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$300 crude, bullish housing, Japan, recession, and oil demand [The Week Ahead – 26 Dec 2022]

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In the current Week Ahead, Harris Kupperman (Kuppy) of Praetorian Capital discusses his hypothesis that crude oil prices may reach $300 per barrel due to a decrease in supply resulting from environmental regulations, a lack of investment, and government actions. Kuppy also argues that high demand for housing in the US, driven by population growth and migration, will lead to a positive outlook for the housing market. However, he notes that high mortgage rates could impact the market, but a pause on interest rates or an acceleration of inflation could lead to a more favorable outlook. Kuppy suggests that the US housing market may see a shift towards lower-priced homes with fewer amenities in order to accommodate growing families. He also highlights the attractiveness of housing markets in emerging markets due to high interest rates and positive real yields on property appreciation.

Next, Brent Johnson of Santiago Capital discusses recent policy changes by the Bank of Japan (BOJ) and the market’s reaction to them. Brent argues that the changes, which included increasing the amount of quantitative easing (QE) and widening the range within which the yield curve control operates, were not a real policy change and that the market misread the situation. He suggests that the BOJ is trying to avoid a repeat of earlier this year, when rising interest rates caused chaos in the Japanese banking system and the market had to be halted. He also discusses the challenges central banks face in balancing the bond market and the currency market, and the impact of these challenges on the yen.

Finally, Tracy Shuchart of High Tower Resource Advisors talks through the relationship between oil demand and household savings during economic recessions, stating that past recessions have not significantly impacted oil demand. She also covers the potential long-term effects of declining population rates on global energy consumption, then comments on the potential for energy consumption to increase in the short-term, citing data from the International Energy Agency and discussing the impact of economic stimulus on household savings and consumption.

Key themes

1. $300 crude & (still?) bullish housing
2. Japan’s “normalization”
3. Recession & oil demand elasticity

This is the 47th 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
Kuppy: https://twitter.com/hkuppy
Brent: https://twitter.com/SantiagoAuFund
Tracy: https://twitter.com/chigrl

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Transcript

Tony

Hi, everyone, and welcome to the Week Ahead. My name is Tony Nash. Today we’re joined by Harris Kupperman. You may know him as Kuppy on Twitter. We’ve also got Brent Johnson and Tracy Shuchart. Kuppy is with Praetorian Capital. Brent Johnson, of course, is with Santiago Capital. And Tracy Shuchart is with High Tower Resource Advisors. So, guys, thank you so much for joining us. I think this is going to be a great discussion.

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We have some key themes here. The first, really looking at some of Kuppy’s discussions lately, looking at $300 crude, and kind of still with a question mark, bullish housing? I think that’s the first thing we’re going to jump into.

Then we’re going to look at Japan’s normalization. We had some news this week with BOJ Chair, kind of starting to normalize the Japanese money supply environment. So we’ll jump into that with Brent. And then we’re going to look at recession on oil demand elasticity with Tracy.

So, guys, thanks again for joining us. I’m looking forward to just a great discussion today.

So, Kuppy, you know, you have posted quite a lot about $300 oil in your newsletter and online. And, you know, there are a lot of, we had a show last week that was full of oil bulls. I don’t know that anybody particularly said $300. So I’m really curious about your $300 call. Can you walk through your thesis and just help us understand what you’re thinking?

Kuppy

Yeah, sure. I mean, overall, oil is just like all the commodities. It’s supply and demand. And since 2014, no one’s really invested and the supply side is really constricted. You have ESG mandates. You have lack of capital from institutional investors. You have banks that won’t lend. You have governments around the world that are canceling pipelines and canceling permits. And now you have UK talking about excess profits, taxes. That’s not an environment for guys to go explore and drill. And the thing about oil is that if you’re not drilling new wells, they decline over time. And so the question keeps being, where does the oil come from? People just think that the US. Shale, you can flip a switch and barrels show up. And maybe that was the case a decade ago, but that’s not how it works anymore. We’ve really hit the best acreage.

And from here on out, not only are you working mostly at tier two locations, but you’ve seen massive inflation in terms of oilfield services and those wells that everyone used to lie about and say it had 100 IRRs at 60, what we learned is they don’t break even at 60. And now you have massive oilfield inflation. I don’t know if you have decent IRRs at 80 or maybe even 100 in a lot of these places.

And I mean, it’s no secret why no one’s drilling. The numbers don’t work. And then, you know, you flip it to the other side on the demand side. Look, 6 billion people want the same standard of living and the same energy per capita utilization that all of us have. And you could have said this decades ago, but what’s changed is that they’re all in that part of the S curve where their per capita consumption explodes. I mean, look what’s happened in India. We’re having, I guess, a global recession this year, but demand is up teens.

You look all around the world, Africa, LatAM and demand is up. Even in the US demand is up. And so demand grows one or 2 million barrels every year. And where is the supply going to come from? What we’ve seen, like I said, is the supply is restricted. And even if you try to add supply, it takes a couple of years.

And so I think you’re going to have a massive mismatch. And what’s hidden that for the last year is that China has been offline. That’s two or 3 million barrels. The SPR is globally of about a million, million five. So you’re really looking at, let’s call it four and a half million barrels. That that’s been kind of like subsidizing the balances.

And, you know, you could debate, you know, exactly what the number is, and it moves around some. But for the most part, you’ve had this weird subsidy to the oil price, and I don’t think that’s going to be there next year. China has been pretty clear they’re opening and the SPR is empty. Meanwhile, Russian production is in free to fall after the US firms left. That’s another million. And like I said, global demand grows a million or two a year.

And I don’t think we can see much growth on the supply side. I think you’re going to have a four to 5 million barrel deficit, and that’s one of the biggest deficits in 40 years. And it may even be as large as we saw in World War II as a percentage of total consumption. And I think the price is going to scream out of control. I don’t think 300 is the clearing price long term, but I think you could get there in a super spike, especially given how much structured products out there that’s synthetically short. So that’s how I see it, and that’s why I’m so bullish.

Tony

Okay, so is your time frame for ’23 for the $300 price, or is that just kind of a longer term target?

Kuppy

I think it’s like the next year or two.

Tony

Okay.

Kuppy

Like I said, we’re going to have massive supply demand mismatch next year, and I think it’s going to scream out of control. There’s some things we could still do. They’re going to jump some more SPR. Maybe there’s some things around the margin they can do. But in the end, if you’re structurally short oil and there’s no oil to be had, I think the price goes crazy. And you always have a geopolitical kind of upside there to whatever happens to the price of oil, because it’s never really the downside, but it’s usually the upside if something crazy happens.

Tony

Right. Okay. We just had Zelensky speak to US Congress this week here in the US. And it doesn’t really sound like the war there is slowing down. Maybe it is, maybe it isn’t. I don’t know that we get a clear picture anyway, but I think there are a lot of assumptions that that will calm down next year for some of these guys who aren’t seeing super high oil prices. If that war intensifies, does that speed up your $300 price target, or does it affect it at all?

Kuppy

I don’t think it affects it at all. I mean, Russian oil is still making its way to the market. But US technology for the Russian oil fields isn’t. And so Russia is going to be in slow motion decline in terms of production, and I don’t really see what would change in the Ukraine situation. I think it’s very likely that as soon as the ground freezes there, those half million conscripts will be set loose behind the Ukrainian army and kind of surround them all. The only reason that Ukraine is still in the war is really just because it’s been kind of warm there. I think it doesn’t look very good, but that’s like more of a personal view. But I don’t think it really matters who wins this war. In the end, Russian production is rolling over.

Tony

Right, okay. And is there a possibility of, let’s say, a load of investment going into Venezuela in the short term and that volume that supply, hitting markets to save markets? I’m just trying to kind of figure out, is there a near term supply side solution?

Kuppy

Not really. I mean, who wants to invest in Venezuela? You can get a bunch of pieces of paper with guarantees, but the history…

Tony

Chevron does, of course.

Tracy

No, but it’s absolutely true. I mean, it would take billions. And it’s still the problem is geology there? And what’s going on…

Tony

Explain that. When you say the problem is geology.

