Tag: copper gap

Perfect Storm: Synchronized Global Risks, an Unstoppable US Consumer, & Copper Gap in Energy

Post author By admin
Post date April 1, 2023

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In the latest “Week Ahead” discussion, three experts delve into three crucial topics: synchronized global risks, the spending patterns of the US consumer, and the copper gap in the energy transition.

Keith Dicker of IceCap Asset Management and Loonie Hour Podcast takes the lead on synchronized global risks, highlighting how a banking crisis in Silicon Valley has led to crises at other regional banks in the US and abroad. He also discusses the potential risks of the Hong Kong dollar breaking its peg and its impact on the Canadian dollar.

Albert Marko shares his insights on the spending patterns of US consumers, presenting surprising findings on mainstream companies like Carnival Cruise Lines and McCormick, which have been able to raise prices despite the economic recession. These findings challenge the notion of the Federal Reserve’s ability to pivot or pause.

Tracy Shuchart from Hilltower Resource Advisors warns about the copper gap in the energy transition, which is emerging just as the energy transition gains speed. She provides insights into what this means for copper prices in 2023 and how it will impact the energy transition.

The episode concludes with the experts’ predictions for the week ahead.

Key themes:
1. Synchronized global risks
2. The US consumer isn’t slowing down
3. Copper gap & energy transition

This is the 59th 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
Keith: https://twitter.com/IceCapGlobal
Albert: https://twitter.com/amlivemon
Tracy: https://twitter.com/chigrl

Transcript

Tony

Hi, everyone, and welcome to the Week Ahead. I’m Tony Nash, and today we’re joined by Keith Dicker. You’ll know Keith on Twitter as @IceCapGlobal. He’s with Ice Cap Asset Management. He also hosts the Looney Hour Podcast, which is one of the most popular business podcasts in Canada. So we’re really lucky to have them today. We’ve also got Tracy Shuchart from Hilltower Resource Advisors and Sam Rines from Corbu. Sam Rines will be joining us a little bit later.

Tony

So let’s get started, guys. We’ve got a few key themes this week. First is synchronized global risks. And we saw that recently with the banking issues, and we’ll get that into a little bit into that a little bit deeper with Keith. With Sam, we’ll talk about the US consumer and how it really isn’t slowing down. And we’ll go into some detail on company annual reports and quarterly reports on that. And then with Tracy, we’ll talk about the copper gap and the energy transition and a message that she’s been talking about for maybe about a year, but is really kind of coming to the forefront now. So, guys, welcome. And Keith, thanks again for joining us for the first time. We really appreciate it.

Keith

Yeah, thank you for having me here. And I think with Tracy, I consider you like half Canadian, sort of with the Quebec ties, but still like one and a half Canadian against one guy from Texas. We’re still not winning, are we?

Tony

Yeah, you’re welcome here anytime.

Keith

So I’ll just talk a little bit about how we do things. We manage money for individuals and family offices, basically across Canada, as well as some European clients, in the US, and Asia. And so we’ve had a lot of success with our strategy and just a couple of things to get the view started, which I think is important. We’re Canadian. I founded Ice Cap back in 2010-2011ish around then, but prior to that, I was offshore in Bermuda for over a decade. And then before that, I was with one of the big bad Canadian banks. But I like to share this Bermuda story because I think it’s really important today because I think a lot of people today get so focused on the day-to-day and short-term factors, what’s happening. And the other challenge a lot of investors have, we tend to see the world through the eyes and minds of where you live and where you’re from. And our view, the financial world does revolve around the US. That’s just the way it’s put together. But being offshore, you don’t really belong to any country. You’re living in between the seams.

Keith

So you get to see and feel and live the world from the perspective of all these other ex-pats you hang out with and so forth. So I just share that with you because, like up here in Canada, if you know the Canadian environment or not, Tony, you should head up when it’s a bit warmer. Maybe for you, I know, but Canadians have this very insular view of our banking system and our housing market. Everyone around the world should behave and act and walk the way Canadians do and so forth. As we all know, that’s not the case at all. It’s a very bigger world out there. With just that in mind, just before I go into the immediate view that we have with the world, it’s our view that long-term interest rates, looking at the ten or 30 years, really did peak in 1982. That’s when it peaked. Back then, rates were called 20%. So from the early 80s right up to eight nine, they went to 0%. And everybody makes money when that’s happening, especially the bond managers. And when that hit zero in 809, policymakers should have let the world reset.

Keith

But we know, of course, that wasn’t permitted, and some jurisdictions did a better and worse job than others that trying to protect that. But effectively, what happened then, for the next decade-plus, we’ve been living in this world with zero rates, negative rates, unbelievable re-escalation of borrowing at both the sovereign debt level households and companies, and so forth. And the other part I like to add to it a bit of a joking way, but it’s also factual. We now have basically two generations of university kids coming out for their entire university academic careers. And now ten years of working in, say, the investment world has been in this period that just doesn’t exist. It’s zero rates. Nothing exists, because as we know, Tony, you put a zero in your denominator for any number. You’re calculating what happens. It doesn’t work. Right. So what we see now today in response to all the policies we have with the Pandemic and COVID, for better or worse, all of the economies and central banks in the world, now they’ve all synchronized. So risk has been synchronized in the US. Canada, Australia, Asia, Europe, you name it.

Keith

And now we’ve gone from this period with zero negative rates. Short term rates are now they exploded higher, and it’s created this moment where increasingly we’re starting to see these risk just come out of the blue.

Tony

Just to clarify something, and I want to make sure that I understand correctly, when you have a zero or negative interest rate, the cost of risk is only the nominal cost of the money that you put at stake. But with an actual interest rate, you have a multiplier on that risk. It may be just a small portion of the multiplier, but there is an accelerator on that risk, right? And so I think this is what it’s been really hard for people well, really easy for people to fall in love with, with zero risk, I think, is that if I risk $100 and I lose it, the value of it is only $100. But if I’ve got a 10% interest rate, then I’m not just losing $100, I’m losing $110. Right. So as we transition back into a positive interest rate environment, the financial planning and the investment planning for people, as you mentioned, say, two generations of people coming out of school, this is an environment people have never had to deal with before. Right. And at the same time, we have BOJ, ECB, and the Fed, who to varying degrees, have had zero or nerp environments where nobody’s had to deal with that.

Tony

And it’s crazy. So I know that is just some basic, basic stuff compared to the advanced calculus you’re talking about, but I think we really kind of need to highlight that that there is an actual cost to risk now that we have real interest rates.

Keith

Yeah. And it’s something we haven’t experienced for a long time. So people tend to forget that. In school, and these CFA studies that we all went through, we call that the risk free rate of return. And it’s been zero for a long time, and it’s been reset. I think this is the greatest global macro setup that we’ll ever see in our lifetime. I mean, if you’re a money manager and you’re not enjoying this right now, then I think you should get a different career, move along somewhere else. But if you think about, for example, over the last five or six months, the Brits had their crisis in their pension fund and guilt market. Of course, then we had Silicon Valley Bank just recently, and then right behind that, Credit Suisse was there. So one good result about that, policymakers, which is mostly the Fed Reserve, of course, were able to react very quickly to prevent contagion. And so they should be complemented for that. I know it’s not nice to compliment or it’s not cool to compliment Central Bank. Yeah, definitely not cool. But that’s something that is a result that did happen. However, it’s also telling us here at Ice Cap that if you went back six months ago and I said, hey, I want you to list ten things that could blow up over the next six months, you wouldn’t have had those three events on your bingo card.

Keith

Maybe the Credit Suisse story, maybe, but the other two were pretty hard to find. So that tells us that, hey, there’s other events that are out there lurking around. And because they’re out there, it doesn’t mean they have to occur. It just means that the probability of them occurring, in our opinion, it’s a lot higher than it normally would. It normally would be your normal distribution chart or graph. So we have that happening, and it seems like every day there’s increasingly more data coming out. We just say, wow, I can’t believe that’s still going down that path. But these are the things that we look at. And again, we find it’s incredibly interesting. It means it does create a lot of opportunities coming up for people managing the portfolios. But you have to be aware of these fattail events that are out there because they could happen and maybe the next one is central banks are not able to save us.

Tony

So let me ask you on the, on the kind of synchronized risk part, seems to me that developed markets are highly calibrated to these risks. A small issue causes a huge reaction in developed markets. I spent a lot of my life in emerging markets, China, Sri Lanka, India, Southeast Asia, Eastern Europe, all over the place. And so it seems to me that emerging markets can bounce around a lot and the perception of risk is a bit lower. I know that there’s a perception that if the US or if developing markets have problems they’re going to be felt even more in emerging markets. But is that true when you talk about these synchronized risks? Do they necessarily feel worse in emerging markets?

