The BBC’s Business Matters podcast covers a range of topics, including the positive economic signs in the US, the Russian tech brain drain, and the potential for a new plug to be the secret to a green transition.
Guests Emily Eng, NPR’s Beijing correspondent, and Tony Nash, founder and CEO of the financial forecasting platform Complete Intelligence in Houston, provide their insights on these topics.
They discuss the impact of economic sanctions on Russia and how the country is responding to them, including increasing exports to China and reducing its crude oil supplies by 500,000 barrels per day to push up prices.
The conversation also touches on a controversial proposal by the European Commission to seize Russian assets to help rebuild Ukraine.
Additionally, the podcast covers the announcement by the US federal government that all new garages and four courts built in the country will have to include charging points for electric vehicles and its potential impact on accelerating EV adoption.
Transcript
BBC
Hi there. Welcome to Business Matters. My name is Ed Butler, and today, despite all the political rows we’ve been hearing about a potential debt default, there are more positive economic signs from the United States. This week, we read the tea leaves with a former presidential economic adviser and hear about the new incumbent in that job. Also, we consider the Russian tech brain drain, and why a new plug could be the secret to a green transition.
Emily
This will definitely help accelerate EV adoption. Charging is one of the things that really does stand in the way of someone’s decision about going electric.
BBC
All the latest on electric vehicles in the States coming up in the show, and I’m going to be joined throughout the program by two guests on opposite sides of the world. Emily eng is NPR’s Beijing correspondent, although she is based in Taiwan at the moment. Hi, Emily, can you hear us?
Emily
Yes, I can. Good morning.
BBC
Great to have you on the show. Tony Nash. He’s the founder and CEO of the financial forecasting platform Complete Intelligence in Houston, Texas. Hi, Tony.
Tony
Hi, Ed. Thank you.
BBC
Great to have you both with us. Tony Nash this is obviously a function of, to some extent of the economic sanctions that we’ve been talking about, those applied against Russia. I mean, the funny thing about this is to some extent Russia hasn’t done that badly in the last twelve months, at least initially. I mean, that’s what the headline data is telling us. You look further into the future, I mean, are you seeing a kind of more serious decline potentially with Russia now because of what’s been applied against it?
Tony
Sure, there are a couple of things to look at. First, in the four weeks in January, Russia exported more crude oil than during any four-week period in 2021. So they are recovering their export capacity to places like India, China, parts of Africa, and other places. So, you know, it really hasn’t necessarily hurt their crude exports. When you look at imports, they’ve really substituted, say, the west for China. Their imports from China have grown by, I think, $8 billion a month. It’s got to be more than that, but I saw some numbers recently, but they’ve substituted imports from China. So in terms of trade, they’ve really turned eastward and southward instead of westward, which is just a natural response to sanctions. So where they’ve hurt is domestically in terms of things like industrial production of, say, machinery and domestic goods outside of, say, coal and oil and gas.
BBC
What the west, of course, has tried to do most recently is apply these caps on Russian crude exports. Now you’re saying that they’re getting around those or are they simply selling a larger amount of crude but at a lower price?
Tony
They’re getting around them. They haven’t hit the price cap yet. The crude is trading, or what has been trading at, I think, a $20 discount to the price cap. So they’re not even hitting the price cap. There’s a $20 discount to Euros crude. What Russia on its own, announced last week is that they’ll reduce their supplies by 500,000 barrels per day. So Russia is, on its own, taking barrels off the market as a way to push up crude prices. So the volume and the price caps really aren’t having an impact necessarily on crude itself. Of course, the Russian economy is being hit. Of course the isolation, of course other things are impacting Russia. I’m not trying to say that there are no impacts at all, but in terms of that natural resources, trade, and some of the import substitution, they’re actually doing okay.
BBC
Yeah, import substitution. This is the thing, and it’s a fascinating subject, actually. I was suddenly trying to dig into this, and it’s really complicated. But Tony, one last tantalizing thought on this. An element we understand, what Bloomberg is reporting that may be part of these new sanctions from the EU is to force banks to report more information on what Russian central bank assets they are actually holding. Because of course, the EU and other countries want to know how much has been frozen in Western bank accounts that used to belong to the Russian state budget. Now, this is seen possibly as a first step towards a controversial move touted by the European Commission, not just to freeze Russian assets, but to actually seize them, to use them to start rebuilding Ukraine or to at least pay Ukraine back for the damage that’s been caused. I mean, gosh. Do you think that that could be something we’ll be looking at in the next few weeks?
Tony
I think as a threat, I guess useful as a threat, but as an actual policy, I think it would be very difficult to execute and justify. Usually, these things are seized for years or decades. Sorry, frozen for years or decades, not necessarily seized. So I think that could be a very problematic policy to carry out.
BBC
Because it would set precedents.
Tony
Yes, that’s right.
BBC
For western countries, I suppose. Okay.
Tony
And the banking system that supports Russian assets or sovereign assets, would be dangerous for people like Russia going forward.
BBC
Tony Nash, thank you for now but stay tuned to this because this is big news. If you’re a car owner who wants to buy an electric vehicle, maybe you’ve got an electric vehicle already, especially if you’re in the US. The Us federal government has said that from now on, all charges that are used in the garages and the four courts around the states must be American made and have to be usable for all-electric vehicles. That means that Tesla, which has had most of the existing charging points, they have to carry, adapters, allowing other cars to use them. I spoke earlier about this with Alexis and John of Business Insider in Detroit. Well, Tony Nash, there you are in the big oil state, famously, there Texas. How is EV adoption going in the States?
Tony
It’s great. I’m sorry. It’s great. A lot of my neighbors have EVs, and I think it’s probably not as dense as, say, San Francisco or something. But we do have a lot of EVs here in Texas.
BBC
You’ve got a lot of territories to cover, though, don’t you? I mean, if you’re a driver. We do, and I have an electric vehicle. Every time I’ve gone 100 miles down the road, of course, I’m starting to sweat at the thought that, you know, at some point I’m going to have to refuel, otherwise I’m going to stop on the highway. Tony Nash are you confident that the move to electric vehicles is going to move as fast as some politicians, I suppose particularly politicians in Europe, are saying that we can sort of phase out the internal combustion engine in the next few years and rely entirely on electric vehicles? It’s going to require an awful lot of infrastructure. An awful lot of rare earth. Exactly, that’s right.
Tony
A lot of infrastructure. I mean, I understand the aggressive plans, but I just don’t think it can happen on that time scale. So it seems to me that maybe add ten years to it and sure, that makes sense. And to be honest, ten years in terms of adoption, in terms of building this stuff is really just the blink of an eye. So sure, I think it’ll happen, but I think it’s going to take a bit longer than people right now believe.
BBC
Right, it’s going to take longer, but that’s going to leave, I guess, a lot of politicians with egg on their faces, isn’t it?
Tony
That won’t be the first time. Quite true. Especially American politicians. Won’t be the first time.
BBC
Quite true. evelyn professor Jason Furman. Tony Nash, obviously he’s speaking in an upbeat way. He’s a supporter of the Democratic cause. Are you sensing a slightly kind of warmer, more positive mood in the US right now over its economic performance?
Tony
I think the mood is tentative because inflation is affecting everything. So if we look at that retail sales number, if you look at it in inflation-adjusted terms, we actually saw a decline of retail sales by 2.3%, and it was the fifth consecutive year-on-year decline. So five months in a row we’ve seen negative retail sales if we adjust for inflation. So I think inflation really covers everything. One of the things that the professor said that I’m not really sure is right is he says the White House can’t do anything about inflation. So we have Janet Yellen, who is a Treasury Secretary reporting to the White House, who is spending $140,000,000,000 a month from the treasury general account, and it’s offsetting all of the work that the Fed is doing. So the treasury is actually putting $140,000,000,000 into markets every month to keep markets booming. When the Fed is raising interest rates and selling off its balance sheet. So the US Treasury is actually and literally offsetting all of the good that the Fed is trying to do.
BBC
It’s interesting because we got Lyle Brainer coming from the Fed right this week to the White House as an economic advisor. You’re seeing that the political executive and the Fed are basically in conflict.
Tony
Absolutely. And Lail Brainerd is very smart. She’s fantastic. But she is very much a dove. She’s very much a loose monetary policy believer. And so what Janet Yellen is doing at the Fed in terms of pumping money in through the treasury general account, Lail Brainerd would be an absolute supporter of. And so we have to be very, very careful of inflation. All of these stimulatory activities really hurt your average worker. So there’s a concept called core inflation which really takes out everything energy, food, and so on and so forth. And really all it’s reflective of is service industry wages. Okay? So what we like to see is a headline number which will say 6% or something and what we’ll talk about is a core number which may be 1.2%. All that really means is that your hourly workers are being squeezed by inflation. So when the headline exceeds the super core inflation rate it just means that your hourly workers are being squeezed. And so it’s a really tough environment for wage workers.
BBC
Okay? It’s a tough environment. The bigger issue perhaps. Meanwhile, Tony, we still have this debt default issue, don’t we? We’ve been hearing about it in the headlines. Yet another cliff edge approaching in the United States. The wearyingly inevitable to some people kind of confrontation between Republicans and Democrats in Congress.
Tony
Yeah, I think what’s happened is the US has not actually had a budget for years and my understanding is what is trying to be negotiated is for the US to actually start doing an annual budget again that gets approved by Congress which is their constitutional role. One of the other items that I know are under discussion is this Treasury general account issue. Kind of profligate spending from the treasury to support markets. So there are some issues. It’s not just about the full faith and credit of the US. Of course, nobody wants the US to default but we’ve had some pretty ugly spending patterns for the past well as far as I can remember and I think some of that is just being discussed to come under control. So the US won’t default but it’s going to take some time to come to an agreement.
BBC
Yeah, indeed it will. We’re probably just going to be talking about it for weeks and weeks and weeks.
Tony
Well, I don’t think people realize there are thousands of protests in China every year. It’s not rare to have protests in China. Some of them are local workplace protests. Some of them are bigger. There was a protest east of Wuhan a few years ago about the location of I think a plastics factory or something like that. And there was one in Guangdong about, I think, an incineration plant or something, probably four or five years ago. But there are thousands of protests in China. It’s good that this is happening, and it’s a good discussion to have, and it’s good that Western media are able to view it. So every society has protested and every society has disagreements, and China is no different. Yeah, but there are older people, and even during the COVID lockdowns, the aunties in the buildings were yelling at the people, bringing food to them, and yelling at the police. So there is a difference in the age population in China. So I just don’t find any of this surprising, whether it’s a protest or a deference to old people.
BBC
What are they yelling down at the government? I mean, is this an escalation in the sense of the language, perhaps the boldness of some of the protesting and the way it’s being put?
Tony
They’re not saying, down with the CCP. Right? So if Beijing will let local governments take the flak for local issues, that’s not all that abnormal. It’s not a daily occurrence, but it’s not all that abnormal. If they were shouting down at the CCP, of course, that protest would have been squashed, but local governments and local government officials always take the hit for these types of issues. That’s normal in China.
BBC
Okay, Tony and Emily and Tony Nash, I suppose workers, you know, if they did kick up a fuss, for example, at a handful of Starbucks stores, they are still, particularly they’re still potentially vulnerable to just being fired, aren’t they? I mean, how protected are they from that kind of retaliatory action if they were to try and organize just on a shop-by-shop basis?
Tony
Yeah, I honestly don’t know. I think that would have to do with the contracts they negotiate. As your guest said, unionizing is one thing, but getting a contract is a whole different level. So I think her interview is very interesting. And what’s really interesting to me is what is leading to this desire to unionize. People obviously don’t feel like they’re getting fair pay and fair benefits, and that’s something that really needs to be looked at across companies.
BBC
Yes. And that is what seems to be a legacy of the pandemic, partly, wasn’t it? People went home, they were kind of laid off or furloughed for often long periods, they reflected, and there is a kind of militancy that seems to have left as a legacy.
Tony
What’s interesting to me is Starbucks is supportive of this, but they’re also the company that people want to unionize under. Right? And so they have the orientation toward doing that, but they’re not providing on their own the benefits and the pay that would keep people from unionizing. So I just think it’s an interesting circular discussion. Tesla is a different story. They’re an auto company in different parts of the country, automakers are highly unionized. So I don’t think it should be any surprise to Musk that that’s happening in Taiwan.
BBC
Thank you so much for all your thoughts, your words, and your wisdom. And to Tony nash there at Complete Intelligence in Houston, Texas. My name is Ed Butler.
In this video, our first-time guest Jim Iuorio leads the discussion on the topic of whether markets are too good for the Fed. With speculation around CPI, layoffs, and interest rates, the question of the Fed’s direction and potential pivots later in the year is raised.
Jim also delves into the recent success of the metals market and offers insight into where the market may go in the future. He also offers his thoughts on the potential impact on equities if the S&P hits his target of 4060.
Next, Tracy takes the lead in discussing cracks and Freeport. She explains the significance of rising crack spreads and its impact on the market. She also shares her insights on the recent opening of the Freeport facility and its effect on US natural gas prices.
Albert then discusses the risks associated with Ukraine’s new hardware. He addresses the classification of “direct involvement” and its potential impact on European countries. He also offers insight into what actions Russia may take to further complicate the situation and the potential impact on markets such as wheat.
Finally, the team gives their expectations for the upcoming Fed meeting and what to look for in the week ahead.
This is the 51st episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
Hi, and welcome to the Week Ahead. I’m Tony Nash and today we’re joined by Jim Urio. Jim is at TJM Institutional and he’s with the Futuresedge podcast. Or is it on the Futuresddge podcast, right? Yes. Also with Albert Marko and Tracy Shuchart with Hightower Resources Advisors.
