now you have growth that may actually go negative and then they’ve got a real big problem. I think Europe is facing that as well.

Tony

Europe, I think we’re hitting up against some energy derived base effects over the next few months where I think people may be declaring victory over inflation and the battle may not be over. But we saw, especially gas, really rise Q3 Q4 of last year. And so they’ll be measuring inflation against that. I’m not sure that is going to be the battle is won type of environment for Europe.

Blake

I want to defer to Tracy and Albert as well. But Tracy, you follow a lot of these commodities. I was really, really carefully watching cotton over the course of the last couple of weeks. It had been basing since I want to say, the fall of last year of 2022. And it just broke out of a base, literally this week. And when you see these commodities percolate, that’s going to make life a little tough, especially when you have certain financial conditions are looser than they should be with equities where they’re at with the trickle down effect. You got people feeling a little wealthier. Their housing their houses or their multiple homes haven’t really lost a lot in value yet. And then you throw that type of spending on top of commodities staying very perky. I think this last leg of getting inflation from 3 % to 2 % is like running the 22nd to 26th mile of a marathon. And that’s where they’re at. It’s not going to be the easiest part.

Albert

Yeah. What we really should look at is the core CPI. That’s still raging hot. All the points that you made were absolutely correct. We’ve discussed this for many months now, Tony and with Tracy that Europe is just a zombie economy. And the moment they start taking up in any which way, inflation starts to rage again. And then energy inflation is gaining steam, not only there, but also in the United States. And we have a problem. I mean, the chairleaders of… We’ve solved inflation because they have a three handle, which is a little bit silly and way premature in my opinion.

Tony

Let’s circle back, Blake, for just a minute to talk about BOJ. I know we’re going to talk about a lot of the commodity stuff in the next section with Tracy, but let’s circle back to BOJ. There are some stories out today on Thursday about the BoJ tweaking yield curve control to cap it by 0.5 %. So that is a pretty massive change.

I know they just changed their BoJ chair about three or four months ago, so he didn’t want to make any changes right away. But it sounds like he’s really starting to talk about some incremental changes. This is a pretty small change, but it’s actually a pretty big change. Can you talk to us about that a little bit?

Blake

Well, I think it is a big change because it would be a step in the direction that the markets don’t want to see. The last time Bank of Japan tried to move off the zero bound was just pre GFC, the financial crisis in 2008. So here they are again trying to move off the zero bound first starting with yield curve control tweaks. Now the BOJ, we have a new governor, BOJ Ueta, which is really interesting is he had been so in his academic papers that he’s written over the last couple of decades, how critical he’s been of the BOJ and where they’re at. He jumps into the BOJ driver’s seat and he ends up being just pretty much the same as Kuroda. Probably from a political standpoint, not wanting to rock the boat too much.

Blake

However, he also pulled a very similar move to Kuroda this last week where they leaked out from official sources to Reuters, probably every journalist from Vogue to who knows what, The Economist, saying that they weren’t going to tweak yield curve control. We saw move in the Yen move lower. So people like myself that were pre positioned waiting for this yield curve control leak, we got stopped out. I took some losses last week because of it. And then here goes today from the Nikkei paper suggesting that tonight or tomorrow morning in Japan, they’re actually going to make the tweak and move the band so they can allow it to trade up to 0.5 %. Now, that in itself is that tweak of that yield curve controller allowing it to move is basically step one of probably many steps of trying to normalize their monetary policy. But if you think about that, that’s the last central bank that we have that really is keeping ultra loose policy. And that’s I think the takeaway that the markets need to start looking at, especially equity markets globally.

Tony

Right. Very hard for them to continue importing inflation, but also very hard for them to fight against demographics in terms of the productivity value add in their economy. So they’re in a really rough place. So can we look at a number of currencies? I have a chart up now on several currencies. I want to just walk through some things with you as we look at where we are. First, on the top and blue, we’ve got Japanese Yen, which we’ve seen real depreciation since 2022. Can we talk about within the context of the dollar, if this BOJ policy really does go through, do we expect marginal appreciation in JPY or do you think it’ll really come back down to say 120 or something like that?

Blake

That’s a great question. I think over time, depending on how aggressive the BOJ has to be, I think 120 would be probably a realistic expectation from a technical point of view because you’d be looking at an equal leg move from the highs down to the lows that we put in in January of this year. So that would probably take us in the range of 120. And it’s not going to happen overnight, but it’s baby steps for the Bank of Japan. And I think that the first real key is going to be what I saw as channel support, which it would be around the 136 level. We start trading below 136, 135. I think a lot of longer term yen shorts might be looking to exit those positions at that point.

Tony

Okay. And then looking at CNY, China’s economy is in a really bad real tough spot and we’ve seen some devaluation there. What’s your expectation with CNY, CNH? Do you expect to see continued devaluation there, or are we in that zone where the monetary guys in China are comfortable?

Blake

Well, I don’t think they’re comfortable at all. And that’s a great question. And it’s a really, as you pointed out, it’s a really complex situation that China is dealing with. They thought their opening would be great. The issue that China has, and if you’ve watched China over the last 20 to 30 years, trying to shift their economy to a consumer based economy, hasn’t They’ve made a lot of billionaires and millionaires as you could imagine, but still a majority of their country is not in that situation yet. Yes, I get to eat five bowls of rice today versus 10 years ago, and they had three bowls of rice. Maybe that’s the difference for a lot of their population. But the fact of the matter is, is they’re really trying to rely on domestic demand, and they just said it in the Politburo meetings this week that they are struggling with that particular issue. So they have a few levers that they can pull, stimulus levers, reserve ratio requirements. They can try to spur domestic loan demand, but the real estate markets are a little iffie at best because a lot of Chinese, they have multiple properties that they own.

Blake

So trying to get them to leverage up and borrow a little bit more. It’s a hard or a tough ask for the Chinese people. So China’s got a few levers left and one of them happens to be with the C&H. And the C&H and the C&Y. Trying to get the Wan or the Renminbi lower to spur more demand from Europe, from the US, make their goods cheaper. But it’s hard for the the PBOC to pull that lever without looking too obvious, right? Because we know they have the lever, we know they can pull the lever, but we know politically it’ll be frowned upon. So I eventually expect the US dollar C&H to break above 730 and maybe even go towards 750. And that would be signaling to us as investors in capital markets globally that China is really feeling the heat. So can the US dollar C&H continue to dip, maybe down towards the 200 day moving average around 7? Sure. Do I think it’s probably a buy down there? I don’t trade it, but I think people that do are probably looking at that level as an attractive level to be on the long side.

Tony

Okay, yeah. I think one of the key things that I look at when I look, especially at Northeast Asian currency is you have this movement with the BOJ, which will likely appreciate JPY.

You have the Korean won that’s appreciating. China’s domestic economy is a mess and they really need to goose exports so they can use that industry to further develop domest. Given all the troubles they have at home, that might be an easy decision for them to make to devalue just a bit to goose some exports, especially as more industries move off of the Chinese mainland for a lot of political reasons. In terms of moving industries, I want to also talk about the Mexican Pesso. We had a viewer question about the Mexican Pesso, and we’ve seen the Mexican Pesso appreciate pretty nicely against US dollar over the last, say, nine months or something. Can you help us talk through and understand why the Mexican Pesso is moving in that direction?

Blake

Yeah, you bet. This has been the darling of the FX market. By the way, going back to China, I just want to say I’m not the best China expert. I have some European members in the forex analytics team that trade the US dollar C&Y and C&H quite aggressively. So they’re better. I just take from them what I can. But as far as the Mexican Peso, it is something that I trade quite actively and aggressively at that. It’s been the darling of the FX market as a carry trade. When you can carry the Mexico’s higher rates over anything else, especially the euro, the yen, the Mexican, M XN, JPY, the euro, M XN, dollar and Mexican Peso. The Mexican Peso has been the star. And the reason why is because the rates are extremely high and FX institutions will park their money in Pesos and they’ll sell other currencies. And that’s great in a market where stocks are rising, we see that volatility is low. Those we call carry trades. That is the carry trade. It’s like the yin of the mid 2004 to 2005 era. The Mexican Pesso is in that situation. The risk at this point is that we’re starting to see other LATAM currencies l ike…

Blake

Oh, I always forget the central bank. The Chilean Central Bank, BCCH, is that what it is? Anyway, they’re about ready to embark on a rate cut campaign. Now, Chile is not Mexico, but it is a La Tène currency, and you’re starting to see some of these emerging market currencies, banks go stop raising rates as well. Will they start cutting rates? If they do, that the margin that you’re going to get on that carries a little bit less. Then if you start to see equity markets really come under pressure, like let’s say the and P trades from 40, it’s trading around 4,500, 4550 right now. We trade down to 4400 or 4,300, you’re going to see the air come out of the Mexican pay zone. You’re going to start to see the dollar outperform, the yen outperform as the BOJ adjusts their policies. Even the EuroMexican Peso is probably going to recover after having such a big slide. So I’d be careful with the Mexican Peso as it trades below 17. I think if it trades back above 17, 1705, especially 1750, we’re probably looking at a squeeze well over 18 again.

Tony

Okay, great. Thanks. We don’t talk about Mexico a lot, so this is really interesting.

Albert

I like the Mexican pace, though, simply because the trade has increased tremendously between Mexico and the United States.

Blake

I cannot disagree with that. And I think Mexico is the US is China. And specifically when I played a couple of rounds of golf with a gentleman that he has a chip company that he’s actually migrated his employees from China to Mexico over the last three, four years because of cost, labor cost. And so I am actually a Mexican pesos bowl. People that know me know that I believe the dollar Mexican pesos is eventually going to be trading in the lower teens over the course of the next couple of years. But right now, the specific risk is that we trade back to 18 before 15. How about that? Maybe that makes sense.

Albert

Yeah, I’ll leave the forex stuff in the levels of the U.

Tracy

And that was the exact question I was going to ask. I was going to say, does it have to do with trade with the United States as we’re seeing a lot of manufacturing, which was big in, say, the 80s in Mexico, now returning to Mexico with trade to the United States or say US companies moving their manufacturing to Mexico rather than China per se.

Blake

Yeah. And Tracy, I gave you that one example. It’s anecdotal evidence, right? It’s not like something I’d hang my hat on. But I think that is a trend that we will see in the years ahead is as China’s labor force shrinks and it costs more to produce in China, the rest of the world is going to search for alternatives. Most of them, like a lot of Europe, is going to go to India. We’ll go to India. But Mexico is our next door neighbor and labor is still cheap there. So we will find alternatives and I think the rest of the world will away from China. That’s one of the issues that Tony, you brought up about China. They got issues. You try to change your whole demographic of your entire ginormous country, there will be repercussions. And this is one of them, I think.

Tony

And it’ll happen. It’ll start slowly and then people will realize it and it’ll hit heart pretty quickly at some point. So I think looking at CNY, CNH right now is really important because I think we’re in the early days of something larger happening over the next few years.

AI

Great news, traders and investors. CI markets has expanded its coverage to include stocks from the S&P 500, Nasdaq, Nike, FTSE 100, and the top 50 ETFs. With more than 1,500 forecasted assets, our AI powered platform provides highly accurate forecasts. Join our community of successful investors who rely on CI Market’s insights to make informed decisions. Subscribe now for as low as $20 per month and unlock the power of comprehensive forecasting. To learn more or book a demo, visit completeintel.com/markets.

Tony

So Tracy, let’s talk about resources for a minute, I know that’s where you live every day. So we’ve seen strength in commodities over the last three months. I’ve got a chart up on copper, WTI and net gas up on the screen right now.

So why are we seeing a rally in commodities now? Is this really on the back of a week or dollar or is there something more to it?

Tracy

Well, I think we need to look at each one of these separately, to be honest. Just for example, Blake brought up the cotton issue and why is cotton starting to rally off the lows now. And that’s a China stimulus story right now because they have a lot of manufacturing to make a lot of cotton T shirts, etc. I think it’s really hard to lump all of the commodities together. So I would like to look at… I think we should look at oil or the energy sector in particular separately from, say, the metal sector, separately from, say, the softs.

Tracy

I think if you’re looking at the energy sector in particular, you are looking at a week or dollar. That always helps. And that all ends suddenly signs of life from China, meaning people are starting to believe China’s stimulus matters. Whether it’s come true or not, we really haven’t seen them say a whole lot until the last couple of weeks. You can even look at the hang saying on this in which we’re down 5 % on the year. And over the last weeks, it’s surging right away. Goldman just put out a note on Wednesday that said funds are piling back into China at the fastest pace in nine months over the last week, which is huge based on what they have said over the last week. It happened.

Tracy

Whether you believe them or not, the markets believe them at this point. And then as far as energy is concerned, we still have that supply demand issue. We have Russian S exports down. We have voluntary cuts filtering into global markets right now. And we are also seeing recession fears seeming to subside a bit because markets are seeming to starting to believe in this soft landing, or at least the commodities markets are.

Tracy

The equities markets, that’s a whole another story. And then if you look at the metals, again, I think if you look at the metals, this is again a China story. Suddenly, everybody’s believing China stimulus at this point. Again, I don’t know what exactly changed and what exactly changed the market’s mind, but I think it was helping a little bit of the property sector, which is definitely not enough, in my opinion, as well as the tech sector, the couple of announcements that they put out over the last two weeks. And so I think that’s really what we’re looking at right now. And again, a lot of it is the China story.

Tony

Right. So we’ve got Europe dead. We’ve got China dead with some commitment to them to maybe get stimulus, and we’ve got the US slowing down into the end of the year.

Tracy

Well, if we’re talking about the energy sector in particular with the United States, we have implied demand over the last several weeks has risen from 19 million barrels a day to 21.7 million barrels a day, which is huge. That’s over 2019 levels. And so we’re not really seeing And implied demand, you can take in different ways, but that is what product supply is implied demand. That’s what everybody takes it to be. So we’re not really seeing demand being lowered in the United States. We are also looking at a place in August where we’re going to see a lot of exports to China because Russian oil is getting to be more expensive right now. We’re above that price cap. And so we’re seeing China has put a lot of orders in for the United States, for WTI, Midland, for August deliveries. So we will see a reans here in the United States as far as inventories are concerned. And we still haven’t seen China overall. I mean, over this whole period that everybody’s thinking China is imploding, which they may or may not be. They’ve been buying oil hand over fist. And perhaps, yes, that’s a lot of it is going into storage.

Tracy

They can build storage out. But a lot of it, if you look at the refinery runs, are also huge.

Tony

I’m so glad you didn’t say China is talking up to go to war because I’m so tired of that.

Tracy

No, I don’t think China likes cheap oil, let’s be real. So they can get a huge discount from Russia, right? And get this price cap. And so at the time, it was $23, $20 below the price cap. Of course, who’s not going to stock up? India stocked up. Everybody’s going to stock up at that point, right? You’re going to buy high end over this. Actually, the best thing that the United States could are the best thing the West could hope for is that Russian oil is trading over that price cap because you know why? That doesn’t make it as desirable anymore. Nobody’s going to buy as much anymore. I think it’s short sighted thinking to say, Oh, my God. They’re trading over the price cap. Well, great. That means it’s not as desirable anymore. Why would I deal with the hassle of buying with them if it’s only a few dollars discount?

Blake

Do you mind if I interject and ask a question?

Tony

Yeah, absolutely, yes.

Blake

Okay. And Tracy, this is something I think about quite a bit just because we’re having this discussion or we’re having this discussion about crude oil and inflation, going back to the inflation question. It’s interesting. You watch crude oil rally and everybody cheers like, Oh, things must be getting better. But there’s always that inflection point, and I’m not sure where it is in crude or R Bob or whatever you’re looking at, but at what point do these higher energy costs really start to translate to, Oh, my God, that’s going to bite the consumer here in US globally, wherever you’re talking about. And crude going higher is not a good thing. There is that inflection point. I don’t know where it’s at. I don’t know if it’s at 80, 85 at 100. Do you have any thoughts on that?

Tracy

I think it really depends on the state of the economy and where we’re at. Our I think at $70, we’re still in that 70 to 80 range.

Blake

And I think that’s… Goldilocks, right? Goldilocks? That’s comfortable.

Tracy

It’s very comfortable, right? You’re not seeing $5 oil or gasoline prices at the pump. Not saying that’s a very comfortable position for oil to be in at this juncture. If we start to see oil prices spike higher than that, of course, that’s going to matter. And of course, this is all going to filter into energy runs the economy. You can’t do anything without energy. You can’t run a business because you have to keep the lights on. You can’t grow food because you need energy to grow food. So energy runs the economy. So at some point, yes, it’s going to matter. It’s going to filter in. It’s going to make prices higher. And I don’t think we’re going to see 2 % inflation anytime soon. In fact, even Powell doesn’t think we’re going to see 2 % inflation anytime soon. He said yesterday we’re not going to see this to 2025. I tend to think that ambitious goal because I think that no matter what we do at this point, if we’re looking at energy transition and we’re looking at all of these policies we want to put forward, we’re still lacking a lot of these materials, we’re still lacking a lot of energy for this.

Tracy

And this is going to be a huge problem that central banks just cannot counteract no matter… They may try. Actually, Peter Bookfire brought up a really good point yesterday when I was interviewing him. He said it’s easy to bring inflation down quickly with high rates. It’s harder to keep it down.

Albert

Tony, who told you that the more they rally this market, the more inflation is going to be a problem?

Tony

You did, Albert. You said it a long time ago. You said it.

Albert

Why people think that as they rally this market in silly, silly stratospheric levels, that they didn’t think that commodities in oil and wheat and cotton and every other thing is not going to run? Of course it is. Their problem is they’re running out of room now for rate hikes. So what they get, the only other option that I can see that they’re going to use is the US dollar. That’s the only thing they can do is take the dollar back up to the 108, 109 area just before you start breaking Europe and the rest of the world to try to team inflation because they don’t want to see 6, 7 % CPI prints going into an election year. That’s just ridiculous.

Blake

Isn’t it crazy, Albert, how the dollar can be weaponized? And it really can be, I believe.

Albert

Of course it’s going to be weaponized. It’s a reserve currency and Janet Yellen controls the policy. She’s going to do what she needs to do whenever she wants to do it. Unfortunately, that’s just the reality. It’s just the reality of the situation. And as I was saying, rate hike runway is pretty much ending. So the dollars is the only thing that they’re going to be able to use.

Tony

So your thesis is that US rates will top out at 6 %, and that’s going to crush China. Is that right?

Albert

Oh, yeah. China was never prepared for 6 % rates. Absolutely.

Tony

And again, tell us why? I want to make sure everyone understands.

Albert

Well, it’s just the debt level, the amount of debt that they had and the way they funded their debt. No one was, I don’t think anybody on Earth was thinking that 6 % % Fed Fund rate was coming. But here we are at 550 almost with probably another two hikes to go.