Keith

I think in a normal cycle that is the case. You just go with it because from a fundamental perspective, emerging markets look awesome. You know, they have lower debt, faster growth rates, younger, you know, younger demographics and, and things like that. However, again because we’re in this world again I call it synchronized risk. And a quick example is housing markets, real estate markets like Canada and Australia as an example. Again it’s our view that if risk does re escalate, so it happens rapidly. Then because the world.. It operates on the US dollar, that’s just a fact. That’s the way it works. All of a sudden liquidity dries up and liquidity comes out of those markets. So then it doesn’t matter how strong or weak the fundamentals are. If you don’t have dollars to operate, you have US dollar tax revenues coming in or economic gross domestic product revenues, all that stuff, then it’s going to push someone off sides. I think back prior to the 809 housing crisis it would have been hey yeah, just ride it out and you’ll be fine. But these days for example, we’re avoiding these markets. We’re not in the EM markets at all.

Keith

And sometimes that’s great, other times it’s oh wow, you missed one there Ice Cap. The main goal with investment management that we look at is if you avoid the large drawdowns for your primary portfolios then the return side will take care of itself. But if you get these big chops in value and I mean we know the numbers, if you’re down 50% you need a 100% return to get back to where you started. Again it’s being cognizant of these risks that are out there and we keep going back to this US dollar wheel that’s greasing the world.

Tony

Yeah. Speaking of currencies, Keith, you had posted this tweet earlier this week responding to a message from Kyle Bass about the Hong Kong dollar breaking and you said if the Hong Kong dollar breaks, the CAD also breaks. Can you talk us through that a little bit?

Keith

Yeah, because obviously we’re Canadian up here and the challenge that most Canadian investors have is that they don’t appreciate that the Canadian dollar and the Canadian economy and the yield curve up here in Canada, it can be significantly influenced by an external factor and that’s lost on most investors up here. So if you’re reading, like, big bank research, like, they’ll never. Sorry, they’ll rarely talk about these outside events. It could be something within the eurozone, for example, like the Italians or something. We know China is struggling quite a bit, but I will frequently talk and write and chat about these events and that if they happen, it is going to affect Canada. So the comment this week sort of stems back to… So we know the Fed opened their USD swap lines with all their friendly central banks that are set up for it and everyone drew on it. Everyone immediately. “Hey, yeah, we need the dollars.” But they also have this other repo line set up. It’s FIMA. I think it’s Foreign International Monetary Authorities. I think it is that stands for. So basically it’s a repo facility for central banks that are not attached to the swap line option.

Keith

That’s my understanding of it. And at some point, it was one week ago Friday, someone out there borrowed 60 billion USD for that. And if I think of people if you’re not aware how the repo facility works, Tracy, if I’m giving you $60 billion, you have to exchange with me at least 60 billion plus in US Treasuries to act as collateral for it. Even though you have Treasuries, you don’t have US dollars. We like to joke about if you go to a restaurant, you get your bill at the end of the night. You can’t pay it with a T bill. They’ll laugh at you. You need US dollars for it. So someone needed US dollars last week. And because of the size, and because they’re not one of the USD swap line friendly nations, you’re looking around who has that much in Treasuries that they can use for a repo? It really looks like it was or is China. And Hong Kong is the conduit for capital flows coming out of China. And it happened on a Friday afternoon. And as you know, if anyone here is running a bank, your goal is to last Friday afternoon and then you try to sort it out to get through to the weekend.

Keith

And then with that then 60 billion, it went to the Chinese, supposedly. And then every day this week we’ve had the Hong Kong dollar peg. It’s been up against its upper range, so it’s been sitting at 785, basically. And when it did open on Sunday evening, it actually broke through the range. So for this brief moment in time, it was up there. And so when I referenced that tweet, I’m more or less just pointing out to Canadians that, hey, if this peg was going to break, it is definitely going to affect world capital flows. Money will flow into the dollar, which means it’s coming out of the Canadian dollar. I like to poke Canadians sometimes with these things because they know we all feel we’re the best in the world at a lot of things, but that was the message with that.

Tony

Okay, so just staying on the Canadian dollar for a second, do you think the sensitivity with CAD, where outflows from CAD is as sensitive as, say, Hong Kong dollar could be? Especially given that CAD is so resource driven, do you think that would have an impact on it?

Keith

Yeah. So just be clear, if the Hong Kong dollar peg broke, this would be a once in two lifetime financial economic event. It will reverberate around the world several times over. If it doesn’t, and we’re just having a normal economic cycle, Canadian dollar is just going to ebb and flow with the demand for commodities and something else. But up here in Canada right now, we have a very tightly wound housing market. Everyone is familiar with that. There’s lots of reasons to support why it is strong. Our population growth has been unbelievable. We’ve had a million immigrants come in. In Californians, too. I don’t think they would last with the weather.

Tony

Albert’s got the New Yorkers. Albert and Tracy have the New Yorkers. We have the Californians.

Keith

So Albert and I met a few years back. I’ll give you guys one guess where we met in a location.

Tony

I don’t know if we can talk about that publicly.

Albert

It was actually Orlando. It was actually Orlando. I do like the Canadian dollar short term, anyways. But speaking about the population, I mean, the demographics for Canada is excellent. Probably the best they’ve had in a generation. The housing market is interesting, though, because I saw a statistic where in 2003, the average income for Canada was $60,000, yet the average home was 213. Now it’s $64,000 and $612,000 for a home. So the housing market is quite an anomaly in Canada. It’s over my head, but it’s something that I definitely should pay attention to.

Tony

I don’t mean this to sound stupid, but do you have the generational loans like they did in Japan back in the day? Do you guys do that up there?

Keith

What do you mean? No, our mortgage is…

Tony

One generation to nother to pay off a house.

Keith

No, we have 25 year amortization periods. The banks now have to do a few funny things to keep these loans from being impaired. So they’re extending to amortization period. But just a couple of quick things with Canada to be aware of right now. We have basically five major banks up here, and their loan portfolios are homogenous. They will tell you, no, we’re a little bit different than the next guy, but they’re all the same. So if we were to experience some kind of crisis in our economy or in the housing market, it will affect all banks at the same time. So we also have our term deposit insurance up here. It’s $100,000 canadian. It’s highly likely they’re going to need to increase that, but they’re not able to increase it to any level. That would actually be helpful if we were to experience a crisis because if one bank ran into trouble and they had to go to the CDIC to make a claim, all the banks are going at the same time. That’s just a function of what it is. But we are in this sort of precarious moment right now. We just had a budget came out yesterday, or the day before, I think it was.

Keith

And again, it’s like deficits forever, debt is going to grow forever, there will never be a recession. All these perfect scenarios are lining up. Again, we just like to highlight that we are in this global world and some kind of event can happen outside of your country. It doesn’t matter if it’s Canadian or Australian or British, something can happen that will trigger most likely would be a shift in your yield curve in some way where the credit spreads are hit or the long end of the curve gets hit, or banks have to take actual losses and things like that. And that’s when things get a bit funny out there. But that’s the story on what we see. Again, we think it’s incredibly interesting. There are great opportunities coming up, especially in the commodity world. We’ve been adding that space over the last three to four weeks. And the path that we like to talk about, not journey. The path, and it seems to be going where we’re expecting this year.

Tony

Perfect. We’ll talk about Canadians or commodities with Tracy in a little bit. But first, how is the Canadian consumer doing? We’re going to talk about the US consumer in a second with Albert, but how is the Canadian consumer doing?

Keith

You look everywhere, everyone is over levered. So you have that happening. Employment growth is fine, but if you look under the hood, it’s really in the service sector. One person might have they’re running three jobs, they’re an Uber driver, they’re running Uber food or DoorDash, whatever they call it, and maybe something else at the same time, because it’s kind of interesting in that we’re all expecting a recession to hit up here, but the data is still not showing that it’s going to happen. And the most important contributor, the positive contributor again, is population growth. So again, we’ve taken in over a million immigrants this year and I think that works out to about two and a half percent population. So our GDP per capita is actually declining, right? So if you take out the population growth, then we are struggling a bit. But Canadians right now, and banks are tightening their standards on lending. There’s increasing evidence that if we do start to see job losses, then it could be a bit rough. A lot of Canadians have bought houses over the last three years. They went with variable overnight mortgages, and all of a sudden, they’ve been resetting lock and step with the Bank of Canada.

Keith

So the good news is the Bank of Canada is done. They ain’t hiking anymore. Yeah, maybe we’ll get some relief with that. But the Canadian story, if something bad happened in Canada, it’s not going to affect the rest of the world. If something outside of the rest of the world happened, it will affect Canada. So we have this bit of a challenge here.