We’ve got a couple of key themes. Obviously, it’s the week before the Fed and we’ve had a really good week in markets. So one of our key themes is our market is too good for the Fed. Second I think Tracy is going to talk about crack spreads and Freeport and what’s happening there. And then we’re going to look at the risk with Ukraine’s new hardware. There’s been a lot of talk about tanks going to Ukraine this week, so we’re going to talk about some geopolitical risks with Albert.
So Jim, first, thanks again for joining us and watching some of your comments through the week with markets breaking through some of the key levels that you were looking at, the Fed’s direction is obviously a big factor in markets and there’s a lot of conjecture around CPI, layoffs, rates going lower or pause or pivot or whatever you want to call it, and people saying the Fed may do 25 and then pause.
What’s your view on that? You’ve been obviously speaking about this several times this week. So I’m curious, what’s your view after seeing a whole week, where do you think we go from here?
Jim
Well, I’ve been somewhat more of a bull, I think, than most over the last few months. And I’m not trying to take a victory lap or anything, it’s just a fact. And my reasoning was that every one of us knows that these Fed rate hikes have a huge lag period before we feel the efficacy. Fed knows that too. As stupid as the Fed is, this is something that’s so fundamental, but I think they genuinely do know that. So now we’re starting to see things happen. We saw a pretty good PCE report today. CPI has been trending lower too. The only things in CPI that are stubbornly high, consistently, are food and energy, which are the two things that are least rate sensitive. The yield curve is still wildly inverted, signaling to them that they still are in a financially tight market. I believe that the Fed is getting close to having some sort of gentler language. Now, whether they go 25 basis points this time and then 25 basis points again, that’s fine to me. Now, the one thing I do have a problem with is that the Fed Funds futures curve says 50 basis points over the next two meetings.
And then toward the end of ’23, there’s going to be an ease. But they say it’s only going to be a quarter, two and a half point ease. And that I say “no way.” If they’re ever going to actually pivot and start easing, it’s only going to be as if something is burning and something is falling down and then it’s not going to be a quarter point ease. That being said, I still like risk assets. And I have because I think we are nearing the end of the Fed tightening cycle. I believed, I’ve been doing my podcast for the last hour. I wanted the market to settle above 4070. It certainly did, right? We went into the closed pretty strong, I thought. And I think that that green lights the next move higher. I particularly like the metals market, and I’ll shut up in 1 second, I swear to God. I particularly like the metals market because I think that… I don’t mean to talk for so long. I thought copper was being held down by China news, by the Fed, by the strength of the dollar, and all those things have seemed disappeared. And I’ve made good money on that so far, and I plan on keeping those lumps.
Tony
So it’s a good question about metals. What are you looking at? You said China and you said China reopening other things. What are you looking at in metals? Are you looking at industrial metals, copper and so on? Are you looking at precious metals or kind of all of the above?
Jim
Copper is number one and that’s my biggest position. Silver and then go down from base industrial all the way to just gold being pressured. And the gold thesis for me is different than the copper one in that I believed at the time when I started buying more gold, that Bitcoin and Etherium in the crypto market and all that dollar safety hedge or whatever the hell it is, if that was disappearing, then money would go back into gold. Well, that didn’t disappear. Bitcoin is butting up against new cycle highs now, but gold is still doing well. So in that I was kind of wrong on the thesis. The thesis was also the dollar weakening, which happened as well. Once the Pound of the Euro started really bouncing off those October lows, I thought, okay, the green light is on for all these metals. So I’ve done okay in gold, even though my thesis about crypto was wrong.
Tony
Okay, but was your thesis wrong? Do you see crypto and gold as substitutional somewhat at the margin still?
Jim
I don’t know. I was going to ask you that same question. I always did. And I thought that the $3 trillion crypto market was sucking away some of the gold. And I thought that that was a big deal. But then it doesn’t seem to be now, so I guess I can’t answer that. I’m confused, I guess.
Tony
Yeah. I’m curious. What do you think about that, Tracy, in terms of crypto and gold? Do you think there’s a trade off there?
Tracy
This is not really my… Crypto market, is not really my market.
Tony
Internet, say whatever you want.
Tracy
Albert knows way more about this than I do, to be honest, because I’ve never traded crypto, and he’s traded a lot in the past. So I’m going to defer this to Albert.
Albert
Before I do think that there was a correlation between how much money was flying into crypto versus taken away from gold, I think there is no doubt that gold suffered because of that. I don’t think that as the case right now, simply because there’s been too many blow ups in the crypto world at the moment. I don’t really know how liquid it really is. There’s certainly no retail left in the crypto market, so it looks like it’s all institutional. So I don’t know. You can’t really make a fundamental call on crypto at the moment.
Tony
Could you ever make a fundamental call on crypto?
Albert
You could at some point, because institutional money was flying in there because their clients were forcing them to get into the space. So you could make a little bit of a fundamental case for crypto, but as all these ponzi schemes blew up, like FTX and everything, that’s just gone completely out the window at the moment.
Jim
Sure, Tony, I can make a slight fundamental argument of it. When they were adding an additional $7 trillion, throwing it into the money supply, and really being poor stewards of the dollar, that was somewhat of a fundamental argument for crypto, I guess, right?
Tony
Yeah. Okay. Are markets too good for the Fed. As we’re going into next week, are these levels too good for the fed? Is Powell going to come out and really, you know, say, look, this is irrational or whatever, and it’s too much, and is he going to pour out, say, 50 basis points and disappoint a lot of people?
Jim
Just to punish me a rug pull? I mean, I think he’s capable of that. He certainly did at the Jackson Hole meeting a while back. So you have identified, I think, the major risk, and it’ll probably go into that somewhat hedged. And again, hedging is probably going to be expensive going into it because people realize that that’s where the risk is. So on balance, I will say, no, I don’t believe he is. I think he believes that going too far this way. And again, I think he thinks going not far enough in this direction is the worst possible thing. But I also think he’s starting to realize going too far and what that looks like. He sits around and talks about creating slack in the job market, and to him, it’s just an equation on a whiteboard where the reality is talking about people losing their jobs. I think he balances a lot of realities. I think he’s incompetent. His entire tenure has been mostly incompetent, but I think he’s done a pretty good job trying to clean up the mess that he made over the last year and a half, and I don’t think he’s going to do something stupid like that. But, yes, to your point, it is a risk.
Albert
I actually disagree with Jim on this.
I think it’s going to really matter about what the market does. If we start flying into the 4200 before Tuesday on the SPX and whatnot. I think that Powell will come out. I don’t know if he’ll do 50. I don’t think he’ll do 50, but he might come out with a 25 basis point rate hike and then start talking extremely hawkish and dismiss all the rate cuts that everybody’s been talking about, which would be essentially the same thing as doing 50 to the market. If the market says that. If the market here is that we’re not getting rate cuts till 2024, I don’t see that as positive whatsoever.
Jim
I certainly hope you’re right in the near term, too, because I’m short some of those 4200 calls, like, too many. That’s the position I keep checking in my bold position was like, oh, sh*t, they’re getting too expensive. So I actually like what you’re saying a little bit in the short term.
Albert
Yeah, I have a problem because of this is falling liquidity right now and tightness at the same time. I look at the market and I’m like, well, money is starting to fly out into Asia, which we talked about Tony, repetitively for months now. Where are we going to get that $5 trillion incremental money coming into the market to keep this thing afloat? For me, it’s like I don’t see the math adding up to 4300 on the S&P and anytime soon. And on top of that, if you calculate rate hikes and everything you’re looking at the market, 4150 or 4200 is more expensive than 4800 was. It’s technically even higher valuation. So for these things, I’m just like I think we’re probably going to retrace the 3850 on some kind of ridiculous Powell talk. And on top of that, Brainard is talking about leaving. She’s not leaving if Powell is talking about being dovish. She wouldn’t be doing that, in my opinion.
Tracy
I asked a question. I was just saying and that’s for both of you. I mean, considering that the Fed has hiked so quickly, do we even think, and the data has remained pretty good, considering right, so do we think that the rate hikes have actually even been able to filter down into the economy at?
Jim
I don’t, Tracy. I think that that’s the point. I think when you look, just take the real estate market. How in the world is it not going to be a major hurdle for the real estate market to take mortgage rates from 2.8% to 7%? I think that it’s silly to think that if they just left things the way it is, I believe that we would certainly go in recession at some point in time with money being restrictive as it is compared to… I’ve argued for 30 years that rates had to be inorganically low to make up for the fact that we have all these crappy regulations and punitive taxes on companies. They need low rates to function. I think rates are to point now where eventually they would drag on us too much. Albert, do you agree with that?
Albert
I do. But the flip side of that is, like, if Powell doesn’t stay the course, Yellen is using the TGA, in my opinion, from what I heard, to offset quantitative tightening. This could set off another round of inflation if China comes on too fast, or even Europe starts to gear up a little bit and reset their manufacturing sectors with stimulus. The fear I have is a second half inflationary run again, and then we’re going to be talking no more pauses, but another round of 50-75 basis point rate hikes.
Tony
Second half of Q2. I don’t think it’s a second half inflation run. I think it’s Q2. I think it happens a little bit sooner than that.
Albert
Yeah, it could. I mean, you could have any kind of geopolitical event like Russia re-invading Ukraine with some gusto this time.
Tony
Okay, guys, here’s my question, though. We’re talking all this potential dovishness, but all we’ve seen is the rate of inflation slow. We haven’t seen prices come down. Okay, so why would he go to zero? Or why would he just do 25? I’m not seeing it. When you look at the job market, sure, you’ve lost 70,000 tech jobs, but they hired 2 million since 2020 or something like that, right? So it’s nothing. It’s dropping the bucket.
Tracy
Chipotle hiring 15,000 so those people can get a job.
Tony
Exactly. What is it that would tell us that he’s going to go 25 or pivot or whatever? I’m just not seeing that thing because the job market is still really strong.
Jim
So here’s what I would say to that, is that the job market is going to be strong and tighten. It’s a weird kind of anomaly that happened with 3 million boomers leaving the job market prematurely over the last three years. To your point about why would he not stay the course if prices aren’t coming down? Because, remember, ultimately, the end of the day, the inflation was intentional and it was done because of this wild indebtedness all over the board. But I always focus on the five states that could not possibly have paid their bills under any possible scenario. And that’s why for ten years, they kept telling us that they needed inflation. So I think in Powell’s mind, he tells us 2%. I think he’d be perfectly happy with three and a half.
Albert
And they’ll get three and a half because they’re starting to change the way CPI has waited starting 2023.
Jim
Just like when Nixon changed the definition of unemployment back in the 70s.
Albert
The BLS have done that in the past. They changed the way unemployment is calculated. Now they changed the way the CPI is calculated.
Tracy
They changed the way inflation is calculated.
Albert
Perception is reality in the market. We can sit there and b*tch about fake data from China and fake data from the Europe and the US. But perception is reality in the markets.
Tony
Yes. So we’re going to change the rules to win.
Albert
Well, yeah, of course.
Tony
And the CPAC calculation changes this month, right?
Albert
Yeah, January 2023.
Tony
Fantastic. Okay, so you guys are in the 25 basis point camp for next week, right? 25 and very hawkish. 25 and very hawkish.
Jim
Okay, I don’t I like what Albert saying. I say 25 and mildly hawkish.
Tony
All right, we’ll see. I think it might be a little harder than that. So we’ll see. That’s good, though. I appreciate that.
Tony
Okay, Tracy, I want to talk a little bit about refineries and crack spread. You sent out a tweet on Monday about diesel prices.
Can you help us, help us understand what’s happening at refineries and what’s happening with diesel and gasoline and other refined products prices?
Tracy
Well, this is actually the perfect segue because I tweeted out a chart of ULSD, which is diesel, basically. And so we’re seeing those refinery margins explode again. And most people say, well, that’s anticipation of the diesel embargo in Russia and refineries across the world that are not part of Russia are seeing these increases. But that’s not just happening in the diesel market, that’s also happening in gasoline cracks. And so higher refining, basically the long and short, higher refining margins mean higher prices for consumers. Right. So Tuesday we just hit a three month high of $42. And when oil was at its highest price, those crack spreads were at $60. So this should start ringing alarm bells a little bit about inflation. This is why it kind of correlates to what we were just talking about. And so CBs, even though they don’t count energy in the CPI as part of inflation, they should be keeping an eye on these indicators because it kind of indicates that we’re going to see higher gasoline, diesel costs, jet fuel, et cetera. And that could add to inflationary pressures across the board, not only for just the consumer, you and I, but for companies that are heavily dependent on these products.
Tony
And when there’s inflation in energy, there’s inflation in everything.
Tracy
Right, right.
Tony
Second or two tier impacts.
Tracy
Exactly, yeah.
Albert
One of my oil friends was telling me that normally January, February, they’re running at minimum rates, trying not to lose money. But this has been like absolutely insane, where they’re just making money hand over fist right now because the demand is so high.
Jim
Tracy, I have a quick question for tracy, by the way. Is that okay?
Tony
Yes.
Jim
So, Tracy, just last week, I don’t know if it was Chevron or Conical Phillips, where they announced raising the dividend or whatever, paying bonuses and not investing in it. Was that an indication that they still feel that the government is not smiling upon fossil fuel companies expanding their operation?
Tracy
Oh, 100%. Right. For over a year now, we’ve seen elevated energy prices in that seventy dollars to eighty dollars range. Negating, the spikes that we saw from the Ukraine invasion. But so after a year of pretty much stable higher energy prices, we are still not seeing anybody want to invest in this sector. Right. They still want to cater to the investor. They still want to pay down debts. They still want to do higher dividends. They still want to engage in stock buybacks. All to placate the investor. And so that is very telling that after a year, they’re still not willing to reinvest into capex, particularly in shale.