Tony

So we hit 6 % now. Now, China has been evergreening debt since 2009. They have all that debt for 20 years ago. They’ve continued to evergreen because they haven’t been able to pay it off and so on and so forth. Fed funds hit 6 % and the Chinese are practically begging the US not to raise anymore. Is that fair to say?

Albert

Oh, absolutely. And it’s funny because Yellen was just over there and then coincidentally, the dollar tanked underneath 100. As soon as she left for a day or two.

Tony

Total coincidence, Albert.

Albert

Total coincidence. Total coincidence.

Tracy

I tweeted that out. I tweeted that out. Absolutely.

Blake

Her getting psychedelics was total coincidence as well.

Tracy

That was the best part of the whole…

Albert

But I agree with Tracy wholeheartedly. I think 65 is the floor for oil, and I think probably 85 is probably a top for oil. It’s a comfortable zone that they’re willing to deal for the next whatever year or so.

Tony

Great. Let’s move on to earnings, Albert. I just want to cover a little bit on earnings here. What are your thoughts on future earnings? So far, we’ve seen S&P 500 companies report the slowest growth in margins since Q4 of 2020.

So over the last probably year, year and a half, we’ve talked about the pricing power that companies have had since about Q2 ’22 where they were able to continue to expand their margins and raise prices on customers and customers would just accept it. That seems to have come to an end at least a bit. So is that what’s driving this margin compression? I’ve got a chart from faxing on the screen showing the margins of companies coming down to right around 11 %.

Albert

It’s not just that. We talked about this maybe six months ago saying that this is probably going to end up happening where margins are going to start ticking down second half of the year. And that’s exactly what we’re seeing. The issue is, labor rates are still advancing. Their fake CPI is still a little bit of tailwind for earnings, but that’s slowing down too. So they don’t have that inflationary tailwind to jump up prices as demand is starting to take down. Consumers at this moment are a little bit more price sensitive. They don’t really need a Rolex watch or a secondary home or a third boat and whatnot. So as that money is starting to dry up, margins are starting to dry up too. I think that it’s going to be a bigger problem for Q4 However, if I’m right and inflation is ticking back up, there might be a little bit of earnings tailwind into mid 2024 again. Of course.

Blake

Albert, since you and I just met for the very first time today, it sounds like you’re obviously following earnings pretty closely. How do you feel about the Reishmont group last week and then Louis Vuitton this week? What does that tell you about the high end stuff and the high end global consumer consumer.

Albert

The high end global consumer, I’ve always watched to see when they start retracting spending is when I start to get nervous. Whenever the big homes in Naples, Florida stop selling and Louis Vuitton start getting worried about their demand, that’s always problematic. Now, I personally love Brunello Cucinelli. That’s my brand. I’ve watched them for years, seen their stock price go from 38 to 80. And as recently this last couple of weeks, I’ve been noticing their ticker trending downward. And I looked at their sales and their stores are not getting as many people in. Their online stuff is going more to outlet than it is into the stores and out to top consumers. So yeah, I think the top consumers are about to pause. If not paused already, they’re about to start pausing in Q4.

Blake

Yeah. The Reishmont group, I think last week they were down 10 % in European trade. And Tony, that goes back to your point about China and they decided to solve the Chinese high end consumer. They’re the problem.

Albert

Yeah, they say that. But that’s more than just that. The Chinese high end consumer is one component of it, probably a real big one. But the Middle East is probably showing the same little drawbacks. North America and Europe is obviously going to have falling sales in the luxury market. So they can blame China, but it’s a lot bigger than that.

Blake

Yeah, right. Cool.

Tony

I want to talk for a second about tech, Howard, because I know you love to beat on AI, even though I run an AI company. I don’t take it personally. So on tech, I thought it was really interesting that Microsoft’s growth for Azure hit 25 %, but AI was only about one and a half % of that growth. So I think some real questions have come. People have really started to think about AI. If Microsoft can’t get money out of AI because they’re effectively the owner of Open AI, right? So if they can’t make money out of AI, who can? We’ve seen for the past two, or at least earning calls, AI is mentioned dozens of times on so many earnings calls, right? So when do you think we’ll start to see that? Or do you think AI is just a feature in larger products that just help people retain and marginally grow?

Albert

Yeah, I think that’s correct. I think that’s just the feature and the larger products. The only AI that I would be excited about is whatever comes out of Apple.

Tony

And Complete Intelligence, of course.

Albert

Of course, Complete Intelligence. Truly dollar money maker right here.

Albert

But as a stock that’s actually traded, Apple would be my number one for AI. From what I hear, they have a working AI internally that’s just off the chain. But Apple is really smart. They wait years to perfect something before they start releasing things. So I just think that AI is a little bit too premature, and I don’t really like the marketing talk by some people. It just throwing AI around as if it’s some godlike feature on an app. It’s not. So I think we got a ways to go for that.

Tony

Yeah. My view is large language models like JMP and all the stuff that Microsoft is starting to do is really just a synthesized search engine. It makes your search a lot smarter. It’s all it does. It’ll take out some low level analyst jobs to write some papers for you. It’ll make your searches better, that thing. But we’re not to the point where those LLMs are real money makers right now. They make those applications more useful. Does that make sense?

Tracy

Anecdotally, wasn’t there just an article out that saying AI is getting dumber?

Albert

Well, it’s garbage in, garbage out. I think you’re talking about where chat GPT was answering 98 % of math problems correctly, and then just recently it dropped down to 2 %.

Tony

It answered 2 % correctly?

Albert

Yeah, 2 % correctly. It’s just garbage in, garbage out.

Tony

I’m going to look that up.

Albert

Yeah, I posted it.

Tracy

He posted it. I actually read it before he posted it. It’s true.

Tony

Because I don’t need AI to do those problems. I can get 98 % of them.

Albert

That’s the thing, Tony. I always tell people, whether it’s technological or political, social, things happen. Things happen incrementally. There’s never some jackpot trade or technology that comes out that changes the world like we’ve never seen before. It’s just things happen in stages.

Tony

But to OpenAI’s credit, AI, I think, was a really far off imaginary word to a lot of people until chat tipit e was brought to market. And then I think people went, Oh, my gosh, this really changes things. And I think it did. I think it’s the biggest change to search that we’ve seen in 20 years. I completely agree. It’s made it a lot easier.

Tracy

You just have to make sure it’s correct, right? Because you hear these stories, some lawyer used this for a brief and they brought in a whole bunch of…

Albert

Legal trouble. Yeah, you got.

Tracy

To say it. It didn’t really happen.

Blake

Yeah. It’s definitely like an assistant and you have to go back and double check the work. I look at AI as the Google Glass of today. Yes. I’m sure at some point we’ll all be wearing weird things on our heads. Whether it’s…

Tony

I hope not.

Blake

Not. Whatever. Well, just wake me up when Ex-Machina actually happens, and then I’m going to go run for the Hills.

Tony

Right, exactly. Just circling back to earnings for a minute, Albert, as we finish out this earnings season, are you looking for… Are we recapturing earnings momentum, say, later this quarter or into the next quarter, or do you see things continuing to gradually deteriorate?

Albert

I think we’re going to gradually deteriorate into the end of the year with probably earnings starting to tick back up Q1 Q2 of next year in the run up to the election. Obviously, tech earnings, it’s the fabulous five of Microsoft, Google, Apple, NVIDia, so on and so forth. Those are the ones driving the market. So that’s the ones that I would be watching.

Tony

Very good. Guys, thank you so much for your time. This has been excellent. Blake, thanks for joining us for the first time. Albert, Tracy, thank you your time as always. Have a great week ahead. Thank you. Thank you.

Tracy

Thank you.

Blake

Thank you all. Thank you.

In this episode of the Week Ahead, Tony Nash moderates a panel discussion with Brent Johnson, Albert Marko, and Michael Green, covering various key themes in the market.

The panelists address the uncertainty surrounding market direction, with predictions varying among experts. A correction is expected in the next 3-6 months, and while a crash is possible, monetary authorities may intervene to counteract it.

Factors such as the Federal Reserve’s tightening measures and rising interest rates are anticipated to impact market performance. Government responses to market downturns also play a role in stabilizing and stimulating the economy. The historical trend suggests that assets tend to trend upward in the long term.

Market sentiment is currently high, but positioning is no longer extremely bullish. Earnings are expected to decline in Q3, influenced by slowing demand and decreasing inflation. Large companies like Samsung, Ford, and GM may experience significant earnings declines. The limited ability to raise prices puts pressure on corporations’ bottom line, and lower volatility enables consumers to engage in comparison shopping.

The panelists discuss the complexities of inflation calculations and emphasize the influence of perception on market dynamics. Understanding the gap between the Fed’s reaction and the market’s perception is crucial for informed trading.

China’s challenges with inflation, manufacturing, debt loads, and demographics are highlighted. The struggles faced by the Chinese yuan (CNY) and the need for devaluation to enhance competitiveness are explored. The panelists also touched on China’s risk of collapsing due to demographics and limited consumption growth.

The discussion shifts to the interplay between the US and China, emphasizing the preference for economic fights over geopolitical or war fights. The strained relations between the two countries and the potential for unintended consequences are examined. The US dollar’s role as a tool in geopolitical events and its impact on asset prices and credit quality are discussed.

Chapter 11 bankruptcies in the US have surged despite tightening credit conditions, indicating market fragility. The broken relationship between bankruptcies and credit spreads is analyzed. Mechanisms such as preventing market clearing events and refinancing avoidance are examined. The potential for a severe correction, investment opportunities in defense companies, and the struggle of levered companies are also discussed. Overall, the panelists provide valuable insights into the evolving market dynamics and potential risks moving forward.

Key themes:
1. Epic crash or correction
2. Chinadestruct.exe
3. Credit divergence

This is the 72nd episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.

Follow The Week Ahead panel on Twitter:
Tony: https://twitter.com/TonyNashNerd
Brent: https://twitter.com/santiagoaufund
Albert: https://twitter.com/amlivemon
Mike: https://twitter.com/profplum99

Transcript

Tony

Hi, everyone, and welcome to the Week Ahead. I’m Tony Nash. Today, we’re joined by Brent Johnson, Albert Marko, and Michael Green. We’ve got three of the smartest guys on Twitter with us today and we’re really happy about it. We’ve got a few key themes we’re looking at. Brent will talk to us about an epic crash or a correction or what’s next in markets. Albert’s going to talk to us about a little program he calls Chinadestruct.exe, which we’ll get into. And then Mike’s going to talk us through credit divergence.

Tony

Before we get started, I’d like to let you know about a promotion we’re doing for CI Markets, our forecasting platform for stocks, ETFs, indices, commodities, currencies, forex, and economics. For the next two weeks, we’ll buy the first month of CI Markets for you. Go to the link to find out more. At checkout, use the code 25OFF. That’s the number two, the number five, and the letters O, F, F. This will give you the first month free when you subscribe to our $20 or $25 a month plans.

Get fresh market forecasts every week, accountable forecasts where CI discloses our error rates, and a growing set of capabilities.

Tony

We’ve just launched the top 50 US ETFs, Nasdaq 100, Nikkei 100, Fuzzi 100, and so on. Check out CI markets today and use the promo code 25off. Thank you.

Tony

Brent, I want to start out with the survey you took in January, showing that you were brilliant followers thought gold would outperform the S&P 500 for the first half of 2023.

I love surveys like this. I do this stuff all the time. I have one running myself right now about whether it will be inflation, deflation or stagflation in 2024, and I run it once a month just to see how those opinions track. So I love this stuff. You followed this with an actual performance showing that the S&P 500 outperformed anything in your survey, gold, TLT, and so on.

We’re at a place where a lot of people are confused about market direction. I’m confused, honestly. It’s really hard to look too far out given where some of the data is and it’s a little bit mixed. Without looking too far ahead, because I think it’s easy to predict extremes, where do you think we’re heading in the next, say, 3 to 6 months? Are we heading for a continued bull market? Do you see an epic crash or mild correction or something else? Can you walk us through that a little bit?

Brent

Yeah. I’m happy to tell you what I think it’s going to happen. But I’m going to preface this by saying that I don’t know. It’s confusing for me as well. And I think that one of the… And I’ve talked about this a lot. I’ve probably talked about it with you before, Tony, but one of the most amazing things to me is in this environment, I talk to so many people who think they have it all figured out. And I don’t have it all figured out. And I’ve been doing this for 25 years. And I talk to other really smart people who have been super successful and they don’t have it figured out. So when I do talk to people who are so certain to me, it comes off as a little too much. And I don’t think this is the type of environment to be certain about anything. Now, having said that, my base case is that we are going to get a correction sometime in Q3 or maybe in Q4, but sometime in the second half of the year. As of right now, I think it’ll be a correction. I don’t think it will be an epic crash.

Brent

I understand the arguments for the epic crash, and I won’t rule that out. There’s a number of factors that could lead to that, but that’s not my base case. My base case is that we will get some a correction. The rest of the world, I think, will feel it more than the United States will. But I think that the tailwinds that the markets had for the first half of the year are gone, and there are a number of headwinds now. Now, again, whether those headwinds lead to a crash, I’m not sure about that, but I do think there are their headwinds. I don’t think the going will be as easy in the second half as it was in the first half. We had a lot of stuff happen in the first half, and I think the reason it is confusing is not all of it was good. Some of it was bad. I think since 2008, there’s this predilection for people to want to predict the crash. And I think part of it is, I know we’ve talked about this before, part of it is this, they want to see it happen. They almost feel like the US deserves to have this happen to them.

Brent

And as a result, because the US deserves to have it happen, it’s going to happen. And again, I understand the arguments for that. But the reality is if you look at a long term chart of assets, they trend up into the right. They tend to do that, and they tend to do that because Fiat tends to lose value over time. And even though that upward into the right graph over time is punctuated by draw downs, usually there is some a monetary response or government response to get it back on track of up and to the right. And so I’ve always managed money with that in mind. I want to be long assets because Fiat loses value and assets trend up, but I almost always have some hedge or some cash on the sideline in order to be ready for those draw downs that will inevitably come and then try to take advantage of whatever government response comes as a result of those draw downs. Now, the tailwinds that we’ve had for the last, let’s call it nine months, eight or nine months is that we had bumped up against the debt ceiling. So while then in 2022, Powell hiked like crazy, yelling, wanted a stronger dollar.

Brent

And so through October of last year, early November, that happened. But since then, even though Powell continued to tighten, his tone changed, his pace, the race and the pace of change slowed, and he spoke not as hawkish. And so a lot of people have assumed that we are at the end of the tightening cycle, and they’ve front ran that. Now, in addition to that, what we had was as we bumped up against the debt ceiling, the treasury could no longer issue bonds. And so typically what is happening is while the government is spending a lot of money into the economy, they’re typically draining it from the economy simultaneously by issuing treasury bonds. They give the public treasury bonds, the public gives them cash. They’re spending money in the economy, but they’re also pulling it out in order to fund their own operations. But as they bumped up against the debt ceiling, they couldn’t issue those bonds anymore. But they were still spending money. They were spending money out of their TGA account. And so that was providing tailwind of liquidity to markets at the same time that Powell was slowing rate hikes. And so that provided, in my opinion, an extra boost of liquidity that otherwise wouldn’t have been there had we not been up against the debt ceiling.

Brent

Well, now they’ve raised the debt ceiling and Powell, I think, continues to raise. And until markets force him to turn, I don’t think he’s going to turn. I think he’s going to raise. Now, he’s not going to start doing 1 % hikes again and he’s not going to do five of them in a row. But I think his proclivity is to continue to tighten. So that will, in my opinion, pull some liquidity out. The treasury will continue to issue bonds. So that’s no longer a tailwind. It’s now a headwind. We have the student loan forbearance that I think in sometime in October or sometime between August and October. So that would be a headwind. And not only that, but think about all the rate hikes we have had in the last 15 months. Oftentimes it takes anywhere from 12 to 18 months for rate hikes to show up in the real economy as old loans or old credit lines come due and they get refined nanced at the now higher rate. Those are going to start getting refinanced at a higher rate. And I think that will be a tailwind look to liquidity. And so it’s for all those reasons that I expect us to have a pull back or a correction.

Brent

The reason I don’t yet think we’re going to have a full on crash, like many are predicting, is because I think monetary authorities will counteract that, or at least will try to counteract that. And I know there’s people out there saying, Well, markets are bigger than governments. And you’re absolutely right, they will. They are. And eventually that will happen. But I am not someone who believes that the Fed is out of bullets. I think there is a lot of things that the central banks can still do. I think there’s a lot of things that the monetary authorities can do. Whether they should do them or not, that’s an entirely different conversation. But I think they will. And so I think right now, to me, it’s a fairly easy decision for me to be hedged. I’m actually neutral to even maybe slightly net short right now based on the number of hedges that we have. And to me, it’s a fairly easy decision right now because sentiment is pretty high, not as high as it was a couple of weeks ago, but it’s pretty high. Positioning is no longer super bullish and we no longer have the tailwind.

Brent

Where I think it gets really hard, Tony, is if we do get a 10 % correction, then what do you do? Is that dip that you buy or is that where you really get careful because the crash is coming? And again, I don’t know the answer to it, but I’m happy to be neutral to net short right now and just wait and see what happens over the next month or two. That was a very long, rambling answer to your question. Hope that explained it.

Albert

I agree with Brent. I don’t really see a crash coming. They’ve repeatedly said that they’re looking at a soft landing and performing that when the market is performing that way. Another thing that I want to touch on is inflation had a lot of inflated earnings for corporations, so it just kept rallying the market over and over again. And I think that’s probably coming to an end in Q3 and Q4. Fed funds rate, I think it’s probably going to 6 %. That’s going to be another headwind that Brent was talking about. But the Fed does it. They’re certainly not out of tools. They can use a VIX crush. They can use zero day trades. They can text stocks rallying repeatedly. I mean, like, AMD or Apple in any given day goes up 5 %, 6 %. I don’t see a crash coming just like Brent was talking about.

Tony

It’s interesting, but Brent noted that 10 %. Is that the marker? Is that the number? Is it 10 %, 20 %? When does the Fed get…

Brent

I don’t think it is. I think they would have to go back to the levels we saw last September or potentially even lower for the Fed to fully reverse. Now, it’s not to say that they wouldn’t come out and jawbone or talk about slowing paces or say we have tools to reuse this, but I don’t see them going back to QE unless we get at least back to where we were last September. And here’s why I think this is that when they started their rate hiking cycle 15 months ago, very few people thought that they could pull it off or at least pull it off to the extent that they have. But they have. They have taken rates from a half a % to five and a half % on their way to 6 %. And markets are within what, 3 or 4 or 5 % of their all time highs? If you would have told Powell 15 months ago that he could take rates from 50 basis points to 6 % and markets would be within 5 or 10 % of their all time highs, I think he would have said done. Thank you very much.