Tony

Okay, great. Keith has been it’s been really helpful to I mean, for people outside of the US and Canada. We’re different. The US and Canada are different. And Americans, I’m sorry to say, don’t really pay a whole lot of attention to what happens in Canada. So this really is helpful for us to understand this stuff. It is America’s largest trading partner, but we are a little bit selfish. And I’m sorry to say it, but it’s true. So it’s helpful for us to learn this stuff.

Tony

So let’s move on to the US consumer and little programming note. Sam Rines does not look like Albert. This is actually Albert. And so Sam Rines is ill. So Albert has so very graciously jumped in to this spot. And so, Albert, thank you so much. So I want to ask about the health of the US consumer. And Sam had done this newsletter earlier this week, and this is very much in line with things that you have been saying about inflation, Albert. And so let me just bring up a couple of things. And Sam brought up Carnival Cruise Lines earnings. And the highlighted part of this thing on screen says the company experienced the highest booking volumes for any quarter in its history, breaking booking records for both North America and Australia and Europe segments.

Tony

Okay, so Carnival Cruise Lines is not exactly a high end cruise line. This is a middle America cruise line. And they’re seeing bookings that are far beyond what they’ve ever seen. And next, Sam looked at the earnings for McCormick, a spices company, and McCormick talked about 11% growth from their pricing actions while they saw a 3% decline in volumes.

So this goes along with this concept that Sam has been talking about for about nine months called price over volume, where companies have been passing on their costs through their prices to their consumers while accepting a small volume decline. And so we’re definitely seeing the broad basis of prices continuing to rise in the US. And Keith mentioned this, that there is some broad expectation that we’re going to see a recession in the US. But Albert, we still see hiring relatively strong. We still see service wages strong. We still see price rises coming. What’s happening? How are we going to see a recession? First of all, what is your view of the US consumer. And second of all, how are we going to have a US recession while all this stuff is happening?

Albert

Well, the US consumer has been surging. It’s been relentless. I mean, wage inflation is at the core of it. I mean, people are finally the public is getting a 20-30% jump in their wages after 40 years of stagnation basically. It’s become such a problem for the Fed that they’re resorting to bank crises now to stop lending and credit from the banks. It’s just the reality of what’s happened. I don’t see it lighten up. They want the market up. That’s providing liquidity. Consumers are getting liquidity from all over the place. Certain states still have stimulus. It’s just relentless. And it’s really problematic for the Fed.

Tony

Wait, certain states still have stimulus?

Albert

Yeah, they still have stimulus programs. California has inflation checks and certain unemployment benefits are still rolled on. I think it’s 16 or 22 states still have some sort of stimulus programs kicked in for unemployment.

Tony

Okay, so one of the things that I’ve said today actually on Twitter about trying to pull back on the consumer is that we’re going to have to see some change in the housing market in order for the consumer to stop spending in the US. Because the perception of wealth in the US. Comes more from the perceived value of your house than it does from equity markets. There is this belief that as equity markets rally, there’s this broad basis of spending that comes from consumers. And while that’s certainly true for a portion of them, the value of someone’s house is so much more a part of their spending habits in practice. So does that make sense to you?

Albert

It does, but it creates another problem politically. Washington wants housing more affordable for their constituents. But on the flip end, the boomers don’t want to give up their increased prices of their homes. And on top of that, people are taking out Helocs and buying secondary and third homes for rental income. So this problem is just simply not going to end in the near term. And on top of that, thinking about jobs, when you talk about layoffs, it’s only tech. There’s not any construction jobs that are being laid off. I don’t know one company in the housing or construction field that’s dropped workers, the significant amount of workers, zero.

Tony

Right. Well, because there’s supposedly an undersupply of housing. That’s what we keep hearing. But when we hear about people taking home equity loans to buy a second house to rent out, how real is that housing shortage? I just don’t know. I mean, you can see all kinds of different data showing that there’s a shortage or not a shortage. But when we have a synthetically low interest rate and we have the Fed holding a lot of mortgage backed securities, we do have an interest rate that’s lower than it naturally would be.

Albert

Of course, there is. But when it comes to the housing shortages or oversupply or whatnot, you can’t even look at it at a national level. You have to take it state by state or even city by city. I mean, Florida and Texas are absolutely booming, but the same can’t be said for Pennsylvania. So I think we have to look at it from that aspect. It’s really hard to look at the housing.

Tony

We’re still seeing wages surge in the middle of the country, although they may not be surging on the coast. We’re still seeing prices rise and price and margins expand. With a lot of these consumer companies and services companies. We’re seeing patchy housing values rise or stagnate. What does the Fed do? Will we see a pause this year? Will we see a pivot this year?

Albert

I don’t think pivots even in the cards at the moment. A pause certainly is in the cards. The problem that the Fed faces is super core inflation. It’s just services like, even in Canada, like Keith was saying, is just sky high, rocketing up. It’s just not stopping. This is the biggest roadblock that the Fed has for combating inflation at the moment.

Tony

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Tony

Right, so we expect to see, I think you said before, at least a couple more 25.

Albert

I think two more before a pause hits.

Tony

Is it possible they could take some action on QT for MBS to hit the housing sector a little bit?

Albert

They could, but again, they’re facing headwinds from the boomers that are up there with Hank Paulson and Larry Summers and their crews. They certainly don’t want to hear from them that the housing market is crashing and their wealth being erased slowly. So that’s just again, there’s two dynamics. You have the middle class voters that can’t afford houses, and then you have the boomers that don’t want to lose their value and their wealth. So that’s what we’re stuck between.

Tony

I suspect that at some point that might be one of the only levers they have to pull to slow things down.

Albert

It’s a dangerous level to pull.

Tony

It is, but I don’t know.

Albert

I don’t even know if the banking sector can absorb too much of that kind of pain. I don’t know. I haven’t really analyzed that in any way. But theoretically, you start dropping housing prices 20, 30%, and I don’t even know what. That does to loans for people and the banks.

Tony

Keith, what do you think about that?

Keith

Just to add to that, back to the Fed comment, Albert. If you have the Fed hiking another 50 basis points and everyone else has effectively stopped, I think the ECB has stopped or they’re pretty well close to that. You could have this environment where maybe the economy does slow somewhat in the US. Yet the dollar is surging. Like it’s continually gets stronger and you just get this vicious cycle going back and forth with it. But it’s funny because everyone has been watching the Fed now since Jackson Hole back in August, expecting that they’re going to pivot. They’re going to pivot. And in my mind, I think the Powell has been very clear with which direction they want to go. And somehow they dodged that there at their last meeting, they had every opportunity to pause if they wanted to because of the banking crisis, and they just plowed straight through. So I agree with Albert. They want to continue hiking until they’re told they’re not able to do it anymore. And if they can get through several banks basically going under within a few days of each other and to continue hiking, then maybe there’s a world to get more than 50.

Keith

And again, if that happens, it’s going to push someone off sides out there. But that goes back to the whole global macro view.

Tony

Right? Well, we used to talk about how the Fed is going to push until something breaks. And so we saw some banks break and they’re continuing to push. So something else has to break. Right.

Albert

Something bigger.

Tony

What’s that?

Albert

Something bigger has to break. Something with more gusto to limit to help out the Fed right now. I mean, they unwound six months or nine months of QT in a week. Exactly. We’re back to square one now.

Tony

Right. And so banks failed, didn’t break enough. They want something else to break.

Albert

Joke. This bank failure thing is an entire joke.

Tony

Of course it is.

Albert

It’s a pre planned event. I mean, when First Republic loses 90% or 60% of their deposits and the founder is pushing back on the FDIC about a plan for salvaging the bank, it’s a joke. It really is.

Tony

Okay, so, Keith, you mentioned Fed continues to rise, stronger dollar. That seems to me to put pressure on downward pressure on commodity prices. Not necessarily everything, but it seems to put some serious pressure on commodity prices if we have a rising dollar, is that fair?

Keith

Yeah. I mean, our expected path this year with commodities prices that we go lower Q1 into Q2, and that’s exactly where we are. We start to see slower economic data coming out, Q2, Q3. They should bottom before any recession actually hits. So in that world, unless there’s a major supply disruption or discovery or something like that, we’re using this as an opportunity to start building small positions in that space, but you keep going back to like, is it a normal cycle or is there something else that may happen here at this point.

Keith

I think everyone’s been calling out for a recession. Say, hey, if you go from zero to five with overnight rates and the yield curve gets inverted so much, no matter which way you want to look at it, the recession is here and people have been looking for this back in Q4. Here we are, like five months into it and still no sign of it coming. Again, something is a bit odd out there. Maybe it’s just delaying the inevitable or maybe it’s as, you know, a bubble. You keep blowing into a bubble. I don’t mean that the economy is in a bubble or anything like that.