Tony
It’s nothing but downside to invest, right?
Jim
No doubt.
Tracy
Yeah, absolutely.
Jim
It’s maddening when you think about it. Everything seems like it’s such a self inflicted wound. And this is the kind of thing that keeps me up at night. It seems like a government that’s working against us. And I’m not trying to be that guy. I’m not political. I just see policies and they’re asinine.
Tracy
Who wants to invest when they say, we want to phase you out, we want to kill you?
Jim
Right? Yeah.
Albert
Well, this is the problem when politics gets mixed up in economic policy, it starts muddying things up and mistakes become exponential at this point.
Tony
But politics is always mixed up in economic policy everywhere. You know that. I’m not telling you you don’t know, but it’s always there. When I hear you talk about refineries, and it’s been how many decades since we built refineries in the US, Tracy? The 70s was the last time we built refinery?
Tracy
70s was the last major. We’ve had a lot of brown projects, which means we’ve added refinery capacity to already existing refineries, but we haven’t had any new green projects, which means building new refineries. And we were talking about, I think, last week or the week before the expansion that we’re having in Texas. But the problem is that the amount of refining that is coming offline is more than the refining capacity that is coming online.
Tony
Right. So what’s our capacity utilization right now in refineries?
Tracy
Well, we’re down right now because we’re in the middle of maintenance. And we also had Elliot storm, which some refineries, for instance, Baytown, is just coming back up this week from the storm in December. So utilization rates right now at about 89.5%. But, you know, you have to realize that, you know, we’ve been over, well over 90%.
Tony
Yeah, 94 or something like that. Right?
Tracy
Yeah. And we have aging refineries. And so what does that mean? Those refineries are more prone to breakdown because we’re running them at, like, ridiculous max capacity. Right, exactly.
Tony
Okay, so since you mentioned Texas, let’s look at this tweet that you put out a couple of days ago saying that Freeport gets approval.
So USLNG, the Freeport terminal has been approved and reopened. So can you talk us through what that means for European nat gas and what that means for US nat gas prices?
Tracy
Well, for US natural prices, that is positive. And I know that all nat gas prices have tumbled 35% to 45%. Regardless, we’re back into that two area that is pretty much where we’ve been for several years. But it is a good thing. I think the market, I think, spiked 15% or 15% $0.15 sorry, on that move. And they kind of retraced it. I think the market is a very Freeport is an export place. So what that means is that if Freeport being closed basically landlocks US nat gas, which is obviously a negative because we have a lot of it. But I think that the market in general is a little bit skeptical. But as soon as we actually start seeing export capacity increase from that facility, then I think that the markets will be more enthusiastic about the success of that because it’s really been since August since that facility is shut down.
Tony
So you’re saying we should see US nat gas prices rise as we have more export volumes from Freeport?
Tracy
Absolutely. And even this week, Semper Energy announced that their new Port Arthur facility has already been booked. And that facility isn’t even all the way built yet. And that’s another export facility. So there’s a lot coming online and a lot being built out that we will be able to see. I think that just market participants have become a little bit placated because they look at European stocks and European stocks, of course they’re still full. They’ve had a mild winter, but everybody kind of forgets that last year 50% of their storage capacity came from cheap Russian pipeline. And that’s not going to happen this year.
Tony
Yeah. So all of those new roads that are being built in Texas, it may have been started with other money, but it’s going to be finished with European money. Right. So I just want to take this moment to thank our European friends for finishing our transportation.
Albert
About time they give back.
Tony
That’s right.
Jim
Finally, their currency has come back a little bit, so now they can actually buy stuff here.
Tony
Perfect. Okay, very good, Tracy. Anything else on nat gas? Are you still keeping eye on fertilizer for kind of late spring time period?
Tracy
Yes, absolutely. I think that’ll still come into play. I mean, nat gas prices are extremely low right now, which is great news for fertilizer prices. That will give farmers a break. This is all good news in that respect, but I still think we need to keep an eye on this going forward and keep an eye on that gas prices because obviously that’s going to affect fertilizer prices and farming in general.
Tony
Jim?
Jim
Tracy, you talked about diesel before, and I don’t trade diesel. Is the spread between diesel and regular WTI still blown out? And what could possibly get diesel back in line?
Tracy
Well, I think that there’s been a shortage for a very long time. That spreads come in a lot, comparatively speaking. But now it’s starting to blow out again because again, you have the EU embargo of diesel, and they got literally like 95% of their diesel came from Russia. Another dependent project. And I’m sure Russian diesel will go somewhere else. It’s not more about that, but it’s more about really boils down to refining capacity as well. Because even in the United States, we can’t refine. If Europe wants to buy from us, we can’t even refine enough. We’re sending what we have over there as well as our domestic needs. So really, diesel to me comes down to refining capacity altogether.
Jim
That’s an unfixable problem, right?
Tony
Until Russia’s solved, right?
Albert
What about the Jones Act waivers for sending diesel up to these coast cheaper?
Tracy
Yes, they could do that, but they haven’t done that. They’ve done that in the past for Puerto Rico after the hurricane and all of that, but they still haven’t given waivers. Even when prices were extremely high in the United States, when we were at the height back in June, July, when prices, gas prices were highest, diesel prices were highest, they still wouldn’t give Jones Act waivers. You have to understand that the Jones Act came into play into 1920 when we had a fleet of over 1000 vessels, and we now have under 100 vessels that can transport that. So, you know, it’s the government could do it. They’ve chosen not to. Why? I’m not sure, but…
Jim
We can come up with some guesses. They’re either stupid or they’re nefarious. I believe at some point in time you’re going to have to say some of it’s nefarious, where they keep making the wrong decision at every turn. And I apologize for that.
Tony
No, don’t apologize. Look, it’s making it more expensive for people on the East Coast to get diesel. It’s not good.
Tony
Okay, great. Speaking of Russia, Albert, we saw a lot of news over last week about tanks going to Ukraine. And there’s a tweet from Max Abrams, who’s a great geopolitical professor talking about Russia, says that tanks from the west count as, quote, “direct involvement in the war”.
So I wanted to get your… Jim said what would solve the diesel problem. Obviously, Russia coming back into the market would solve the diesel problem. Now with a lot of Western countries sending tanks to Ukraine, that doesn’t sound like we’re coming closer to a solution on that. So first of all, why are they sending them if they don’t have the people to operate them? Second, tanks are to take land. Right? So what do you think is being planned? And third, how risky is it? Do you think it really implicates these kind of donor countries as direct participants in the war?
Albert
I don’t really buy into the whole direct participants of the war. The rhetoric coming out of Russia is a little bit bombastic in that respect. Referring to those tanks, there’s only going to be about 100 of them, right? They’re not going to be able to push out the Russians with those tanks. On top of that, they’re going to be about six months out until they’re actually even deliver, and then you still have to train these guys and they need supplies, and the Ukrainians don’t really have all that. So the best guess that I have is that they’re forcing Russia to come into a ceasefire in about six to eight months time, which gives them a window now to try to take Dambus and have some kind of wind before these tanks get delivered. Listen, they’re no joke. The Leopard tanks and the Abrams are better than what the Russians have. But in terms of the Ukrainians using them to push Russians out of all Ukrainian territories, that’s just not happening.
Tony
Right. So are these just old tanks or is it a quality kit that they’re getting?
Albert
Well, I think they’re getting like the second tier tanks of what the west has, but that’s still better than what the Russians have or even willing to use for Ukraine. So, like I said, this is more of a measure to force the ceasefire later on in the year.
Tony
Okay. Yeah, Jim?
Jim
Albert, a couple of days ago, when this escalation started in Germany, we announced I immediately put on my screens, looked at oil, wheat, even the defense sector ETF, and nothing really budged. Do you think the market was looking at it like it wasn’t a big deal? Or do you think the market was looking at it as somewhat balanced, perhaps a quicker end of the war and not an escalation, or perhaps an escalation, the two things come around?
Albert
Oh, man, that’s a good one, Jim. I honestly think that the market’s probably in a wait and see position at the moment.
Jim
Numb to the shit kind of. Right?
Albert
Yeah. You got to wait and see what Moscow is going to do. I certainly think they’re going to use wheat and grains and other grains asymmetrical responses to the west to push inflation out over there, make it hurt. That’s the only thing they have. They don’t really have anything else to go after. I mean, the oil that they’re selling to India and China is enough to sustain their pocketbooks for a little while until this gets sorted out. But until there’s some sort of major upheaval in Ukraine, I don’t think the defense stocks will take off or wheat yet. But they will. I think they will. They haven’t moved.
Tony
The defense stocks haven’t moved for a while. If it is we and other AG stuff that is going to be their lever, that probably means the Turks will get more involved in the discussion because they’re the ones who arbitrated the discussion earlier. Is that right?
Albert
Well, they’re trying to get into the discussion. I actually have really good connections with the Turks and their main thing is to distract the West and the Russians into Ukraine while they push their trade deals out into Africa at the moment. You know, the Turks have a great drone, the TB Two, which they sell to pretty much everybody. So that’s as far as they’ll actually get into the war besides making media comments.
Tony
Right, okay. And so what risk do you think there is on wheat? Do you think we see more wheat risks, say, in Q2 – Q3 this year?
Albert
I absolutely do. The Ukrainians, they’re planting a lot less. I think 40% less is what they’re reporting, is probably even more than that.
Tony
Right.
Albert
And on top of that, if the Russians decide to blow up a port or blow up a few ships that are trying to get out with wheat, and all of a sudden, wheat, you know, takes off back to the 900 or $1,000 mark again. So I definitely see that happening in Q2 Q3.
Tony
Okay. That could be exciting. All right, guys, let’s close it up. We’re in that quiet period for the Fed. We have that Fed discussion next week. So what are you keeping an eye on next week aside from the Fed, of course, but what are you keeping an eye on in markets? Tracy, why don’t you get us started.
Tracy
Well, I know that most people are looking forward to OPEC is next week at the beginning of February. My personal stance on that is that I think they will keep everything as is. Right. They made that 2 million cut, even though it’s technically not 2 million, because they were under quota anyway. They said they were going to carry that through 2023 unless something came up that they really needed to address. And I just don’t see anything coming. I don’t see any reason they would need to change this policy stance right now. We have Russian barrels still on the market. We have China is still kind of an unknown because they haven’t really opened up yet. So that’s what I’m looking forward to, or at least that’s what my feeling is about the data.
Tony
Great. Okay. Albert, what are you looking at next week?
Albert
Well, obviously the Fed. I think, is in order with a hawkish tone, but honestly, I want to see how the dollar reacts to all this. And the VIX. The VIX at 17, start looking at some good old put options and call options with the 17 VIX is fantastic. But, yeah, basically what the dollar is going to do. I really want to see if the dollar breaks into the 90s with some kind of bull market talk.
Tony
Excellent. Okay. And Jim. Wrap us up. What are you looking at?
Jim
The unemployment numbers on Friday. Big deal. The last shooter drop is going to be the slack in the labor market that they want. Albert mentioned that level on the dollar. I call it like 101 to 100. As soon as it goes below that, as soon as we get a nine handle on the dollar, I think it greenlights a lot of risk assets. But the thing I’m mostly focused on is unemployment and then the week after that my trip to South Florida. Because every time I leave these damn markets, something crazy happened. So you guys can count on that. I’ll tell you when I’m on my flight. Something weird is going to happen.
Tony
When is that?
Jim
I don’t know. My wife makes the arrangements. I think it’s the next, like a week from next Thursday. I think we’re going on vacation.
Tony
Keep an eye on. Jim, thanks so much for joining us, Jim. Guys, this has been great. Thanks very much everyone have a great weekend. Thanks Jim.
In this episode, Ross Kennedy of Fortis Analysis, Ralph Schoellhammer of Webster Vienna Private University and Albert Marko joined Tony to discuss three main themes: supply chains in 2023, the existence of China in 10 years and Germany’s dependence on Russian gas.
Ross Kennedy led the discussion on supply chains in 2023, and he explained that although supply chain issues have appeared to normalize over the last 4 months, with trans-Pacific shipping rates falling to levels at the start of the Covid pandemic, there are still things to watch out for in the upcoming year.
Albert Marko led the discussion on the prediction that China will not exist in 10 years. This claim was made by Peter Zeihan, a geopolitical analyst, during his appearance on Joe Rogan’s podcast. He went on to say that some of Zeihan’s predictions sound impressive, but he and Ross Kennedy both have doubts about the validity of this claim.
Tony pointed out that similar predictions were made by George Friedman in his book “The Next 100 Years” (2009), where he said that China would split into 5 countries. However, both Albert and Ross argue that China’s economy, military, and political power are too strong for this to happen in the near future. They also highlighted the fact that China’s growth and development have been hindered by the pandemic, but the country has managed to recover quickly and is still a major player in the global economy.
Ralph Schoellhammer led the discussion on Germany’s ongoing dependence on Russian gas. He wrote about how the green push in Germany has led to a decrease in the country’s dependence on Russian gas, but there are other considerations. He explained that the Russia-Ukraine War had a major impact on Germany’s dependence on Russian gas and that when the war stops, it is likely that Germany will welcome Russian gas again. He also highlighted the fact that Germany’s dependence on Russian gas is not just a matter of energy security, but also a matter of economic and political considerations.