Brent

I love that solution. Yeah. Now, I think that they’re going to be surprised. I think things are going to deteriorate quicker than they think it’s going to, but I don’t think they’re going to react until it does deteriorate. And I know that if it deteriorates bad enough, they will react because that’s literally their job is to go in there and react and be the lender of last resort or save the system, however you want to define that. But I don’t think that their be upset with asset prices 10 % lower than here. I mean, we were basically there last November and it didn’t really stop them.

Tony

Right. Brent, it’s interesting when you talk about them coming in and job owning and the Fed job owning and saying, don’t force us to support markets. I mean, how hard could that be? It’s not like it’s punitive, right? And so Albert mentioned earnings. Albert, can you talk a little bit about where you see earnings going in Q3? Because we’re starting up soon.

Albert

I don’t think they’re going to be good at all. I think we’re going to start looking at earnings starting to come back down. There’s no tailwinds of inflation to help out these inflated prices that a lot of the corporations are reporting. Demand is certainly slowing no matter what data they spit out. Their demand is slowing. Inflation is coming down. Certainly it’s coming down. But I don’t see how corporations are going to be able to make up all that in their earnings with their reporting in Q1 and Q2. I just don’t see it continuing.

Tony

Well, we saw Samsung report earlier today with a 96 % decline in their earnings or something like that. Of course, they’re not American company, they’re a Korean company, and it’s a specific industry issue. But when we start to see very large companies with those type of prints, I think it really does start to raise some eyebrows.

Albert

Yeah, you’re going to see Ford and GM do the same thing. Those EV sales are slow and lackluster and recalls keep coming in. I just think the earnings are just going to take an absolute nosedive.

Tony

Right. And we also, I think for a year or so, we talked about how companies, whether it’s restaurants or consumer goods, would raise price and they wouldn’t really see their volume decline. But that’s changed pretty dramatically over the last, say, four or five months. And so companies don’t have the ability to continue to raise price to grow their bottom line. Yeah.

Mike

I was just going to add to that. I mean, the General Mills report is obviously the one that everybody responds to on that where they have limited ability of indicated that there’s limited ability to raise prices further. And I do think it’s funny, people have used this term greedflation, and they’ve used it in both directions. There’s a lot of people who I think take it quite seriously. I m among them. There’s also people that treat it quite dismissively and say something along the lines of, Oh, surprise. Corporations are greedy. They’re in search of profits. That’s not actually what the message was. The message was that what we were seeing is corporations were taking advantage of the volatility of price data to raise prices whenever they could. Saying to their customers, It’s not really our fault. You understand, inflation, things are crazy. That created the opportunity for them to raise prices. But as the inflation, as Albert is pointing out, has retreated, and more importantly, the volatility of that inflation has retreated, it’s becoming easier and easier for people to, again, comparison shop, make the articulation, I’m not going to buy these eggs at 7.99 because I see them next to another pack cheaper at 2.99. Suddenly, that is happening again.

Mike

That ability for consumers, both on the institutional side, supply chain managers and on the retail side, the consumer themselves to actually start to do the process of comparison shop again in a lower volatility environment is putting tremendous pressure on these types of prices.

AI

Great news, traders and investors. CI Markets has expanded its coverage to include stocks from the S&P 500, Nasdaq, Nikkei, FTSE 100, and the top 50 ETFs. With more than 1,500 forecasted assets, our AI-powered platform provides highly accurate forecasts. Join our community of successful investors who rely on CI Market’s insights to make informed decisions. Subscribe now for as low as $20 per month and unlock the power of comprehensive forecasting. To learn more or book a demo, visit completeintel.com markets.

Tony

It seems to me that July and August, say, CPI prints may reflect a bit of a slowdown and potentially disinflation based on some of the base effects we had last summer around crude and the secondary tertiary impacts of crude. Is that a fair assertion to make? And do you think in two months time, we’ll declare victory over inflation?

Mike

I don’t think that we’re going to declare victory over inflation in two months time, in part because I think that we’ve actually created some of our own inflation. And so this has been an area that I’ve spent a lot of time trying to educate people on. Many of the components of what’s called the super core services, actually, crazily enough, have interest rates embedded in them. The most extreme one I can give is the cost of banking services. The cost of banking services in the CPI is defined as the spread between the risk free rate on government bonds and the interest rate you’re receiving on your deposit. Jp Morgan, for example, it’s perceived that their banking services have risen in price dramatically and that people value them so deeply because they’re paying effectively 500 basis points, 5 % for a bank service that they used to get for 25 basis points. Now, there’s been no change to the services cost. There’s been no articulation of an actual price change, but that’s what’s showing up in the CPI suddenly. Likewise, I know that you guys are active in financial markets. You’d be very surprised to discover that mutual fund fees have exploded.

Mike

The cost to investors of mutual funds, of financial services management has exploded. Why? Because the cost of securities lending has risen so much because it’s tied to the financing rate. So again, these silly things show up auto leases. Same dynamic where the actual cost of financing is now actually showing up in the cost of the auto lease. All of these are things that are feedback loops in inflation, and the Fed seems very unwilling to actually engage in discussions around that. I’m with Brent that says, one, I think it’s going to be very hard to get them to reverse. I don’t think it’s actually tied to the equity market s at all. I think it’s tied to the credit markets. I think within the credit markets, they’re going to be extremely slow to react because this is a general mantra that we saw take hold with Silicon Valley Bank and First Republic of, Oh, it’s their fault. They shouldn’t have been so greedy and stupid. So we’ll see stress begin to emerge there. And I think it’s only really when you begin to see the unemployment kick up in a violent way that they’re really going to feel any real pressure.

Tony

Okay. So on that first, I’m shocked to hear that not everyone at Silicon Valley Bank was stupid. Kidding. But we saw the employment report today. It was obviously not as aggressive as ADP earlier this week, but still very strong.

Mike

Just as a quick modifier on that observation, though, remember that the birth death on average on a seasonally adjusted number, which is what we saw, is adding about 100,000 jobs to the private sector. That’s all it does.

Tony

Every month.

Mike

Every month. So right now, we’re running on an annual average about 108 to 120,000 jobs per month that are being created using this, what I would describe as fictitious model of birth depth. That 144, in my math, was 32,000, basically.

Tony

Yes. That’s one of my bigger points that I try to hammer home on Twitter all the time. The least trustworthy data that I’ve found are jobs data, inflation data, and retail or consumer spending data because these are what get headlines in media and you always have to wait for the late revisions to really understand what’s going on. So that’s a great point. Mike, so.

Brent

Can I jump in real quick? I want to say something on that because this is where I think markets get really interesting. And this is why I think I’d be interested to hear what Albert and Mike think about this. But it’s also why I think markets will trend in a certain direction before they typically gap is that you’ve got to play what the fundamentals actually are, but you also have to play the common knowledge game. If you and I and Marco or Albert and Mike, if we know that the inflation numbers or the way they’re calculated are a little off and the jobs numbers are calculated a little off, that’s fine. But if nobody else knows it and everybody else goes off of the headline, then the markets are going to react to the headline. Now, eventually the fundamentals will catch up to the headlines and eventually you’ll hit the wall and you’ll get this hard draw down. But I think this is a mistake a lot of people make in the markets is they will try to look through the data, which is good. I’m not saying it’s a bad thing to look through the data, but you also have to understand I’ll talk to so many people say, Well, the CPI data, they don’t calculate it the way they used to.

Brent

If they calculated it the way they did in 1982, it would be much higher. Okay, that’s fine. And it’s good to know that. But markets react off of the way it’s priced right now. And so eventually, maybe those fundamentals will catch up with it, and we will have an epic reversal because the Fed also ignores how it used to be done. Mike just said the Fed is reluctant to look into this or engage with it any deeper. And so that’s why and with all the work Marcus, Mike has done with the structure of markets with passive investing, it’s really hard to change the trend. But when the trend does finally change, then it can move really quickly in the other direction. So anyway, I think to me, that’s one of the more interesting parts of markets.

Albert

Yeah, I agree with Brent. I mean, the BLS number, as Mike just pointed out, it was changed, I think under Obama and then Trump railed against it, but he kept it. And the way they calculated it is now even more inflated than it was previously. But even knowing that Brent’s right, perception is reality at the end. And that’s just the way the market is working. If they’re going to come out there with Fed speakers trying to rally the market and these employment and CPI prints rally the market, then it is what it is and you just have to react to it. Even I know this market is just full of crap at the moment. But, I’m forced to take five tech stocks and hedge against all my puts because I know what the game is at the moment.

Mike

I’m going to actually say, first, obviously, I agree. At the end of the day, markets are right, whether regardless of your analysis, price goes up, you have to mark your book. It is a luxury that private equity doesn’t have, for example. And we know that, but there is also a reality associated with this dynamic of transactions or forced behavior. The only reason I care about that data is because I actually am trying to understand what’s really going on, effectively identifying the alligator jobs that are opening up between what the Fed is reacting to and what market they’re reacting to. And what I’m seeing is the underlying phenomenon. That’s really all you can do. I agree with what Marco is saying and what Brent is saying. You have to trade the market. But at the same time, it is a variant. I think one of the most misunderstood statements was Chuck Prince, when the music’s playing, you got to keep dancing. Everybody universally shit on that coming out of the global financial crisis because we all had the hindsight to look at that. But he was right. It’s the same thing we’re experiencing right now.

Brent

That’s exactly right. That’s exactly right.

Tony

Hey, speaking of keeping dancing, let’s move on to China. These are great guys. We could talk for hours on this stuff. Let’s move on to China. Albert, you posted something a couple of weeks ago on June 29 talking about this Chinadestruct.exe when US rates go to 6 %. Really interesting. And a viewer asked us to talk about this on the show.

So can you talk to us about how rates approaching 6 % impact China? Also, we’ve seen some real pressure on CNY. So our view is that we’ll continue to see pressure through the end of the year.

But why is CNY struggling? Can you talk us through that stuff? And obviously everyone join in. But, Albert, if you don’t mind, if you can start on your Chinadistract.exe, that would be fascinating.

Albert

Well, it’s predicated on the notion that it’s better to face China and stress them in the economic markets rather than face them globally on a geopolitical level or in a military conflict or any one of those different variables that people like to talk about in the doomsday preppers. But China was never ready for 6 % Fed funders. They’re not ready for it. It was out of their calculations. They didn’t think it would ever go up that high. They’re just simply not prepared for it. And that’s going to take a significant chunk out of their purchasing power. They got debt issues or the dollar debt issues. They have issues all over the place. 4.5 % on the ten year for Asia and whole, that’s really problematic from what I was told. I think we’re just discussing it off camera that just takes a lot of the inflows back into the US dollar and the US markets. And Yellen knows this. Yellen knows this. Right before she goes to visit China, the DXY is still elevated at 103, 104. So she’s over there lecturing the Chinese on what she thinks needs to be done and whatnot. But it’s clear as day at the moment that the United States has a policy within, whether it’s the treasury or the Biden administration, to keep a cap on China’s ability to stimulate the economy and potentially launch another round of inflation globally.

Tony

So why haven’t they, in your view, why haven’t hasn’t China really focused on stimulating their domestic economy?

Albert

Well, they got an inflation problem themselves right now, currently with commodities all over the world just being elevated. Their manufacturing sector is still a little bit… It’s not running on full cylinders at the moment. They’re not in a good place, put it that way.

Tony

They’re a little bit stagflationary. I wouldn’t say fully, but a little bit it seems.

Albert

Yeah, they got a demographics problem, as many people have pointed out on Twitter and everywhere else in the media. But they’re just… He has so many problems economically and politically that for him to even talk about devaluing the RMMB is almost a non starter. But the reality is that that’s probably what’s going to have to happen at some point.

Tony

Well, they have to. You’ve got a depreciated JPY, you’ve got a depreciated KRW. Those guys in Taiwan are the major competitors for exports. So if China is going to raise dollars, they’re going to have to do something to make their export. I mean, it’s an overly simplified argument, but at some point they’re going to have to do value because they’re still carrying debt loads from pre 2008.

Albert

Yeah, their debt loads. Their debt is anywhere between 500 and 700 to the GDP. So it’s not really… The reported debt loads that they have is probably three times as much.

Tony

I want to go back to that because you said their debt loads are between five and seven times GDP. What we typically hear is something like 230 %. So can you talk us through a little bit of your assertions there?

Albert

Well, even the Chinese have started to talk about being able to identify the debt within the country in the real estate sector and the commodity sector. I knew people in China that would look at a pile of copper and inquire about it, and they were told it’s been leveraged already five, six times. So it’s like all this hidden debt in China is still relatively unknown.

Tony

Okay, interesting. Brent, do you have any thoughts on C&Y and what’s going to happen there?

Brent

Yeah. I sent you a chart before we started that goes back, I don’t know, maybe 10 years, and it shows the mini deval they did in 2015.

And if people remember, just that small little deval caused, at least for a couple of months, a little bit of chaos in the markets back then. And now C&Y is significantly weaker since then. And to me, it’s a function of the US being in a place where they are better able to raise rates than the rest of the world. For all the people who say that the US cannot get away with keep raising rates, I completely understand the argument they’re making. But the US can get away with it better than everybody else. And as a result, the yield differential between a US Treasury and a C&Y Treasury, but you get to hold the dollar rather than holding C&Y, just more money flows into the dollar and makes the dollar stronger. And then they have a lot of dollar debt and it’s now getting refinanced at higher levels. They’ve got a slowing real estate market, which they’ve been dealing with for a number of years now, and they’ve been able to plug those holes, but it’s just becoming harder and harder to do.

Brent

And I think they’re getting it. The C&Y has gotten fairly weak this year. My guess, if I just had to guess on what will happen is, they will do something in the next month or so to strengthen it in order to show they’re tough on it, in order to scare anybody who wants to short it. But I think by the time we get into the second half of the second half, I think the C&Y is significantly weaker than it is right now because I just think that they have too many problems, in my opinion. And if they lower rates or they stimulate, then that causes their inflationary problems to pick up internally, which causes social problems internally. But if they don’t do that, then their real estate market comes under pressure. And I think ultimately that they will sacrifice the currency.

Tony

Well, I think what a lot of people underestimate is, of course, fiat currency is a faith based activity. And your currency is only as good as your central bank. And the amount that people understand about the PBOC is almost nothing. And the transparency of the PBOC is almost nonexistent. I’ve said this several times and I’ll say it again, PBOC management borders on numerology. At some point, it is literally numerology when they make policy changes. So for people who claim that the CNY is the globe’s next reserve currency, or that it’s credible, or whatever, they obviously don’t watch the PBOC very hard because there’s some very weird moves that they make.

Brent

I know Mike’s done work on this as well and be curious to hear his thoughts. But it’s just one of these things, and I know I’ve harped on this for years now, and I would encourage any of the listeners who have taken a hard look at the US and have come to the conclusion that the US is in so much trouble because we have all these problems, do that same level analysis on these other countries. And you’ll realize that they have all the same problems, but they don’t have nearly the same advantages as the US. So this is not to scapegoat the US. It’s not to say that we are immune. It’s not to say that we won’t eventually feel the pain. We will. But on a relative basis, the US it still looks much better in my opinion in the rest of the world. And the other thing is, we talked about rates earlier, but real rates, I think the US has, I think, has the highest real rates in the world right now. That is a magnet for capital as well. Money will go where it’s treated best. And even though we have problems here with rates where they are and inflation coming down, the real rates are positive and getting more positive, at least for now. That can change very quickly, but at least for now.

Tony

Sure. It could. Mike, do you have any thoughts on that?

Mike

Well, so I would hit on a couple of things. One is, first, I agree with a lot of what you guys are saying. I do think that it’s important to recognize that the US, while it has tremendous resource advantages and has well documented advantages in terms of navigable rivers, separation from the rest of the world. We effectively have two somewhat friendly countries on our borders. We don’t really have to worry about hostile competitors in the same way that others do.

Mike

The problem for the US is social cohesion. Are we actually one country now? Are we two countries? Are we three countries split into two various flyover regimes with a standout group in the middle? We just don’t know yet. And that I think is really part of what we need to be very aware of. If we pull together and we behave as a cohesive unit, you can’t fight us. We can’t be stopped, at least not within the normal framework. But that is the key risk for us is the social cohesion dynamic. For China, they have a totally different one, which is that they have built up the productive capacity to serve the world. The rest of the world is suddenly saying, Hey, we don’t really trust you, China, to do that. And we certainly don’t want to take more of your excess production as we’re struggling with demand dynamics at home. And as a result, China is now facing risk of collapsing due to demographics and inability to grow faster than the rest of the world on the productive side at the same time that they just can’t grow their consumption. So you’re potentially looking at a true collapse.

Mike

It’s not dissimilar to what happened to Japan. It’s just they’re starting from a much lower point, which means there’s a very real risk that it turns into something really ugly.

Tony

And every Chinese economic planner’s nightmare is becoming Japan. And every Chinese, and they swear it’ll never happen.

Mike

Well, and the problem is for them to become Japan, they have to do what Japan did actually in 1989, which is roll over, expose their belly and say, Please, America, protect us. And this is something that I’ve said for going on explicitly with Europe. I’ve said it for Japan for 20 years. These places are… Europe and Japan have rolled over effectively and said, We are subservient to the United States. They may not acknowledge that yet. That’s much harder for Europe to engage in. Germany was Eastern European and Chinese flirtatious for an extended period of time. That honeymoon is beginning to break. And the problem is that if they want to rely on us to protect them, they have to actually be a little bit nicer to us, I guess, the way that I would describe it and stop talking so much smack. If I look at China, to me, the really critical relationships that I’m watching in the currency space are much less tied to the US, China, which I agree has the potential for a meaningful devaluation and would highlight that it’s had a much more significant devaluation than the mini one in 2015.

Mike

I actually think the much more interesting one is the within Asia relationships. So if I look at the Singapore dollar versus the Chinese one, to me, that’s just a very clear indication of capital flight out of China. You’re effectively seeing everyone who can get money out go to Singapore in one way or another or to other areas around the region. That is really concerning because I would actually turn around and say, I know that the crypto bros and Bitcoiners have gotten this world where we’re told that Fiat is faith based. That’s actually not what it is. It is force based. It is your ability to force your citizens to exclusively transact and pay taxes in your local currency. And when you have capital flight like we’re describing, where the money is actually taking every opportunity it can to get out of China, not return to China, and instead go to safe havens like Singapore, that’s telling you that the force based character of China is getting weaker and weaker.