Keith

It just means that, again, everything has been synchronized around the world that it is giving the opportunity for something to go off sides. And when that happens, because everyone has so much risk on the table, people can start running around. And again, that doesn’t mean that you go all into cash or whatever your favorite overnight holding is. It just means you had to be aware of it and be positioned for it. And then when it does happen, it’s funny how nobody buys low and sells high anymore and most people do the opposite. So I think, though, maybe you can be a bit traditional, that opportunity will come up.

Tony

A recession is whatever we call it. So we had two quarters negative growth last year with strong employment. Right. So will we see the opposite of that this year with employment weakening but continuing GDP growth and maybe call that a recession? I have no idea.

Keith

Yeah, I think one of the main contributors to recession coming up is when banks stop providing credit to the economy or they slow the growth of credit. That’s the main thing to look for. And just using the Canadian economy as an example, that is happening. It’s now more difficult to get a mortgage. If you need credit, you’re using credit cards or stuff like that. I know the boomers are doing well. We always have access.

Tony

Boomers have always done well. It’s been good for boomers since they were 18 years old. They’re never going to suffer until they die.

Albert

That’s exactly what Keith is saying, is until the banks stop lending out, this is just going to continue. And this is most likely why this bank crisis was preempted, to stop the banks from lending.

Tony

Okay, so, Tracy, we started going down the path of commodities and with Albert and Keith, Albert thinks we’re going to see at least two more rate rises. If that strengthens the dollar. What’s your view on that in terms of general commodity prices? Does that push commodity prices down or do we start to see growth toward the end of the year pick back up and that helps commodity prices?

Tony

Sorry, you’re muted.

Tracy

Sorry. I think that it’s really going to depend on multitude of factors. The thing is that if you’re looking at some of these base metals, battery metals and things of that nature between energy transition and in Europe and North America have committed to this at all costs, even asking central banks to look past inflation in these areas. And so I think that demand particularly, and if we see pickup in China, which is also one of the largest EV makers in the world, I think that we’re going to have a problem where we’re going to have these metals go higher even in conjunction with a higher dollar. I think it’s very possible.

Tony

Okay, so let’s look at a comment you put out on Twitter earlier this week about copper.

Copper is critical to the clean energy transition. Europe and North America have committed to the transition. After 2023, incremental copper supply decelerates into 2030. And then you actually sent out a chart in November of ’22 showing kind of the copper supply gap. So can you talk us through why is there a copper supply gap? It looks like the supply just kind of flattens after growing. Why is the supply flattening out as demand is rising?

Tracy

Because we don’t have, because nobody’s mining it, really. We have about 1.1 million tons being added this year to supply as far as supply growth is concerned, and new supply coming online from new mining. But after that it levels off. And I actually sent you those charts so that you can show everybody, but you can see where supply growth literally goes from 1.1 million tons to literally nothing from here to out to 2030.

And then you have this incremental supply growth. When you’re looking at just take for example, an EV, right, it requires four and a half times the amount of copper as an ice vehicle. And when you start talking about buses, that’s twelve times as much. This doesn’t even include solar, wind, charging infrastructure and stationary energy storage that also require huge amount of copper.

And you have the green plan in the United States, and you have Europe’s rendition of a green plan, right? And so they’re planning to build all this out, and we just don’t have the supply available, and we’re just not going to have it. And if you add into this, for the past seven years, the mining industry suffered from the same problem that the oil industry has. Lack of capex.

Tracy

So you’re coming from already seven years of no cap, barely any capex, declining capex. So you’re not having supply really come haven’t had supply really come on in any notable amounts in the last seven years. And then moving forward to 2030, we’re not seeing that increase at all either.

Tony

Do you know that Simpsons meme, where they’re like barts in class and they say, say the line, say the line.

Tony

We’re going to think about that there when I say why has there been a lack of capex in mining?

Tracy

Because it’s dirty.

Tracy

Right? Is the reason.

Tracy

And nobody wants mining. Same with the oil sector. Nobody wants oil to drill for oil either. It’s dirty. Right? ESG these things are dirty, but yeah, we need them. So here’s our conundrum, and it’s not going to I think that not get any better. Regardless if we’re in a recession and regardless if we see the dollar spike. I mean, we’re already seeing copper prices are still holding up very well through this banking crisis, where we have seen oil wobble a little bit and the dollar has been over 100 and we’re still seeing these metals. We did see a pullback from the summer high when we had the electricity crisis or the natural gas crisis, right. So we did see those metals pull back from 2022 highs, but we’re starting to see them all spike again because again, we have these green programs that are coming to light now, particularly in the United States, and then again with Europe having their own kind of rendition of the IRA plan.

Tony

What will win? If you look five years out? Okay. And we have these ESG constraints on upstream development and mining and other things, and it almost seems like we’re going to have to continue to have some sort of subsidy for energy in places or some of that ESG regulation or legislation can change what will happen? Will ESG loosen or will we just continue to subsidize these things until we’ve kind of finished the transition, whatever that means?

Tracy

I don’t think just to reach 2035 goals right now, we need $35 trillion, right?

Tony

Because we’re just making money up now, right? So what is that $35 trillion spent on?

Tracy

And that’s just to get us to where the countries have their 2035 goals. So really, that’s not going to happen. You know, that’s not going to… Europe is not going to cough that up. United States is going to cough that. Canada is not going to cough that up.

Tony

Remember the Kyoto Protocol from the UN talking about green goals? It was done in 1992 or whatever. And I think the only country that did it was I think there were only two countries that did it, maybe three, like Canada, the US, and Iceland or something like that, right? So everyone signed this deal. These were all aspirational the goals were far enough advanced that nobody who signed the treaty was going to be in office when the accountability was made.

Tracy

Exactly. And that’s where it gets me to. My next thing is that they’re going to have to push these goals out. You know that, right. Because everybody decided these 2035 goals, whoever’s in office, we have the UK, and all these people are going to be gone, right?

Tony

Whoever is the chancellor in Germany will still be there because they keep those guys.

Tracy

That’s true. So my opinion is we’re not going to have enough money. You still aren’t getting these mining companies excited enough to you can’t get oil companies excited enough to drill right now. Right. They’re all focused on investor returns, paying down debts, capital discipline. It’s no different in the mining industry. Right. So we’re going to have a problem. So you’re going to have to pull just by pure logistics. You’re going to have to push those out. I mean, it’s just logistically impossible. We just don’t have enough metals, period. And you can’t just wish that into existence.

Tony

I don’t necessarily need to get into company names. And Keith, I know you want to comment. I just come to you in just a second. But I’ve been trying to think of how do you play this ultimately, because all of these green things plug into a grid. So is the ultimate play for the energy transition power companies or the companies that provide hardware for the power grids? What is the real play here?

Tracy

I think that it’s infrastructure to build all this stuff out. Right. So I like things like heavy machinery, steel, things that make infrastructure to actually build this out or to mine, right. Not necessarily the actual metals themselves because those tend to be very volatile. So I would look at what goes into making these metals, what goes into making these grids. That’s where you’re playing. Utility companies are, I think, going for the utility companies, they always get screwed in the end. That wouldn’t be my go to for an investment longer term, looking at this sector. So I was more into kind of the infrastructure again.

Tony

Good. Okay, Keith, you had a couple of things you wanted to say.

Keith

Yeah, I just love this conversation. And maybe one thing for us to think about is that maybe the current path we’re on, it changes. So we get the pendulum swinging to the other side where it’s no longer whether it’s socially or politically, you don’t have that huge push towards green technology and so forth. It doesn’t mean that people don’t want it, but it’s not going to be pushed by the public sector. Instead, it’s going to be into the private sector. And that could change a lot of things. I do think that a lot of countries are going to be prohibited from doing a lot of these investments because they just won’t be able to raise the capital in their bond markets. And there’s also going to be other needs coming up. Again, I go back to here in Canada right now with their budget that just came out. 10% of our at the federal level of our tax revenues are now going to interest expense on the federal debt. Again, I suspect everyone is in that kind of position. So what worth goes. I love the concept of stranded assets in the energy and commodity space.

Keith

I’m incredibly bullish on this space and maybe the dirtier that the commodity is is probably the better opportunity for return. And again we’re just in this world now, we’re even having this conversation. It’s not acceptable by some sides but I think we have to be realistic that we live in a period of extremes and I think if we’re using linear thinking that that’s going to be wrong. Like something will swing back to the other side.

Tony

Extrapolate today until forever.

Tracy

I actually tweeted out a German survey today. So only 10% of Germans believe that renewable energies will be able to meet energy needs for the foreseeable future. Even among the Green voters, that figures only 18%. Instead citizens want natural gas 59% and nuclear power 57%. And that’s across all parties in Germany. So the citizens wants, needs, likes are not necessarily coinciding with our government overlords. Right.

Tony

Because they’ve lived over the past year. Right. They’ve seen how this stuff can’t meet their needs.

Tracy

Swinging.