Key themes: 1. Supply Chains in 2023 2. Will China exist in 10 years? 3. Germany can’t quit Russian gas
This is the 49th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
Hi, everyone, and welcome to the Week Ahead. I’m Tony Nash. Today we’re joined by two new guests. We’ve got Ross Kennedy. You may know Ross as Huntsman on Twitter. He’s with Fortis Analysis. And we’ve got Ralph Schoellhammer. Ralph is at Webster Vienna Private University. And we have the honor of having Albert Marko with us again today. So there’s a lot that’s happened really over the past couple of years around supply chains. And we’re going to kick off talking about supply chains in 2023, and Ross is going to lead us on that. But next we’re going to look at China. There have been some claims made about kind of existential claims made about China over the past couple of weeks, and Albert is going to walk us through those. And then finally, Ralph is going to help us talk about Russian or sorry, German energy and German dependence on Russian gas. So let’s get into it, guys. Thanks for joining us. Ross, you know, I’ve seen a lot on Twitter. You’re you’re talking quite a lot about supply chains. And in 20 and 21, you really opened a lot of our eyes to some of those issues.
So I’ve wanted to have you on the show for a long time. On the screen right now, I’ve got a chart of shipping rates, Asia to us, west coast seafood rates, and those obviously ballooned up in 21, came back down in 22. And we’re kind of now down to about where we were in Q, one of 20. So the last four months, things have really started to calm down in terms of the costs.
But I guess really what I want to get into with you is, are supply chain risks a thing of the past? You know, what should be we be looking for in 2023? I guess that’s let’s just start with that. Are they a thing of the past? And what should we be looking for in supply chains in 23?
Ross
Yeah, I think supply chains have changed in terms of the scope of risk. Certainly it shifted from one to the other. We had a short term risk that was very systemic as far as manufacturing in China being completely disrupted, the ability to ship out. And then we had the entire issue of people changing their buying habits basically by force as far as lockdowns from a lot of events, a lot of entertainment, a lot of things where their dollars are being spent on, not physical things that actually have to be chipped. And all of a sudden, everybody took that spending, they took the stimulus money, and they just began buying things that were feathering their nest or occupying their attention. And so you had the disruption not only of lockdowns, not only of that, but you had this very enormous shift in purchasing from experiences or non tangible things to physical things that have to be shipped. That’s why you saw the run up in stock for Amazon and numerous others, it was because people were doing that right. So we had this enormous crunch that was driven by that fundamentally. And now we’ve seen we have the bullet effect.
Ross
Inventories were dramatically over ordered and now we’ve got inflation happening. So inventories are full and demand is down, particularly on the transpacific trade to the West Coast, the US. China. What we have seen, though, is that there has been container volume shifted to the Gulf. It’s also shifted to the East Coast because we’ve had the risk really since July of last year of longshoreman strikes. And then you have the concurrent risk of rail strikes coming off the West Coast. So we have seen some volume that’s still in place shift. But depending on who you are as a company, we’ll determine if that has actually your supply chain problems have begin to unwind a little bit or if they have really only begun or if they’ve just changed as far as what they are. If you’re a retailer in the US, you really just started shipping over the East Coast if you’re concerned about West Coast risk and you still have to move inventory. But that’s assuming that now the lockdown, lockdown, lockdown, no lockdown, back to lockdown and now no lockdown again with people out sick right in front of the Chinese New Year, if that hasn’t dramatically impacted your business.
Ross
There are some sectors that have been heavily hit by that hard. The impact is less to China in some ways because they’re heavily subsidized in a lot of their industries. The impact is more so, I think, felt by the US. And I know Albert will talk about the China side of that factor. But what we’ve seen now is a dramatic disruption, really, to the way things are. Not in a foreseeable way, not in a way that a lot of people know how to forecast. In a very I would say very unexpected way where you’ve got this sort of well, not unexpected to this group, but unexpected through a lot of supply chain and planners and executives of. They went from huge amounts of demand to very little demand due to inflation here in the US. And then you also have the supply side disruption in Asia. So that’s sort of the twin monsters that a lot of North American companies and European companies are dealing with related to planning this.
Tony
It sounds to me like we have a couple of things in general that are helping to alleviate this. First is price, right? Things are more expensive and so that’s pushing down demand on a volume basis. But we also have China opening up and so that is alleviating supply chains on the supply side. So those two dynamics seem to be really helping us into 23. Have we also seen I know there’s been a lot of talk about this, but to what extent are we seeing rotation of manufacturing locations? Is that a major effect or are we in the early stages of that?
Ross
I think we’re in the very early stages of it. It takes multiple years if you’re going to uproot a semiconductor foundry, for example, which everybody’s made a big deal about, the chips act and all that. And I think Nancy Pelosi had a great run financially because of that for a while. But it takes three to four years, even five years, from soup to nuts, be able to get the process of moving something halfway around the world from one location to another. You have to make a lot of things before you install them and then begin making chips. Other things that are able to transition very quickly are doing so. Things that are fungible, where you’re essentially reprogramming a machine to print a T shirt in China versus Vietnam, that stuff is already shifting. You’re already seeing demand pick up for things like garments and textiles in Southeast Asia and India and Bangladesh. Pakistan also has gained a little bit on the textile side, but things that are energy intensive to manufacture, things that require critical raw materials or certain types of inputs that China does very well. We’ll probably talk a little bit about Zahance hypothesis with regards to China, but China is very dominant in a lot of raw material sectors, and assuming they continue to have the energy and labor available, it’s going to be a lot slower to ship that type of stuff away from China.
Ross
But things that can shift. Are you’re seeing more tires produced outside of China again, for example? So, again, it’s very sector dependent, and a lot of people want to make projections or economic plans or suggestions about the way things are on a macro scale without really understanding that in certain ways, china still very much holds the whip hand. And you won’t see manufacturing shift in other ways. You’re seeing it shift very rapidly away from China and that’ll have an impact on them as well.
Tony
Okay, so let’s take a step back to, say, 2019. Okay? We had Trump, who was trying to get different things out of China and bring things to the US. And reduce China’s centrality or centricity to supply chains. And then we have COVID come in, and that really disrupts supply chains. And then there’s this wake up call for people to kind of regionalize manufacturing, right? So this reminds me a lot of, say, 2007 eight, when it started with Japanese companies doing a China plus one, china plus two, China plus three strategy, right? That’s happening again. But after we got through the financial crisis, everyone just was like, China is easy. Let’s just go back and do that. Are we going to see that again? Are people just going to kind of shrug shoulders at the end of the day and go, people are inherently lazy. I don’t want to have to do the work to have three different sites to manufacture this stuff. So let’s just put it back in China. Is that likely to happen? Or was this wake up call the one that really pushes people to have resiliency in their supply chain?
Ross
I think, again, from a sector dependent standpoint, it’s yes and no. To the extent that if the stakeholder, if the primary stakeholder of a company is the US. Let’s say a Honeywell, for example, they will have to pull out US policies. We have reached a point that even if the US has a company is US based and they’re like, we’re going to still try to manufacture there for whatever reason, it is too much of a lift to pull out of there. In a lot of respects, xi Jinping has a vote on that too. If he wants a company out, or if he wants to just see that company’s manufacturing capacity or whatever, he’ll do it. Right. So the bad guy always has a vote on how the fight goes too. So that is one group of companies that very much can be expected to either leave on their own or be forced out in other sectors where a company can be co opted or the US. Isn’t really paying attention. Yeah, I think you’ll see the impetus to just kind of try to hunker down and ride out this ten year sort of economic cold war, if you will.
Ross
In their mind, they’ll do that as well. But again, so many of the unknowns that are driven here are the fact that China has a vast ability, if it chooses to, to leverage its own strategic advantages to push us around the anchor companies there if they want to, to kick them out if they choose to. And for whatever reason, really, outside of a relatively small group of Natsych types and people that do analysis really well, they’re not discussing what the calculus is on the other side. They’re just discussing what the US. May or may not be able to do through our own policy. At the end of the day, particularly when it comes to energy, anything that’s super energy intensive to manufacture, it’s not attractive to restore to the US right now because the Biden Administration, the Department of Energy, particularly FERC, they’re not going to get out of the way, and they have not proven to do that. So we’re not going to be able to make the fertilizers and fuels that we need to if we are continuing to drive them away with terrible energy policy and drive the price of energy sky high.
Tony
And as a Texan, I will tell you, we have all the raw materials here, right? There’s no reason for us not to do that. A lot of Americans may not like Texans, but generating wealth here really does help all of America, right?
Ross
So in my view, particularly when you talk about the Gulf, the raw capacity is there from a transportation side, from a labor side, from a raw material side, particularly energy, to to turn the south MidSouth all the way down to the Gulf into a manufacturing mega region. That that would be one of the great economic success stories of all time anywhere in the world. And that’s a policy issue. It’s certainly not a capability or capacity issue.
Albert
Yeah, the problem with that is the EPA makes a lot of manufacturing in the United States inefficient and uneconomical, just something yeah, we can’t get around it. It’s the problem.
Tony
Okay.
Ross
And Europe has done very well with a lot of that stuff as well, too. But again, it’s subsidized in Europe, some of those offsets, if you will, they’re heavily subsidized. And so the companies don’t bear that burden to the extent that they would in the US. Where that type of thing is just as heavily regulated and penalized with zero subsidy.
Tony
Right. So since we’re talking about supply chains mostly into the US. Since we’re often here, let’s talk a little bit about Germany. We’ve seen German politicians go to China over the past couple of months, and German heads of industry go to China and kind of almost double down on their commitment to China and double down on their dependency. And it almost feels like Germany is having the opposite conversation from a policy perspective that the US. Is in terms of the US. Is trying to reduce its dependence on China. It seems like Germany is just going all in. Is that a misread, what’s going on there?
Ralph
Well, yes and no. There have been voices in Germany getting louder, particularly when it came, for example, to the Chinese buying parts of the harbor in Hamburg or a German Chip producer. So there are some voices that are getting more critical, but overall, the Chinese market is still crucial for German exports. So kind of when the German Foreign Minister, Angelina Bieberk was in Asia a couple of months ago and she said, we will stand side by side with Taiwan in the case of a conflict. That kind of was immediately backpedaled by other German parliamentarians who said, well, the Taiwanese didn’t ask moral support, so we have no intention to give tomorrow support. So I guess it would be very similar to the Russia Ukraine thing. I mean, in a sense, I think what’s always very important when we look at particular German foreign policy, they are not really for or against someone. They primarily want to maintain the status quo. So they want to maintain as much as they can the 1990s early 2000s status quo. That is true in the Asian case. It’s also true in the case with Russia and Ukraine. Right. Because some people say, why are the Germans not more supportive of Ukraine?
Ralph
Or are they all in the pockets of the Russians? I don’t think that’s the case. I think German policy is to maintain a status quo when it comes to exports in China, when it comes to energy with Russia and everything that quote unquote disturbs the peace is seen as a nuisance, and they usually kind of bet on the party that they hope can end that nuisance as quick as possible. And then I think was a little bit the miscalculation in the Russia case that they originally believed that this is going to be a war like Georgia, like other earlier conflicts, that this is going to end very quickly.
Tony
And we can all pretend it didn’t happen, right? If it ends quick, it didn’t happen.
Ralph
Precisely.
Ross
And that didn’t happen too, that are like leading indicators of German behavior with regards to China. BASF is one of them. Not only is BASF not recognizing its potential position of dominance on the vitamin and specialty chemical side, it’s actually doubling down on China and expanding its manufacturing operations there, not retracing from it. And if you look at Mercedes, for example, I love Mercedes Benz as a company, and I think they make some of the most amazing machines in the world. But you’re not going to tell Mercedes, get the hell out of China. They’ll do, and they can.
Tony
But they have got Volkswagen cans. Mercedes can.
Ross
Volkswagen can.
Ralph
And as a quick second point of this, the German energy planet, we’re going to talk about this a little later in more detail, but they still want to double down, particularly on solar and wind. And they need China as a partner to have good relations with China because they control most of the supply chains in these areas. So as long as Germany doesn’t really have this often announced but never actually materialized u turn in their foreign and domestic policy, this is not going to change. So I think, as you guys correctly point out, whatever the headlines say, whatever the Sunday speeches by politicians are, I think the underlying indicators still strongly point towards not just Germany, I would say all of Europe kind of being at least economically very benevolent towards China. And I think sooner or later, with the exception of some Eastern and Central European countries, I think many Europeans would be more than happy to renormalize relations with Russia as much as possible.
Tony
Let’s get on that later.
Ralph
Okay.
Tony
Before we move on, what do you see in supply chains that people aren’t talking about, that we need to know about? What is a thing where you’re just like, gosh, why don’t people see this? What is that? What’s supply chains?
Ross
It’s food. Probably the biggest and most obvious one that comes to mind. Everyone’s talking about semiconductors. That’s an obvious one too. But that gets beat to death. And frankly, the US. Really holds some major strategic advantages with that as well that don’t get discussed enough when we talk about that issue. On the food side, though, particularly with regards to China and Russia, russia is an enormous manufacturer of certain fertilizers. That’s very true. Now. The US. Has tremendous optionality with Canada next door. We make a tremendous amount of nitrogen. We have the ability to make more. We do find for ourselves on phosphates. We have significant phosphate reserves on the potash side. Canada has the far and away the most reserves in the world and an untapped capacity to move more to the US. So I don’t subscribe at least as far as like Europe and the US are concerned to the macro nutrient issue of NP and K that you’ve heard recently and for a long term elsewhere, that Russia and China control the world on it. They don’t. We do find out fertilizers amino acids are an enormous issue. Vitamins and micronutrients. And those are the ones where, when you’re talking about there’s roughly ten major vitamins that go into animal and human nutrition, but particularly into animal feed to keep them alive, to help them grow faster, to help them produce higher quality meat and eggs and milk.