Tony

Yes, and that should be terrifying for them.

Mike

I agree.

Tony

Going back to what Albert said at the very beginning, I would much rather we fight economic fights than fight genetic geopolitical political or war fights. It’s so much more desirable to do this. And the other part about that, Mike, when you talk about Europe and Japan rolling over, they’re not bad places to be. And the US is not a harsh, I guess, master. I hate to put it that way, but the US is not a harsh party to bail someone out. Japan is a great place to be. Europe is a great place to be. So for China to become more accommodative to US support and US guidance, I don’t think that’s necessarily a bad thing for them. It will take a lot for the TCP leadership to acknowledge that. So I think there’ll be more suffering at home before they’re ready to acknowledge that.

Mike

Unfortunately, I think that’s correct. I think that the key issue is that we are facing conflict with the TCP, not necessarily the Chinese people. How we choose to interact, how they choose to interact in that process is going to define a lot of it. And in many ways, the US has squandered a lot of the goodwill that was created. We remember Pepsi and McDonald’s going into Russia or the USSR, and all the goodwill that existed there. That’s now largely been squandered. There’s a very real risk that we go through similar dynamics with China. I would argue that we’re actually well on our way to that where the Chinese domestic narrative is turning to this century of humiliation at the hands of Westerners, and we have to act to preserve our rising and recentency.

Mike

All the language that’s there is used by every externally focused authoritarian government in history, from North Korea through Germany, through various bad guys as we view them in history in Europe and elsewhere. So I just think that’s unfortunately the case. I would also say, though, that even when you do have the economic competition as compared to the kinetic competition of a war, obviously, I would prefer to have the economic competition as well, but it’s foolish to think that there are not important ramifications associated with that.

Mike

So just like it takes resources for us to go and fight a war, it’s going to take resources for us to go off and fight economically. What I don’t know, and this is Albert and many others are more connected to this stuff, I don’t see the actual awareness of using US interest rate policy to fight against the Chinese. I think it is an unintended benefit, but I don’t think that there’s actually a fully intentional process associated with this. I really do think that this is mostly about domestic concerns, but it has the unintended benefit of behaving like John Connolly. It’s our currency, your problem. The problem is, do we get to the point when I sent you guys an email that shows the history of the DOW versus gold.

One of the things that’s really interesting about what happens is when you start to see these unanticipated reversals, it’s almost always tied to some form of breaking point that’s happened in a geopolitical and economic framework, whether that’s the Sino Japanese War in the 1930s, the Mexican Peso and British pound devaluations in the 1970s. I don’t know what it is this time, but that is absolutely the way it feels is that somebody out there is preparing to break.

Mike

And I can’t help but look around at the few remaining pegged currencies to the US dollar, and I’m just like, why? I mean, the Middle East, Saudi Arabia is playing a terrible game in terms of aligning itself with the United States, is doing everything that every small, potent, a dictator does in history to basically tick us off. And it’s playing a a very dangerous game in my view. Hong Kong, it’s literally, if we were to just decide that we’re going to sever some banking relationships which are increasingly irrelevant, that currency has to collapse against the US dollar. So we have all these characteristics that are sitting out there and some of these things. I think those are going to be very interesting potential shocks to the system.

Albert

Yeah, you have a lot of political risk there. People within the White House and the State Department acting a fool and forcing one of these issues to break and causing economic calamities around the world. So I agree with Mike on that one. It’s one of those things where there’s no competitor to the United States right now economically. So it gives us benefits, but it also gives us a lot of room to make mistakes.

Mike

We are an elephant in a tea shop. It’s really easy to unintentionally break stuff.

Brent

Yeah, I would just say that I tend to agree with Mike that the US does not lead with the dollar as a weapon, but I think that they are fully aware that it is one and they know how to use it if they choose to do so. I don’t think that they actively do so on a regular basis, but I think they know they have the capability to use it if they want to. And so I think that is why we could have a similar break. As we’re talking, I’m looking at this chart you just sent, and I could see some a break similar to these other geopolitical events in which the dollar would be used as a tool to do that.

Mike

Well, that’s what the chart… Again, Tony, if you want to put it up, you’re welcome to. Yeah, it’s going to be up.

Mike

The point that I would emphasize is just that when this is going down, we usually think about this as the dynamic of the US dollar weakening against gold. So this is just showing the ratio of DOW and gold. But what’s really happening in a lot of these situations is that the dollar becomes impossibly strong in a manner that effectively causes chaos. That in turn causes people to recognize that that can’t continue. So they begin moving into gold, allowing gold to appreciate at the same time that the dollars appreciating against everything. This is Brent’s dollar milk shake.

Tony

Yeah.

Mike

That unanticipated strengthening of the dollar hits assets that are from the private sector and designed to deliver dollars in the future, which is all common equities and corporate bonds and household mortgages, etc, are, they are instruments that are designed to return dollars in the future. If you spike the price of the dollar, they have to fall in price and the credit quality has to deteriorate because it becomes more uncertain that you’re going to be able to meet those commitments. Is.

Brent

Yeah, and I think that’s absolutely right. And the point I just want to make, because I think a lot of times when people hear me say this or you say this is the milk shake theory is that they automatically think that because I think the dollar gets stronger and the US is best on a relative basis, that this is a good thing for the United States. I don’t necessarily think that. It could be these unintended consequences. It could be a really bad thing for the US, but I just think it would be even worse for everybody else. So I don’t think that this is a situation where the US is having a picnic and the rest of the world is in flames. It’s just on a relative basis, if you’re holding the sword, you typically tend to be the one that’s better off.

Albert

Yeah. No, I agree. We saw the dollar get up to the Dixie, get up to like 112, 113, 114. And I mean, Europe was on the verge of breaking.

Mike

Yeah, that’s another chart that I’ve shared. I put it on Twitter the other day. I put it in our tier one note earlier today, which is this dynamic of everyone’s pointing to the Dixie and saying it can’t get out of its own way. It’s like, guys, wait a second. You understand what happened last time last year was the Euro got killed on a terms of trade deal where they suddenly had to buy our super expensive oil and gas. That caused Europe to move into a structural trade deficit as long as oil and gas prices remained that high. They’ve now unwind that. And now we’re looking at the interest rate differential story. Unless, of course, the US output in terms of oil and gas continues to depreciate sharply. But I just think that’s really hard from here. So a very temporary relationship, Kip, and I put it into a Twitter chart saying, this is the source of so much macro confusion where the euro, which traditionally trades with oil because it tends to be an anti dollar trade, suddenly completely reversed. That was just terms of trade. And within FX, it’s very rare that major developed market currencies trade on a terms of trade basis because they tend not to move that radically, but this was truly unique.

Tony

Yeah. Hey, guys, speaking of breaking things, let’s talk about credit for a little while. Mike, we were talking yesterday about credit divergence, and data were released earlier this week by Epiq showing that Chapter 11 bankruptcies in the US have surged by 68 % year on year in the first half. So we’re not seeing that in high-yield credit spreads.

We would expect to see this in a very loose credit environment, but not with the tightening we’re seeing with the Fed and regional banks, meaning the low credits. So what’s wrong and what are we missing here? You sent me a great chart showing bankruptcies and credit spreads and how that’s a bit broken. Can you walk us through this chart?

Mike

Sure. So the chart I believe that I sent you is one that shows the actual bankruptcy is rolling four week average.

So it’s not looking at that percentage change which can be colored by coming off a very low level. So we’re currently seeing levels of bankruptcies that are similar to COVID, similar to 2008. What we’re not seeing is credit spreads react to that. And there’s two reasons that I think that that’s happening. And by the way, the other chart that’s on there is my credit model, which perfectly matches the bankruptcies. It’s just not showing up in market pricing yet. Part of the reason why I think that’s happening is the same thing that happened going into the global financial crisis, which is as everybody recognizes that their portfolio is increasingly marked not on a fundamental basis, but on a relative value basis, they do everything they can to prevent the transaction from occurring that exposes that the actual value has fallen, causing everything on a relative value basis to be marked lower. We’re seeing this action, particularly in commercial real estate, but also within corporations. The Bye Bye Baby story today, I thought was fantastic on hitting this, where we’re doing everything we can to prevent the transaction from actually being a market clearing event.

Mike

If you read the headlines on what’s happening in commercial real estate, they’re handing the keys back to the lenders without even trying to sell it. Why? Why would you do that? Well, the answer is because you already know you’re under water and if you actually execute a market transaction, the rest of your book may get better.

Brent

Everything else goes, yeah.

Mike

So we’re seeing almost no transactions within high yield. There is a story, and I was just listening to Bruce Karsch highlight this, and I think there’s some truth to this, that within high yield, we’re seeing relatively higher quality credits. But those higher quality credits are only higher quality because their current debt levels, their current interest rate levels are so low. If you actually see the refinancing wall ahead of us in 24, 25 for those high yield credits and they repriced to the current levels of interest rates, the profitability of the entire high yield universe collapses and everybody gets downgraded. So everybody is trying not to refinance because the minute that they put this new stuff on, people do the calculations on debt to EBITDA or interest coverage expense. They’re like, Wait, now you’re a terrible credit. And nobody wants to do that. And so what we’re seeing within credit is only a few high quality credits are trading. The actual volume of transactions is way down. And I just think that very similar to the dynamics that led into the global financial crisis, we’re in this, let’s pretend nothing is actually happening in the hopes that nothing really does.

Tony

But that doesn’t really work out, right?

Mike

It can. Right, it can. This is part of the irony. People are constantly saying, slamming people in the financial markets and saying, Oh, you’re a bag holder and you’re just trying to get the Fed to pivot to save you from your positions being marked down. Like, Man, I’m running net short right now and suffering from it. So I’m sitting there like, Oh, man, they want to keep interest rates higher. I would absolutely love that. So that dynamic of the pivot, the begging and pleading is isn’t actually happening from financial market participants. I think they’ve largely come to terms with it. The begging and pleading is actually starting to happen in the real economy where businesses are constantly filing for bankruptcy. Businesses are basically being forced to hand over the keys and say, We can’t do it. And because those businesses in many situations are owned by private equity or players who have multiple properties, they’re just doing everything they can to prevent the thing from clearing. And it should tell people so much look at what just happened with Bed Bath & Beyond. The prime piece of property that they supposedly owned that justified all the valuation that everyone thought and the potential for this thing to survive even as it was selling six week old roasted peanuts and its checkout lines.

Mike

The underlying dynamic was this bye bye baby was a crown jewel. No bids, nobody wanted it. That tells you so much.

Tony

So what happens, Mike? In this type of cycle, when do people start recognizing that it’s a pretend game?

Mike

Well, I think this is going to be the real question because it is very much like the housing bubble in 2006, 2007, where it’s when the for sale occurred. And the ability to hold that off, you’re actually seeing the Fed guide lenders to negotiate gently. Let’s try to work constructively, etc. I think they’re increasingly aware of this, but the problem is, once it breaks, it’s like Humpty Dumpty. How do you put it back together again?

Tony

So that’s the credit that we’re looking for, and that may be the excuse that Brent’s looking for or mentioned for the.

Mike

Fed to come in and get that. I would just describe the market. To me, so many parts of the market have this characteristic where they are inherently stable within a small range. But if you move out side of that range, they become incredibly unstable. It’s fragility in the market as compared to any other reasonable expression of it.

Brent

Hey, Tony, I actually got to jump in a minute, but I wanted to make one point related to this that, again, I think is, to me, it’s very interesting. And I think a lot of people just miss it. And it leads to what Mike’s talking about is everything goes along until it goes out of bounds and then it changes very quickly is that there is a positive aspect of the higher rates too. So far, we’ve talked a lot about how there’s these negative aspects of rates, and eventually it’s going to catch up and it’s going to cause this downturn. But in the short term, until you hit the wall, the higher rates are somewhat stimulative because the government is putting more and more money into people’s accounts. Even money market funds are paying much higher than they were a year ago. So people who have asset balances are getting paid more. And so the government is putting more money into the economy through that channel. That helps to push prices higher. It helps the economy to go on longer. And then in a weird way, paying higher rates allows the Fed to raise again, potentially because of this tailwind.

Brent

But then it’s also why when you eventually do hit that wall, when you eventually do go out of bounds and things have to get priced, people have to mark their books, it’s the elevator shaft down.

Tony

Yeah. And guys, is this something typically that is… Are we going to wait two or three years for this to happen, or is this something that happens within a matter of months? How long does it take people to recognize these things?

Mike

It’s not a recognize. I just want to emphasize that. As Brent is highlighting, it’s an actual realization. The reason why commercial real estate is happening faster than other areas is because the financing there tends to be variable. They’re already experiencing these dynamics. There was another transaction that just occurred where the keys were literally just handed over. The reason that you do this, it’s not that the facility it’s not that the units were vacant or anything else. It’s just the cost of actually servicing the new or higher levels of debt meant that you had no prospect. The cap rate that you were earning on the rents, effectively, were so far below your financing costs. It’s like, Fine, give it to the bank. There’s nothing we can do here.

Mike

We’re seeing that in commercial real estate. The corporate sector, we’re starting to see it in many of the companies that were bought by private equity. I gave the example in one of my pieces on my sub stack talking about the difference between Veritas, which is an enterprise software company whose high yield… I’m sorry, whose first lean term loan, which is a variable rate, is now yielding 18 % against SAP, which is a direct competitor that’s trading in 100 times earnings. You just do the math on those two costs of capital and like, Wait a second, that doesn’t make any sense whatsoever. The spread between those two is so absurd. That dynamic, those who are in the variable rate are moving fast. They’re starting to hit already. Those who are in the fixed rate space have more time claim, and they’re praying to God that the Fed is forced to turn before their business deteriorates to the point that the operations start to hammer them. And that’s the last thing I would just hit on this, which is chump tax reform in 2017 took a step to try to get rid of excess leverage in the corporate space.

Mike

You may remember this. They moved to requirements that you’re any interest above 30 % of EBITDA was no longer tax deductible. So basically three times EBITDA to interest expense, which is highly levered. In 2022, that changed to 30 % of EBITDA. That’s a much more restrictive model because depreciation and amortization tends to be one of the tools that you actually use to conceal profitability in a variety of ways. As a private equity business, you simply fail to replace the capital. You can generate the cash flow that’s used to generate and pay down debt or to return dividends in the form of dividend recapitalizations. That change means that combined with a much higher interest expense, tons of companies are going to be moving into an environment in which their interest is no longer tax deductible. That’s a huge increase in the effective cost of interest rate. It then goes a step further, the same tax rules change so that you can no longer use losses to claim against prior tax payments. So tax benefits no longer extend back to prior profits. They can only be used going forward. That’s a huge diminution of the value of those tax laws carry forward.

Mike

This is hitting it all at the same time. So we’ve got this perfect storm for levered companies, and it’s crazy, but this is part of the reason why you’re seeing the Russell struggle. But across the universe of relatively highly levered companies, they’re not reflecting any of this. I see most of them as bankrupt. Wow. It’s pretty crazy.

Albert

We could go on for hours on this one. Just the sectors, the auto sector is one of my concerns because of the job layoffs that would be coming pretty soon afterwards if they blew up in the credit cycle. So it’s very interesting.

Tony

So, Brent, before you go, do you still think it’s going to be a correction rather than a big washout?

Brent

My answer right now, I think it could be a pretty severe correction. I don’t think that we have this crash and we’re in a depression for three or four years. I’m not willing to necessarily put a percentage on the correction. I don’t think that this is the crash and we’re in another Great Depression until 2032 or something like that. The last thing I’d say is before I got to jump is I know somebody asked on Twitter, you asked what questions asked and somebody asked about investing in defense companies or whatever. If this is going to lead to military engagement at some point of the geopolitical situation, wouldn’t that be a good place to invest? And I would tend to say yes. I own defense contractors. I think that’s probably an area that will get more funding in the years ahead as opposed to less. If you look at the top 10 defense contractors, I think seven or eight of them are public and a lot of them pay between a two and a three % dividend. And with my idea that the US will get flows anyway and then probably get funding from the government, though, I think those are perfectly legitimate companies to be looking at if you’re looking to buy the dip and equities.

Brent

With that, I will say…

Tony

Brent, thank you. I’m just going to thank all of you guys. This has been a long discussion. Albert, Brent, Mike, I just want to thank you guys for your time. I want to thank you for your thoughts and just have a great weekend and have a great week ahead. Thank you.

Mike

Thanks a lot. Thank you very much, guys. 

Be a more intelligent trader/investor with CI Markets. AI-powered market forecasts. Transparent error rates.

Join host Tony Nash and experts Michael Gayed of  @leadlagreport , Adem Tumerkan  @AdemTumerkan , and Leo Nelissen in this latest episode of The Week Ahead. They discuss pressing economic topics, providing valuable insights into global markets.

Michael Gayed explains the looming credit event, highlighting widening credit spreads and underperformance of high-yield junk debt. Leo Nelissen shares European market trends and inflation concerns.

The panel discusses deflation and reaccelerating inflation in the US. Michael suggests deflation risks while considering a potential surge in money velocity that could reignite inflation, challenging the Federal Reserve’s target. Adapting views based on evolving information is crucial amid uncertainties. Tony presents a hypothesis on deflation followed by reaccelerating inflation. Michael draws parallels to past deflation pulses, like the 1987 crisis.

Adem discusses China’s lack of an opening boost and the prevailing deflationary atmosphere. The US banking system’s challenges, including declining borrowing and impact on net interest margins (NIMs), are explained. Concerns arise over banks’ heavy borrowing and the implications of an inverted yield curve. China’s economic challenges are examined, including its net exporter status and low consumer demand leading to a deflationary environment. The high savings rate, excessive household debt ratios, and declining consumer confidence are discussed. Parallels with Japan’s balance sheet recession caution against China’s potential trap. Housing sales decline, reserve hoarding, and hidden debts exacerbate challenges, emphasizing the need for debt restructuring and a shift to a household sector focus.

Germany’s negative prints and prevailing pessimism are explored as it serves as Europe’s manufacturing hub. Long-standing issues, such as deindustrialization and nuclear reactor shutdowns, impact the economy. Declining demand and China’s automotive dominance pose challenges. The quality of Chinese exports and outsourcing of chemical production are scrutinized. Germany’s anemic consumer base and low-interest rates impact consumer confidence. A comparison between Europe and the US underscores the role of the Federal Reserve and the potential for deflation followed by inflation.

Key themes:
1. Looming credit event
2. China weakness
3. German pessimism

This is the 71st episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.