Albert

Well, the wall of reality is starting to hit these governments. Like what do you do here? You got a budget, you have to increase your defense. Specifically for the Europeans, you have to increase your defense budget. You still have to maintain your social programs. You still want to push these subsidies for renewables. There’s no money for that.

Tony

It also comes at a time where you have a lot of baby boomers retiring so you don’t have the income taxes on those guys going into your budgets. Right. So you’ve got a gap of say ten years until millennials hit that income level. And so there is a revenue issue and a spending issue and yeah, I think there are so many things in this calculation that it’s just a very.

Albert

These renewable programs are nothing more than tax schemes by the government. They see their budgets dwindling so they know that they can tax and spend a little bit more by throwing out these beautiful narratives like the Paris Accords where nobody but the United States had haired to.

Tony

So whatever we’ll go from there just a little fact and I’m sure I’m not going to become anybody’s friend from this, but I actually co authored a couple of papers with my friend David who was the person who pulled the US out of the Paris Accords in 2017 on behalf of the Trump administration.

Albert

Good. Exactly what they should have done. If people are going to make up their own numbers and have no mechanism for enforcement, then what do we do?

Tony

Exactly. So that’s where I sit in that anyway. Okay guys, really quickly to wrap up. Keith, your first. If we look at the week ahead, what are you looking for in the week ahead? I’m not looking for companies or anything here, but what are you looking for in terms of issues whether in Canada or globally or the US or something? What do you see in the week ahead?

Keith

I mean for one week ignoring any economic data points coming up, we’re finishing quarter end today it’s been risk on for the last ten days. I suspect on Monday morning we might see a bit of a shift in that stance, but that’s it. We continue on this. I keep going back to this path and where’s the next kind of crisis going to escalate from.

Tony

Good call. Great. Tracy, what are you looking for?

Tracy

Well, OPEC meetings this week. I expect no change, so nothing really to get that excited about in the oil sector.

Tony

Even with crude prices continuing to wait.

Tracy

No, I think they’ll stay the course right now because I still think that we did have Russia come out and say they’re cutting 500,000 barrels per day. It was just supposed to be just for March. They pushed that out to June. So I think that OPEC will kind of look at that and want to see how that is factoring into everything as it is.

Tony

Very good. Albert?

Albert

Specifically grains. I’m very curious to see how grains are in the commodities market, and whether food inflation starts to go up because wheat starts going up also. The Ukrainians said that they’re 10% lower on their crop yields. The Russians have been starting to make noise about Cargill. So I’m going to be very curious to see if we can catch a bid and drive itself up into the 800s.

Tony

Okay, very good, guys. Thank you so much. Thank you so much for your time. Have a great weekend, and have a great week ahead.

Week Ahead

Liquidity Drain and QT, Copper Gap, & Retail and the US Consumer w/ Daniel Lacalle

Post author By admin
Post date November 19, 2022

This Week Ahead, we’re joined by Daniel Lacalle, Tracy Shuchart, and Sam Rines.

First discussion is on liquidity drain and quantitative tightening (QT). How difficult is it?

Rate hikes get a lot of the headlines, but QT peaked at just under $9 trillion in April of this year. The Fed has pulled just over $200 billion from the balance sheet since then, which isn’t nothing, but it’s not much compared to the total.

Where do we go from here? Most of the Fed’s balance sheet is in Treasuries, followed by Mortgage-backed securities. What does the path ahead look like – and where is the pain felt most acutely? Daniel leads on this discussion.

We also look at the copper gap with Tracy. We don’t really have enough copper over the next ten years to fill the demand. Despite that, we’ve seen copper prices fall this year – and Complete Intelligence doesn’t expect them to rise in the coming months. Tracy helps us understand why we’re seeing this and what’s the reason for the more recent fall in the copper price. Is it just recession? Will we see prices snap upward to fill the gap or will it be a gradual upward price trend?

We’ve had some earnings reports for retail over the past couple of weeks and Sam had a fantastic newsletter on that. On previous shows, we’ve talked about how successful US retailers have pushed price (because of inflation) over volume.

Costco and Home Depot have done this successfully. Walmart had serious inventory problems earlier this year, but their grocery has really saved them. Target has problems, but as Sam showed in his newsletter, general merchandise retailers have had a harder time pushing price. What does this mean? Is Target an early indicator that the US consumer is dead?

Key themes:
1. Liquidity drain and QT
2. Copper Gap
3. Retail and the US Consumer
4. What’s up for the Week Ahead?

This is the 42nd 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
Daniel: https://twitter.com/dlacalle_IA
Sam: https://twitter.com/SamuelRines
Tracy: https://twitter.com/chigrl

Transcript

Tony

Hi, and welcome to The Week Ahead. I am Tony Nash. And this week we’re joined by Dr. Daniel Lacalle or Daniel Lacalle. Daniel is a chief economist, he is a fund manager, he’s an author, he’s a professor. Kind of everything under the sun, Daniel does.

Daniel, thank you so much for joining us today. I know you have a very busy schedule. I appreciate you taking the time to join us. We’re also joined by Tracy Shuart. Tracy is the president at Hightower Resources, a brand-new firm. So pop over and see Tracy’s new firm and subscribe. We’re also joined by Sam Rines of Corbu. Thanks all of you guys for taking the time out of today.

Before we get started. I’m going to take 30 seconds on CI Futures, our core subscription product. CI Futures is a machine learning platform where we forecast market and economic variables. We forecast currencies commodities, equity indices.

Every week markets closed, we automatically download that data, have trillions of calculations, have new forecasts up for you Monday morning. We show you our error. You understand the risk associated with using our data. I don’t know if anybody else in the market who shows you their forecast error.

We also forecast about two thousand economic variables for the top 50 economies globally, and that is reforcast every month.

There are a few key themes we’re going to look at today. First is liquidity drain and quantitative tightening, or QT. Daniel will lead on that and I think everyone will have a little bit to join in on that.

We’ll then look at copper gap, meaning we don’t really have enough copper over the next, say, ten years to fill the needs of EVs and other things. So Tracy will dig into that a little bit.

We’ve had some earnings reports for retail over the past couple weeks and Sam had a fantastic newsletter on that this week. So we’ll dig into that as well. Then we’ll look at what we expect for the week ahead.

So Daniel, thanks again for joining us. It’s fantastic. You’ve spoken to our group about a year ago or so. It was amazing.

So you tweeted out this item on screen right now about the liquidity drain.

You sent that out earlier this week and it really got me thinking about the complexities of draining liquidity from global markets, especially the US. Since I guess global markets are hypersensitive to draining in the US.

Of course, rate hikes get a lot of headlines, but you mentioned QT, so it’s a bit more complicated. Obviously, QT peaked in April of this year. There’s a chart on the screen right now at just under $9 trillion.

And the Fed’s put about $200 billion back from their balance sheet, back in the market from their balance sheet, which isn’t nothing, but it’s really not much compared to the total.

So I guess my question is, where do we go from here? Most of the Fed’s balance sheet is in Treasuries as we’re showing on the screen right now, followed by mortgage backed securities.

So what does this say about the path ahead? What do you expect? How quickly do you expect? Does it matter that much?

Daniel

Thank you very much, Tony. I think that it’s very important for the following reason. When people talk about liquidity, they tend to think of liquidity as something is static, as something that is simply there. And when central banks inject liquidity, it’s an added. And when they take liquidity away from the system, that simply balances the whole thing. And it doesn’t work that way.

Capital is either created or destroyed. Capital is not static. So when quantitative easing happens, what basically happens is the equivalent of a tsunami. Now, you basically add into the balance sheet of central banks trillion, whatever it is, of assets, though, by taking those assets away from the market, you generate an increased leverage that makes every unit of money that is created from the balance sheet of the central bank basically multiplied by five, six, we don’t know how many times. And it also depends on the transmission mechanism of monetary policy, which is at the end of the day, what the reason why central banks do QE is precisely to free up the balance sheet commercial banks so that they can lend more.

Tony

Let me stop you there. Just to dig into so people understand what you’re talking about. When you talk about transmission mechanism, and the Fed holds mortgage backed securities, the transmission mechanism would be through mortgages taken out by people because mortgages are cheaper, because the Fed is buying MBS. Is that fair to say?

Daniel

Not cheaper. They don’t necessarily have to be cheaper. They have to be more abundant. Ultimately…

Tony

That’s fair. Yeah. Okay.

Daniel

Ultimately, this is why when people talk so much about rate hikes, rate hikes or rate cuts are not that important. But liquidity injections and liquidity training are incredibly important for markets because rate hikes or rate cuts do not generate multiple expansions. Yet liquidity injections do create multiple expansion, and liquidity draining is much more severe than the impact of the rate hike.

Tony

Okay, so when you say multiple expansion, you’re talking in the equity markets?