Tracy

It’s not only their infrastructure which is decrepid after, it’s also geology. Right. They have very sludgy oil. It’s very hard to get out of the ground. So even with investments, you’re facing an additional challenge of the geology there being very, very difficult. And so that’s just going to add. So anybody thinking that Venezuela oil is going to change this dynamic is off base, in my opinion.

Tony

Okay, and then Africa supplies other stuff. There’re Brazil. There isn’t really anything that can be accelerated on the supply side. I’m just trying to poke through this, guys, just to get a better view.

Kuppy

I think you’re going to see an increase in offshore oil production around the middle of this decade. Guiana, Suriname, West Africa, Brazil, it’s all coming online. But it doesn’t come online fast.

Tony

Right?

Kuppy

Well, you have a lot of places that are rolling over or really struggling just to stand in place. I think we should look at is what’s happening in Saudi, where they’re frantically procuring every jackup that could be had globally. They’re going off into the Gulf. I mean, if their oil production was stable or they thought they had more onshore, which is the cheap stuff, they’d just be drilling more onshore. The fact that they’re going into the Gulf, it’s an increase in complexity and cost means that their existing fields are now getting old. And it’s obvious they’re old. They’ve been going for 70 years, but they’re finally seeing that water cut really pick up and they’re starting to panic. No, I think you have a lot of problems everywhere. Plus you have some swing places. Iraq, Libya gets cut off again from exports. You have a bunch of places where you could lose a million barrels in a hurry.

Tony

Okay. No, it sounds pretty ominous, actually. So I’m trying to find ways to push back on that. But again, we have some really smart folks last week, including Tracy, who had a similar thesis, maybe not 300, but a similar thesis. And I think what you’re saying, Kuppy, makes a lot of sense.

Kuppy

I think the pushback is really that something could happen on the demand side where you have a global economic crisis. They lock us down for monkey pox or the next pox they invent. Something like that is what I’d be looking at in terms of the wild card where demand falls off. But all it really does is postpone things. I mean, look, it’s December. 2023 budgets are being set at all the majors, and they’re being set in the context of mid 70s WTI. Do you think board of directors are going to approve an increase in spending? Like, I think 2023, and as a result of ’24 production, at least onshore US, is kind of baking the cake based on @75 price today.

Brent

Hey, Tony, I typically would defer, and I will defer on all things oil to Kuppy and Tracy, but I would say that to be completely truthful, I actually shorted a little bit of oil this morning. And it’s just a tactical thing. It’s not a huge deal. If it goes against me, we’ll stop out and it’ll be fine. But what Kuppy just said, I think could happen. The interesting thing is I think it’s possible we do get this demand shock right, and we get some kind of a global slowdown in the first half, which could potentially push oil a little bit lower. But if that were to happen, I would then, well, I already do agree with Kuppy’s thesis kind of medium to longer term. I think he’s kind of nailed the overall structural issues and why it is. And I would just say that if we do get kind of a short term demand drop that pushes the price lower, that could actually help to cut supply even more because firms go bankrupt or they can’t invest or whatever it is, and then it constricts supply even more, and then you get a military action. And in my opinion, that’s how you get oil at $200 or $300. I tend to agree with the Kuppy’s overall position.

Kuppy

You’re just talking about the slingshop, right?

Brent

Yeah, that’s exactly right.

Tracy

Absolutely. And you have to realize that if we have the lower oil prices we have and gasoline prices we have, that increases demand in a supply side constricting environment. So that’s where you get your selling shot. So it really depends on, I think, how you’re trading this definitely depends on your time frame. If you’re longer term, that’s one thing. If you’re shorter term, I think oil is going to be volatile for the next few quarters.

Tony

So because we’re actually talking about $300 oil, I think it’s Citi who always does the extremes in crude. So now we’re going to have a Citi report that says $500 oil. Right. Thank you.

So, Kuppy, you also had a very interesting call on housing. And when I sent out the Tweet about this recording, I had some questions about your housing call, your bullish housing call. And I want to ask, are you still bullish housing? And can you go into that thesis a little bit either way? What’s your thinking on US housing now?

Kuppy

I’m bullish US housing. Structurally, you have a shortage of 5 million homes. This is population growth, especially people my age a little younger that are starting families and they need homes. And there’s been a lot of migration in the US. And so you need a lot of homes in Texas and Tennessee and Florida and not where these people are fleeing from. And so as a result, there’s just strong demand for homes. At the same time, if you take mortgages up to 7%, no one could afford a home. 

And so we’re having a bit of a pause as the Federal Reserve kind of intercedes in the housing market. And it’s kind of like a Brent Slingshot in oil. All you’re going to do is make the problem worse if you’re not building enough homes for the demand. Because the demand keeps growing, the population keeps growing and so they’ve kind of postponed us a little. You’ve seen rent spike out of control, though. That’s kind of stabilizing a little just with the economy kind of slowering. But no, I think the housing market is going to do very well, but it’s going to need a pause on interest rates or an acceleration on inflation.

I mean, you could look at a lot of emerging markets where you can’t borrow for 30 years, you can’t maybe get five years and you’re going to pay 15% interest rate on that. But you know what? They’re having huge demand for housing because if inflation is 20 and you fund it at 15 and you get put a couple of terms of debt on that, well, you’re making 20 30% on your equity. That’s a good place to be as a 25 year old guy or 30 year old guy with a family trying to get a home.

Tony

Yeah. When people don’t understand why real estate is so attractive in Asia and why, say, Hong Kong homes or Chinese homes or whatever, why you always have this inflationary environment in real estate in Asia? What you talked about, Kuppy, is exactly why. I think it’s very hard for people in the US particularly to understand why real estate in Asia is so appealing. And it’s exactly for that reason.

Kuppy

Yeah, LatAm and Africa too, where interest rates are high, but you still have a positive real yield on owning your property because it’s appreciating.

I think the other thing I’d say in the US and I think people kind of lost the narrative here. Guys are complaining that when their parents, like my parents were buying homes, it used to cost two or three years of salary and now it’s eight years or ten years of salary. And they say homes are really expensive.

Yes, homes are really expensive. But the guys got buying a McMansion today. It’s like a 4000 square foot home in the suburbs. If you look at what the people were buying in the 70s and 80s, it was like 1200 square feet, it was a two bedroom with a little kitchen. Now the kitchen has $200,000 of appliances in it. Like right. The reason these things got really expensive and, and unaffordable.

I think you’ll see some reversion back to a lower price point home with, with less amenities because you got to put people into homes as they were to put them. And so, big picture, I’m super bullish you know, you, you can’t go indefinitely with, you know, having a family with three kids and they’re in a two bedroom that’s 1200 sqft.

They need space, but that’s going to take until rates come back and as soon as rates peak out and start dropping or when inflation accelerates again, I’m going to be all over housing.

Tony

Great. Okay, that’s good. Thanks for that clarification. I think that’s really interesting, but in the near term you’re not necessarily bullish on housing in the near term, while rates are rising?

Kuppy

I think housing is going to do just fine because the tailwind is so strong, but at the same time, I think there’s better stuff to own. I’d much rather be in things that are pro inflation. I really just want to stick with energy. Uranium. I think those are trends that do well really in either market environment, but just because of the supply demand imbalances of the next year or two, I think they just work idiosyncratically no matter what. And I don’t know, I just think it’s easier trades.

Tony

Great. Okay, we did have some questions actually about emerging markets, so I just want to ask you first Kuppy, but then the rest of you guys, what emerging markets are you looking at and why?

Kuppy

I’m not really looking at any, so I can’t say. I will say I have a lot of friends that specialize in emerging markets, and they could show me a bunch of metrics that say emerging markets haven’t been this cheap in a very long time on cash flow, book value dividend. And there’s some reasons why maybe they deserve to be cheap. But those things come and go in terms of the why. But you buy cheap assets, things usually happen to you that are beneficial over time. I see Brent laughing, so explain.