Follow The Week Ahead panel on Twitter:
Tony: https://twitter.com/TonyNashNerd
Michael: https://twitter.com/leadlagreport
Adem: https://twitter.com/RadicalAdem
Leo: https://twitter.com/Growth_Value_

Transcript

Tony

Hi everyone. And welcome to the Week Ahead. I’m Tony Nash. Today, we’re joined by Michael Gayed, Adem Tumerkan, and Leo Nelissen. Guys, thanks so much for being here. I really appreciate your time. I know it’s been a pretty hectic week and we’re headed into, at least in the US here, we’re headed into a holiday weekend.

Tony

Today we’re going to talk about a looming credit event. Michael’s been on this for probably seven, eight months, maybe longer. I really want to dig into that. Adem has been talking about China weakness, and we’ve all seen that over the last six months. That’s something that we can dig deeper into as we’re starting to see that really get some traction. And then Leo is going to talk to us about Germany. So I think that’ll be really exciting.

Tony

Before we get started, I want to take a second to talk about our subscription product called CI Markets. CI Markets is our AI platform that forecasts stocks, ETFs, commodities, currencies, and economics on a weekly and monthly basis. Stocks include the S&P 500, Nasdaq, FTSE, Nikkei, and others, as well as the top 50 US ETFs. We forecast over a 12-month horizon and we show you our one-month and three-month error rates so you understand the likely risk associated with our forecast data. Subscriptions to CI Markets start at $20 a month and you can find out more at completeintel.com.

Tony

So guys, thanks again for joining us. Michael, let’s start with you if you don’t mind. I’d like to talk about this credit event that you’ve been tweeting about. You posted this very diplomatic tweet this week about the melt up, which you were early on board with that, and this looming credit event.

You’ve been on this and the deflationary bus for quite a while, as I’ve said. Can you talk us through your view? Why is this important right now?

Michael

First of all, I think we have it just to define what the credit event means. Credit event means a sequence whereby credit spreads widen, high yield junk debt ends up performing significantly worse for a moment in time than higher quality Triple A bond paper. And that tends to coincide with a fixed spike. And most fixed spikes tend to mark the end of a major volatility swing. So I’ve said many times before, I believe, oddly enough, we’re probably still in a bear market, which is not a popular opinion, but we can go through some of those reasoning. And the bear market probably ends in that fashion. Now, to your point, I’ve been saying that for a year now. Back in June of last year, I said every duration crisis eventually becomes a credit crisis. Now, there are lags, and it can take time to play out as we know. But that’s I think the major point. Now, the fact that you have a lot of these loans rolling over next year and the year after. A lot of these companies are going to be suddenly faced with higher financing costs on the rollover of their existing debt, which were at low rates post COVID.

Michael

They roll over that debt, that may not be able to survive. If they don’t survive, that’s when you end up having a lot of stress. Now, the thing is, if you’re going to have a lot of refinancing of loans next year, the stock and bond markets have to respond off of it this year because it’s a discounting mechanism of the future. So I think if I’m right that there is a crisis coming and it’s going to be around the debt rollovers of next year, this is going to be a year that a lot of people are going to be surprised by for like, what do you say?

Tony

What comes first is it do we start to see deflation appear first? Do we start to see equity market action first? So that VIX spike. What really comes first? Because if that refinancing is next year, and is not refinancing. I know there’s a number of questions here and apologies for that. Is that refinance commercial? Is it residential? Is it corporate? First of all, what are those refinance things you’re talking about next year? Then let’s get into the other.

Michael

Yeah, it’s primarily on the corporate loan side. We’re having to even touched the commercial real estate risks, housing risks, which I think are still out there. But just to be clear, I’m not like a firm or bear. Actually, I would argue that I’ve been wrong on the Melta this year. Okay, so early October last year, I said, I made that point, the end of the world is at hand. That’s why stocks are about to have a Melta. And I said that word because at the time, the speed with which yields were rising would have suggested that in a month, mortgage rates would have been like 20 %. So you can’t bet on that. So you might as well bet on stabilization of the bomber, which causes the move higher in equities. December, I said there’s a risk of a crash. You didn’t have a crash. 50 % of it was December in history. And then early January, I said back to melt up. But I think I’ve been wrong in the sense that if you look at what’s happened in terms of leadership, it’s not a broad melt up. It’s a melt up really just a select number of stocks which are driving the market at weighted averages.

Michael

You play at retailers, they’re not a melt up. You look at dividend stocks, they’re not a melt up. You look at merging markets are not a melt up. You look at small caps are not a melt up. So it’s like in Europe, in some parts it might be in a melt up. But for the most part, as I’m sure we’ll get into, right? Not so much. So my point is, people are focusing on the wrong thing. The market is already not following the pre election year script. And all that means to me is nobody knows what the hell is going to happen next. A lot of people are pulled up. It could very well be that everyone’s going to get surprised at the downside.

Tony

I have people ask me regularly, so what’s going to happen? And I can honestly say right now I can make a case for anything happening. We really are in one of those environments. And that type of environment to me is a little bit scary because I can normally look at a market and go, Okay, X is going to happen, then Y, then Z. And generally, it’s pretty straightforward. But right now, you can really make a case either way. I like that you said the point that you’re not a perma bear because it’s easy to… Because you’ve said this for a while, it’s easy for people to say, Oh, Michael’s a Pro of error. Let’s just dismiss what he says. But you do… First of all, I watch you change your outlook regularly. You calibrate it, of course. You don’t change it 180 degrees.

Michael

I flip flopped, is what people say, which is like…

Tony

Sorry?

Michael

People say I flip flopped. My answer is, you’re supposed to flip flopped. When there’s a new information, you’re supposed to adjust.

Tony

Your assumptions change. The context changes. You have to change with that. And so okay, so what happens first? Deflationary indicators? Is it equity markets changing? Is it more on the debt side and treasury side? What do you see changing first?

Michael

The bond markets that you’d see a more aggressive in credit spreads. Actually, I pushed the question to Leo, just bring Leo in because I think if you’re going to talk about the parallel of what comes first, you’re seeing it already happening in Europe. The ESB has to keep on hiking rates. You saw UK inflation brutal.

Leo

Oh, it’s brutal. Core inflation is a mess. I think it was today, coin inflation is actually up again in June. It’s an incredible mess. I think Spain inflation is below 2 %, but that’s only because of government measures. So that’s not sustainable. Not once, as you already said, credit, especially in commercial real estate, there are some incredible risk brewing over here, actually, because I’m in Europe. But yeah, that’s an issue. We have on one side weakness and on the other side high inflation, which is so keen on fighting. So it’s a trickier situation.

Tony

So do you see inflation reasserting itself in the US, Michael?

Michael

No. Well, let me put it that way. It’s all about probabilities. So I would argue that you’re much more likely to have left tail deflation risk for moment in time. And by the way, if you believe that the Fed is going to be effective in reaching the average of 2 %, you have to believe in a period of outright deflation. Because if you’re going to have an average of 2 %, you have to go past 2 %, given how high inflation was to smooth it out. So I don’t think it’s actually inconsistent from the way people think about it. But let’s talk about the other side for a second, though. There is a possibility that really what surprises people is exactly what happened in Europe. It happens in the US, meaning inflation reaccelerates. And what would cause that? It will be the thing nobody’s paying attention to anymore, which is the velocity of money, which has been in its downtrend for a really long time. Remember, inflation is more than just money supply, it’s transactions. So if you end up having conceivably a bottoming and picking up in the velocity of money, that’s going to be scary.

Michael

It’s not a base case, but that’s where it’s like, this is where we get.

Tony

Out of it. A pickup in the velocity of money is scary. Is that what you’re saying?

Michael

Yes. It would be against the backdrop of what the Fed has already done, hiking rates.

Tony

Okay. So let me just put a hypothesis out there. Last summer, a year ago, we saw crude spike, we saw inflation really start to pick up, other things. Now, we’re seeing a lot of downward pressure on crude. And of course, there’s the secondary and tertiary impacts of crude markets. So is it possible that we start to see that deflationary impact permanently? And then once that passes, we start to see a re pickup of inflation, meaning, say, late Q3, early Q4, we start to see a reacceleration of inflation. Is that a plausible, say, path for the next, say, six months?

Michael

Every credit crisis is a deflation pulse. That would make sense, actually, from a sequencing perspective, which is why I keep saying, for all you know, this year could play out a bit like 1987, where you had DAO up 38 % towards the peak, then a crash, then a Fed pivot all in one year, and all in a pre election year. So if that sequence is about now, that’s a good transition I’d argue to Adem because the part of this equation is what the PBOC and the fiscal side on China does. Perfect. Given that inflation has been actually much the opposite of everybody else. China reopened and inflation just is not trending up at all. The reopening trade is nowhere near looked like everyone else’s experience.

Tony

Yeah, a lot of slack in the market. Before we go on to Adem, Michael, I think it’s a huge factor that it is the year before an election here in the US. And I don’t think that should be discounted by anybody. The election cycles are major factors in the economy and in Fed policy here in the US. I like that you raised that and I like that you put that forward. With that, Adem, good morning. It’s pretty early where Adem is this morning, so I’m grateful that he got up to have the discussion. Good morning, Adem. Let’s start talking about China because what Michael raises is a good point. We obviously haven’t seen that China opening boost, and that’s obviously a lot of people have talked about that. You’ve posted some great stuff on Chinese incomes and house values this past week.

Can you talk us through some of that? And within the context of the deflationary vibe that we’re getting in China?

Adem

Yeah. And just before we go on to China, I just wanted to add to what Michael was saying. Also in the US banking system right now with the credit risk and deflation, we’ve seen bank lending pretty much grind to a halt over the last few months. And in a credit-driven economy, which is like the 1980s world at this point, that’s pretty deflationary. You’re having more debt being repaid than new loans, and that will probably weigh down growth, the prices and increase bank instability. The Fed stress tests yesterday pretty much showed how they’re all borrowing from the federal home loan banks and BTP at very costly rates. So as the NIMS gets spread, I think it’s going to be pretty deflationary in the US. But sorry, back to China.

Tony

Sorry, before you move on, there was a lot that you just said. When you talk about the NIMS, you’re talking about net interest margin, right? So could you talk to us, first of all, about the magnitude of the fall of borrowing, and then can you talk us through net interest margins a little bit?

Adem

Sure. Yeah, net interest margins is basically how a bank makes money. They make a loan, which is an asset for them, and then the equivalent deposit is the liability. And like we saw with SVB, they had pretty good assets. But the problem is, once you have capital flight.

Leo

Or.

Adem

Etc. Come in, you have to persuade depositors to stay. And we can see how a liquidity crisis can start and happen extremely quickly and wipe out bank capital ratios, which usually hover around 10 %, capital ratios for anyone that’s basically bank equity. Once you have non-performing loans or asset prices drop 10 % in aggregate on the balance sheet of the bank, they’re essentially insolvent. And then you have to liquidate assets to meet the liabilities, which pushes the loans below their book value. And once you get below insolvency or wipe out that 10 %, you can’t lend anymore. I don’t think banks are done. We saw the recent stress test. They tested or they looked at 84 banks under the analysis, and Bloomberg did a good piece on this. And they showed that banks have been borrowing heavily from the federal home loan banks. Federal home loan banks are basically government-sponsored enterprises in the US. They don’t have access to the interest on excess reserve market, so they arbitrage their money, like they lend to other banks, and then they can park it as reserves, collect it from the Fed, or lend out. But it’s costly right now.

Adem

It’s about 5 %. So the end of the yield curve right now is what? I mean, it’s inverted, essentially. So banks are finding it very costly to hold this money. And we actually just saw for the first time in eight years at least, banks now in the last quarter paid more in net interest income… I’m sorry, net interest than they made in quarterly profits. And yeah, I’d imagine that. And this was pre SVB or right up to that late March. And this is when they’re already borrowing heavily from the federal home loan banks and the BTP. So I’m assuming that it’s going to probably get worse in the coming quarters because nothing’s fundamentally changed.

AI

With CI markets, you can access AI-powered market forecasting for as low as $20 a month. Get 94.7 % market forecast accuracy for over 1200 assets across stocks, commodities, currencies, equity indices, and economics. With weekly updates and one-month and three-month error rates, you can rely on CI Markets to help you make informed decisions. Join a growing number of satisfied users who already transformed the way they invest and trade with CI markets. Don’t miss on another opportunity. Start forecasting with confidence today for as low as $20 a month. Visit completeintel. Com markets to learn more.

Tony

Great. With that train over, let’s move on to China.

Adem

Yeah, China’s stuck. I know a lot of people thought… I actually remember being in a space with Michael a few months back, and everyone was talking about inflation, and they were saying when the China reopening happened, and me and Michael were the only people saying, That’s going to be deflationary just because China is structurally in balance at the point that they’re a net exporter. They have no demand in that economy. So when you see everyone say like, Oh, when they reopen, there’s going to be a big consumption boom. The problem is they don’t really have the buying capacity that the US… For the second largest economy in the world, China’s revealed GDP per capita, it’s about 12,000. It’s very small and their gross savings rate is a % of GDP. It’s 45 %. It’s excessively high. To put it in context, Japan’s and Germany, which also have anemic consumers, they’re about 30 %. Saudi Arabia is 30 %. South Korea is around 30 %. So you can see a trend. All these net surplus running countries have very high savings rate. So China now has a crisis of confidence in the consumer, and their solution is, Let’s cut interest rates.

Adem

And we’ve seen the Yuan get obliterated over the last few months. And that’s going to make things worse for the Chinese consumer because a weaker currency is a tax on imports. And that’s exactly China’s problem right now. So they’re trying to get exports to grow their way out of whatever situation there is of slowing growth. But how much more can you depend on the rest of the world to absorb your excess if you can’t fund it domest? And Germany, same thing. All these other countries are in the same boat. South Korea, etc. Japan. So China now is in a thing, in my opinion, called a balance sheet recession and a balance sheet recession, BSR. It’s a term by Richard Kueh. He’s the head of macro analyst at Nomura. He wrote a great book on this called Escaping the Balance Sheet Trap about a decade ago. He was looking at Japan and he was seeing how basically in Japan in 1990, you had very high, the late 80s, household debt soared in Japan. Their currency, the Yen, appreciated about 40 %. It effectively popped their asset bubble. Their exports to GDP dropped from about it was about 12 %, 15 %, it dropped to about eight.

Adem

And that was after the Plaus Accord basically Ray in and told Japan and Germany, hey, we’re running deficits. You need to let your currency appreciate our dollars way too strong right now. Kind of like what Trump was doing with China. So you could see it’s very cyclical with these countries when they start absorbing their surplus, it means you have to run a deficit. So China, the whole theory behind China in the early 2000s, like you were talking about earlier is, they were very under invested back then when they entered the WTO. So savings flowed into the country. It made sense. The investment returns, the infrastructure was needed. But now they’ve hit that law of diminishing returns and you can see it in their debt ratios. If the amount of debt they were spending on these infrastructure projects and investment were matching growth, the debt ratios wouldn’t be exploding. Clearly, they’re putting more debt to get less returns, hence the ratio is widening significantly. China’s macro leverage to GDP, not even including local governments, is already 300 % of GDP. Household debt went from about 28 % in a way. Now it’s about 63 %. To put it in context, the US is about 73 %.

Adem

So they’re already right behind the US’s household debt to GDP for their entire economy, but their buying power is essentially one sixth of the US. And that’s troubling for China because if they cut interest rates here, and this is where the balance sheet recession comes in, they’re falling right behind Japan. Because if you cut interest rates, the idea is it will stimulate growth. In macro theory, it’s, oh, cut interest rates, it allows the production to go further out. You’ll have investment, more consumption in a rational market. But in a balance sheet recession, it’s when the consumer’s confidence is shaken and they stop borrowing. When you stop borrowing, interest rates and deflation… I’m sorry, inflation sinks, interest rates sink to zero until you find equilibrium. So China is cutting interest rates to effectively try to spur consumption and investment. But the business side, the private side of China’s investment is way down. And it makes sense because if you have a weak consumer, why are you going to invest domestically? That was the same problem Japan had. If you have no consumption in your economy or it’s very weak, you’re not going to keep investing in your own private business.

Adem

So we’ve seen that state own enterprises in China stepping up. But the government subsidies are very high there. The investment to GDP is very high there. They would have to reverse that entire balance of their entire economy to the household sector. And I don’t think China wants to do that. Or it’ll be very painful to do it because you’d have to let GDP fall and let household incomes rise for multiple years. And that’s a painful process. And yeah, so the Chinese consumer is a big saver right now, clearly, and they don’t have safety nets. So cutting interest rates will probably aggravate the problem, like in Japan, because they have a huge demographic problem coming up. They need to save for retirement. Home prices are essentially there… I think home prices in China are the world’s largest asset class. It’s about two plus times bigger than the US’s, and they are depending on that for future investment. You retire, you sell your home, you have the cash. Now, if home prices are falling and they can’t get confidence back up, we’ve seen mortgage loans taken out in China, just they’ve collapsed. It used to be about 10 %, 15 % per year.

Adem

It’s zero now. It’s actually literally dropped over the last six months all the way to zero. So they’re just not borrowing. I mean, if you look at China’s household debt to GDP, it’s been flat, essentially flat for three years. And if you don’t have new credit coming out, I don’t see how cutting interest rates is going to fix that. And they’re just flying to the same trap Japan did.

Tony

Yeah. If you talk to any Chinese leader or senior bureaucrat, there are two things that they’ll say is, first, they will not become the Soviet Union politically, and they will not become Japan economically. They are paranoid about those two things. And so the case you lay out for China becoming Japan… In Asia, you have these four demographic waves. First was Japan, then was Taiwan, then was South Korea, and now is China, where they’re just aging so fast that it’s really hard to keep up the growth rates and the monetary and fiscal policies that they had when you had such a large working group and you had such a young, large young group that you could balance out those costs across age groups. And they just can’t do that anymore. They don’t have the growth of income, they don’t have the growth of foreign investment, they don’t have the growth of exports. As other markets get older, Europe and other places get older, their consumption goes down too. So it’s a huge problem for them. And so in the balance sheet recession in 2009, first of all, before we get to that, can we talk a little bit about housing sales?

Tony

You sent a couple charts across on housing sales. I want to make sure I know you discuss these generally, but I want to talk about these a little more specifically where you say there’s no signs of a pickup in housing sales.

Leo

The.

Tony

Income’s dropping, where do you derive the Chinese income’s dropping from that chart?

Adem

So yeah, the PBOC or the MBS, they do a survey on household wealth and confidence. And the latest one showed that it did below 50. I think it’s the first time it’s done that in a few years, actually. And it was one sixth of surveyed. And granted, it’s a survey, so keep it with a grain of salt. But they were saying that their incomes have actually been declining in China, which makes sense. The yuans been battered.

Tony

And it will get even more battered, right?

Adem

Yeah, I agree. It’s interesting, the PBOC is essentially letting it fall because they could step in. They have what, 3 plus trillion in reserves.