Daniel

In equity markets or in the valuation of bonds price. That means lower bond yields or in the valuation of private equity. We saw, for example, in the period of quantitative easing, how the multiples of private equity transactions went from ten times EV to even to 15 times easily without any problem.

So what quantitative tightening does is much worse than what quantitative easing does, because the market can absorb an increase of liquidity through all these multiple assets. However, when quantitative tightening happens, the process is the reverse. Is that the first thing that happens, obviously, is that the treasury, the allegedly lowest risk asset, becomes more cheap, ie, the bond yield goes up, the price goes down, the bond yield goes up, and in turn it creates the same multiplier effect, but a larger dividing effect on the way out.

Tony

So the divisor is greater than the multiplier.

Daniel

The divisor is greater. And I tell you why. In the process of capital creation, there is always misinformation that leads to multiple expansion. Okay? So one unit of capital adds two more units of capital plus a certain excess valuation, et cetera. Now from that point, if you reduce one unit of the balance yield of the central bank, the impact down is much larger. So where it goes to, this is the problem that we as investors find it very difficult to analyze is where is the multiple at which equities, bonds, certain assets are going to stop because it is very likely to be below the level where they started.

The challenge of quantitative tightening is even worse when the process of quantitative easing has been prolonged, not just in period of compression of economic activity or recessions, but also in the periods of growth.

Tony

Okay?

Daniel

Because the level of risk that investors take becomes not just larger but exponential under QE. Under QT. Under QE, you get Bitcoin going from 20 to 60 under QT, you get bitcoin going from 60 to maybe zero.

I don’t know. I don’t know.

Tony

The comments are going to be full of angry bitcoin people.

Daniel

I just want people to understand that just like on the way up in a roller coaster, you go slowly and it seems that everything is going relatively smoothly. When you start to go down, you go down really fast and it’s truly scary.

Tony

Okay, so let me ask you this, because when you talk about multiple expansion, I’m sure we’re going to get some comments back about tech firms because we’ve seen tech firms multiple expansion decline pretty dramatically in the past, say six months, certainly past year, for companies like Meta. So although we’ve only seen $200 billion in quantitative tightening, how does that reconcile with your statement about interest rates not necessarily impacting valuations.

Daniel

No, interest rates impact valuations, but not as aggressive as quantitative tightenint. They do, particularly in tech for a very simple reason. I think that all of us can understand that a technology company is in the process of money creation. A technology company is one of the first recipients of newly created money because it absorbs capital quicker and it obviously benefits enormously from low interest rates, obviously.

But the process of multiple expansion tends to happen in the early stages of those companies. Now the process of multiple compression is much more viscious because I would be genuinely interested to have a discussion with, I don’t know, with people that invest in nonprofitable tech, but I would really like to understand how they get to the current levels of valuation comfortably.

The biggest problem I see of quantitative tightening is the same problem I see of the hidden risks of quantitative easing is that central banks cannot discern which part of the wealth effect comes from the improvement in the real economy or simply from bubbles. And the creation of bubbles obviously, we can imagine that something is a bubble, but we don’t really know until it bursts.

So it’s going to be very problematic for a central bank to achieve almost one thing and the opposite, which is what they’re trying to do. What they’re trying to do is to say, okay, we’re going to reduce the balance sheet. Hey, we’re going to reduce the balance sheet by 95 billion a month and think that that will have no impact on the bond market, on the equity market, and on the housing market. The housing market is already showing.

Tony

Yeah, I don’t necessarily think they’re saying that will have no impact on that stuff. Sam, from your point of view, is that their expectation that QT would have no impact on asset prices?

Sam

I wouldn’t say it’s their expectation that it wouldn’t have an impact on asset prices. I think they understand that there’s an impact on asset prices from just the narrative of tightening generally. But to the point, I think it is very difficult to parse what portion of their tightening is doing what particularly for them.

You look at some of the research on coming out of the Fed, on what QT is expected to do and what QT does, and you come out of it thinking they have no idea. I think that they would probably say that quietly behind closed doors, without microphones. But to the point, I would agree that there is an effect and that the Fed likes to say set it and forget it, because they don’t really understand what the actual impact is on either the real economy or the financial economy. Come up with our star-star, which is some stupid concept that they decided to come up with to rationalize some of their ideas. But I would say no, that makes perfect sense, that they really don’t understand exactly how much it is. Which is why they say we’re just going to set it, forget it, and we’re not really going to talk about it.

Because if you listen to the Fed, their concentration is on the path to the terminal rate and the length of holding the terminal rate there. And if you Google or try to find any sort of commentary about quantitative tightening within their speeches and their statements, it’s actually pretty hard to find.

Daniel

Yeah. So just to clarify one thing, just to clarify. In the messages from, for example, of the ECB and the Bank of Japan, less so of the Fed. And I would absolutely agree with that because the Fed is not so worried because they know that they have the world reserve currency, but the ECB and the Bank of Japan certainly expect very little impact on asset prices. For example, the ECB are just saying right now that they’re expecting to reduce the balance sheet in the next two years by almost a trillion euros without seeing spreads widening in the sovereign market. That is insane to be fairly honest. So that is what I’m trying to put together is that the same… A central bank that is unable to see that negative bond yield and that compressed spreads of sovereign nations relative to Germany is a bubble. It’s certainly not going to see the risk of tightening.

Sam

I would start with saying that if the ECB thinks they are going to take a trillion off the books in a couple of years, that’s the first insane part of that statement.

Tony

Good. Okay. So what I’m getting from this is taking liquidity out of markets can be really damaging and the guys who are doing it don’t really know the impact of their actions. Is that good top level summary?

Daniel

Absolutely. That is the summary.

Tony

Okay, so since they’ve only taken 200 billion off, I say “only,” but compared to 9 trillion, it’s not much. Since they’re pulling the interest rate lever now at the Fed and they’re kind of tepidly moving forward on the balance sheet, do we expect them to finish the interest rate activities before they aggressively go after the balance sheet or are they just going to go march forward with everything?

Daniel

No, I think that’s.. They want to see the impact of interest rates first before they make a drastic action on the balance sheet. Particularly in the case of the Fed with mortgage backed securities, and the case of the Bank of Japan with ETFs because the Bank of Japan is going to kill the Nikkei if it starts to get rid of ETFs. And certainly the Fed is going to kill the housing market with mortgage backed securities are warranted.

Tony

Yup.

Sam

And then it’s kind of interesting because there’s two dynamics that I think are intriguing here. One is that the Fed’s balance sheet is getting longer in duration as interest rates rise because those mortgage backs are just blowing out to the right because you’re not going to have to have the roll down and you’re not going to have the prepays on those mortgages anytime soon. So the Fed is putting themselves in a position where hitting those caps on mortgage backs is just simply not going to happen on a mechanical basis. And they’re either going to have to sell or they’re going to have to say, we’re just not going to hit we’re not going to hit our cap on mortgage backed securities for the next 20 years.

Tony

Yup. So I get to put those to maturity like they’re doing with all the treasury debt.

Sam

Yeah, they’re just letting them roll off, which means they’re not going to have mortgage backs rolling off with a six and a half percent refi rate.

Daniel

Yeah, I agree with that.

Tony

Wow. It’s almost as if QT potentially is a non issue for the longer duration debt? Are you saying they’ll continue holding? Sam you’re saying , “No.” So what am I missing? What I’m hearing is they may just hold the longer duration stuff. So if that’s the case, is it kind of a non issue if they just hold it?

Daniel

It’s not a non issue. They are in conversations all the time with the Bank of Japan to do this composite yield curve management, which in a sense means playing with duration here and there on the asset base. But it doesn’t work when the yield curve is flattening all over the place and when you have a negative yield curve in almost every part of the structure.

So the point is that by the time that markets realize the difficulty of unwinding the balance sheet, the way that central banks have said, probably the impact on asset prices has already happened because commercial banks need to end margin calls, et cetera, margin calls become more expensive. Commercial banks cannot lend with the same amount of leverage that they did before. Capital is already being destroyed as we speak.

Sam

Into the point. As soon as you had the Bank of England announce that they were going to have an outright sale of Gilts, you saw what happened to their market. They broke themselves in two minutes.

Tony

Right. Okay. So that’s what I’m looking for. So it’s a little muddy. We’re not exactly sure. Right. QT is complicated. It’s really complicated. And liquidity is dangerous, as you say, Daniel. It’s easy on the way up. It’s really hard coming down from it. And that’s where…

Daniel

I think it was Jim Grant recently who said how easy it is to become a heroin addict and how difficult it is to get out of it.

Tony

Sure, yeah. I mean, not that I know, but I can see that.

Daniel

We don’t know it, obviously. None of us do. But it’s a very visual way of understanding how you build risk in the system and how difficult it is to reduce that risk from the system.