Brent

Okay, to be clear, I’m not laughing at Kuppy’s answer. I tend to agree with, if his friends are telling him these things, I’m sure that’s true because they tell me the same thing. I just kind of laugh because I feel like every year for the last seven years, the trade of the year at the beginning of the year is to short the dollar and go long EM. It’s always the trade, it’s always the big idea, and to me it just never plays out. And I don’t think it’s going to play out right now.

I personally am not looking at any EM other than to stay away from it or perhaps to go on vacation to it. I don’t want anything to do with it from an investment perspective. Probably, not surprisingly, I don’t think the move in the dollar is over. And I think if we get a slowdown in the first half, which I think we will, I think that will play out in the Euro dollar market, and the emerging markets just as much, if not stronger than it will in the US markets. I don’t see an environment where EM outperforms the United States right now

Tony

In dollar terms.

Brent

In dollar terms. Yeah. Maybe in local terms. In local terms, that could easily happen. I mean, take a look at Turkey, right?

Tony

Right.

Brent

Turkey stock market has gone up two or 300% in the last 18 months, but they’ve got 80% inflation in local terms.

Tony

Right. So you have to.

Brent

So you have to yeah, right.

Tony

So Brent, can you talk us through you mentioned the dollar and you know, everyone always wants to know what your thoughts on the dollar? Can you walk us through what you’re looking for, say, over the next three to six months with the dollar?

Brent

Yeah, so, I mean, over the next three to six weeks or a couple of months, I don’t know, maybe it just goes sideways. But I think by, if not the end of Q1, beginning of Q1, kind of April-May time frame, I think the dollar is much higher than it is right now because I think that, you know, I sent out a tweet earlier today where because I, was kind of laughing.

I was talking to somebody and they said, well, rate hikes are over, so the dollar is done. And I was like, well the, the dollar can go up for reason other than rate hikes. And he was like, what are you talking about? And here’s the thing. From 2008 to 2019, the dollar went up 20% and there weren’t any rate hikes. I mean, there was a few in 2018. And in 2014, in 2014 and 2015, the DXY went up 25%. There were zero rate hikes. It’s because there was a global slowdown, right.

And when dollars aren’t circulating and the world needs dollars, there’s a dollar shortage. Supply, demand, it pushes the dollar higher. And so I feel like the move of the dollar in 2020, I’m sorry, in 2022 was all about rate hikes. Interest rate differentials, right. And maybe that is potentially over.

But the dollar can move for reasons other than interest rate differentials. And I think people have forgotten that if we go into a recession or if we go into a global slowdown, all that debt that is issued in dollar still needs to be serviced. And so I think perhaps the run in the dollar due to rate hike differentials is over. But I don’t think the run due to dollar shortage, due to a global slowdown and the need to service dollar debt is over.

Now, if I’m wrong, I don’t think that the Fed will come out and totally flip until they’re forced to do it. And the only reason they would be forced to do it is if the dollar was higher and all these asset prices were lower. So is it possible by the end of 2023 the dollar is lower? Sure. But I think at some point in 2023 we’re going to get another run in the dollar. And I think it’s probably in the kind of the March to April-May time frame.

Tony

Well, I think what people also forget is that the Fed has eight plus trillion dollars on its balance sheet, and if they start to sell it off in any sort of volume, that takes dollars out of circulation, right?

So that’s a big assumption because they’re shrinking it on a small basis now. But if they accelerated that, that would take dollars out of circulation. That’s bullish dollar as well, right.

Brent

Well, the other thing I want to make this point because I think this is a critical point. And I was speaking to, I went to a conference in October, and I’m not going to pick on this conference because it’s happened at every conference I’ve gone to. And I had so many people come up and me and say, what’s going to happen with the Fed? How’s the Fed going to get out of this? How’s the Fed going to get out of this? They’re trapped. Nobody has ever come up and asked me how the ECB is going to get out of it.

Nobody’s ever come up and asked me how the bank of Japan is going to get out of it. Nobody’s ever asked me how the Bank of England is going to get out of it. And the thing is, they’re in worse shape than we are. I hear you, and I understand all the problems associated with the dollar. Listen, it’s a horrible currency. It’s just better than the other three jokers.

Tony

Gold or CNY, Brent. Gold and CNY solves everything.

Brent

Exactly. So my views on the dollar are not just based on what the Fed is going to do. A lot of it’s based on what these other central banks are going to do. And I just don’t think their leaders are any smarter than ours.

Tony

Perfect.

Brent

And I think they’re trapped even more than we are. So anyway, not to go off on a whole tangent, but that’s why I don’t want to have anything to do with emerging markets.

Tony

That is not a tangent. In fact, that’s a segue to our Japan normalization discussion. Right.

So thanks for that. So we saw Kuruda come out, talk about changing policy a little bit, and markets reacted with a stronger yen and yada yada. Right.

So is this, do you see this as a real change? I see this tweet that you sent out earlier this week saying if you think happened to think today’s move in the BOJ is going to work out for Japan, it’s not.

So can you talk us through? Is it just preparing for the next BOJ chair to reduce risk if they change policy? Is it a real policy change? Is it going to work out? What do you see there?

Brent

I don’t really think it’s a policy change. And if you actually look at a lot of people, just see the headline and just react, and they don’t even think about what the headline means. And I think the market has got into a habit, and people in general have got into a habit of reading into it what they want to read into it. So I think very much the world wants Japan to get out of this, and they want the dollar to go down. And so anything that shows that another central bank is going to outperform the dollar, they ultimately want that to be true, whether it is or not.

If you read what they actually are doing, they’re actually increasing the amount of QE that they’re doing. So if you just read that sentence, you’d say, holy cow, the end is going to go even lower. Because not only did it have a horrible year this year, but now they’re going to increase QE. But at the same time, what they said is that we’re going to let the bond, the yield curve control, the band with which in yield curve control moves, we’re going to widen that.

So we could have interest rates in Japan go up to 50 basis points rather than 25 basis points. And so the market kind of interpreted that as, okay, they’re actually moving towards rate hikes. Now, they didn’t say they’re moving towards rate hikes. They didn’t do a rate hike. But everybody wants to believe that they’re going to raise rates.

But here’s the thing. Earlier this year, and I think it was March or April, interest rates in Japan, because of inflationary pressures, are now actually even hitting Japan. Long term rates in Japan moved up 25 basis points. And because the two to five to ten years prior to that, they were doing QE and negative rates. The banking system is chock full. And when I say the banking system, the banks, the hedge funds, the endowments, the all the institutions in Japan have all these zero yielding bonds, Japanese bonds on their banks, and because, and they’re long term bonds.

And so when yields even go up 25 basis points, the convexity makes the balance sheet of all these institutions go upside down. And so when interest rates went up 25 basis points in April, it caused all kinds of chaos in the Japanese banking system, and the market had to be halted, and the Bank of Japan had to come in and promise to do more yield curve control in order to keep it from blowing up.

And two days ago, or three days ago, whenever that announcement was, they made that announcement, the market took it as an interest rate hike. And guess what happened? They had to halt the Japanese bond market again. So I understand if they do raise rates, that would strengthen the yen.

But the problem is you cannot, and this is for every country, the US included, again, there’s a progression in how it’ll go, but you cannot save both the bond market and the currency market because they work at cross purposes. Whatever you do to save the bond market hurts the currency. Whatever you do to save the currency hurts the bond market. And every central bank in history has promised they won’t sacrifice the currency, and every central bank in history has ultimately sacrificed the currency.

And the reason they always choose the currency over the bond or the reason they always choose to sacrifice the currency over the bond market is two reasons. One, the currency affects the citizens more than the government, and the bond market affects the government more than citizens. So they’re going to bail themselves out before they bail the citizens out. And the second thing is, if the bond market blows up and the banking system blows up, there is no longer a distribution system for the government to raise money.

So they can’t let the bond market blow up because then they can’t get money anymore. And then if they can’t get money, they can’t operate. So this is a very long way of saying that I understand why the market moved the way it did. I think maybe in the short term it makes sense, but in the medium to long term, it doesn’t make any sense to me at all. Again, kind of watch what they do, not what they say. I think the yen is going much, much lower.