Tony

Supposedly.

Adem

Yeah. I think they have at least five or six trillion. I mean, if you look at the current account balance of trade, they’ve had 3 trillion for It’s been what, like a decade? It’s just been flat. But they’ve been running current account surpluses since then. I’m assuming they’re offloading it to the state banks or like a shadow banking with their reserves because they have way more than three trillion, which is a problem too, obviously, because they’re just hoarding the money. They’re just sitting on it. They’re not.

Tony

Investing it. Let’s look at that for a minute, though, because after the financial crisis, they had all these loans that they continued to evergreen and pass across to other banks. They’ve had to really pay off some of those loans. So all of these dollars that China has, they’re not necessarily being stashed away, they’re being used to offset those loans that have been evergreen for the last decade plus. Yeah, that’s true. There’s this global assumption that China has all of these dollars, but they have all of this debt that’s 20 plus years old that has needed to be offset on those bank balance sheets. So do they have all of the dollars that they claim to have? Maybe. Maybe they do, maybe they don’t. But that’s how they dealt with their balance sheet recession previously, was just evergreening these loans. And so this time around, they’ll likely have to evergreen these residential and commercial real estate loans at those lower rates. Does that make sense? Yeah. And so those new dollars that come in are going to have to have to be used on evergreening those Chinese real estate loans that have taken place over just the last 10 years.

Tony

That says nothing about the ones that are over 10 years old. Is that does that make sense?

Adem

Yeah. Well, that’s also a problem in China. I agree with you because they’re cutting rates is essentially just going to let these big toxic debt piles be rolled over. Banks in China now, their nims are below 2 %. I think it’s the first time it’s actually been below 2 %, it’s like 1.9 % right now. So they’re getting squeezed pretty hard. Nonperforming loans already up to about two and a half percentage points on a $52 trillion or one y ou on a banking system. So even if they have the dollar reserves, the local government debts, which are the real problems in China right now, no one knows what they really have. But I’ve seen estimates. They’re not going to be looked at it’s about 4 trillion, but they said hidden debts are another 6. So let’s say it’s 10.

Tony

It’s 10 trillion.

Adem

Yeah. So that’s 50 % of their GDP, if not more at this point. So we’ve had to see them now they’ve been doing big fees. And this is a structural problem with China is that they’re taking more away from households, which is exactly the opposite problem. As the local governments now are straining under land sales and property values, we’ve seen record fines and taxes right now actually happening in China. There was some restaurants that their fines for serving a certain dish away, they got fined like $700 US dollars or something because they’re trying any way they can to raise capital at this point. But the thing is, when you’re taking money away from… I mean, it’s a subsidy to the government, right? And that’s the problem. You’re taking the money out of the consumer and you’re moving it back to the state.

Tony

And.

Adem

Then what does the state use it for? To roll over debt, use it on wasteful investment. So everything China is doing now is just making the anemic consumer worse. And that’s why the last six months I’ve just looked at it and I’ve just said there’s no way that you’re not going to see a booming economy with this imbalance. They have to rebalance.

Tony

And this is why it’s important to have the bad bank, right? I mean, the old archetypal, I guess, bad bank, it started, I guess, here in the S&L crisis, and Korea did it pretty successfully. And you’ve got to have a bad bank to take all those debts and then offload that onto the public so the value can be discounted so that those loans can come to some conclusion, right? Otherwise, they continue to be carried by the government. And in a.

Adem

Central crowded state… You need some restructuring.

Tony

And in a central planning state as government, if there isn’t really an actual value of money, this is why the C&Y, at least for now, can’t be a global currency because there is no actual market to market value of loans, of financial instruments, of the currency and other things. Great. I love the chart that you put up on mortgage borrowing as well. As that becomes more anemic, what that says to me is not only are people afraid of the economy, but they don’t really trust the institutions around homes generally, banks, even the real estate companies, and so on and so forth. That’s where a lot of the wealth is kept, retirement wealth and other wealth is kept is in real estate.

Adem

Yeah. The confidence is very shaken in China consumer, and that’s going to be a big problem for them.

Tony

Well, and that’s a great point. Confidence is, once the flow slows down, you can’t play musical chairs anymore. That’s the real problem with mortgages in China because you can’t the Ponsy has to stop once the flow stops. Great. Okay, so I’m really pessimistic on China now. Thanks, Adem. I really appreciate that. Let’s go to Germany, where I think we’ve had some really negative prints, and sentiment prints, Leo, over the past week. One is on business expectations and the other is on manufacturing export expectations. Leo, why are these two prints so important? First and second, what is driving that pessimism?

Leo

Well, they’re so important because Germany is essentially the manufacturing hub, actually the manufacturing hub of Europe. Just the other day, I saw that Dutch politicians were saying, Germany is struggling and that’s going to have a big impact on us as well, whether it’s transportation or services. The economies are so well connected. What I find so interesting about these indicators, I said, they just tell a story. I was just googling the other day the IFO index that you are referring to, EFO. I googled it and I saw that multiple news articles from 2019 and 2018 already said, Germany is actually headed for a recession. They’re obviously in a recession right now and it’s self inflicted. So all these issues, everyone is talking about deindustrialisation, they are right, and all these issues that Germany has, but none of these issues started after the pandemic. I think they started in 2011 after Fukoshima when Merkel decided to take these nuclear reactors offline. And that’s when it started very slowly. I think Germany peaked in 2017 when automotive production peaked. And since then, things have gone downhill quite rapidly, especially after the pandemic. I noticed in late 2020, early 2021, everyone was talking about pent up demand, which was right.

Leo

There was a lot of pent up demand. And sentiments started to come down because of the weakening economy. And everyone said, Yeah, but that’s not an issue because supply chains are easing supply chain bottlenecks. So that’s good for Germany. I was always a bit skeptical because yes, supply chains are getting healthier, much healthier, but demand is struggling right now. So I actually looked it up from the EFN and they said backlogs are a huge issue. So demand is basically gone at this point for cars, chemicals, and that’s what they’re saying. So chemicals in a very bad place, machinery, which is essentially 50 % of Germany’s export chemicals, machinery, and stuff related to this. And then transportation and logistics are struggling right now. So Germany was, especially after the Euro crisis, one of the strongest players in Europe. And now it’s the only G7 nation with negative growth expectations for this year. So that’s a big problem. And now you’re seeing export weakness again, which is triggered because of China weakness and in general, the global economy is quite bad, or it’s weakening. What I need to add as well is Germany has rapid population growth.

Leo

Last year, population grew by 1.4 %. Obviously, a lot of refugees, Ukraine, Syria and refugees and everything, but Germany isn’t handling these things quite well. Most of these people are unemployed. The government is basically paying people to be unemployed. There are no incentives for people to get into work. Germany right now is a structural mess. It’s incredible. And then China now, we’re talking about China, China is getting stronger in automotive. Essentially, Germany helped China grow after the 1970s. They saw a nation wanted to grow with manufacturing. They needed machinery for construction and everything. And then once China’s middle class started to grow, Germany saw an opportunity to sell cars, Volkswagen and luxury cars like Mercedes and BMW and whatnot. But now China is saying, Hey, we want to take this market back. So especially in electric segment, the test drive is quite a big player, but the vast majority of cars are Chinese that are sold right now in the EV space. And China controls EV related commodities. So the Europeans actually, in another problem, they’re just now pushing for EVs. I think they want to ban fossil fuel cars after 2035 or something. Not entirely sure on that one.

Leo

But they would essentially now give China more power and harm their own economies because China is now starting to export cars. I looked it up the other day and it’s just wild. Germany is now exporting fewer cars than China. Last year, Germany exported 2.6 million cars and China exported 500,000 cars more than Germany. And that’s almost 400 % growth in the past seven, eight years, China. These developments are just incredibly bad for Germany.

Tony

It’s easy for people to go, Yeah, but those China exports are low value, low quality exports, and German exports are high quality, high value exports. I think that’s the knee jerk reaction to that. Is that the case?

Leo

In general, a lot of products from China have inferior quality. German companies already said for over decades, we want to work with the Chinese, but the workforce and the equipment we get, I want to work with what we need for our production. Quality has always been a Chinese issue and I expect it to continue. But in EVs, China is actually doing quite well. There are a few brands that I never heard of that just came popping up in the past few years that are now flooding. Growth is high, but they’re not dominant right now. But the quality of these cars is great. People actually, great reviews and everything. That’s a big problem. The EV quality is great and that’s the thing that hurts. Then chemical production is going overseas as well. That’s one thing that really started to accelerate after the invasion of Ukraine. Big companies as BISF, they are just outsourcing now. They made crystal clear, we’re not going to invest in Germany anymore. So production, I think BISF is accelerating investment in Texas, Louisiana, in China. That’s a big issue, especially because chemicals are so important in pretty much every supply chain. That’s probably coming from structural inflation.

Tony

Yeah.

Adem

Go.

Tony

Ahead, Adem, sorry.

Adem

I was just going to ask Leo, a lot of people call the UK the sick man of Europe, but I’ve actually argued that post 2000, Germany has been the sick man of Europe because their consumer is so anemic. Their current account surplus is… I don’t know if you guys have seen that chart after the Hartz reforms in Germany, early 2000s. It’s enormous how much they’ve been excess dumping their savings and unconsumed goods abroad. So I was just curious what you thought about that.

Leo

Yeah, I think that was one of the things that I think some Germans actually enjoyed when the UK went pretty much south after Brexit vote. I always so argue that the UK is somewhat of a mess right now. But yeah, Germany is a stick man. I mean, the UK has become way more flexible when it comes to international trade deals and geopolitical play. Uk is quite dominant and Germany is lacking all of these things. And just another number that I looked up, outside investments in Germany last year were actually 11 billion. And German companies invested more than close to 150 billion outside of Germany. And add to this, as you said, the consumer is in a pretty bad spot because not just because of inflation and higher rents and everything, but because of low interest rates after the Great Financial Crisis. People just spend it all. Germans, just like us Dutch, we barely spend. We are very frugal, but still, people spend a lot. And everyone was saying, Yeah, it’s because rates are so low. That’s one of the things that’s now hitting us in the back. That’s really stinging. If you look at consumer confidence, it has bounced a bit, but I think it’s close to or even below the 2020 pandemic laws right now.

Tony

Right now.

Leo

In Germany? Yeah, right now in Germany.

Tony

So business confidence and consumer confidence are? Consumer confidence is the thing that’s the difference. I wasn’t aware of.

Leo

Consumer confidence.

Tony

What’s inflation in Germany right now?

Leo

I don’t know the numbers on top of my head, but I had to look it up. But core inflation is actually coming up again. I mean, food inflation is high. Energy inflation is down everywhere, but I don’t know the numbers exactly, but it’s way above where the ECB wanted to be.

Tony

Hearing Michael’s views at the start, and he pointed to Europe as a leading edge of what could happen here in the US, do you see that happening in Europe right now, particularly in Germany?

Leo

It’s tricky. I think because a lot of what’s going on depends on the Fed. I think they’re way more powerful than ECB. The ECB now, they’re way more reactionary. Europe is different because we have a lot of structural issues. Right now, Italy and Spain, they’re just complaining about high rates, obviously. And still, a lot of the debt issues, they have just been massed by cheap money prior to the hiking cycle. I think it’s a difficult situation to compare. But overall, I think it’s similar. If you get a situation where deflation were to occur, I think it could, but it would be a very short period because it would probably be followed by quantitative easing, rapid rate cutting, and that would be unwind some of the structural issues, especially in energy. So I think you would get a second wave of inflation very quickly, even if deflation were to happen, both in Europe and in the US.

Tony

Interesting. Okay, very interesting show today, guys. I really appreciate this. Thank you so much for your time. I really appreciate it. Have a great weekend and have a great week ahead.

Leo

Thank you very much, guys. Thanks for having me.

Adem

Yeah, thank you. Bye. bye..

“The Week Ahead” episode combines the wisdom of Tracy Shuchart, Chris Berry, and Corey Lavinsky, as they explore peak oil, battery technology, and biofuels. Tracy shares insights from the recent IEA study, predicting peak oil around 2028. Though oil demand may decline, it won’t vanish entirely. The talk shifts to electric vehicles (EVs) and Tracy’s reminder that their power source in China is still primarily coal, underscoring the significance of considering the energy mix behind EVs.

Transitioning to EVs poses challenges, particularly with grid infrastructure. Tracy stresses the need for substantial investment in grid systems, particularly in the United States, to support the surging demand for EVs. China and India boast differing grid systems with potential for growth, albeit with their respective hurdles.

Chris Berry adds his perspective, emphasizing the crucial role of raw materials in battery production. Securing a sustainable supply of lithium, cobalt, and graphite becomes vital to meet the surging demand for EV batteries. The hurdles of domestic sourcing and the time required for new mining operations are discussed.

The episode unravels the complexities surrounding the energy transition and the multitude of factors shaping the energy sector’s future. It highlights the need for a holistic approach that encompasses technological advancements alongside infrastructure, grid systems, and raw material supply chains, all critical for sustainable energy solutions.

The episode further delves into battery metals’ impact on battery affordability and supply chains. Chris discusses the price volatility of battery metals, particularly lithium, and their limited influence on battery economics. Lithium prices fluctuate significantly but constitute a small portion of the overall battery cost. However, the concern lies in potential price hikes of metals like nickel, which could disrupt supply chains and pose challenges for automakers and battery manufacturers. Managing price volatility necessitates battery chemistry innovation and metal substitution.

Regarding lithium sources, Chris clarifies that lithium is not scarce and can be found in multiple locations, including North America. However, refining processes, mainly conducted in China, pose supply chain bottlenecks. The urgency to secure raw material access surfaces, exemplified by General Motors and Ford investing heavily in lithium projects. Partnerships between American and Chinese companies underscore automakers’ concerns about potential supply shortages and the need to secure critical metals for battery production.

The discussion discusses the conflict between climate goals and the North American mining permitting process. Tracy highlights the protracted and burdensome permitting process, hindering climate goal attainment. Chris raises the issue of coal’s use in nickel production for EV batteries, contributing to carbon footprints. Environmental impact considerations extend to mining, refining, and transportation within the supply chain. Alternative solutions like lithium-ion battery recycling and direct lithium extraction are explored, yet acknowledging their own CO2 footprints.

Shifting gears, the dialogue focuses on refining’s role in corporate mining investments. While Liontown concentrates on mining, Lithium America’s plans include refining. Presently, China dominates the lithium refining industry, with most raw materials sent there. Chris mentions upcoming lithium refineries in the United States, aiming to lessen reliance on China. The discussion culminates with Tony suggesting using biofuels for transporting lithium, potentially mitigating the CO2 footprint.

In another segment, Tony engages Corey in a conversation about biofuels and the recent EPA announcement on biofuel mandates. Corey reveals that biofuels are derived from biomass or organic matter, predominantly ethanol in the United States. Biofuel sources range from corn, sorghum, and sugar cane to biodiesel derived from fats and recycled oils. While biofuels presently represent a small fraction of diesel and aviation fuel markets, their growth prospects are promising.

The dialogue explores biofuels’ potential in aviation and the challenges posed by electric-powered long-haul flights. Corey highlights biofuels’ remarkable growth in the United States, propelled by the Renewable Fuel Standard program, which has fostered ethanol and biodiesel production expansion.

The EPA’s biofuel mandates encompass various categories like renewable fuels, biomass-based diesel, advanced biofuels, and cellulosic fuels. Corey discusses the reduction in proposed mandates for corn-based ethanol, causing discontent among biofuel companies. Biomass-based diesel mandates exhibit sluggish growth, despite substantial investments in renewable diesel and sustainable aviation fuel facilities.

The episode delves into biofuels’ current state and future prospects, specifically focusing on ethanol and sustainable aviation fuel (SAF). Tony initiates the conversation, underscoring conventional fuel production’s plateau and potential Midwest disappointment due to sluggish biofuel requirements. Corey envisions a reduced demand for ethanol in gasoline-powered vehicles due to increased electric vehicle adoption. However, he views SAF production as a promising opportunity for the industry. Corey highlights ethanol’s potential as a SAF feedstock, enabling aviation decarbonization. Tracy raises concerns about SAF’s cost for consumers, prompting Corey to mention existing SAF mandates in Europe and planned future mandates in the United States. Limited SAF availability stems from technological development and the absence of past SAF mandates. Corey predicts increased SAF production as airlines enter offtake agreements with renewable fuel producers.

Lastly, Tony moderates a discussion with Chris, Corey, and Tracy on near-term opportunities in battery metals, biofuels, and oil. Chris emphasizes battery technology advancements, specifically advancements in cathode and anode formulations. He spotlights the intriguing investment potential in the refining aspect of the battery supply chain. Corey accentuates ethanol’s utility as a sustainable aviation fuel (SAF) feedstock and outlines federal and state incentives propelling SAF facility advancements. Tracy highlights how some traditional oil refining companies invest in biofuels, noting that oil and gas industries differ from mining metals, oil, and gas. She reveals that many oil companies remain unaware of alternative energy sector developments, allocating funds to avoid falling behind. Chris adds that historically, oil and gas companies hesitated to invest in battery metals due to the limited market size, but changing political dynamics are now driving exploration into such opportunities.

Key themes:

1. Peak Oil in 2028

2. Batteries

3. Biofuels

This is the 70th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.

Follow The Week Ahead panel on Twitter:

Tony: https://twitter.com/TonyNashNerd
Tracy: https://twitter.com/chigrl
Chris: https://twitter.com/cberry1
Corey: https://twitter.com/biofuelslaw

Transcript

Tony

Hi everyone, and welcome to The Week Ahead. I’m Tony Nash, and today, we’re joined by Tracy Schucart from Hilltower Resource Advisors, Chris Berry from House Mountain Partners and Corey Lavinsky from S&P Global.

Tony

I want to take the opportunity really to talk about energy. We’re going to talk about peak oil with Tracy. We’re going to talk about battery technology and battery minerals, metals with Chris Berry, and then we’re going to talk about biofuels with Corey. So really excited about this show so we can get really deep in one sector.

Tony

Before we get started, I’d like to take a second to talk about our subscription product called CI Markets. CI Markets is our AI platform that forecasts stocks, ETFs, commodities, currencies and economics on a weekly and monthly basis. Stocks include the S&P 500, Nasdaq, FTSE, Nikkei as well as the top 50 ETFs. We forecast over a twelve-month horizon and we show one- and three-month error rates, so you understand the likely risk associated with our forecast data. Subscriptions to CI Markets start at $20 a month and you can find out more at completencel.com.

Tony

So guys, thanks. I’m really excited about this show.

Tony

Tracy, I want to talk a little bit about peak oil. There was this IEA note that came out last week saying that we’ll see peak oil around 2028.