Ross
Almost all of those vitamins are 90% or more manufactured in China, most of them at 100%. When you talk about key minerals that needs to go into their diets, whether it’s a zinc, calcium, or you see sometimes manganese and magnesium added in as well. Other than Turkey, India and Brazil, most of that stuff comes from China, too. And then you talk about the big amino acids. The US. Is far and away the largest meat producer in the world per capita, even more so than China. But we make about 40% of the amino acids needed in the diet. So we make far and away adequate supplies of DDGs or soybean meal that we use as the crude protein and the crude fiber. But the other 20% of that is completely, almost completely controlled by China. And then BASF and one other company based in Switzerland. And so if they turned off the tap on that, I hope you got it, that she’s not watching this, they turn off the tap on that, it would be crushing for our food sector.
Tony
So is there anybody who’s talking about rotating that production elsewhere? Any company is making that?
Ross
Adm and Cargill talk about it because they’re the only ones that actually make the stuff in the US. In ADM’s case, they manufacture in house. In Cargill’s case, they’re actually the glucose or dextro stream that gets fed into that fermentation cycle to make aminos. You have Ivana and Blair, Nebraska. You’ve got two companies in Iowa, korean and Japanese. And that’s CJ and International and Naji Namoto. They are also an over the fence agreement with an extra cargo, corn mills. That’s it, really, as far as that type of product in the US. We could expand that capacity relatively rapidly. But we have seen amino acids in particular go through so many expansion contraction, volatility cycles that to an American company, particularly one that’s publicly owned, one like Adm, the juice isn’t there for them. They’re not going to take a 20 year investment risk on something that on a year to year basis could lose a lot of money.
Tony
Okay, but if they had to, how long would it take to get that up and running?
Ross
It takes less than two years to build a wet corn mill. But if you were to expand fermentation capacity at any of the already existing wet corn mills in the US that are making, let’s say, high fructose corn syrup, I think of Golden Growers, which is a 50% joint venture with Cargill up in the southeastern corner of North Dakota. All they’re making up there is high fructose corn syrup for food. They can easily convert that stream into fermentation inside twelve months or less. So we do have a dormant quick to market capacity, relatively speaking, the faster we could get that type of thing online, you could do it with subsidies, you could do it with some market protections, you can do it in the food bill and just add certain things in there that favor that type of production. So these are not unsolvable problems. Vitamins. We are, pardon the language, if China really does decide to cut us off on that, that becomes very problematic in a hurry because it’s three to five years to get vitamin production online. If you’re talking synthetic vitamin production, all of that is adjacent and utilizes coproduct from the petrochemical industry.
Tony
Okay. So when I hear this stuff, it makes me wonder, with all of the money that the federal government puked out in 20 and 21 and early 22, this seems like a relatively small investment.
Ross
And it’s very small. A couple years to build a massive vitamin plant? Yeah, you could co locate a vitamin plant right next to Port Arthur, any of the places that are along the Gulf that are very dense and natural gas, and within 24 to 36 months, depending on permitting, if you put a fast lane in place, you could do it in 24 months. And the expertise exists in the US. To build that.
Tony
Okay, thanks for that frustrating example, but it’s something we need to talk about, right? And people need to know about it.
Ross
Albert will tell you this. It’s not talked about much in DC. I’ve briefed numerous Senate committees over the last year on this. A couple of House committees, a whole lot of staff members and Congressmen to their faces. And I show them the charts, I show them the numbers. And it’s really outside of anybody who’s part of the Midwestern congressional delegations. They have no idea. It’s completely foreign to them, and it’s really one of our pacing. Strategic risk.
Albert
Yeah, there’s like deer in headlights when you start bringing up these complex issues, supply chains and asymmetrical responses that the Chinese hold against us, it’s just nothing. It just doesn’t register.
Tony
Yeah, it’s terrible. Okay. Thank you, Ross. Sober, let’s move over to you. And I want to since we are talking about China, let’s talk about, I guess, a Twitter discussion that you and Ross had last week where you invited him on the podcast to talk about some of Peter Zaan’s comments about China.
So, just so everyone knows, I tried to connect with Peter Zion on Twitter and invite him to come on, but he’s very popular and we’re really small time for him, so I don’t blame him for not coming on.
Ross
But anyway, he just doesn’t want to be challenged, maybe.
Tony
Well, possibly. Look, the guy is a great speaker. When I watch him speak, I wish I could speak that well. Right. He’s obviously very smart and he says some stuff that sounds really impressive. Big old predictions, all that stuff. So, having said all of that, he was on Joe Rogan last week and talked about China and basically said that China won’t exist in ten years. Right. Now, this, to be honest, is a derivative of George Friedman’s hypothesis in a book called The Next Hundred Years that was published in 2009, where Friedman said that China would split into, I think, five countries. You know, part of it owned by Japan, part of it, you know, whatever. It’s it’s a really interesting book where he talks about a research in Turkey, a stronger Mexico, all that stuff. I definitely recommend that to people. Some of the stuff doesn’t sound real, but directionally it’s interesting. But Albert, both you and Ross have opinions on this, and you can talk about any of the stuff that Peter Town said. But I guess, broadly, do you see China as a nation state by 2033?
Ross
Of course I do.
Albert
It’s an absurd comment to say that it’s going to break apart within ten years. I mean, you’d have to have something cataclysmic to break up some major industrial nation into ceasing to exist. I don’t understand how that could possibly even come to come to fruition. I mean, China has a strong economic growth. They’ve brought up a middle class, they have a CCP that’s a centralized government that can initiate policies and stimulate the economy at will. They have a grasp on the country, they have a good grasp on the population. Everything that you see that comes out of these protests or whatnot, that’s something that the politicians in China allow you to see. And it’s a messaging thing. I was on here what is it, like, a month ago with Atlantic Council guys, and they’re about the COVID lockdowns and whatnot, and I said, this is your signal that China is opening. And literally, I think it was like a week later, they opened. The thing is, people look at China and they take things at face value with politicians and with data that comes out of China at face value, and you simply cannot do that.
Albert
As much as we blast the Chinese for their belt and road initiative, the key component of that is they have food security coming through that. They have farmlands in Africa, they have meat coming through the South American border. And even if we were to cut off their meat supply, by some measure or another, they still can fish the Sea of Japan, that has 5% of the world’s fish. So they have options for feeding their population in a pinch, and they have the stability and the military and the police force to keep people aligned. So I don’t see how, barring a meteor hitting the place or barring some kind of like, supercharged COVID starting to kill millions and millions of Chinese people, I don’t see how it’s even possible, even logical, to say that it can end up ceasing to exist in ten years. Just the asymmetrical challenges that the world would have to bring China down if they tried to would be devastating for the global economy.
Tony
Yeah. Ross, what do you think there?
Ross
Yeah, I think almost every discussion about the demise of China ignores one simple thing, and that’s not unique to Communists. Will to power is certainly very baked into the cake when you’re talking about communism. But in terms of strategic optionality, china has done a better job than any communist country ever at reinforcing their flanks strategically in a lot of different ways. And so you have to account for that. You have to account for the agency, again, of the adversary, which I think a lot of the discussions about the decline of China do not account for. It at least makes it incredibly complex and certainly is by no means is anything certain one way or the other. On the demographic time bomb issue. I have a very cold hearted way to say this. I don’t think they care. I don’t think they care. When you look at an enormous number of people that are, on the one hand, potentially would die off in some sort of food shortage, certainly with the reopening the percentage of people that at least from the people I talk to and deal with in China on a daily basis. It’s not a lot of young people, it’s not a lot of the productive workforce.
Ross
Again, just like in the US. It’s a lot of people that are unhealthy or older or both. And so you’re talking about people that already have significant respiratory issues in the cities, then getting hit with any sort of cold that’s beyond a basic cold, it’s going to be a problem for them. Right. So even if they survive, you’re still talking about a percentage of the population that in the communist mentality are viewed as less productive or drains on the state’s resources. They don’t really care if a lot of these people die. They truly don’t. And some level of very minor famine where they have the ability to begin to marshal resources and shepherd them a certain way where they can even target who wins and who dies, that type of thing, we will see in that sort of scenario. And they will be able to almost indefinitely put on not indefinitely, but for a much longer. Period of time be able to put off the more severe impacts of a demographic time bomb. And the other issue is, of course, too, they’re atheistic, right? They don’t recognize Christianity or a Jewish god or an Islamic god or whatever.
Ross
So they’re really unbound by any sort of traditional moral or ethical constraints that we have in the west. And so who knows what sorts of technology, what sorts of medical procedures and things they’re pursuing that will in addition to things like automation, they’re now one of the top 15 most automated manufacturing economies. A lot of the robots in the world have shifted production to China from Europe. So they’re dealing with things in a way that all these other models talk about the demographic time bomb don’t account for. They’re going to be a smaller population, but I think long term that also may be baked into their calculus or even serve the interests of what they’re looking towards. Absolutely.
Albert
Yeah, I could have said it better myself for us, I mean, the Chinese are pragmatic. They don’t make foolish mistakes when it comes to their existence. They went out and bought grains for a year and a half. They went out and secured meat for a year and a half. They took advantage of the Ukraine war and secured energy supplies for a year and a half. I mean, they’re not some kind of blind entity that’s going to be taken by surprise. They know their challenges. They understand these problems. There’s something that it’s not as simple. The population goes down, they’re in trouble, they cease to exist. Those dots I just can’t connect.
Tony
Sorry, Ralph, you had some comments.
Ralph
Yeah, just that I fully agree with Albert and Ross said, and I think the demographic part what is often overlooked. I mean, imagine you as a dictator, right? What kind of population would you like to have? One that is on average in the early 20s, or one that’s, on average in the late 30s or early forty s? I think an older population is easier to control because we see this in the Middle East and in Palestine. In these areas, it’s young men who are the biggest problem for social stability. If you can find this golden middle ground of late 30s, early forty s, I think that actually could be to the advantage of the stability of the political system. The only thing because Ross, you mentioned the religion part. I mean, I don’t know if this is still true. It was definitely true a couple of years ago, right, that China had the fastest growing Christian minority in the world. So that doesn’t matter if it doesn’t penetrate the political system or the political leadership. I’d be curious. That’s kind of the only scenario where I would see major changes if all of a sudden kind of these ideas, for whatever reason, start to penetrate the inner circle of Chinese leadership in a kind of ancient Roman scenario.
Ralph
Where all of a sudden the Roman Empire became Christian in an exaggerated fashion. But otherwise, I think you guys are completely right. The I think the the rumors of China’s immediate demise are strongly, strongly exaggerated.
Tony
Yeah. Let me let me add a couple things here. I think when when people make comments about the demise of China, I don’t think they understand modern Chinese history. If you look from, say, the mid 50s until today, certainly well, I guess the 19 teens until today, right. The the volatility that you’ve seen in China’s social structures, the conflict you’ve seen, the famines you’ve seen, the deaths you’ve seen. And certainly in the CCP area, the tolerance that the population has had for leadership, whether that’s coercive tolerance or whether that’s genuine tolerance, they have tolerated a lot. Okay? Now, when we look at, I think, part of the pressure on the CCP, maybe not China as a nation state, but the CCP as a ruling party is through much of the CCP’s existence. The population was very poor and not very educated. And this was Deng Xiaoping was really the one to say, hey, we need an educated leadership. Because until then, most of the people kind of dumb and not really well educated. And a lot of the universities were closed down in the 60s. Right. And so they really started having this educated leadership in the an educated business class starting in the 90s.
Tony
Right. And so you now have a very widespread level of education, and you have a pretty widespread communications platform where people can understand what life is like in other parts of the world. And so I do think that there will be more pressure put onto the CCP to open up and to do things like respect individual rights, whether that’s Christian or not. It’s something that with wealth comes an expectation that individual rights are respected. Right? And so if somehow there was some sort of economic regression where people were poor again, fine, but that would make people really angry. But as people get more wealthy and as they get more educated, I think that does put more pressure on the CCP to be more responsive to the population. Because in the past, people would go into their government guy or woman and they didn’t really have any ability to push back, say, intellectually necessarily. Right now they can go into their government representative and go, oh, that person’s stupid. They don’t know what they’re talking about. And we do that in the US. And we do that in Europe, and we go, our politicians are stupid.
Tony
Right. And so that’s happening more and more in China. And so I don’t think that it leads to the demise of China as a nation state. I think it leads to heavy pressure to the CCP to evolve into something different. And I’m not sure what that is, but I think the pressure on the CCP to evolve will become immense over the next five to six years. And maybe that’s what Dion meant and he just kind of simplified language.
Albert
I don’t know. The CCP morphing into something slightly more liberal is obviously going to happen. I mean, they’ve used actually done quite a good job of promoting national unity. If you want to give them any sort of praise, you know, national unity within China has risen over the past five to ten years. The CCP, like I said, they’ve been around for 70 years. Tony, you said that they’ve got a grip on the country, and I just don’t see it releasing anytime soon under any circumstances.
Tony
Let me just go back and say one thing. We’re all disagree with you. It’s a rare moment of disagreement, Albert, but I actually think the CCP are terrible planners. They’re terrible, yes, they bought things for a year and a half at a time, but they’re just terrible planners. And because they have such a heavy current account surplus, they have the money to make up for their mistakes. And that’s been their situation for the past 30 years. But I think in general, central planning is horrific, and I think Chinese central planners are incredibly awful. So the belief and I’m not accusing you of having this belief, but I think there is among kind of Western intellectuals, there is a belief that Chinese are amazing planners. And central planners, they’re really thoughtful, and I think that’s garbage because it’s just not true. They make a lot of mistakes.