Tony

Okay, interesting. How long do you think it will take before markets call their bluff, is that?

Brent

Maybe a couple of months?

Tony

Really?

Brent

Again, I think we’re going to have a lot of problems by the end of Q1 all over the world, not just in Japan, not just in the US, not just in Europe, but everywhere. I think we’ve been slowly moving towards this crisis, and I think we’re almost there.

Kuppy

Brent, I think a lot of the move in the yen over the past couple of weeks is really just guys degrosing. That was the funding currency for all the risk assets, and risk assets went no bid, basically all year, and guys are finally getting redeemed from their hedge funds, and it’s year end redemptions. You got to pay it out. It’s got to unwind your yen to unwind your Tesla, which is also in free fall.

Brent

That plays into it as well. Yeah, I see your Tesla queue there. That’s a good timing.

Kuppy

I’ve had this, what, five years? Six years. It’s probably coming due today.

Tony

When is the Twitter Q month coming?

Kuppy

I don’t know.

Brent

Oh, they should have one of those, shouldn’t that’s a good idea. We should start selling those.

Kuppy

I’m a little conflicted here because I feel like Elon might be doing the right thing on the Twitter side, whereas Tesla is still like the evil empire. So I don’t know.

Tony

Okay, we’ll have another discussion about that at some point. Brent, you talk about things coming in Q1. Can you share a little bit of your thoughts there around markets, potential recession that might…

Brent

Well, yeah. I mean, in general, it’s kind of amazing. Now, let’s reverse ten days ago to the Fed meeting. At that time, the Fed had raised four and a half, almost 4% for the year, and markets were down, but they weren’t down that much. Now, since then, they’ve sold off another 5% or 10%. So now they’re getting close to the lows of September again.

But this is what I think. I think a lot of people are surprised that the market hasn’t crashed more than it has based on the four and a half percent or, or  4% rate hikes. And I think what sometimes people forget is that we may not even be feeling the effects of the very first rate hike yet, because oftentimes rate hikes take nine months to a year to actually.. The effects of the rate hike to show up in the economy and work their way through the economy.

Tony

Powell talked about that a lot in his last…

Brent

Well, no, exactly. And the first rate hike was nine months ago. It was in March. So it really wasn’t that long ago. Right. And now they’ve raised four times since then. So I just feel like by the time we get into February, March, that stuff is going to have started to show up, perhaps dramatically. And I think the Fed is going to continue raising until they just can’t raise anymore.

Now, whether they should or not, whether you believe Powell or not, again, that’s kind of a separate subject. I just think he’s going to do it because he wants to do it, and the last thing he wants is for inflation to reaccelerate on his watch. Right. And if he crashes the market, then everybody will be begging him to do QE and he can go do QE and be the hero. So I just kind of see that that’s how it’s playing. And I think that probably a lot of people agree with me on that. I don’t think that’s any kind of a crazy view right now. I think a lot of people think he’s going to hike until it crashes the economy, but I don’t see him slowing down until he has to.

Kuppy

Brent, I got a question. Lagarde has been super dovish for a very long time. Depending which country in the Eurozone you’re at teens, maybe even high teens inflation all of a sudden, last week, she just came out swinging.

Brent

She did.

Kuppy

And what do you think changed? Did someone just whisper in her ear? Did she look at a debt bad data point? Did a politician be like, hey, the peasants are upset about the price of bree? Like, what happened?

Brent

I think it’s a little bit of that latter. I’ve talked about this before. I think we all know that financial repression is the name of the game for governments. That’s how they get out of these big debt, these big debts that they, you know, they want to inflate it away over time. The problem, though, is what they would ultimately like to do is to get very steady rate of inflation at four or 5% a year for ten years right. And inflate away 50% of the debt. The problem, as we’ve kind of figured out and found out that it’s very hard to just get four for four or 5% inflation. It goes from 2% to 12% pretty quickly. They don’t have as much control as they think they do, right?

And the problem with four or 5% inflation, you can kind of get away with it because it’s annoying and it is frustrating, but it’s not totally ruining your life. But with 8, 9, 10, 12, 15, 80% inflation, that starts to ruin the pledge life, as you mentioned. And that’s when they start to push back from a political perspective. And that’s what central banks and governments don’t want. They don’t want the populace revolting. But when you’re cold and you’re hungry, that’s when you revolt. Nobody revolts when they’re full and warm and have a great job and going on vacation. Why would you revolt in that environment? But when things are going against you and they start pushing back politically. And so I think that the pressures in Europe are a little bit just too much for them to not at least acknowledge it publicly. Now, whether they actually do anything and follow through on it, that will be interesting to see because, again, ultimately, I think they will save the currency rather than save the bond market, or I’m sorry, they will save the bond markets rather than save the currency. But I do think it’s a little bit of why Lagarde came out as strong as she did.

Kuppy

Do you think she follows through or?

Brent

No, she’ll try again. And it’s like Powell. Powell will keep trying it. Well, eventually the markets will push back on them and won’t let them, but I think she might try. But I think Europe is just screwed for lack of a better word.

Tony

So let me ask you guys and Europe, are we in a position where we have to approach what Japan is doing, where eventually the central bank will come in and buy up equities and they’ll buy their debt? And this is a cycle that just can’t stop? Is that what’s going to happen in the US and Europe as these central bankers are put in a quarter? And are we getting closer and closer to kind of D Day?

Brent

I think we probably are. Now, and I think there’s many people who believe that there’s nothing that central banks can do to squash inflation. I actually think that’s wrong. I think they could cause a depression which would have put a damper on inflation. Now, I don’t think that they can engineer a soft landing, but I think that’s what could happen at the end of kind of Q again, Q1, Q2. I think we could get some deflationary pressures coming through the markets due to the rate hikes that central banks have been trying and we’ll force them to U turn.

The biggest question I have, to be really honest, I’m not sure how this plays off, is whether or not we can get one more cycle of QE of risk on before they have to kind of reset the whole system. I could see a thing where we just have a couple maybe things just go down from here and a year from now they have to reset everything. But I could also see a scenario where we again have a bad first half of 2023. They reverse everything, we get another QE cycle that takes us into 2023 through the election five.

Yeah, exactly. And I don’t really know how that one plays out. I could see it kind of going either way. But ultimately to your point, Tony, I think the central banks will have to reverse.

It was funny. For several years, we were in a currency war where everybody was cutting rates to weaken their currency. Now, in the last couple of call a year, they’ve been raising rates to kind of strengthen their currency to try to fight against the inflationary pressure. So now the currency wars, who can outhawk the other one? It’s all going to end in tears.

Tony

Sadly. I think you’re right. Speaking of tears, Tracy.

Brent

No. Are you going to cry?

Tony

As we talk about difficulties

Tracy

every day?

Tony

…Recession and consumption and Kuppy started talking about oil at the start and oil demand. You posted a chart about looking at oil demand elasticity and household savings as central banks take different actions. Of course, that changes as stimulus have stopped. If it doesn’t come back on, there are changes to household savings, these sorts of things. So you posted a really interesting chart about household savings and can you talk us through a little bit of that and a little bit around oil demand elasticity?

Tracy

Yeah. What I think, I think there is a misconception that when there is a recession, that oil demand suddenly falls off a cliff. Right. Everybody has a very short memory and they look at COVID when we literally shut down the planet, but that’s not the reality. So if you look at past recessions in general, 2008, the most recent one, great financial crisis.

Now, we did see a dip in demand, but it was only about 2%, and it was only about 2% for two quarters. And then by the third quarter, demand increased over what it was before the great financial crisis. And so when I talk about the fact that everybody talks about savings, rates are going down, credit card rates are going up, nobody’s going to be able to afford oil, everything’s going to shut down, there’s a lot of fears running around. We’re going to have this global recession and nobody’s going to use oil anymore. And that’s kind of been the prevailing narrative. And we’ve seen this in open interest.

We’ve seen many funds sort of lose interest over oil. That’s been a great year for them. They shed their positions. But this prevailing narrative that we keep hearing in the media, “oh, it’s a global recession. Nobody’s going to use oil again.”