They said demand for the chemicals industry will continue to drive oil demand, but demand for transports will shrivel. That was their wording. So 2028 is pretty soon, and it seems like a really quick time frame to change oil consumption. So can you talk to us a little bit about this IEA study and just tell us what some of the key takeaways are?

Tracy

Yeah, absolutely. So first, IEA estimates that global demand reaches 105.7 million barrels per day in 2028. That’s up 5.9 million barrels a day compared with 2022 levels. But really what they said is growth is to flow from there, not decrease. So it’s just the rate of change or the rate of growth is to decline is what they are saying. So they’re not actually saying that peak oil demand. That said, like all of the other forecasts, I do think this is wishful thinking more than anything. And they did, as you are correct, they did include a caveat which included biofuels, petrochemical feedstocks and other non energy uses, which is up to a broad interpretation really, if you kind of work through this report, the only expected growth decline is in Europe and the United States and with increases elsewhere led by China and India. And given that if we look at this study, europe has 742,000,000 people, that’s 9.27% of the global population. North America has six, 4 million. That’s 7.55 million portion of a global population. So really that’s not a lot as a whole, considering there are 8 million people on the planet and many of which are in emerging economies where fossil fuels are necessary to reach levels above poverty.

Tracy

I mean, if we look at Africa, for instance, we have 600 million people alone in that country without electricity, and they’re going to need fossil fuels for a very long time. In addition, again, I can bring up China and India because both of them are expected to increase their consumption. Even if, adding in renewables, their consumption is set to increase together, their population is much larger than Europe or the United States.

Tony

Okay, great. So it sounds like it’s really a both, and it’s not just kind of fossil fuels or, say, renewables, it’s a both and kind of way going forward. But it doesn’t sound like oil is going to collapse in 2029 or anything like that.

Tracy

Correct.

Tony

Okay, so they talked a bit about transports and how much are EVs impacting the expectations around Ice vehicles. So you talk about India and China as being the big growth vehicle. So are EVs, let’s say, in India, going to displace ice cars?

Tracy

Not at this juncture. Not even close. And yes, in China, it’s huge growing industry. However, that’s not their main driver, because if you look at what is powering, their ice vehicles is coal because coal is their main power source. And so you have to take that into account when you’re looking at these things. Oh, yeah, China is the biggest growth in EVs. But what is powering the EVs? Where does that electricity come from? That electricity is basically still coming from coal, along with a mix of hydro, natural gas and crude oil. If we look at the United States, as far as feasibility is concerned, biden administration says he wants 50% of US EVs by 2030. We’re currently at 12%, and we don’t even have the chargers or the grid to even support this. So I have to still go ahead and say a lot of these initiatives are fantastic, but realistically, in seven years, it’s just physically impossible to get to 50% EVs even if people were forced to buy them. Right.

Tony

So we look at guys like Ford who’ve talked about losing billions of dollars this year, and they lose tens of thousands of dollars on every vehicle. And Chris, I want to get into this a bit with you in a second, but we’re not close to that goal yet and it seems very difficult. I want to go back just a second and talk about grids. So, Tracy, again, you talked about India and China. And can their grids sustain the EV growth that’s expected in those countries? Because we have difficulties with grids here in the US. Right. Sustaining. EV. Plugins. So is it first of all, can we hit that here in the US by 2035? 50% just on the grid alone? Second of all, what about India and China? Do they have the grid that can sustain EV growth?

Tracy

Well, we’re talking about two different grid systems, right? If we’re talking about the US. Or we can even include EU in this scenario is that we have particularly aging grid system, right? So really, to realize the goals and I’ll just use the United States as an example, to transition, we’re going to need to build we’re going to need to add over a million miles of transition lines, which first of all, there’s no money in the budget for that. Nobody wants to do that. We’re already hitting over 70% of our current lines are more than 25 years old, and the rest are well into their 50 year timeline. So we have to completely redo our grid system to meet these 20 30, 20, 35, 20 50 goals. And simply no government wants to spend that. And it’s just not in the budget for that right now. So, realistically, it’s just impossible for us to really get there. Now when we go to China and India, right, they’re more of, well, India is an emerging market. I can argue that China may or may not be anymore, but that’s besides the point. But they can grow their grid system because it’s not as advanced or not as mature as our grid systems are.

Tracy

And so, sure, they can add a lot of capacity as far as renewables is concerned, but that doesn’t mean that they’re giving up their power mix. I mean, coal is still really huge in India and China, so it’s natural gas. Hydro is really big in China, which is renewable. It’s easier to transform a country’s grid that is just not aging like ours are.

Tony

Yeah, I would add that I think a lot of the regulatory environment here in the US. Makes grid build out a little more difficult. Maybe Chris or Corey, you guys know more about that. But in China, it’s pretty straightforward. I think they can really build their grids out wherever they want in India, actually, from a regulatory perspective, really complicated. So I think it’s not that easy in India to build out new power lines, to take new real estate to make that more robust. So some of these things, I think, are going to be difficult. I think people will innovate the way around it. I don’t know how they’ll do it, but I think it’s going to be difficult to build out that infrastructure in some of these places. Chris, do you have any thoughts on that?

Chris

Not so much on the infrastructure side. I mean, I certainly agree that that is a limiting factor when we talk about electrification. Whether or not it’s a million miles or whatever it is you use, just from an EV perspective. I mean you use four times as much copper in a single electric vehicle that you do in a traditional or comparable internal combustion engine car. And so my angle on all of this really comes a little bit less from not so much the policy side of the infrastructure side, but where are all these raw materials going to come from? The lithium, the cobalt, the graphite and I’m happy to get into that here in a couple of minutes. I know that’s kind of the topic here, but the infrastructure is certainly, maybe, in my view, a secondary limiting factor or a lack of the infrastructure. But in my view, before we even start thinking about, okay, where are we going to build these lines or the charging stations, or what have you? Where are we going to get the millions of tons of lithium or millions of tons of copper. If we’re talking from a domestic perspective here, when it takes ten plus years to build a brand new mine in the United States, So those, I think, are some of the initial issues.

Chris

And again, we can get into some of those details for sure.

Tony

Great. Okay, let’s do that. Let’s jump there. Tracy. Thanks for that, by the way. Chris, obviously, batteries are a growing share of energy for transports, and you talk about the availability. I also want to talk about the affordability of some of those battery metals. So can you talk us through where, I guess prices first, before we talk about supply, where have those prices been? We have a chart showing nickel, copper, coal, and lithium.

Where have those prices been? How does that impact the overall battery prices? And I guess most importantly, what’s impacting the way companies are investing in their supply chain? So I guess let’s talk about price and availability at the same time. That would be really interesting.

Chris

Sure. I think when you think about the price impacts of the battery metals on lithiumion batteries, it’s a relative discussion. In other words, you sort of need to think about what has gone on with lithium, what has gone on with copper, nickel, cobalt, manganese, graphite, sort of the big Six, as I like to call them. And in the chart that I had sent over from Bloomberg, basically what it does is it looks at what I call the Big Four. Big four battery metals. And I stretched the chart back to early 2018, and the reason why I did that was that was the peak of the last battery metals cycle. And so it just gives you, as the viewer here today, an idea of what I think we’re just seeing, the tip of the iceberg of which is battery metals, price volatility. And there are a number of reasons for that that we’ll get into. But I think, again, we could spend all day long talking about specific metals. Lithium is clearly the bell of the ball, for lack of a better phrase. That’s the one that gets all the press. And there are reasons why you have seen so much lithium pricing volatility.

Chris

Again, back in early 2018, what we call battery-grade lithium carbonate hit a price of around $24,000 a ton, up from historically, around $6,000 a ton. And then things kind of went to sleep. The cycle ended in 2019. COVID came and sort of froze everything or allowed everything to restart, I guess, depending upon how you think about it. And then, as you can see from the chart, things have absolutely exploded. Lithium went from about $8,000 a ton to a peak of about $85,000 a ton, and then crashed down to around 22. And now it’s sort of on its way back up. It’s at about $45,000 a ton on a spot price basis today in China.

So to your point, Tony, what exactly does that do? Okay, well, the interesting to battery economics, the interesting response there is with respect to lithium, it really doesn’t affect battery economics all that much. Okay? The price of lithium in a full electric vehicle battery, really, even at a price of around $80,000 a ton, was about maybe twelve or 13% of the cost of that battery. So not enough to really make these automotive manufacturers say, wait a second, this isn’t affordable, or this is unaffordable.

Chris

The issue is, and this is what purchasing managers at Ford and General Motors and Tesla and BMW are all worried about. The issue is what happens when lithium price goes crazy. Nickel price goes to $100,000 a ton. Everything sort of goes up in the air. It’s very, very difficult to manage. So what that has forced automotive manufacturers and battery manufacturers to do is really innovate, I should say, around battery chemistries, and think through, okay, what is truly irreplaceable, what can be substituted, and quite frankly, the only metal here that can’t be substituted without making some very, I guess, significant issues with respect to performance is lithium. Okay? You can use less nickel, you can use zero cobalt again, et cetera, et cetera. And so, from the standpoint of mobility, again, whether or not we’re talking about cars, trucks, buses, scooters, I don’t think anything is going to challenge lithiumion from a market share perspective for the next ten to 15 years. Okay? It’s a much more interesting conversation when you think about what we call long duration energy storage. So putting batteries in with solar farms and so on and so forth, there’s a lot of competition over there, and again, a lot of it has to do with price and performance.

AI

With CI Markets, you can access AIpowered market forecasting for as low as $20 a month. Get 94.7% market forecast accuracy for over 1200 assets across stocks, commodities, currencies, equity indices, and economics. With weekly updates and one month and three month error rates, you can rely on CI Markets to help you make informed decisions. Join a growing number of satisfied users who already transform the way they invest and trade with CI Markets. Don’t miss on another opportunity. Start forecasting with confidence today for as low as $20 a month. Visit completeintel.com markets to learn more.

Chris

Go ahead. Sorry.

Tony

Yeah. With lithium, we hear maybe I’m misunderstanding, but like China and Chile or something, are the two big sources of lithium. Is lithium in other places? And what other places are there? There’s this perception that it can only be sourced from a limited number of places. What are the bottlenecks there?

Chris

So the bottlenecks are in the upstream, in the mining and the refining. And so lithium can be found either in traditional hard rock sources, primarily in Western Australia. There’s a lot of it in Africa, too, and then traditional Brine sources. You may have heard of the Lithium Triangle, which is, if you’re looking at a map of South America, where Bolivia, Chile, and Argentina sort of converge, there’s an awful lot of lithium. About 50% of global lithium comes from that part of the world. So the interesting thing about lithium is that it’s not rare at all. Again, you could actually extract lithium from seawater if you wanted to. I wouldn’t recommend it because it’s very difficult and costly. But my point is, lithium is not rare. The issue with China, and China isn’t even a major lithium mining source at all. They only produce around 13% or mine, I should say around 13% of lithium globally. And just for the sake of perspective, today lithium is about a 900,000 ton per year market, okay? So compare that to copper at 24, 25,000 tons a year. Excuse me, but the issue is the refining. In other words, taking that raw material, whether or not it’s in the form of liquid Brine or the hard rock concentrate and producing, converting it into what we call battery grade lithium salts, either carbonate or hydroxide.

Chris

Now, about 65% of that happens in China, okay? And then as you go further down the supply chain, when you think about the cathode of the battery, so nickel, manganese, cobalt, lithium, iron phosphate, these different chemical formulations, about 65% to 70% of cathode is produced in China, about close to 100% of the anode. The other side of the grephidic side of the battery is produced in China, and they also have a lock on battery production, overall cell and pack production. So this is one of the things that I think the Inflation Reduction Act is designed to try to counteract over the course of the coming years. But again, coming back to my original point, if we do want to compete with China and sort of level the playing field, the one thing that really isn’t addressed in all this legislation is where will the raw material come from? There is no sort of streamlining of mining permitting or anything like that in the Inflation Reduction Act, and that is one pretty significant limitation, quite frankly.

Tony

So are there lithium sources in North America? I mean, would it be possible to mine it in North America, 100%?

Chris

Absolutely. Again, lithium is not rare. I live in Washington, DC. Now. I used to joke when I lived in New York, I could get a shovel and go to Central Park and start digging, and eventually I would find trace elements of lithium.

Here’s a perfect example. And this is maybe a good way to tie in what corporate America or the OEMs are doing. And so, look, the automotive manufacturers, Ford, General Motors, just to use them as an example, finally woke up, I think, and realized, okay, we are going to have to produce electric vehicles whether we want to or not, regardless of the economics, to Tracy’s point. And so they should have been making multimillion or multibillion dollar investments in supply chain development 5, 6, 10 years ago. And so they’re just doing that now. And got a couple of examples. So General Motors has agreed to invest about $650,000,000 in, I should say, a development stage lithium project out in Nevada run by a company called Lithium Americas.

And so, again, I’ll just cut right to the chase. The bottom line is the lithium that is being produced today is pretty much spoken for. Okay? The question becomes, if we are going to get to 50% EV penetration or anything even remotely close to that by 2030, you need to be making those upstream mining investments today to try to accelerate that.

Chris

And so the interesting thing about that General Motors example is that that mine probably won’t even be in production before 2026. And so it just, I think, speaks to the desperation on the part of General Motors to say, listen, we are willing to pay a very large sum today in this high risk mining environment for the chance to negotiate for offtake by 2025 or 2026.

Tony

Okay, so looking at this graphic, you’ve got Ford with Lion Town. I guess that’s a lithium investment as well.

Chris

Yeah, Liontown is a development stage hard rock lithium mining company development, meaning they’re not in production yet. But again, I think it just speaks to maybe I don’t want too much hyperbole here, but the desperation or the focus on the part of these automotive manufacturers, they finally woke up, probably again, five years too late, and realized, hey, we have a raw material problem. We can get our hands on the intellectual property to build batteries or build gigafactories or what have you. And of course, you’ve got the Department of Energy and the Inflation Reduction Act providing a pretty strong tailwind there. But what good is building a gigafactory or a recycling facility if you don’t have the feedstock for it? And so, again, there are nuances here that we can get into in terms of accessing that feedstock. But all of these players that you see on the screen, again, see a lot of General Motors and Ford and LG Chem there. They’re just very concerned right now about raw material access. And again, it goes beyond lithium. I mean, you can see in the lower right hand corner there ford Valet and Hawaiia Cobalt. Interestingly enough, you’ve got an American automotive manufacturer entering into a multibillion dollar nickel sourcing deal with one of the largest Chinese cobalt players in the world.

Chris

So it just, again, is a sign of, I think, how worried these OEMs are about. They see the tea leaves or the winds shifting or whatever the phrase is, and they don’t want to get left behind.

Tony

Right.

Tracy

I had a question.

Chris

Sure.

Tracy

Okay, so we already know that we have a permitting process problem here in North America. It’s not only in the United States. Canada is facing that same issue as well, where it takes ten years to even get the permit, basically. And so in what ways or how do you think that climate goals are in conflict with sort of this process? Right? We already know we need these metals. We already have this red tape that already existed before. This is like an old problem. Right. And so now we have these climate goals, which is adding to the problem. How do you see this panning out?

Tony

Basically?

Chris

Yeah, no, it’s not a comfortable conversation, quite frankly. And I’ll just give you a perfect example. I mean, when you had talked earlier about China and coal growth to feed the grid, indonesia is going to be one of the largest nickel producers. They already are one of the largest raw nickel ore producers in the world today. They’re expanding capacity there dramatically. And in terms of what is the energy source to build these mines and operate these mines, it’s coal. So all of this nickel that is going to go into these millions and millions and millions of electric vehicle batteries is going to be coal fired. And so you have to take to your point with respect to climate goals and thinking about how green the process is. You have to take that into account. And that’s kind of the uncomfortable part of the conversation. And so a lot of my inbound calls coming from investors are, we understand, like, there’s commodity price risk, there’s ESG risk with mining. Mining industry, quite frankly, doesn’t have a sterling reputation when it comes to hitting things on budget and on time. And so what else is out there?

Chris

What else could feed or should say plug any kind of structural gap in metals demands, number one. And number two, do so in such a way that you hit these ESG goals, which again, are very, I think, fluid in some ways. And so I do a lot of work in lithiumion battery recycling and do a lot of work in a certain type of lithium extraction called direct lithium extraction. Again, don’t want to get too much into the weeds today, but even those processes have their own CO2 footprints. And so, at the end of the day, I sort of look at this as, like, the paradox of green growth, which is everybody wants to decarbonize, and we want to have clean cars or a clean grid or whatever. It is. But there is a price to be paid to get there in the first place, and you’re just not going to do it through recycling or innovating with battery technologies. It’s going to take a lot more raw material, and that is going to have kind of a basic carbon footprint that needs to be accounted for.

Tony

Hey, Chris, before we move on, when you talk about these corporate investments and supply chain investments, it looks like a lot of this stuff is on the mining side. Are these say lithium America’s. Lion town. Are they refining as well, or are they only mining?

Chris

Excellent question. Liontown’s intention is just to mine. Okay. Lithium america. It’s an interesting question because neither of them are in production today. And so we just have to rely on their feasibility study and their stated plans. So lion town is a hard rock asset, or they’re developing a hard rock asset in Western Australia. Their initial intention is just to mine the concentrate, the hard rock concentrate. Where will that go to be refined into battery grade salts? It’s going to go to China, probably.

Tony

At least initially, like we’re going to mine it here, ship it to China, have it refined and send it back.

Chris

This is the issue with well, again, the fact of the matter is the Chinese has spent the last ten or 15 years building a consolidated lithiumion supply chain. I’m not saying it’s going to take us ten or 15 years, but we have the mining issue to think about. We have the refining issue. And to be honest, you could get a lithium refinery here in the United States. And there are actually perfect example, tesla and Corpus Christi, they’re building a lithium refinery company here on the slide, piedmont Lithium. They’re actually building two lithium refineries, one in Tennessee. Again, the source of the feedstock is kind of an open question there, but nevertheless, these companies are going to build these refineries in the next three or four years. It’s much easier to permit midstream to downstream portions of the supply chain than it is the mine. But, yeah, again, think about a lithium molecule, right. Maybe it comes it’s mined in Western Australia, it’s concentrated there. It goes to China, where it’s turned into battery grade salts. Maybe it then ends up in Japan, where it’s turned into cathode. Maybe then it goes to Fremont, California, where it’s put into a Tesla.

Chris

I mean, the journey of a lithium molecule has a rather significant CO2 footprint associated with it. And again, this is, I think, what, the inflation reduction act. And a lot of this legislation, this kind of near shoring or friend shoring legislation is designed to do is to minimize the CO2 footprint. But, yeah, it’s kind of a long winded answer saying some of these guys are going to refine and some of them aren’t. But at the end of the day, for the foreseeable future, everything’s going to go through China.