Albert
Oh, no question about that. When you start talking about, like, central piloting and strategic moves, the Chinese have not been historically not been good. You’re right. But those are like 2030 years out, right? I’m talking about four or five years out. They usually don’t make mistakes when it comes to their own domestic politics within the country itself. I mean, they’re they’re still around 70 years. Nothing’s, you know, nothing’s changed, really, in 70 years. So in that respect, I would give them credit to, hey, for national unity’s sake, if they keep themselves in power, they’re done a good job for everything else.
Tony
They do a terrible job. Yeah.
Ross
Again, the dog not barking so much for China when they talk about this stuff. This is the first time we’ve ever seen any sort of synergy between the PLA and the CPC leadership. There has historically been a significant externally, people don’t realize it, but if you’re in the game, you give it. There has always been a historical significant antagonism in a lot of ways between PLA senior leadership and the CPC, the civilian Mandarins, if you will. And this is the first time that we’ve ever seen. And going all the way back to Mao and before him, any sort of cohesion, whether it’s enforced at the barrel of a gun or not, but cohesion because of all these corruption purges that she’s been on since he took power in 2012, going all the way now to today. We’re seeing for the first time, really, the output of a unified PLA CPC kind of mega deep state, if you will. And that gives for the first time, the civilian side a lot more control over what has historically been a multi trillion dollar dark economy and revenue engine of China. And that’s that massive network of shell companies and enterprises that the PLA owns through everything that they’ve got.
Ross
And I’m not saying necessarily we can predict yet what this means, but if that cohesion, if that’s some sort of maybe for the first time unity, if you will, from a political side and from a commercial side, the more that’s.
Tony
Going to look like, the more that happens, the more fragile that whole infrastructure becomes. It becomes so inflexible. And I think for the adversaries of China, that’s a great thing. So go down that path as fast as they can because it creates a very fragile infrastructure within the Chinese government.
Albert
I’m glad that Ross brought that up because I actually had a Tweet thread today about something similar where Xi has been messing with the CMC, which is the PLA Navy’s group that kind of operated away from the CCP and was instrumental in dialogue with the US navy. He’s like, pretty much eliminated those leadership and starting to put his own people in there. So there’s room for error. When you put civilians inside of a military complex.
Ross
That’s a path that I would say if we see a decline of China as an actual aspiring global head of mine, if you will, I think it’s more likely to come from that vector than it would be any sort of demographic time bomb considerations.
Tony
Yeah, I don’t disagree with you. Okay, guys, let’s move on to Germany. Ralph, you had sent a Tweet earlier, I think you sent it a couple of days ago talking about the German energy mix and the push for clean energy in Germany and how ultimately that will lead to more demand for Russian gas.
Can you talk us through that hypothesis? I know you wrote a detailed thought piece about it. Can you talk us through that and then help us understand when the Russia Ukraine war stops, how long before Germany goes kind of rushing into Russian gas again?
Ralph
Yeah, I think the first and most important takeaway is that the underlying German energy strategy has not changed despite the war in Ukraine. And maybe just to sum it up a little bit, in 2021, where we have the most recent numbers, right, about 40% of German electricity production came from coal and nuclear, all kinds of coal. So lignite and black coal. And they want to phase that out in the next ten years. Actually coal, they want to phase out now faster than originally planned. So that means they have to replace 40% of their electricity production. But at the same time, until 2030, the expectation is by German industry that they will have an increase in 20% of demand. And what is the German plan to kind of meet replacing the lost coal and nuclear and meeting this new demand of 20%? The plan was always gas fired power plants and that plan is still in place. So they still want to double their gas fired power plants. And of course the question is where’s the gas going to come from? Now, the quick answer is always it’s going to be US LNG, but I think this is just going to be an affordability problem at some point.
Ralph
The Germans spent $440,000,000,000 only for energy related matters this year, just to give you a comparison, the entire EU spent $700 billion as the so called relief package for COVID. So just to give you a dimension, we are just talking about Germany here, so this is not sustainable. That’s 12% of their domestic industrial output, so they cannot do this forever. And secondly, kind of the more geopolitical thing, I think they prefer close cooperation with Russia than being dependent either on the US or being dependent on Italy or Spain and these areas where LNG would also come through. So I think that on the medium to long run, if there isn’t a window of opportunity to reopen the gas flow from Russia, which is of course still going on, to other pipelines, I think they will jump on it. And the last point, which I find quite intriguing, because everybody says Nordstream Two, Nordstream One, that was sabotaged by the Americans, but apparently, if you look at it, one pipeline of the Nord Stream Two net is still operational. So to me this looks more if I would speculate, but of course I’m speculating here is that the Russians say, no, we cannot destroy Nordstream One.
Ralph
We leave a bit of Nordstream Two in place because then we have to start at some point Nordstream Two and then kind of when this is already happening, we just also start Nordstream One again once it’s repetitive because that was always in place. So I think the underlying energy outlook is still the same and I think as soon as there is a ceasefire or something, this is going to happen. At the very last point, we talk a lot about gas, but of course there’s still the unanswered diesel question when it comes to energy between Russia and Europe. So, as I said, I think if there is a chance to re engage in the energy market with the Russians, I think Germany primarily, but I think other Europeans as well would be very happy if they could re engage in this area with Russia.
Tony
Perfect. I’m going to stop you real quick and I know Ross has to jump in a couple of minutes. Ross, what thoughts do you have on that, on Germany’s dependence on Russian gas?
Ross
I think it’s obvious if you work in the commercial world, if you deal with German companies, whether it’s a buyer or a seller or supplier, whatever it may be. I do think you’re seeing a play out the clock scenario here. There is obviously positive alignment at a global scale between Russia and China. And there’s disagreements or things where maybe one surprises the other with some of their behaviors, but in general they’re positively aligned. Major German manufacturers doubling down in China is actually an adjacent indicator. Russia is still the cheapest source of natural gas that Germany itself can get its hands on. And it’s not I say this somewhat facetiously, but also sincerely, it’s not like the Germans and the Russians don’t have a history of secret relationships or conflict benefit maybe them or conflict. So I do think that as long as there is a strategic alignment on a long term basis of Germany and through infrastructure and through relationships that have really been built deeply since the end of the cold war connection to Russia, I think it would take a lot to really completely sever that completely. Because on a long term basis, if they don’t have replacement energy capacity, which they don’t not at this point, germany would stand to be tremendously disrupted by that.
Ross
I don’t think they’re going to let it happen, not for NATO, not for the EU.
Ralph
And maybe to add something, since Ross is still here as a supply guy, the other thing is even the idea they would have to double their renewables, including wind and solar. And the problem is, wherever they can build those wind turbines, they cannot get those transmission lines built basically from the north to the industrial heart or in Bavaria, for example. On one hand is because the lines are too expensive and too long at the moment. And the other thing is nobody wants them in their neighborhood, right? Nobody talks about this. So on paper it’s easy to build them, but every little municipality, every local politician says, sure, you can make those transition lines, but not here. And then this has basically been on ice for a long time now. So as Ross also says, I think at some point it’s either continue spending oodles of money, which at some point I think will just get too expensive, or find ways either openly or secretly, to increase imports in the energy sector from Russia.
Tony
Ross, I know you have to jump. I just want to thank you for your time. We’re going to continue the conversation, but I look forward to having you on again. Thank you so much. Thank you very much.
Ross
Thanks gentlemen.
Ralph
Thanks Ross.
Tony
Ross, one of the things you said was that Germany would rather source gas from Russia than from southern Europe. Can you help us understand why that’s the case?
Ralph
Yeah, because I think this is one thing that has been overlooked in the entire debate when it comes to the Russian position. Let’s also Twitter a little bit for the French position that a shift towards the east in focus both economically and politically is not in Germany’s interest. So as many I say now fantasizing. But I don’t mean it in a disrespectful way of a new kind of Baltic Polish Ukrainian alliance under the military protection, let’s say your military cooperation with the UK and the US. That is not something that Germany is particularly interested in because they want to remain the major power in Central and Eastern Europe and a new formed bloc with 44 million Ukrainians is not something that they are particularly interested in. And the same is true with kind of shifting the energy focus, let’s say towards Italy or towards southern Europe. It’s the same thing. I think this is not the kind of power shift that they want to see. And just as a quick add on to this is often forgotten, germany together with the Czech Republic as a smaller player, particularly France, they have been the major electricity exporter in Europe.
Ralph
They in some cases quite literally had the hand on the light switch and I think this is also something that Germany doesn’t want to lose. Now, I don’t know to what extent they are aware of this themselves, but I think if you look at German behavior towards Ukraine, towards Russia in this entire conflict, even now, at the moment, right, where they say, yeah. We might deliver Main Battle tanks if the US delivers them first. And if the Polish deliver them first, then maybe we’ll do it as well. I think this hesitancy is not just facetiousness on part of the Germans. I think it is kind of being concerned that the power could shift further towards the east into this kind of Polish Baltic Ukrainian new power center and it would be economically weaker but it’s already militarily potentially significantly stronger. So I think Germany is playing a kind of geopolitical game here that is not we can have a moral debate whether we agree or disagree but I think from what they are trying to accomplish it’s at least partially understandable and it’s a truly last point. There was a moment if they would have really kind of switched entirely their energy policy in February continuing the nuclear power plants and shifting other areas, I think then it would have been credible that they say they want to kind of emancipate from Russian energy, from Russian gas but they didn’t do anything of that kind.
Ralph
So this is why I think that on the long run, on the medium to long run relations between Russia and Germany will improve, whatever that means for other players.
Tony
I think it’s so interesting that the Polish Baltic Ukrainian that is such an ancient political entity from centuries ago, right? And so it’s just interesting that these things are coming back. But I want to push a little bit harder on that. As much as you say they would rather source from Russia than from southern Europe, why are they so hesitant to source gas from southern Europe? Because it’s a part of the EU, it wouldn’t be a political kind of lever that the south would pull.
Albert
It would be Tony. It would be because the Germans have Spain, and Italy is indebted to Germany a significant amount of money. Right. So that upsets the political dynamic from the Germans being able to counter the French and what are they doing within the EU? So you have a political economic dynamic here where Germany just does not want to give money back to the Italians in the space.
Tony
Okay, so what you’re saying is Germany would rather empower a hostile Russia. I would rather enrich a hostile Russia than give up the political power that they have over the south by giving them money. They would rather have the thumb on southern Europe and control them politically than actually help enrich their fellow Europeans. I wasn’t aware of this.
Ralph
I used to do this 20 years ago.
Tony
I don’t as much anymore.
Albert
I would do the same thing because Russia is not in my political sphere, and there is little to zero chance that the Russians are going to attack NATO lands. So from the German perspective, I get cheap power from Party A, and I still control Party B and C over here under my thumb. Why would I change that dynamic? I would never do that.
Ralph
The German area or the German sphere of interest that they are interested in is central. It’s Europe. Whether it’s the European Union, they don’t really care what’s going on in further to the east or, for example, between Russia and Ukraine, which they have shown quite openly up until February. I think Albert is precisely on the money here. So this was a very good deal for Germany.
Tony
Wow. Just another reason for me to think that the EU, as I’ve thought for the last 30 years, is just a cynical political grouping rather than a functional union.
Albert
It’s very nation states have their own interests at heart. Always first and foremost, before you want to talk about globalist or community.
Tony
Sure, yeah, absolutely. Okay, guys, this has been great. Can you just before we kind of end this, can you guys help us think? What are you looking at, let’s say for the rest of January, kind of the week ahead, the next couple of weeks ahead? What are you guys looking at with, say, ECB or Fed or markets? What are the things that are on your mind right now that you’re looking at for the next week?
Albert
I don’t know about the next week. I think Opex is next week, so it’ll probably be pretty muted before the Fed in February. But honestly, I’m looking at Russia whether or not they desire to have a new surge into Ukraine, albeit a smaller one, more tactical. But they need a win for the PR before they actually try to come into actual peace negotiations, because it’s just not sustainable, what they’re doing right there right now.
Tony
So do you think there will be peace negotiations, say, in March, April, something.
Albert
Like that, as plausible at least June, July, maybe?
Ralph
June, July.
Tony
Okay, ross?
Ralph
I’m kind of looking at the German economic numbers at the moment because they have all been very celebratory, because in the fourth quarter, apparently it grew by 1.9%. My suspicion is that these numbers were particularly pushed because Germany was simply pumping so much money into the economy. This is something oliver, you mentioned this a couple of times on your Twitter feed as well. This is something I don’t think enough people talk about that whatever the ECB does, a lot of this is going to be offset by European programs of pumping money into the system via alternative means. So kind of the celebratory mood that now it’s, I think, just 7.7% inflation and not 10% inflation, I think that’s just going to be temporary. And the same is about economic growth. So this idea that there will not be, as I think Goldman Sachs said, and a couple of other economists as well, that there will not be a recession in Europe next year, I’ll be very surprised. I prefer not to be that one, but at some point I know Albert has said something similar ones, but I’m growing increasingly suspicious of these numbers because they don’t add up with anything.
Ralph
When you talk to people in the industry, when you talk to the banking sector, they tell you it’s not all doom and gloom, but it’s definitely not. That all. Next year we’re going to grow beyond our expectations.
Albert
The celebratory chance for the Europeans right now completely missed the fact that they are dormant. They’re in a zombie state. There’s nothing going on in Europe at the moment. So once they start kicking things back up and manufacturing and demand inflation is going to go right back up to where it was a year ago.