It’s just not a fact. We look at the data, we look at every recession. Recessionary pressures really have not taken much demand off the market. And every time that demand has been taken off the market within a very relatively short period of time, we’ve seen demand increase over that prior level. And so to use this kind of as a narrative, I think is not correct if you actually look at the data.

Tony

Okay, so we had this weird kind of almost recalibration of expectations with COVID where really everything came to a stop, right? So demand just cratered compared to, say, 2008, 2009 crisis. And so kind of the base effect of demand coming back has been really impressive, kind of year on year growth each time, right? And then we’ll continue to see that as China comes back.

But there are some real concerns for example. China’s population peaks out, peaked out in 2022 or ’23 or something like that, right? So their population is peaked out, and it’s all downside from here, right? Unless there’s real growth in their consumption. Europe’s pretty peaked out. Japan’s peaked out. The US hasn’t peaked out.

But we have some of those long term trends, and we have a recession. I’m just trying to play a little bit of devil’s advocate here. How much of an impact do you think those have on consumption, on the consumption dynamics, particularly with regard to savings and how, if people don’t have rising incomes and their saving rates decline just to make ends meet, which wasn’t necessarily the case in say, 2010 eleven. Can all of those things come together to really impact kind of the overall consumption trend or is that just not really a concern?

Tracy

I think there’s two separate things. If we’re talking about declining population rates, that’s sort of a long term view. We’re looking 20-50 years out, does that trend continue? And of course, at that point, you’re talking about global energy consumption decelerating, obviously.

Tony

And we’ll have nuclear powered flying cars right by then. So.

Tracy

Absolutely. But if we talk about, you know, shorter term things or near term things, things that we’re looking at, you know, over the next, say, you know, year to five years to ten years, I mean, there are still, regardless of a recession, we still are seeing year to year global consumption increasing. And in fact, we just had IEA, which I know is a WEF show, but we just had them completely revised their whole global oil growth demand system going back to 2014. They redid their entire numbers and added millions of barrels. And the media really likes to use that IEA data. They just repackage it and whatever. And they’ve been completely wrong at that point.

This goes back to when we had missing barrels and everybody was talking about that back in 2014. But the fact is that by any measure, global consumption is rising, right? Because you still have emerging markets that are trying to get out of the darkness. You look at countries like India, which they’ve had the strongest global demand increases so far this year. So there is always demand coming from somewhere, and the problem always goes back to supply.

In fact, we just don’t have the supply catching up with the demand. So even if we look at the Western world and even perhaps China years out, I mean, you still have to understand they’re still increasing demand, even though they’re absolutely even if their population is elderly and declining, their consumption energy wise is still on the uptrend.

So we still have these huge markets that are still on an uptrend. We’re going to see this in emerging markets. We’re going to see this in India, we’re going to see this in South America. We’re going to see this in Africa in particular, because BRI, suddenly they got a lot of money from China. They can build out this infrastructure, and they need, there is more demand there. So even though the west may be looking towards this green energy transition, we have to realize that that green energy transition also has not been working out. We just saw the biggest increase in coal demand in the EU in ten years this year.

Tony

Yes.

Tracy

Incredible that energy policy is not.

Tony

Reporters on sarcasm. Green energy transition. It’s on sarcasm.

Tracy

Really what we have to boil this all down to, long and short of I know I always talk in, like, broad picture, but really it all boils down to the data. What is the supply coming online? What is the demand going forward? And so far, demand outstrips supply. There is no way around that right now.

Tony

Okay. And it’s fairly inelastic it sounds like.

Tracy

It is fairly inelastic, even if you have, you know, again, look at the data. Anytime we’ve had a recession, demand is bounced back very quickly, and we’ve only seen a 1 to 2% pullback in demand. It’s not like COVID where everything crashed.

Tony

Okay, so we started and ended with crude. And I usually finish up guys with kind of, what do you see for the week ahead? But I’m going to change it up a little bit. As we go into 2023, with regard to markets, what keeps you up at night? What is that thing that you think about and you’re like, well, Account Odd sees this, and it’s obvious to me. What is that thing that keeps you up at night, Kuppy? I know you’ve got some amazing things in there. So what is that thing? And I know none of us see what you see.

Brent

You can’t say bourbon. That’s not a legitimate answer.

Kuppy

I think next year is the year that oil matters. We’ve lived in this world where oil has been sort of range bound, really for eight years. And people just got used to energy being cheap. I mean, we had a little bit of an energy scare in Europe, and I say “little” because that should have been the wake up call. And instead, I think you’re about to see the big one and you’re going to see energy as a percentage of GDP go to some crazy level like in the 1970s. And I think as a result, most of the Q sips on my screen are going to get smashed and everyone’s worried about JPowell. But in the end, JPowell is not the world central banker, oil is. And JPowell is going to chase oil higher on the screen for a while. He effectively has been chasing oil higher on the screen. And when oil rolled over from the summer onwards, that’s what cooled off the inflation. It’s not Fed funds rate that kind of helps. It’s really just oil. And as oil reaccelerates, JPowell is going to chase it higher on the screen and it’s going to get to a price where he’s going to have a dilemma.

He could either keep chasing oil higher or he could bail out the real economy with the rest of the economy. And I think he’s going to bail out the rest of the economy by cutting rates and sending oil parabolic. I think that’s how you get to my 300 number. And I don’t think people realize that oil at 90. Who cares? Oil got to 120 for a couple of weeks this summer. Who cares? What if oil is consistently in the high 100 and it just stays there? I think it just dramatically changes the arithmetic for every other QSIP on the screen. Absolutely. Aren’t plugging that in.

Tony

Okay, good. Thank you. Tracy, what keeps you up at night?

Tracy

I actually think that looking at 2024, I think that the metals markets are going to make a huge comeback. I’m not talking precious metals, I’m talking basin industrial metals only because I think that oil plays a part in that. If we have higher oil prices, we’re going to have higher metals prices. And because the west, in particular the EU, does not seem to want to be giving up on this green energy policy. We’re going to need a lot of metals, we’re going to need a lot of copper, we’re going to cobalt, nickel, whatever, if they want to continue down this path.

Tony

Sorry, you’re saying you need more industrial metals for batteries and other infrastructure for the green transition?

Tracy

More than we’re currently. In fact, we don’t even have the known reserves to get to the 2030 goals right now. If we were talking about copper. And certainly the mining industry has suffered the same problem as the oil industry has a lack of capex for the last seven years. And so we simply just don’t have that. So what I’m looking at, I think that oil is a big story and will continue to be a big story in 2021, 2022, but I think metals are going to start to come into play in 2023 and ’24. And what I’m worried about is we literally, again, no capex, and we don’t even have proven reserves anywhere. So that’s what I worry about. The metals based in industrial metals.

Tony

Okay, so so far it’s commodities keeping you guys up at night. Brent, wrap us up. What keeps you up?

Brent

It’s kind of interesting. I think that the underappreciated risk, even though the dollar made a hell of a run this year, is that we could have a funding market problem in the euro dollar market. And to be honest, it doesn’t keep me up at night because I’m kind of ready for it. I’m expecting it.

You know what keeps me up at night is these guys in Washington and Frankfurt and DC, and Tokyo and Beijing figuring out how to extend this game because they’re masters at keeping the plate spinning. And I’m always trying to figure out what are they going to do next to keep this whole house of cards going. And to me, that’s the wild card. I feel like I can kind of figure out markets. If markets are just left alone, I can kind of figure them out. The wild card is when the masters of the universe are the powers that be, however you want to describe them, come in and start messing with things, because that can change things, at least for a day or a week or a month, and sometimes that’s enough to wipe you out.

Tony

Yeah. Okay, guys, thank you so much. This has been really enlightening. I really appreciate the thought we put into this. Want to wish you all the best for the holidays and a fantastic 2023. Thank you so much.

Kuppy

Happy holidays, everybody.

Tracy

Happy holiday. Sure.

Categories
Week Ahead

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

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.