Tony

But if that lithium was transported with biofuels, Corey, it would really help that CO2 footprint.

Corey

Right. Nice segue, the same thing.

Tony

Thanks, Chris. Thank you. I really appreciate it.

Tracy

That segue was excellent.

Tony

Corey, hey, thanks for joining us. There was a big EPA announcement on biofuels this week, and I want to understand what all of that means. I’m not an expert here at all. So can you please tell us what is a biofuel?

Corey

Sure. A biofuel is a fuel that’s derived from biomass or organic matter. The most common ones in the United States are ethanol. Ethanol is about 98% of the gasoline in the United States has ethanol in it. It’s mostly made from corn or sorghum. In the United States, it is made from corn and wheat. In Canada, it’s made from sugar cane. In Brazil and other areas of the world. Other biofuels that are common are biodiesel and renewable diesel, which are substitutes for diesel as well as sustainable aviation fuel, which is a substitute for jet fuel.

Tony

Okay, so when we hear the words biomass, what does that mean?

Corey

Once again, I’m just re saying organic material, organic plants. Biodiesel is also made from fats, recycled oils and greases. Those are the soybean oil, veggie oil. So that’s kind of what we’re talking about.

Tony

Okay, great. So when you talk about things like biodiesel or aviation biofuels, how much of, say, biodiesel in, say, North America or Europe, or how much of diesel in, say, North America or Europe is biodiesel?

Corey

I would say about five to 7% of the total diesel pool is biodiesel. Renewable diesel. It is a growing percentage primarily because with this EPA announcement, there’s mandates that require refiners and importers to use the fuel, as well as states with low carbon fuel standards that have increasing targets that require increased uses of these fuels.

Tony

Okay. And aviation fuel, bioaviation fuel, how much of the market is biofuel?

Corey

Next to nothing. And that’s where the big opportunity is. I think right now it’s like less than one 10th of 1% of the total jet fuel pool is sustainable aviation pool. And I think production in the United States was less than 16 million gallons last year. When we’re talking about targets of like 3 billion by 2030 and 35 billion by 2050, we’re talking minuscule mounts at this time.

Tony

Okay. I think it’d be much more comfortable in a biofuel powered jet than an electric powered jet at this point. I don’t want to get to that 300 miles limit and have the jet engine just stop.

Corey

That’s very common. I don’t think anybody wants to fly from Los Angeles to Singapore in an electric jet, but maybe if you’re hopping from island to island, then you would be comfortable with those smaller ranges.

Tony

Okay, so can you also tell us on these general segments that you’ve talked about in terms of biofuels, how quickly are they expected to grow? Generally like 400% a year or 20% a year.

Corey

No, I mean, the renewable fuel standard is what jump started the industry. Right? So ethanol was used as an oxygen for gasoline was basically like a 4 billion gallon per year. Industry in the United States. Then the Renewable Fuel Standard came out 2005. It’s been around for around 15 years or so or active. And during that time ethanol has gone from 4 billion gallon industry to a 17 billion gallon industry. So there’s already been the extensive growth for ethanol and biodiesel. Right now there seems to be a transition where more of the construction is going into renewable diesel and SAF. Those fuels can be produced from the same facilities. Like you said, it’s such a small percentage of the total jet fuel market that there’s an increased focus now on decarbonizing it. So if we have over 10% of the gasoline pool that has ethanol, around 5% to 7% of the diesel pool has biodiesel and renewable diesel. Now we’re just kind of making that transition of why is such a small percentage in aviation. And so the Biden administration has had setting these goals of production targets as well. As I know that Chris mentioned the Inflation Reduction Act a few times, that there are incentives for SAF that are better than some of the other fuels.

Corey

There’s higher blending credits for sustainable aviation fuel. And then in 2025, when there’s a new clean Fuel production credit in the Inflation Reduction Act, SAF has preferential treatment as well, where it gets a higher credit. So that’s the tool being used by the government to jump start SAF, just like ethanol and biodiesel were jump started with the onset of the Renewable Fuel Standard program.

Tony

Okay, great. So I understand those are all basic questions and most viewers are probably way beyond me in their understanding biofuel. So thanks for doing that. Can we walk through some of the EPA information that came out yesterday? You sent this great table, and if you could walk us through what that stuff means, I’d appreciate it.

Corey

Sure. Okay, so the intent of Congress was for refiners and importers to use a growing amount of biofuels each year. And there’s four separate categories that are depicted on the chart to the left that they need to blend a certain amount of renewable fuels, they need to blend a certain amount of what’s called biomass based diesel, which are the diesel replacements, a certain amount of advanced biofuels and a certain amount of cellulosic fuels. And what Congress did is that they would set a mandate and every year EPA would look at it and adjust it based on the available domestic supply. The mandates were set by Congress through 2022. And this has really been the first set of mandates where the EPA was setting mandates without the guidance of Congress. And essentially the only guideline that they had was try to keep up with the congressional intent. And essentially the congressional intent was for mandates to get higher and more stringent every year. So if we look at the chart, you can see how volumes are constantly going up a little bit. If we focus on this table, one of the takeaways from the announcement was a lot of biofuel companies were unhappy with it.

Corey

There was a proposal in December of last year followed by a public comment period and taking them about six months in order to finalize these mandates. The ethanol industry got a number less than what was proposed in December. So if we look at the conventional biofuels column of that table, we can see that about 15 billion gallons was basically reserved of a category that corn based ethanol can satisfy. The proposed volume was 15.25 billion and it was reduced to 15 for 2024 and 2025. So the ethanol industry is very upset about that. The higher the mandate is, the more than the greater likelihood there would be higher blending. The ethanol industry wants to move up from the standard of E Ten. The vast majority of the fuel in the country is E Ten, and they are pushing to have more E 15, E 85 and other higher grades. And part of the Inflation Reduction Act too was giving half a billion dollars in order for service stations to update their equipment, update their infrastructure, to enable them to sell more E 15. In terms of the biomass based diesel column, that’s something that you can see that it gets progressively higher each year for the mandates that were set for 2023, 2024 and 2025.

Corey

But it’s growing at a very slow pace and it doesn’t mirror the amount of investment that has been going into the sector. There’s already enough reduction right now to satisfy the mandates in 2025 and hundreds of millions of dollars are going into converting existing oil refineries to produce renewables. So we have renewable diesel facilities being constructed, we have sustainable aviation fuel facilities being constructed, and the actual capacity is going to be way higher than these biomass based diesel mandates, which has upset a lot of companies because historically, the EPA usually has looked at the availability of supply as the guide for setting these mandates. And when these mandates are considerably less than what they expect supply to be, then that has upset a lot of people. And the cellulosic biofuels, there was going to be a really big change in 2023, 2024 and 2025. The EPA was going to include EVs in this renewable fuel standard program. EVs do reduce emissions and they aren’t allowed to generate compliance credits like all these other fuels. And they had proposed a system or proposed regulations that would allow EVs to generate credits under the Renewable Fuel Standard and they were quite complicated.

Corey

The only companies that would be able to generate these valuable Rins are valuable credits known as Rins were EV manufacturers and there was just great opposition to it during the public common period. So the EPA punted having EVs generate these types of credits. So the cellulosic fuels are basically very small amounts of liquid biofuels coupled with biogas.

Tony

Interesting. Okay, so you covered this already, but I’m very interested to see that 15 billion gallons of conventional fuels just kind of plateau. And there must be a lot of disappointed people in the Midwest of the US. About that. And it does look like things are slowing down in terms of biofuel requirements. Maybe too much is strong. But is there more capacity than needed today, or is it just the investment that’s going in? Is planning to have more capacity than is outlined in these regs?

Corey

Well, it depends what type of capacity you’re looking at. If you look at just individual fuels, ethanol, if you kind of look ahead, if you look in the medium term and we’ve been talking about EVs during this discussion, that it’s clear that the increased penetration of EVs is going to take a lot of gasoline powered vehicles off the road. And when you take millions of gasoline powered vehicles off the road, there’s going to be less on road demand for fuel ethanol. So we’re going to reach that stage of what are you going to do with all that ethanol. We have about 17 billion gallons of capacity. So this is where sustainable aviation fuel is a godsend to the industry because one of the technologies that’s being developed to produce SAF is using ethanol as a feedstock for SAF. We talked at the beginning of how veggie oils can be used for biodiesel and corn and sorghum and wheat can be used to make ethanol. Right now they’re developing technology where actually ethanol itself can be used as a feedstock for staff. And once again, when there’s going to be massively declining demand for on road ethanol, the prospect of using ethanol to make something that could help decarbonize the aviation sector is extraordinarily exciting for the industry.

Corey

And also, it’s not a one to one ratio. It takes about 1.7 gallons of ethanol to make one gallon of SAF due to density issues. And so SAP is really opening up a tremendous opportunity for domestic and domestic ethanol producers and also imported fuel.

Tony

Go ahead, Tracy.

Tracy

Sorry, I had a question. So we’ve seen a lot of the aviation industry kind of push back on this state, saying that we can’t do this right now. This is going to cost us a lot of money. We’re going to have to pass these costs on to the consumer. So how do you look at this as far as I mean, obviously this is in the invancy stage, but how do you see this panning out? How long do you think this is going to take until this becomes like a viable fuel for aviation where it doesn’t cost us another $200 per flight to pay for?

Corey

Well, look, there’s already countries that mandate SAF in Europe. France mandates AF Norway and Sweden mandatesf. Already the EU directive is going to institute mandates starting in 2025. So it’s a real thing in Europe right now. Right now, once again, construction is going on. We have very minimal SAF production right now there’s a SAF producer called Montana Renewables in Montana that’s operating. And we have a lot of big facilities that are going to be coming up soon in California, in Georgia, and elsewhere. I’m seeing differently. We’re talking with airlines and more. The public press releases, they say they’re excited about it. They’ve entered into offtake agreements with these renewable fuel producers. They’re part of airline associations that have specific targets. Many of them have targets of 10% SAF by 2030. Whether or not anybody believes that’s Achievable, they may say something as the time comes closer where perhaps they take the position that it’s not feasible because staff is too expensive and consumers are unwilling to bear the added expense. But I think that many airlines are looking towards decarbonization efforts and they’re waiting for the staff to be produced. It’s behind schedule. There’s supposed to be a lot more availability of sustainable staff by now, but they’re waiting for it and they have offtake agreements for when it comes.

Tony

Why is the availability not there?

Corey

The development of technology. And frankly, when we look at the mandates, when I said, hey, there’s mandates for advanced biofuels and biomass based diesel and ethanol can satisfy one of the categories. There isn’t a mandate for SAF. Had there been a mandate for SAF when the Renewable Fuel Standard was amended in 2007, then we would have seen technology being kick started. And back then there’s been over ten years of trials and testing and test flights. Everything would have been accelerated had SAF been a mandated fuel. So right now the Biden administration, they have a target. They have what they call a grand challenge for a certain amount of production. 3 billion gallons of production by 2030. And once again, they’ve had provisions in the Inflation Reduction Act which will support this program, such as blending credits and cleanfield production credits that are pro staff.

Tony

Tracy, I’m sorry, I didn’t mean to interrupt you. You were starting to ask a question.

Tracy

No, you actually almost asked my same question, just rephrased a little bit differently.

Tony

Okay, very good. So in Corey, it also sounds to me like on some level, and I don’t think this is fully level, but it almost sounds to me like biofuels is kind of seeding, say automotive to EVs. Is that fair to say or not?

Corey

There’s no seeding going along.

Tony

Okay.

Corey

SAP is like perhaps a backup plan or the way they’re looking at the future. The ethanol industry right now is trying to make sure that fuels have higher blends. And actually last year there was record sales of E 15. There’s record sales of E 85. Ethanol has been selling at a lower price point than petroleum based fuels. So when you blend, there’s a better economic incentive to blend. So E 15 was selling at a much cheaper price point last year, and E 85 in California was selling up to like $2.50 less a gallon than the normal E ten. So a lot of people, when times are tough and the economy was bad, a lot of people saying, look, I heard that my car can accept E 15. I could fill up my tank for $6 less. And they gave it a shot and the cars didn’t fall apart on the side of the road. So you had essentially a lot of millions of new customers who tried these higher blends for a first time because they didn’t really understand them that well. They saved some money and now we got some new adopters of this fuel.

Tony

Okay, interesting. I’m going to ask both you and Chris the same question about your respective areas of expertise. So what should we be looking for when evaluating companies that are well positioned in biofuels? And Chris, I’ll ask you the same thing about battery metals, but what should we be looking for with those companies?

Corey

The companies are leading the carbonization efforts. One thing I didn’t really focus on is a lot of the new renewable diesel and SAF producers are going to be traditional oil refiners, refiners like Marathon and Chevron and Philips 66 and CVR and HF Sinclair. These are companies that are taking existing facilities and converting them to start processing renewable feedstock in order to produce renewable fuels. They’re making this transition from the old oil stuff and they’re producing these new fuels. And now they could use and they could blend these fuels into their existing petroleum based products. But that’s what we’re seeing. We’re seeing decarbonization efforts and a lot of these big oil refiners that are doing the energy transition and moving towards renewables.

Tony

Great. Chris, how about you? What should we be looking for when evaluating companies that are well positioned in battery metals? What are the main things that you’re seeing?

Chris

Yeah, I mean, look on the upstream with respect to the raw material. I think as I look at specific companies, the whole lithiumion supply chain discussion has this huge geopolitical component to it now. And so when I think about assets, mining assets in particular, I think what I’m looking for first are companies that have what I would call geographic and geologic diversity. Companies that may have lithium assets in Western Australia and in Chile or just different parts of the world. That way if you have an asset in a country and all of a sudden they wake up one morning, the government says, hey, you know what, we’re going to look at those royalty numbers again. Or no more exporting of raw. Well, look at Indonesia, right? I mean, twice in the last eight years they’ve banned raw exports of nickel anyway. So geologic and geographic diversity, number one. And then number two, producing battery metals, in other words, hitting that spec. I’ve talked a couple of times about battery grade lithium carbonate or cobalt sulfate or whatever it is. That is not something that’s easy to do. And while the know how is out there.

Chris

You want to find those management teams that I always like to say they have the right blend of sort of financial markets, acumen, how to raise the capital and manage the balance sheet and manage the capital structure, but also how to produce these chemicals. Because what we’re going to be doing if we are going to get to 50% Ed penetration or whatever the number is in the future, we’re going to be going after lower grade, lower quality assets. And those are more problematic in terms of hitting that battery grade spec. So, again, it’s geologic and geographic diversity, number one. And number two, it’s just management teams that have that technical capability to produce these materials of scale.

Tony

Yes. And I’ll ask you both the same question as well. What do you see as the best near term opportunity, Chris, around battery metals, around that supply chain? What’s the biggest near term, say, three to five year opportunity in that area?

Chris

I think from a higher risk tolerance perspective, I look a lot at battery technologies and so innovations around different cathode formulations. In other words, either using an equivalent amount of lithium or nickel or what have you, and increasing energy density. So I look at a lot of different cathode and anode technologies on the anode side of the battery, really interested in what we call silicon anode technology, which is effectively doping that anode with silicon. And that can increase the energy density up to around 30%. Okay. So you can drive 30% further, charge a little bit faster. So I look at a lot of those types of opportunities. Again, kind of alluding to or going back to what we talked about earlier, the refining aspect of this whole theme and this whole thesis. I mean, Elon Musk will tell you that he thinks that the bottleneck is in refining of these materials, and I think he’s partially right. I think, again, it’s also just getting your hands on the feedstock in general. So building out that refining capacity again, to your point, over the next three to five years is a really interesting place to be as well.

Tony

Right, okay. Corey, how about you in biofuels? What is the biggest opportunity in the next three to five years?

Corey

I’ve already mentioned it. The biggest opportunity is the use of ethanol as a feedstock for SAP.

Tony

For aviation fuel.

Corey

Yes, I’m sorry, I’ve been saying SAP. SAP is short for sustainable aviation fuel. That seems to be a great opportunity. We have once again, they generate Rin credits that can be used for the federal Renewable Fuel standard. They’re beneficial for these state low carbon fuel standard programs like in California, Washington and Oregon, and they’re developing state credits that are incentivizing it as well. So if you there’s a SAF purchase credit in Washington state and Illinois now where they’re adding on tacking on additional incentives to sell staff into those states. So I think ethanol to SAF and the advancement of the construction of these facilities is quite exciting to the industry.

Tony

Okay, thank you. And Tracy, let’s end up where we started out on oil. We’ve talked over the years about the lack of investment in the upstream, in oil and in the downstream in oil and gas. Right. And it sounds like battery metals and biofuels are getting a lot of investment. So are these large energy firms, are they taking funds that could be put into the upstream and substituting them into biofuels and battery materials? Or is it not substitutional? Are they just not doing that capex on energy upstream and they see this as a completely different thing?

Tracy

Well, there are two totally different things when we’re talking about mining for metals and mining for oil and gas. But if we look at the biofuel side of it, of course there are a lot of refiners that have allotted a lot of money to changing over, particularly California to changing over. Some of their refineries to include biofuels. Marathon is one, valero is one for a couple to look up. I definitely think that this industry is they’re not aware of what is happening and where this industry is going. And so, again, like I said, in particular, if we were looking at the refining industry, there are a lot of traditional oil refining companies that have already allotted a lot of money into biofuel technology and refining biofuels because they don’t want to get left behind.

Tony

Great.

Chris

Sorry, Tony. Just as an example of an oil and gas company looking at the battery metals is exxon. There was a story in the Journal a couple of weeks ago about how they’re looking at getting into the lithium production business and the smackover formation in Arkansas. The reason I think why a lot of these oil and gas players have shied away from battery metals or diversifying away from their business from a capex perspective is quite simply because most of the battery metals markets are too small. I mean, I mentioned that lithium is a 900,000 ton a year market that’s I don’t even know at elevated prices, is it 20 billion a year or something like that in revenues? I mean, that’s probably the capex budget for one of these super majors in a specific year. So the battery metals have never really moved the needle from a financial perspective for these guys and that’s one of the reasons why they’ve steered clear of it. But again, with the way the political winds are shifting, you’re starting to see the exxons of the world say, hey, we’ll give this a closer look. So I don’t know what’s going to come of it, but it’s something that is interesting.

Tony

Great. Okay, guys, this has been really helpful for me, really educational, informative for me. So thank you so much for spending your time. Thanks so much for helping us out with this. Have a great weekend and have a great week.

Corey

Ahead.

Tony

Thank you.

Tracy

Thank you.

Chris

Thanks you me out.