Tony

Yeah, just stopping adding liquidity is a good first step, and then figuring out what to do after that is I think they’re right. A lot of people like to knock on the Fed, but doing one thing at a time is, I think, better than trying to reconcile everything at once.

Okay, great. Since we’re taking a little bit of longer term view on things with some of that mortgage backed security debt, I just also was in a longer term mood this week and saw something that Tracy tweeted out about copper consumption and demand.

This was looking at long term demand, say, by 2030, and there’s a gap of what, 20 no, sorry, 10 million tons. Is that right, Tracy?

Tracy

8.1 million tons.

Tony

8.1 million tons. Okay. Now, when we look at copper prices right now, we’ve seen copper prices fall. We don’t really have an expectation of them rising on the screen as our Complete Intelligence forecast of them rising in the next few months.

So why the mismatch, Tracy? What’s going on there? And why aren’t we seeing the impact on copper prices right now?

Tracy

Well, I think if we look at basic industrial metals really as a whole, except for, say, lithium, really, we’ve seen a very large pullback in all these prices in these specific metals that we are going to need for this green transition.

Now, part of that is, I think, part of that is QT, we’re just saying money liquidity drained from the system. But I also think that we have overriding fears of a global recession. We also have seen people are worried about Europe because with high natural gas prices, a lot of their smelting capacity went offline.

And one would think that would be bullish metals, but it’s scaring the market as far as global recession fears. And then, of course, you always have China, which is obviously a major buyer of industrial base and industrial metals. They’re huge consumer as well as producer of the solar panels. Wind turbines and things of that nature.

So I think that’s really the overriding fears and what I’ve been talking about even for the last couple of years, that I think metals is really going to be more of H2 2023 into 2024 story. I didn’t really expect this year for that to be the real story.

I know you thought that energy was still going to be the focus. And I think even though we’ve seen prices come off, energy prices are still very high. And I think energy prices we’re going to see a resurgence of natural gas prices again in Europe as soon as we kind of get past March, when that storage is kind of done. Because we have to realize that even though the storage is still this year, 50% of that did still come from piped in natural gas from Russia.

I think we’ll start to see natural gas prices higher. Oil prices are still high. Even at $75, $80, it’s still traditionally high. So the input cost going into metals to bring it all together, the input cost going in metals, we are going to need a lot of fossil fuels. It’s very expensive. We also see mining capex suffers from the same problem that oil does is that over the last seven years, we’ve seen huge declines. And then when we look at copper in particular, we really haven’t had any new discoveries since 2015. So all of those are contributing factors. But again, I don’t think that’s really a story until last half of 2023 and 2024 going forward.

Tony

Okay, so to me, the copper price tells me, and I could be, tell me if I’m wrong here. Copper rise tells me that markets don’t believe China is going to open up fully anytime soon, and they don’t believe China is going to stimulate anytime soon. Is that a fair assessment?

Tracy

Yes, absolutely. I think we kind of saw metal prices. We’re bouncing on some of the headlines back and forth, but really we haven’t seen anything come to fruition, and I think most people are not looking until probably spring for them to open up. And I think China really hasn’t changed its stance, right. As far as. There Zero Covid policy, they’re still on that. So I think markets have been digesting that over the last couple of weeks or so. And that’s also another contributor to seeing a pullback in some of these metals in the energy sector.

Tony

Yeah, if you look at the headlines over the past week, you definitely see a softer tone towards China, with Xi Jinping coming out in the APEC meeting sorry, not the APEC meeting, the ASEAN meeting. And he’s a real human being and all this stuff, and he’s talking with Biden and he’s talking with European leaders and Southeast Asian leaders.

So I think there’s been a softer tone toward China and this belief that good things can happen in the near term, but I don’t think most investors will believe it until they see it, first of all. And I think places like Japan, Korea, Taiwan, US. Other places, maybe not. The Germans are also a little bit worried about short term sentiment in China. Things could turn pretty quickly. So, like you say, I think base metals prices are down on that. But over the long term, obviously, it doesn’t seem like there’s enough capacity right now. So, anyway, we’ll see. So for bringing that up. Sorry. Go ahead, Sam.

Sam

Yeah, I think there’s just two things to add there. One, if you didn’t have investment in base metals and energy at zero interest rates, you’re not going to get it at five. Let’s be honest. That’s point number one, this isn’t a short term thing. This is a much longer term thing. And you need to have much higher prices for commodities broadly in order to incentivize any sort of investment, because they’re, one, very capital intensive, and two, capital is very expensive right now. So I think that’s also something to keep in mind over the medium term, is we’re not solving this problem at five and a half percent interest rates here. That’s clearly not going to happen. And the other thing is you haven’t seen the Aussie dollar react in a positive way. So if the Aussie dollar is reacting, China is not reopening. It’s just that simple.

Tony

Yeah, that’s a very point.

Daniel

If I may, I would also like to point out that the bullish story for copper, lithium, cobalt is so evident from the energy transition and from the disparity between the available capacity and the demand. But when the gap is so wide between what would be the demand and the available supply, what tends to happen is that the market, rightly so, sees that it’s such an impossibility that you don’t even consider, at least as a net present value view, that bullish signal as Tracy was mentioning until 2023 or 2024, when it starts to manifest itself.

Right now, it’s so far between the reality of the available supply and the expectation of demand that it looks a little bit like what happened with Solar in 2007, 2008. We just saw bankruptcy after bankruptcy because you didn’t match the two. And on top of it, Tracy correct me. But this is the first year in which you had a massive bullish signal on prices, in energy and in metals, yet you’ve seen no response from a capping.

Tracy

Exactly. Nobody’s prepared, nobody wants to really still spend that kind of money, particularly not the oil industry when they’re being demonized by everybody in the west in particular. So you know, you’re not going to see a lot of, nobody wants to invest in a project when they’re saying we want to phase you out in ten years.

Tony

What’s really interesting though also is BHP bought a small midsized copper miner in Australia this week, so I forget their name, but the miners are seeing opportunities, but they’re just not seeing the demand there yet. So we’ll see what happens there. So anyway, thanks guys for that. That’s hugely valuable.

Sam, you wrote on retail this week and you have really brought out some interesting dynamics around pushing price versus volume within stores over the past several months. And your newsletter looked at Target, Walmart, Costco, Home Depot. Earnings across retail sectors.

So Costco and Home Depot seem to have pushed price successfully. Walmart, as you say, had serious inventory problems earlier in the year, but their grocery business seemed to have really saved them. But Target really has problems and their earnings report this week was a mess. So we’ve got on screen a table that you took out of some government data looking at, has made a change of sales for different types of retail firms, building materials, general merchandise and food services. And things seem to be going very well for everyone except general merchandise stores like Target.

So can you help us understand why is that the case for, I mean, maybe Target is just terribly wrong, but why is that the case for general merchandise specifically and what does this say about the US consumer? Is the US consumer kind of dead in some areas?

Sam

No. US consumers is not dead, which is the strangest part about this earning season to me is everybody kind of read into Targets reporting was like, wow, this is horrible. It’s bad, it’s bad. Target is its own problem. Their merchandising, horrible. Their executive team, horrible. I mean, I don’t know how you survive this. With Walmart putting up huge comp numbers on a relative basis. I mean, they pounded Target and to me that was single number one. That’s Target’s issue.

The general merchandise store. We bought a whole bunch of stuff during COVID that we don’t really need to buy at 17 of right? We bought it during COVID You could get Walmart and Target delivered to you, that was a boom for their business and that’s just not being repeated. Same thing with if you look at Best Buy and electronic stores not doing great because we all bought TVs during COVID and computers, we needed them at home. These are just pivots. When you look at the numbers for restaurants, when you look at it for grocery, I mean, again, a lot of it is pushing price onto the consumer, but the consumer is taking it.

And those are pushing revenues higher. Look at something, the company that controls Popeyes and Burger King, absolute blowout, same store numbers. I mean, these are restaurants that are pushing price. They’re still having traffic and they’re not getting enough pushback.

Home Depot pushed 8% pricing, well, almost 9% pricing in the quarter. They didn’t care about foot traffic, but traffic was down mid 4%. They didn’t care about the foot traffic. They got to push the price and they, guess what, blew it out? Loads had a decent quarter. These are housing companies, at least home exposed companies and building exposed companies that had great third quarters that were supposed to be getting smashed, right? The housing is not supposed to be the place that you’re going to right now. And somehow these companies could push in a price.

There’s something of a tailwind to the consumer where the consumer is kind of learning to take it in certain areas and just saying, no, I don’t need another Tshirt or I don’t need to make another trip to Target. I think that it’s pretty much a story of where the consumer spending not if the consumer spending.

That retail sales report, it will get revised, who knows by how much, but the retail sales report, even if it gets knocked down by a few bips called 20 basis points, 0.2%, it’s not going to be a big deal. It’s still blowing number. These are not things you want to see.