Categories
Week Ahead

Crude Oil Supply: The Week Ahead – 29 Aug 2022

Learn more about CI Futures here: http://completeintel.com/2022Promo

Crude and energy are on everybody’s minds, and we spent a lot of the Week Ahead parsing the details. Saudi Arabia came out with some comments about restricting their crude supplies to global markets, and we also have a detailed discussion on the SPR release in the US – when will it end, how will that impact crude prices, etc. 

We also discussed Jackson Hole drama and the conclusions of Powell’s latest speech. Powell really didn’t say anything new, so why are equity markets reacting so dramatically?

And will we finally get some stimulus from China’s government? We’ve seen movement in tech stocks and some talks of the stimulus release, but we expect more after the US election. 

Key themes

1. Crude oil supply: Saudi/UAE cuts vs SPR

2. Jackson Hole Drama

3. China Stimulus (Finally?)

4. What’s ahead for next week?

This is the 31st 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

Albert: https://twitter.com/amlivemon/

Sam: https://twitter.com/samuelrines

Josh: https://twitter.com/Josh_Young_1

Listen on Spotify:

Transcript

Tony Nash: Hi, and welcome to The Week Ahead. I’m Tony Nash. This week, we’re joined by Josh Young for the first time. So I want to thank Josh a lot for taking the time to join us. We’ve got Albert Marko and Samuel Rines. We’re lucky to have these three really valuable guests.

Before we get started, I’d like to ask you to like and subscribe to this YouTube channel. You’ll get reminded every week. Give us comments on the show. We always look at the comments. We always respond to the comments. So thanks for taking the time to do that.

We also have a promo for our product, CI Futures. That product is $50 a month right now. You can go month to month with it, try it out. We cover about 900 assets with weekly forecasts, and we do about 2000 economic variables with monthly forecasts. So check it out. We’re transparent. We disclose our error rates for every month. So it’s good information.

We have a couple of key items this week. First is the crude oil supply. We had Saudi Arabia come out with some comments about restricting their supply. We also have some information on the SPR release in the US. So we’re going to ask Josh to leave the discussion on that. 

Obviously, Jackson Hole drama. We’re probably the only people not leading the Jackson Hole today. But there are some meaningful things happening. There are some things happening that are not meaningful, and Sam will talk us through that. 

And then when we finally get some China stimulus, I think that’s a real question and Albert will lead us on that.

So Josh, thanks again for joining us. You put out a tweet earlier today about the UAE supporting the Saudi comments on supply restrictions.

Can you talk us through that and help us understand why did that happen and why is that important?

Josh Young: So the UAE is supporting what the Saudis and other OPEC members are doing in terms

of threatening to cut production based on the combination of lower price, as well as their observation that there may be some paper market price manipulation and disconnect from what they’re seeing as the largest sort of combined suppliers in the oil market. And it’s particularly important that the UAE did this because what we saw at Bison was that most of the OPEC members were actually producing their maximum production capacity. And when you produce that maximum, the fields aren’t designed for that. It’s sort of like driving with your foot all the way down on the gas 100% of the time. You’ll break your car and you’ll crash.

And so a lot of these fields and their processing facilities, they’re just not designed to run at this. It’s a theoretical capacity that’s supposed to run for a week, a month, three months, not how they’ve been running it. And so there’s a lot of pressure on a lot of fields in many of the OPEC countries to actually reduce production slightly, so it’s not a surprise.

And we forecast that there would be some discussion of this given the high run rate versus their spare capacity. UAE in particular does have some remaining spare capacity, so what we’re seeing is cohesion within OPEC along with supply exhaustion of the other OPEC members. So it’s actually a pretty big thing, and I don’t think people are really picking up on it too much. Although maybe it’s why oils flat up a little.

TN: With the market down a lot today. Is this something that will start small incrementally and then it will accelerate? Meaning will they cut off a little bit of supply and then over time, maybe they take some fields down for maintenance or something like that, and then you start to see bigger chunks? Is that a possible scenario?

JY: Yeah. Honestly, I don’t know exactly what the path will be. I just know that they see it. We were joking before the show that, hey, maybe they’re following my Twitter feed and a few other people’s been observing these problems with the oil market and sort of weird trading patterns versus very strong physical demand and sort of very strong indicators.

And you see Saudi has a very high price relative to their benchmarks. Right. Their poster price, especially Asia, has been very high and usually that’s associated with price strength, and instead we’ve seen price weakness. So I think they’re very frustrated by that, but they may wait for some other things. So oil prices to fall a little more or some other sort of signal, maybe some small amount of demand destruction to the extent that happens. I think it’s a little hard, just given the Saudi relationship  with the US and their sort of hope to maintain a lot of their alliance and their alignment with the west. 

So I think they need sort of an additional catalyst. That being said, once they do it, they might… I don’t know if they start small and then go big, or they might just go big. They might just say, hey, we’re cutting by a million barrels a day. We increased by four over the last year and a half, and we’re fully supportive of the market. We might go a lot bigger if necessary, and there’s a disconnect and we’re going to support it.

TN: Okay, so how much of this is related to the SPR release? Is the SPR release having such an impact on prices that the Saudis are kind of fed up with it, or are there other factors?

JY: I actually don’t think it’s related to the SPR release almost at all. It does look like it’s a little related to some of the job owning around a potential agreement with Iran. And there’s a lot of disagreement in terms of how much oil production could come on if Iran came to an agreement with the west and sort of restarted. JCPOA. I’m in the camp that there’s not a lot left to produce and to export. You can see the amount is getting exported to India and various other countries. It’s up a lot from the last time this was floated, six or seven months ago. So whatever that capacity was for Iran to export, it’s less.

But I think it’s partly tied to that because Iran is a regional foe of Saudi Arabia and UAE and several other OPEC countries. So I think it’s a little bit of that. And I think it’s a lot related to the paper market trading patterns and just this really big weird disconnect where you see consumption fine and you see price down and it’s probably messing up your CI Futures forecasting a little because you’re probably tracking the consumption and the consumption is fine and the price is down. And it’s like. Okay. The inventories are down. This is weird. Again, excluding SPR, when the SPR stops releasing, obviously you’d expect price to recover substantially absent a million barrels a day of demand structure.

TN: Is that what you expect when the SPR release is done, that’s late October or something, right, do you expect prices to rise notably? 

JY: Yeah. And I think like, the EIA forecast for shale production growth and sort of overall US oil production is just totally off base. They haven’t reset it, even though I think they had like a million barrels a day or something forecast for growth. And I think we’re at sort of 300,000 barrels a day so far this year and pretty flat. And the rig count is not up that much, and the frac stack count is definitely not up enough. So I think there’s sort of this disconnect. 

There also in terms of this mark to model from a production perspective versus what’s actually happening in the field.  And then you look at it’s not hard to see who the big producers are on the public side and then which ones had forecast growth and how much they’re actually achieving. 

It’s really hard to reconcile their forecast for production growth versus what’s actually happening. And we’re really well situated for this because we spend most of our time we talk a lot about macro, we spend most of our time just like looking at individual companies and evaluating them and evaluating their securities. And so I think it’s part of why we’ve had such a powerful voice from a macro perspective, because we’re spending most of our time talking to these companies, looking at the rigs, looking at other services, figuring out the bottlenecks, and looking at some of the local stuff.

And when you do that and you step back and say, these numbers don’t make sense, and the companies are not tracking anywhere close to that. So back to SPR, that matters a lot because we’re not achieving the production that is being forecast. And it seems like a lot of market participants, or at least prognosticators, are just accepting as a given. That means that at whatever point… I’m not saying that the SPR release stops in October. They may continue it, but at whatever point, there is a finite amount of oil there. And we’re hitting tank bottom on some of those caverns that are releasing oil. At some point we just run out or we stop releasing and whatever that point is, absent significant demand destruction in a very deep recession, I think we see a lot higher oil prices.

TN: So in terms of the SPR release, you said, you talk about being empty, this sort of thing. How much do you think are you still thinking kind of October? Are you thinking they’re going to continue, but it would kind of have to trickle out, not at the same rate they had been releasing to date. Right? Because they are short on supply in the SPR.