Tony
I never trust a preliminary economic data release. Never. Always wait for the second or third revision. So when markets move on a preliminary release, it’s moving on the belief that other people have expectations around it. Right? And so it’s just this reflective, expectations based move rather than based on the numbers themselves. And I always will often say this on my Twitter feed wait for the revision. Don’t trust the initial preliminary data release because it is PR. It’s nothing more than PR. Maybe it’s directionally correct, maybe, but those preliminary releases are PR. So on that optimistic note, guys, I want to thank you for your time. This has been fantastic. We’ve had such a great, deep discussion. So thanks very much. Have a great weekend and have a great week ahead. Thank you.
This week we’ve seen a lot around dollar hitting almost 110. We’ve seen a lot in the US market downturn. There’s a lot of speculation around the Fed. But we’re really focusing on Europe this week.
Key themes:
1. European Natgas Stock vs Flow
2. Russian Oil Price Cap Fallout
3. Europe’s Food and Fertilizer Fallout
4. What’s ahead for next week?
This is the 32nd episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
Tony Nash: Hi, and welcome to The Week Ahead. I’m Tony Nash. Today we’re joined by Sam Rines, Tracy Shuchart and Albert Marko. We’re going through the events this week and looking toward next week.
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So this week we’ve seen a lot around dollar hitting almost 110. We’ve seen a lot in US market downturn. There’s, a lot of speculation around the Fed. But we’re really focusing on Europe this week.
The key themes this week are really around European natgas stock versus flows. Russian oil price caps and the fallout that has come with that. Food and fertilizer in Europe. And then we’ll look to the week ahead. So I think we’ll look at some non Europe activities for the week ahead.
First for European natgas, Sam Rines in his newsletter came out with some really interesting points around natural gas stocks and flows. You can see the chart on the screen. Sam, can you talk us through kind of what’s happening in storage for natural in Europe and what we should be looking for as winter approaches?
Sam Rines: Yeah, sure. So you get this really interesting dynamic where everybody talks about the stock but very few people talk about the flow. So talking about the stocks of that gas in Europe is a really interesting one. Yeah, you’ve got stocks building up pretty quickly, particularly in Germany, sitting north of 82% overall for European stocks in general, north of 80%.
So it’s good, right? Stocks seem to be well ahead of where you would anticipate. Germany has a 95 target for November. They might actually reach it even with the shutdown of Ms one, Nordstream One. It’s actually not that big of a deal incrementally to Germany in particular. You go from about call it a 3.2 kilowatt hour type pump into Germany to about a three.
You didn’t really lose that much. I mean, it was pretty much anticipated anyway. So if they keep it off
for longer, whatever. You don’t have significant usage coming through at the moment for natural gas.
It’s a time where you can actually afford to not have those significant closing. They’ll probably still have some stock bill that will just be slower.
So overall, I think it’s a lot of headlines that a lot of it’s already priced in. If you were looking at the expectations of complete and utter frozen winter, you’re pretty much not looking at that assuming that Norway and Belgium continue to put their flows through to Germany at the current rate.
So overall, you’re actually sitting on a decent call it stock level. Right? That’s fine. And as long as you continue to have the flows from call it Northern Europe, you should be okay for the winter. You’re not going to be great. It’s going to be expensive, and it’s going to suck. But relative to the expectation of Europe’s going to freeze this winter,
I think that might actually be a little bit of an overblown one, and you might begin to have a significant blowback on that. And you’ve seen significant declines in things like electricity pricing ahead, which is a ridiculous contract anyway. And Dutch TTF, the net gas contract you’ve seen collapse this week, even with the shutdown of Nordstream.
So I think a little bit of the froth, a little bit of that angst is beginning to come out of the market, and you might actually have a positive surprise relative to expectations in Europe.
TN: So Dutch TTF peaked on Tuesday or something, right? It was early in the week, right?
SR: Correct.
TN: And Tracy, what are you seeing with that? Do you expect us to hit back up to those peaks, and do you think that was kind of a one time hit? And what Sam saying about storage is really kind of starting to take hold.
Tracy Shuchart: I think it really depends over the long run and how slow go. I totally agree with Sam here. Right now, for winter, Europe is pretty much okay, not great, as he said, but I think given if we don’t see increased flows, that storage would drain significantly by February. So we really have to keep an eye on flows from other countries, particularly in the United States, in the Middle East, and to see how those flows go. So I think it’s too early to be completely doom and gloom, but that is something we need to be cognizant of, because that storage can only last until February.
TN: Right. And for those people who aren’t in Northern Europe, northern European winter really stays cold, really until like, April, right. It’s not something that February comes and goes and it’s spring and everything’s great. You still have cold temperatures in Northern Europe until probably April or so. Is that about right?
TS: Yeah, absolutely. Anecdotally, if you’re been on Twitter, you see a lot of people starting to buy wood. The big thing on the European sites is to post how much wood you collected before this winter. So people are sourcing. People are expecting energy prices to be high and doing whatever they can personally, to kind of lower the prices. Because you have to understand, when you’re talking about European power prices, it’s not just your solid power price. They have that almost all of their taxes on top is on top of what they actually would be paying, which is outrageous carbon, et cetera.
TN: And so I just want to go back to one point in Sam’s chart as well. I think sam, you said the storage is about 82% full or something and they’re targeting 95%, but we’re ahead in 2022 from where we were in 2021, is that right?
SR: Yeah, that is correct.
TN: Okay, so the doom and gloom that we’re hearing again, we have inflation, we definitely have shortages, but in terms of storage, we’re ahead of where we were. And we don’t expect like a mass extinction event in northern Europe because of heating or whatever, right?
SR: Correct. I think that is a good base case. That’s good for everything. No mass extinction is low bar, but yes, that’s right.
TN: Exactly. Okay, very good. Do you have anything to add on this?
Albert Marko: I’m on middle of the road here. I do agree with Sam that they’ll be okay so long as they’re okay with no manufacturing, no growth in their economy, and so on and so forth. I mean, if they tried to kick things up and the demand starts to rise, I don’t think it will be okay. I don’t think that the Russians are going to play ball, especially when they start talking about these price caps on Russian oil and gas. It’s one of those things where economically, I can understand where Sam is coming from.
Politically, I’m inclined to say that Europeans are going to screw up and just agitate the Russians. And then you start getting into this back and forth. That economic trade and price.
TN: Let’s set the price cap aside for a minute. But when you say no manufacturing, so we’ve seen some manufacturing dial back and some facilities slow down and shutter. Is that expected to continue or do we expect that to ramp back up?
AM: I expect it to completely be just stalled for the entire winter. I just think the energy prices are so astronomically high that it’s just not economical for companies to manufacture anything.
TN: Okay, so if you’re sourcing things in Germany, then you should expect supply chain issues for the next five or so months. Is that fair to say?
AM: At least six months. And this is why I keep saying that this inflation doom loop keeps recurring because as the demand rises, there’s not enough supply and then you get back into an inflationary event. What’s the inflation rate in the UK right now? Like 20% reported. 20%? And in Germany, I think it’s like 19% and rising. It doesn’t stop.
TN: And PPI is in the 30s or something. Just to play this out, I wouldn’t have a whole lot of time to cover this, but if private sector is shutting down, even parts of it, then government spending has to kick up. And if government spending is kicking up and we have an ECB that’s tightening, that’s a difficult environment for the German Finance Ministry, right? Or is it no big deal then?
SR: No, I would completely disagree. I mean, Germany is one of the few countries in the world that has they could basically print their GDP and they’d still be perfectly fine on an ability to pay basis. They spent, like, three years getting paid to have debt.
TN: So very good, because, look, nobody wants Germany to suffer, right? And if government spending
has to kick up, then great. If they’re not going to suffer as a government to be able to do that, then that’s even more fantastic, because with ECB tightening, it could create some difficult trade offs for some countries in the region, of course.
So let’s take this and park it and let’s move on to fertilizer, because, of course, that’s related to natural gas.
And we have some there’s a recent Bloomberg story about Europe’s deepening fertilizer crunch. 70% of fertilizer production is halted. And then we have a chart showing the price of nitrogen fertilizer in Germany. Obviously, it looks pretty extreme. Can we cover that, Albert, and look at the impacts of fertilizer and how that’s going to hit food going into spring or summer of next year?
AM: Oh, yeah, the fertilizer, specifically what you’re talking about, nitrogen based ones, are relying on natural gas. Natural gas prices just keep on spiking over there. And again, we can continue this whole discussion about inflationary, commodity prices, but food is a big problem. They shut down their potash.
On top of that, the farmers, they’re notorious penny pinchers, whether it’s the United States, whether it’s Europe, so on and so forth. But they’re going to have to make up the nutrients for the soil in the spring of 2023 and most likely into 2024, they can’t deprive the land of nutrients.
So, of course, they’re going to have to have another round of demand for fertilizer. I don’t know about the night gas based ones, but potash certainly will have a surge.
That’s why I’ve always on Twitter have been big on Mosaic being the 800 pound gorilla outside of Morocco’s. OCP, but OPC, I think it is. But that’s not a tradable stock mosaic fertilizer. I’m very bullish on that. That’s going to relate to bigger increases in food prices, specifically in the UK.
TN: What crops in Europe would be most impacted by this?
AM: Wheat. Most likely wheat.
TN: Yeah. Okay. And where does Germany traditionally, where does it source most of its fertilizer? Is it from Russia?
AM: I believe they get most of their stuff from Belarus originally. And I know that they have potash fertilizer plants inside of Germany itself, but I’m not sure how. I don’t know the exact numbers on the importance of what they do for a fertilizer, but it’s certainly a problem specifically for Germany. Of course it’s a problem for France. It’s even bigger problem because they’re a big food producer.
TN: Okay, Tracy, you’ve said a lot about fertilizer in the past. What are your thoughts on this? Does it just get even more intense or do we see some relief on the horizon?
TS: Well, I think it does get a little bit more intensive when we just saw And, Norway’s largest fertilizer company, all kind of curve back production in various countries wherever their plants are concerned. So it’s definitely a concern. 100% agree with Albert. Going into next year is going to be a very big problem. I mean, everybody’s harvesting right now. Everything’s fine. We’ve seen big pullback in those prices. But going forward, in particular next year, we’re going to have a problem.
AM: And a lot of that, Tracy, has to do with the national governments are going to look out for their national interests, their own farmers, so that although the imports will drop, so the exports will drop and they’ll just keep it closed within their own nation, so they can feed their own people.
TN: Fertilizer nationalism.
AM: Well, it’s just the same thing with oil. I mean, the countries are not export more than they can handle.
Yeah.
TN: Okay, so sounds pretty dire, but do we see any relief next year? Or, like you said, is it going to go into 24, or does it all depend on Russia?
AM: I think it depends on Russia whether the Europeans and the United States come to their senses and stop trying to put their foot on the throat of the Russians. You’re hampering your own economic growth, and they’re sitting there talking about, oh, we’re going to get away from fossil fuels and do this whole new climate thing. That’s just not realistic. And I don’t think they just haven’t come to grips with that yet.
TN: I think it’s a time frame thing. Right? I mean, it’s going to take some time, and I think there’s a hybrid mix in the interim that I think we’re trying to rush.
AM: Well, that’s the point. They’re trying to rush things. When you rush things, your own people are going to suffer economically and so on and so forth. It’s just not politically. They just can’t swallow it. Some of the voters don’t swallow that. Sort of stuff.
TN: And things break. Like Californians can’t charge their electric cars. Right. These are weird times.
Okay, great. Thanks, guys.
And then on the oil price cap, we had about this week, former Russian President Good about this week, saying that Russia just won’t deal with people who subscribe to the price cap.
And then we had Xavier Blossom, Bloomberg tweet about it, saying that he and his friends are going to agree to a price cap on beer at their local pub and that the guys at the pub don’t agree with it, which is a nice analogy, I guess.
Tracy, what are you seeing on the price cap? Is it actually going to come about?
TS: First, they just announced that they’ve been talking about this for months. Let me give a little bit of background. And they just now say there’s going to be three different kind of price caps, one for crude and two for refined products.
However, if you look at the actual G7 statement that was out today, they were pretty vague on it. Basically, they said, we invite all countries to provide input on the price cap design and to implement this important measure. So in other words, they’ve decided they’re going to do this, but not exactly holiday.
TN: It’s going to be 2030 before they come to an agreement on.
TS: it’s because. They’Re asking all their stakeholders to join in this. And so what I see as the problems with this right now is that there are four specific problems. One, it’s not really enforceable outside of G Seven countries if people don’t sign up for this. Two, Russia already said, again repeating you, that they won’t sell to countries that enact price caps. Three, part of this is the maritime insurance on vessels carrying Russian oil India is already providing safety and notification through IRGC class.
So by Dubai, subsidiary of the Russian shipping group. So I hope I pronounced that right. But anyway, they’ve already kind of gotten their way around this. And four, they’re also thinking about creating their own benchmark.
So right now, Russian crude oil is expressed as a discount to Brent because rent is the benchmark price. They already have an oil trading platform in place via RTS and MYsix. So they could build out this platform, which they’ve been talking about, and go through near Mir, which is basically their version of Swift, and completely by past that and just let market forces work.
I think this price cap is still way off from seeing the light of day. But this actually could turn out much more bullish because this price cap overlooks how Russia could influence global markets.
If they wanted to, they could opt to cut off the EU and NATO, not just G7. G Seven members shut production and raise global crude oil prices through the roof because they would take barrels off the market there by hurting the G7 nation.
I’m not saying that would happen. I’m just saying that’s within the realm of two box. And it’s not surprising after we just saw today, as soon as an oil price cap was announced as a plan, suddenly we just saw gas problem with Nordstream one, therefore I’m off of national gas.
TN: So what’s to stop, let’s say, a European country that signs onto a price cap from buying, let’s say, Russian crude that is sent to Chinese, say ownership and then resold to say, I don’t know, Germany. I mean, that type of circumvention is already happening, right?