If you’re the Fed thinking about going from 75 to 50, 2 reasons there. One is that pricing little too much. And if it begins to become embedded, not necessarily in the consumer’s mind, but also in the business’s mind, I can push price. I can push price. I can push price. That’s a twosided coin where the consumer’s willing to take it and businesses are willing to push it. That is the embedding of inflation expectations moving forward.

Going back to I think it was last quarter, Cracker Barrel announced during like, yeah, we’re seeing some traffic flow, but we’re going to push price next year, and here’s how much we’re going to push it by. These companies aren’t slowing down their price increases, and they’re not seeing enough of a pushback from consumers.

Tony

Cracker Barrel and Walmart are not topend market companies. They’re midmarket companies. And if they’re able to push price at the mid market, then it says that your average consumer is kind of taking it. But the volume is down. So fewer people are buying things, but the ones who are buying are paying more. Is that fair to say?

Sam

It’s fair to say. Fewer trips, more expensive. It’s fair to say. But there’s also something to point out where Macy’s, their flagship brand, kind of had a meh quarter. Bloomingdale’s, heirt luxury? Blew it out.

Tony

Okay.

Sam

So you’re seeing even within general merchandise stores, you’re seeing a significant difference between, call it luxury, middle, and low.

Tony

Okay. So what is it about, say, Target and Macy’s? I’ll say Target more than Macy’s, but is it just the management, or is it the mech?

Sam

It’s merchandising and it’s the Mexican.

Tony

Right, okay.

Sam

And if you don’t have the right stuff that you can push price on, you’re not going to make it.

Tony

So will we see some of these general merchandisers move into other sectors? Grocery or whatever?

Sam

I mean, Target has grocery. TVs closed. They have everything. It’s a question of do you have the right thing to sell right now in terms of that? So I don’t really think you’ll see many big moves, mostly because they already have too much inventory. So their ability to pivot is zero at this point. So it’s going to be a tough holiday season. I think it’s going to be a pretty tough holiday season to Target. But I didn’t see Walmart taking down numbers for the Christmas season. We’ll see with Amazon, but cool.

Tony

It seems healthy. Just observationally. They seem pretty healthy.

Sam

Yeah. And the other thing to mention, just as a side note, there’s a lot of this consternation around FedEx and UPS and their estimated deliveries for Christmas. This is the first year that Amazon has had a very, very large fleet going into the Christmas holiday season where they don’t have to send packages through FedEx and UPS only. They have a very, very large in house fleet of vehicles to do so with, and they built that out massively over the past 18 months. So I would read a lot less into that for the Christmas season, et cetera, than people are. That’s something I think it’s kind of taking the big picture and missing the finer points.

Tracy

I had a question really just on that same vein. I’ve seen a lot of the freight companies that report on freight, like Freight Waves, have been screaming at the top of their lungs, loadings are falling. People are going out of work. They’re firing everybody. Nobody’s delivering anything. Nobody’s delivering any goods. Do you think that’s sort of cyclical or because it seems like there’s a mismatch right now. There’s a lot of goods out there to be delivered, but for some reason, these guys can’t get loading.

Sam

I think it’s two things. One, everybody double ordered in spring and summer. So I think Freight Waves and a lot of other companies saw a lot of livings that they wouldn’t have seen otherwise. And you spread those out, and I think that’s point number one. Point number two is these retailers are stuffed with inventory. Target, even Walmart is somewhat elevated. They don’t have that big problem. They have the inventory. I would say it’s much more of a timing issue. You’ll probably see Freight Waves have too many loadings, called it in the spring and summer of next year because people are playing catch up and trying to get the right merchandise, et cetera, et cetera. So I think it’s just more of a Covid whipsaw than anything else.

Tracy

Makes sense, right?

Tony

Okay, so bottom line, us. Consumer is still taking it, right? They’re still spending, they’re still okay. Despite what bank deposits and other things tell us, things are still moving. And is that largely accumulating credit or how is the US consumer still spending? They’re accumulating credit?

Sam

A couple of things. One, they have their bank deposits are fine, particularly at the middle and upper levels. They’re still relatively elevated. Two, you’re getting a much higher wage. So your marginal propensity to consume when you see a significant pay raise, even if prices are higher, is higher, right. So you’re going to spend that dollar.

So you’re getting paid more. You’re switching jobs a lot more. Your switchers are getting something like a double digit pay increase. These are rather large chefs, so I would say the consumer feels a lot more comfortable with taking the inflation because they’re getting paid a lot more. Unemployment is sub 4%, so they’re not afraid of losing their job unless they’re at Twitter. So the consumer is sitting there like, all right, I’m not losing my job. I’m getting paid increases. Why would I stop spending? I think it’s that simple.

Tony

Great.

Sam

Yeah, they have credit cards.

Daniel

That is a very important point. What you just mentioned, employment. Employment makes all the difference. The pain threshold of consumers is always being tested. Companies raise prices. Volumes are pretty much okay. So they continue to raise prices to maintain their margins. And that works for a period of time.

I think that what is happening both in the Eurozone and in the United States is that after a prolonged period of very low inflation, consumers also feel comfortable about the idea that inflation is temporary. Basically everybody and actually I have this on TV this morning, we’re talking about everybody is saying, okay, so prices are rising a lot, but when are they coming down? But I’m still buying.

The problem, the pain threshold starts to appear when employment growth, wage growth, starts to stop, and at the same time, prices go up. And obviously the companies that feel comfortable about raising prices start to see their inflation rate, rise. So it’s always difficult because we never know. There’s a variable there that we’re very unsure of, which is credits. How much credit are we willing to take to continue to consume the same number of goods and services at a higher price?

But it is absolutely key what you’re saying, which is as long as even though wage growth in real terms might be negative, but you’re getting a pay rise and you still feel comfortable about your job, you feel comfortable about your wealth to a certain extent and credit keeps you safe, consumption in the United States is not going to crack.

However, where do you see it cracking? And we’re seeing it cracking in the eurozone. In Germany, where you don’t get the pay rise, you don’t get the benefit of taking expensive credit from numerous different sources or cheap credit from different numerous sources and at the same time you get elevated inflation. Consumption is actually going down the drain. The way that I see it is that the problem, the consumption, not collapsed, but certainly the consumption crack is very likely to happen more north to south in the eurozone than in the United States at the rate at which the economy is growing.

Tony

Yes, yes, very good. Thanks for that, until on Europe, Daniel, that was really helpful.

Okay, let’s do it very quick. What do you expect for the same week or two weeks ahead? We have a Thanksgiving holiday here in the US, so things are going to be kind of slow. But Tracy, what are you looking for, especially in energy markets for the next couple weeks? We’ve seen energy really come off a little bit this week. So what’s happening there?

Tracy

Yeah, absolutely. Part of the reason of that, besides all the global factors involved, the recession didn’t help UK him out and said they were already in the recession. That then sparked fears. We have pipeline at reduced capacity right now, which means that’s going to funnel some more crude into cushion, TWI contract is actually cushing. So that’s putting a little bit of pressure. I think holidays, obviously I think this next week we’re not really going to see much action as usual. So really looking forward to the following week is we have the Russian oil embargo by the EU and we also have the OPEC meeting and I would suspect that at these lower prices they would probably, they might be considering cutting again. So that’s definitely those two things. I’m looking forward to in that first week in December.

Tony

Great, thanks. Daniel, what are you looking for in the next week or two?

Daniel

The next week or two are going to be pretty uneventful, to be fairly honest. We will see very little action or messages that make a real difference from Fed officials or from the ECB. On the energy front, there’s plenty of news that we pay attention to Tracy’s Twitter account. But in Europe we will get quite a lot of data, quite a lot of data that is likely to show again this slow grind into recession that we’ve been talking and very little help. I think that from here to December, most of the news are not going to change where investors are and that will probably start to reconfigure our views into the end of the trading season, 27 to 28.

Tony

Okay, very good. And Sam, what do you see next week? The week after?

Sam

I’ll just be watching Black Friday sales that are coming in. Honestly, I think that will be a pretty important sign as to how things are developing into the holiday season and begin to set the narrative as we enter in December. Again, there’s no real interesting Fed talk coming out next week, but we’ll begin to have some pretty good data coming from a number of sources on Black Friday, foot traffic, internet traffic, etc. Tuesday and Wednesday.

Tony

Very good.

Sam

The following week. That’s all I care about.

Tony

Excellent. Really appreciate that. For those of you guys in the States, have a great Thanksgiving next week. Daniel, thank you so much. Have a fantastic weekend. Always value your time, guys. Thank you so much. Have a great weekend.

Sam

Thank you.

Daniel

Have a good weekend. Bye bye.

Sam

Thank you.

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