JY: Yeah, I don’t think it has to trickle out. I think they could produce pretty hard for another month or so, and then it starts becoming more of an issue. But as you get down to it, looks like the numbers around 20% or so for any of the individual storage facilities, and for some of them, it might be a little higher, some of it might be a little lower. You start having issues with contamination as well as just physical deliverability, actually extracting it out. 

And I think people take the numbers a little too seriously. And it’s very weird because no one trusts the government about certain things and then other things they just blindly say, oh yeah, it’s right. It’s from, okay, try to reconcile that.

And I think when you talk to engineers and some of the people that have worked on these facilities, their observation is that it’s reasonable to expect less deliverability. But there are enough of the facilities that aren’t drawn down enough that they should be able to supply. I don’t think we’re really hitting deliverability issues yet, but I think we’re likely to start to hit them, let’s say over the next month or so.

TN: Okay. So kind of when we take what you’re talking about and we look at, say, the potential impact of crude prices and refined product prices on inflation and energy prices generally on inflation, seems to me that you’re implying that towards the end of the year we could see those prices rise fairly quickly. Is that fair to say?

JY: It is. But at the same time, gasoline prices are still down a lot. These will start to tick back up the gasoline, which is a big consumer factor, as well as it gets felt through a number of different aspects of the economy. So at least for now, that’s not so much of a risk. But yeah, definitely. Sort of later on in the year, one could expect that. 

And one other way to look at that is there’s been a divergence, and I’ve ignored these historically, to my detriment. There’s been a divergence in between the oil price and oil and gas equity prices and oil and gas equities have done a lot better over the last, let’s say, month and a half than oil prices have. And it looks like the equity market is telling us that the companies… 

I mean, one, the companies are just very cheap, so I would think naturally they should rise. But the degree of divergence is so much that it seems like the equity market is making a forward looking bet on higher than strip prices in the future. And the forward market and the oil paper market is making the bet that it will be lower.

So there does seem to be a noteworthy divergence that could mean much higher inflation, like you’re saying, but it might also be that shelter matters a lot more and some other stuff matters a lot more, and it might really take diesel rising a lot and gasoline rising a lot to actually shift back into high inflation.

TN: Okay, is that divergence between only upstream companies or is it upstream midstream? Is it the whole stack? What is that divergence? What does that include?

JY: So I’m most focused on upstream. I don’t actually remember whether it also included the pipelines and services. But on the upstream, definitely both the large cap, the XLE ETF that includes Exxon and Chevron and stuff, as well as XOP, which includes sort of independence.

TN: Fantastic. Okay, Josh, that is excellent. Thank you so much for that. On that inflation topic,

let’s move to Jackson Hole. Of course, there’s a lot of breathy analysis of Jackson Hole over the last couple of days, and there will be over the weekend. But Sam Rines, who has the most valuable newsletter that I know of that’s available in America today, covered this week, and there’s a chart that he has in there looking at the meeting probabilities and also looking at the headlines that may or may not come out of Jackson Hole.

Sam, can you talk us through that? And what do you expect some of the conclusions to be?

Sam Rines: Yeah, so I thought it was really interesting. The Fed said nothing all that interesting today. I mean, it might have been a shock to people who weren’t paying attention, but the Fed just reiterated about, I don’t know, 99% of what it’s already said and set it in different words. And Powell said it basically eight and a half minutes. Right. That was the big change. All he did was take a bunch of time out of the speech, condense it and say, we’re not pivoting. They were never pivoting. The pivot was out of the picture at the last meeting. He made that pretty clear during that press conference. 

So it’s really interesting to me that there was an actual equity reaction to it. It’s also really interesting

that there was relatively little reaction out of Currencies, relatively little reaction out of global interest rates and only a reaction on the equity front. It was like it was a shock to the equity guys, and everybody else was like, yeah, we need that. So I think that was really the big takeaway was it was a shock to the equity

markets, but everyone who had to be paying attention for the last six months was like, yeah, no big deal.

So Jackson Hole I think one of the things that I had said about it in the newsletter was, you’re not going

to learn anything new. And the only thing that we learned was that Paul was going to say absolutely nothing new and absolutely nothing interesting, and equity markets would still react to it in a pretty meaningful way. The idea that we were going to go to 4% and then stay at 4% was already priced in to Fed fund futures through the end of ’23.

So this whole idea that Powell somehow shocked the market. It’s one of the more entertaining things

today, in my opinion, is just that equity markets were so taken aback by it while you had three or four basis point moves in interest rates across the US curve. And just a big shrug. 

To me, the big news today was probably out of Europe where people were potentially discussing 75 basis

point hike from the ECB. The Czech Republic doing an emergency meeting on energy.

There were some more interesting things that happened in the market today, but I think I overlooked in favor of an eight and a half minute speech by somebody just re iterating what he had already said 900 times.

TN: So let’s talk about Europe a little bit, because that’s interesting. I mean, Europe is in a world of hurt, right? We’ve talked about that several times. So what do you think the path for the ECB is from here? Do you think they’re going to hike 75?

SR: No, I think they hike 50. I think 75 is probably a little too aggressive for them. I mean, we were talking about ten basis points three months ago as being something that we thought would be interesting. And now the idea of floating 75, I think that was mostly to defend the currency, right. They knew that there was a known that you were going into Jackson Hole and if you front ran that with the leak that you might go 75, you’re going to defend your currency somewhat against a potentially hawkish Powell. It’s pretty straightforward in terms of defending a Euro at one. So I think that was basically the case. Call 50, maybe 75, I don’t really care. They’re going to hike, and they’re going to hike in a pretty meaningful way, particularly for a place that is already screwed. Right into the recession, right? Yeah.

I think it’s a pretty interesting opportunity to go long the long-end booned and short the Euro. Yeah, we’ve talked about that a few times here and that’s great.

TN: Okay, guys, what else do you have on the, Albert, Josh? Are you guys hearing anything else on US economy or Jackson Hole? 

Albert Marko: Sam mentioned about the equity reaction. How much of that is really because

of the low liquidity right now? There’s no traders really out there, no volume out there really, at the moment. 

SR: But liquidity works both ways, right? If you have low liquidity, you can rip it. It can get ripped either way. And I think what you saw immediately following his speech was you saw a leg down, then you saw 1% leg down, 1% leg back up, and then a two to 3% leg down, depending on what industry you want to look at. Right. So liquidity works.

AM: But you’re right, nothing was new. That rally that they launched for the weeks prior to that, you expected them to go hawkish after that, what are they going to do? Go dovish and go to 4400, 4500 and look ridiculous? Nothing new came out of this. He’s right about that. 

SR: I think there was an opportunity for them to potentially begin to say, hey, we’re going 50s and then 25s, and then we’re going to pause at 4% and we’re going to see how much we’ve ruined everything. There was the potential for that.

But then when you get STIs, you get financial conditions ripping higher, you have meme stocks

coming back into the news. Yeah. The Fed is not going to consider that type policy. If anything, they’re going to look at that and say, hey, it looks like short term neutral is a little bit higher than we thought it was. We need to move a little further and then begin to pause.

So if anything, the equity rally going into Jackson Hole was more problematic for equity markets than people thought. 

TN: So do you think some of those 25 expected 25s could be 50s in say, Q4?

SR: I don’t care if they’re going to get to four and then they’re going to stop and they’re going to get to four before they’re going to get to four around December and then they’re going to see what kind of carnage they’ve done. If they haven’t done enough carnage, they go higher. Pause there.

TN: That makes sense.

SR: The pace is probably I would say the pace kind of matters for shock and all purposes,

but in general the pace is kind of meh.

The end is really important and the length of staying at the peak is what is truly the most important thing here. If they’re there for a year and a half and they don’t care about a recession, that’s one thing. If they’re there for six months and cut by 75 because we’re in a recession, then go back, that’s a different thing. But I really don’t care how quickly they get there.

TN: Okay. And the run up to the midterms has no bearing on what the Fed is going to do, is that? 

SR: None.

TN: None. Okay. I just hear that from time to time. Well, the midterms are coming, so the Fed

is going to just relax for a few months.

AM: You hear that mainly from me. From my perspective, it’s always been like when I say Fed, I want to say Treasury and Fed together because of Yellen.  But sometimes they have those concerns. Like they don’t want the current administration looking bad. I had a midterm. Yeah.

SR: That should sail.

AM: Well, that should sail because just because of the ridiculous antics that they pulled recently with inflation, it’s being ridiculous. So you’re right, that ship has sailed.

TN: Well, I mean, are they ridiculous or not? I mean, inflation has definitely risen and they’ve definitely taken action to offset inflation.

AM: Yeah, they’ve done that in a vacuum because China is not online yet and Europe is a complete disaster at the moment. Right. And we haven’t had a real event to drive oil up into like the 130s, 140s again. God forbid we have a hurricane in like a week that goes into the Gulf of Mexico while Grandhome is sending out letters to all the refiners saying you can’t export anything anymore. There’s plenty of room. 

TN: She’s encouraging them. She’s not requiring them. Right?

AM: Yeah. Okay, well, we’ll see about that.

JY: She’s making them an offer that they can’t refuse. So my general take was just like, I’m not a Fed watcher. My general take was kind of stagflation coming out of this. Right? It’s like policy that can’t get too extreme to really like they’re going to try to torch the economy, but they’re also not going to go to a 15 interest rate or anything like that. They’re going to go to a four or whatever, and maybe they’ll go slower or faster.

I think there’s some political motivation there. So maybe they go slower and then they turn on higher after the election. Maybe not. Unclear. Kind of doesn’t matter from my perspective.

What does matter is, like Albert was saying, I think there’s a decent shot that we end up with higher oil prices. We end up with other factors. So, like, there are various drivers that are pushing, especially in the rental market, shelter higher, not lower. And so with persistent inflation in the biggest household bucket, and then with a likely move higher this winter in oil and diesel and probably also gasoline, it’s going to look pretty ugly. And if you have them stopping kind of at four, maybe going to let’s say five or something, but inflation is at ten or nine or whatever, right? Some directionally, really high number. At some point, you just start ticking in where you have negative real and positive nominal, and that’s just hard to break unless they go a lot higher. But if the economy is sucking, that makes it really hard. So that was my sort of general take from what they were saying.

AM: I wanted to come back and ask you about the SPR just real quick about the oil in it. Some of it has got to have degradation, and there’s a lot less barrels there that they can actually release. They might have to stop in end of September. You might start seeing oil rise even before October.

JY: Yes. My base case is not that. My base case is there’s a little bit of contamination, but they’ve managed to reduce that either by not pulling from the caverns that have had contamination historically or by treating the oil or something. My base case is that the oil there is extractable, except they can’t get the last barrel because there’s a certain percentage that needs to be there for the caverns to continue to be

functional, and they’re not going to destroy the storage caverns just to get the last oil. That’s my base case.

But I think there’s a reasonable expectation that there’s less oil there, given the history of contamination and the issues. And they did have a big draw this past week, but prior to that, they had multiple smaller draws. There’s also the crude quality thing, which I’m not really in the crude quality matters camp. I think there’s sort of this bizarre notion that crude, which is mostly fungible, really matters. It did to some extent before you could export oil and before various changes in US refineries.

At this point, it matters a little in terms of getting a couple of dollars, more or less per barrel, depending on transport cost. But I don’t think that’s really affecting the global balance. And I think it’s sort of like

a magic trick, right? It’s like focus on this and not like the thing that actually matters.

And so I’m glad you didn’t bring it up. I guess I brought it up and I just don’t think it matters, though.

TN: Great. Thanks for that, guys. Okay, let’s move on to China. Albert, over the past a week or so, we’ve seen a number of stories saying that China fiscal stimulus may finally be coming.

And we’ve seen some movements, say, in China, tech stocks, these sorts of things. So can you talk us through what you’re seeing with China in the stimulus camping? And why now? They’ve waited so long. Why would it be coming now?

AM: Well, it’s coming out because the policy and the dollar is so high, the Chinese economy is struggling at the moment and they come out with these mini stimulus announcements and there were shots across the bow. I mean, the worst thing right now that the Fed can happen is China stimulating commodities ripping at the moment, that would be absolutely atrocious. Inflation will start going higher and we seen like Josh said a 10% CPI prints coming out and they’re going to be forced to do 75 basis points again. It would throw a wrench in a lot of things and it’s not good if they stimulate it right now. 

But after the election, after the US election, they can do what they want to do because they have their own interests at heart at the moment. They cannot let the Chinese economy fall to a point where they can’t recover in the near future.

TN: So what do you see coming out in the near term? This $229 billion bond sale? That was a start, right? So do you see more than that or dramatically more than that coming out? And how quickly do you expect? 

AM: Yeah, I expect by January that will have a significant stimulus package coming out. This little SEC audit deal was basically a gift to delay it as much as long as they can.

TN: Okay, very good. And then so you don’t expect a significant amount of Chinese stimulus before, say, December or something like that?

AM: Yeah, before December. 

TN: Okay. Sam, what do you think about that? Do you think China stimulus hurts the US? 

SR: I really don’t think that the Fed would care or go 75. I mean, it’s commodities, right? And the Fed tries to ignore commodities as much as possible. So yeah, you’re going to get a rip in oil because there’s not enough oil to go around, there’s not enough oil for China and it’s going to coincide with the end of the SPR release. So you’re kind of screwed there. 

Copper, all that stuff goes higher. I don’t think the Fed cares. The Fed is going to try to cut that out. Then they’ll pivot core and you’re going to have a really weak Renminbi and you’re going to have probably at least a little bit of a pass through to US consumers on the goods front as you get goods to flow back. 

So you could actually see kind of an interesting offset where core goods kind of begins to decline on a Chinese reopen. Commodities rip and you get the, hey look, it looks like core is moving back towards two. We’re not going to have to raise rates as much because we don’t really care about headline, we can’t control oil, we can’t pump more oil. 

So I think it’s a weird kind of catch 22 where the Fed is going to have to pivot from talking about headline to talking about core. But I think they’re happy to do it as long as that core is really moving lower because I think they know they’re screwed on energy. They’re in so much trouble in energy, commodities, et cetera, that there’s nothing they can do.

TN: I think you’re right and we’ve needed a weaker CNY for about six, seven months now. So I think it’s about time and we’ve started to see it move, but I think we’ll start to see it move more dramatically soon.

Okay, guys, let’s start looking at the week ahead. Just a quick kind of round the horn of what do you think, Albert, what are you looking for for the coming week?

AM: I’m looking for a little bit of a rally back off these loads here, try to bring it back to 4200. I just personally think that the economy is in trouble, they’re delaying a recession as long as they possibly can, but it’s coming. So I think a little bit of a pump next week and then probably heading back down into September.

TN: Okay, Sam? 

SR: Oh, I agree with Albert there. I think the knee jerk reaction today to the Fed is going to be unloud as people begin to look at what really went on in rates. What’s going on in FX. The concentration should be on what’s going on in Europe. And the flow versus the stock problem that nobody seems to be able to figure out. Which is you can stock as much gas as you want in a bunch of caverns in Europe. If you don’t have flow over the winter, your stocks really don’t matter. I think there’s going to be a little bit of a realization that stock versus flow matter more than stocks and at some point you’ve got to figure that one out. So that’s what I’m watching.

TN: Interesting. Okay, Josh, what are you looking for in the week ahead?

JY: Just more information on oil demand. So we’re starting to see reports of surprise, higher oil demand than people would have thought, which coincide with actual reports of oil demand when you look at the raw data. So that should be interesting to see sort of how that gets processed and then sort of how oil price may or may not get suppressed. Again, just as we get more good data points, price should go higher, but it doesn’t seem to want you for now.

TN: Very good. From the energy capital of the Universe in Houston, Texas, Josh Young, Sam Rines.

Guys. Thanks very much. Albert, thanks. Have a great day, have a great weekend and a great week ahead.