TS: No, you can definitely do that. What we’re really seeing now is that kind of circumvention is happening in the product market. So it’s very easy for, say, India to buy Russian crude oil, refine it until it’s anywhere else because it’s very hard to track where those barrels really came from. It’s easier to track a resale. Right, if that makes sense.
TN: Sure it does. But they put in a barrel of, say, Emirati crude with a million barrels of Russian crude and then they label it Emirati crude. Right? Something like that.
TS: Yeah. If they both have the same API level, depends. You could mix them. If they both were the same exact API level, then you could mix them. It’s kind of different than, say, the natural gas market. Yeah.
AM: The Iranians do this with the Iraqi oil and bozzar. Often they mix it and label it As Iraqi
TS: because they share oil fields. I mean, Albert and I have been talking about this for years now.
AM: Years.
TN: Let’s be honest, the rules apply to the people who abide by the rules. Right. And so even if these price caps are put in place, there will be circumvention in a big way, of course, at least a refined product, if not crude product. And so a lot of it’s for sure. Is that fair to say?
AM: Of course, yeah. A lot of it is for show. This is a political thing right now for scapegoating Russia
for inflation problems. Now they’re just snowballing things and saying Russia’s gas is the problem
for inflation, Russia’s oil is the inflation problem, and other caps. But like I said earlier, and even just Tracy reaffirmed it’s like the moment you mentioned price caps against Russia, Moscow finds an issue, whether it’s gas, prom leak or Belarus problems, or Algeria has problems with Wagner. They create these issues all the time.
TN: Of course, anytime there are sanctions on a country, right. These things happen. Okay, very good. Thank you, guys. We spent a lot of time talking about Europe. So let’s move on to the week ahead and
what we expect to happen the week ahead.
We saw some really interesting action in markets, and last week we talked about how Palo speech, we really should have been a surprise to no one, but markets seem to kind of take it on the chin this week, acting shocked that he repeated himself again. So what do we expect going into next week? Do we expect things to kind of moderate a little bit or do we at least in equity markets, do we still expect some downward movement and also, say energy markets? We saw crude down, I think at 86 or something.
Tracy, do you expect, say, energy markets to continue to fall next week?
TS: What I would really look at, and what I’m looking at more, instead of looking at just reprice, which seems highly manipulated right now, especially going into midterms, not suggesting anything, but I think what I would start looking at is in like second and third month spreads or fourth month spreads. Right. So you really want to be looking, I think, just a couple of months down that curve a little bit. And if you start seeing because those curves are still kind of telling us that the market is very tight and curves, you can’t really manipulate as much as you can somewhat of the front line. So I think that’s where you should be looking at. I think we’ll really get a better grasp on these markets and to see what front market is next week is OPEC meeting, right. So they were talking about cuts, right, over the last couple of weeks. That’s right. That’s all. I will be on that. That’s on the fifth.
TN: And SPR keeps going until October. So we’re only looking at November,December before we’ll see some upward pressure on prices. At least a stand up pressure.
TS: Yeah, exactly. And depending on what OPEC says, we could see an initial pull back. The general consensus is they’re not going to do anything in September. However, OPEC has been known
to give us some surprises. So just keep that in mind.
TN: That’s good all right. Very good. Sam, what are you looking for for next week?
SR: Next week I’m looking at the ECB. I want to hear how hawkish they are and how quick they’re going to go and what type of language they’re using. They’re still in the QE boat, right? They’re still buying Italy, they’re still buying Spain, they’re still buying a bunch of the southern debt periphery type debt.
So I want to hear what they’re saying, how they’re saying it, and just how call it, quote, unquote, inflation-oriented. They are. They probably should be particularly versus the bank of England, who is very hawkish and likely to continue to, one, explore actually outright sales from their asset purchases to shrink their balance sheet and how quickly the relative moves are there.
I think that can create some fireworks, particularly called the Euro pound type crossed I think that could be really interesting and cross asset class could be.
TN: Do you think you should be able to surprise hawkish?
SR: Yes.
TN: You do? Okay, interesting. That would be very interesting to see. Wow. Okay. And so you think the Euro recovers a little bit on that?
SR: I think it knee jerks, yes. But the question is how long does that last? Right. That, I think, is a much more important question than the initial knee jerk. And I think over time, it would be a fade the news move.
TN: Okay, very interesting. Okay, very good. Thanks for that, Albert, close this out. What do you see for next week?
AM: The big boys come back to play from vacation. That’s right, they do. I think they’re going to start holding the market a little bit more accountable for all this bad data. And I think earnings were just atrocious when you look at what inflation was. I’m actually going to be watching though
China as we get closer to the CCP, the Party meeting, I think it’s October 16, I think XI might start announcing many stimulus packages in certain sectors. So I want to see if those materialize and what that does with commodities that are attached to them.
TN: Okay. I just want to say, with regard to the Party meeting in November, if anybody talks about reading tea leaves or any of that garbage, you’re banned immediately. Okay.
So we’re not going to imply, like, cultural mysteriousness on Chinese political processes. It’s just they’re a bureaucracy like everyone else. They make decisions like everyone else. They’re no more or less mysterious than anyone else. So I would say that for the people watching, because the people watching are going to see a lot of kind of China experts or whatever China watchers talked about how mysterious the CCP is and a lot of question marks. A lot of them are Fed talking points from the CCP spin machine. So they’re not mysterious, they’re a bureaucracy. They’re boring, just like every other country.
AM: Yeah. And the Party is I believe that Congress is October 16, not November. Yeah. So it’s closer than people realize. It’s only 30 days away, but China is going to have to probably stimulate some sectors associated with whoever is in line with the party leadership to keep them happy. So that’s what I’ll be watching next week.
TN: Yes. Very good, guys. Thank you so much. Looking forward to have a great holiday weekend, and I look forward to seeing you next week. Thank you very much.
There’s all this buzz around Nancy Pelosi’s visit to Taiwan. What is she doing there? Why all the stress? Why is China upset?
Also, Yellen got China to stop the stimulus. If China starts the stimulus, will that be a really good thing for Chinese equities? And what does that do for the CNY?
We also discussed the likelihood now with Pelosi’s visit that China will start stimulating. And what does that mean for oil and gas imports and Europe?
Will China try to hurt US companies that are in China? Do you think they could push against ex-pats in China and make life difficult for them? What are possible aggressive moves that China could take? Like cyberattacks?
There have been some potential whispers of China taking over some of Taiwan’s small islands to make a statement. Is that possible? And will they take it on other countries like India? What is the likelihood of China and the US in direct warfare engagement in the next twelve months?
Listen to Spotify here:
This is the 28th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
TN: Hi, everyone, and welcome to the Week Ahead. I’m Tony Nash, and we’ve got a special Week Ahead right now. We’re joined by Albert Marko and Dr. Christopher Balding to talk about the Taiwan-China issues around Nancy Pelosi’s visit.
Before we get started, I want to let you know about a special we’re having for CI Futures. We’re doing CI Futures for $50 a month. With CI Futures, we forecast about 2000 economic variables every month and about 900 market variables (currencies, commodities, equities) every week. That $50 deal is for the next couple of weeks. And you don’t even have to take a year-long commitment. For the next couple of weeks, you do it a month at a time, and it’s $50 a month.
So let’s get onto the show, guys. Thanks again for joining. I appreciate it.
I want to get into there’s all this buzz around Nancy Pelosi’s visit to Taiwan, and I want to take a step back and go, why all the stress? Why is China upset? Because I think there are a lot of loaded assumptions in the discussions that are happening. So can you guys talk us through a little bit, maybe? Chris, if you want to start, why is China so upset about this?
CB: So there’s the full history of the claim of Taiwan as Chinese territory. They refer to it as a Chinese province. That’s the general background. I’m going to assume that most of your listeners or watchers already know that.
However, if we jump ahead to this specific visit, to be honest, I’m a little bit mystified as to why this
specific visit has turned into this small crisis. Trump was sending a cabinet secretary and undersecretaries. There’s been a steady stream of Congresspeople to Taiwan. So why this specific visit? I think there’s very reasonable speculation we can go through those. But why this specific visit has turned into what it has, I think there are probably only a couple of people that could answer that question.
TN: Okay, Albert?
AM: Well, to expand on that, I can understand why the Chinese have a little bit more drama involved in this visit simply because the economic situation in China at the moment is so dire for Xi that they need a little bit of a distraction just to get the headlines out of the way at the moment.
TN: Yeah, I think that’s a good point. And when I think about this, it’s, yes, you can go back into all the history and the UNC, the 1971 and all of this stuff, but I think my view is democrats need a distraction for the midterms. You have the Afghanistan anniversary coming up, all of these things coming up. A bill was just passed that either does or doesn’t raise taxes on a lot of the population. There’s a lot of discussion around that.
Are we in a recession? Not a recession. I think this is a convenient foreign policy issue for Democrats to grab onto before the Midterms to raise some external issues that are a little bit more mysterious for people, a little more exciting. Will there be a war? That sort of thing.
And I think, Albert, you’re exactly right. With the November meeting coming up in Beijing, where Xi is supposed to be this golden boy and a lot more power and all this stuff, the new Mao or whatever, I think China’s economy is in a horrific state. I think the provinces and cities are not falling in line with Beijing, and I think politics in China is terrible. So I think this helps galvanize people in China, it helps galvanize people in the US. And I think it’s more of a convenient event than anything.
AM: It is a convenient event. Other issues are going on within China with the actual US.
Fed and Yellen are Yellen got them to capitulate to stop stimulus to fight inflation. So from the Chinese perspective, they’re a little bit they feel a little bit betrayed here. Seeing Nancy Pelosi
nude sunbathing on Taiwanese beaches, it’s like, what are you doing?
TN: Yellen got them to capitulate, to stop safely. So you’re saying Yellen got China to stop stimulus?
AM: Yeah. I don’t know if it was direct or indirect, but Xi warned them to don’t stimulate while we’re trying to combat inflation. Look what happened to the Russians. And from the Chinese elite perspective, looking at the oligarchs in Russia, being completely isolated from the rest of the world, that’s just something that a pill that they didn’t want to swallow, and they were glad to hold off stimulus up until this event. Now, I don’t know, after this event, the Chinese might renege on that gentleman’s deal, but we’ll see at this point.
TN: Okay, let me pursue that in a minute because that’s interesting. So if you’re saying that the Chinese were holding back stimulus because of a quiet bargain, and they reverse on that and they start, as I’ve been expecting them to do for the last six months, just dump truckloads of cash on the squares in Chinese cities, if they start doing that, that could potentially actually be a perfect thing for Chinese equities, right?
AM: Well, of course, but it’s negative for the US inflation and the commodities will start ripping. It’s an asymmetric shot against the US. So it’s something that they have in their toolbox and they haven’t used yet, but they certainly could after this.
TN: Okay, and so what does that do for the CNY, guys? If China starts stimulus, if it’s fiscal that appreciates CNY, at least from a textbook perspective, right?
AM: Yeah, from the textbook perspective, sure. They control whatever they want to set the CNY at, so, I mean, I can’t see them allowing it to shoot up too far just because they are an export-dependent economy.
TN: Okay, Chris.
CB: I just wanted to circle back to what we were talking about before jumping back to the CNY issue because this has been a real puzzle about they’ve been pretty restrained, and there are all kinds of questions as to why that is.
And again, I wish we could provide good, solid answers about that. I think a lot of the issues, like with Taiwan and stuff like that, I think there’s like, Tony, you mentioned the economy. I think that’s distinctly possible. I think it’s also one of those issues. If you go back right after the first of the year, they changed the language about reunification and how they were going to solve that problem for the new era.
What’s the new era? It’s Xi getting the third term. So is it possible that the economy is, like, pushing this along, egging it forward, so to speak? Yeah, I think that’s possible. I also think there’s much more like Xi has staked his credibility on, I’m making China great again, come hell or high water, if I have to drive it off a cliff to do it. That’s part of what you’re seeing.
AM: Yeah, I agree with Balding on that one. The only caveat that I would throw in there is that would be exactly the case up until the Ukraine situation where Russia got their butts handed to them. 30,000 troops lost, flagship battleship gone, sunk.
From the PLA perspective, it’s like, hey, what happens if we lose? Because it’s not a 0% chance, right? What happens if we get decimated? Our military could be set back 50 years, 100 years. And I think that at this point, it’s too much of a cost for them to take an adventure in Taiwan.
CB: Yeah. I will say you and I disagreed on this previously. Like, what were the risks? Let’s assume Ukraine had never happened. I would say there’s probably a not immaterial chance of something
happening with China and Taiwan in the next, let’s say six to 18 months.
At this point, I definitely would push that back a little bit. If something’s going to happen, I think, within the next few years. But absolutely. I think they’re going back to the drawing board because they see what’s happening to Russia in Ukraine, and they’re like, there’s absolutely no way in hell this can happen to us.
AM: Yeah, they saw Afghanistan as a point where they could probably take some territory away from the US sphere of influence. But then again, Ukraine happened, and that threw everything through, wrenching all the plans.
TN: Okay, so let’s talk about that a little bit. The Russia-Ukraine angle is interesting. So when sanctions were put on Russia, Russia can do okay without sanctions, not thrive, but can survive. But China is so intermingled in global trade that if sanctions are put on China, it could be very difficult for them. Right. Or what am I missing?
AM: It could, but they’re the world’s manufacturing base, so it’s like, you put sanctions on them, they’ll put sanctions, they’ll do something asymmetric, and it’ll hurt the West more than the West can hurt China, to be honest. I mean, The US can handle it. The Europeans can’t. They’re already in dire rates.
CB: The other thing that I would add to that is people make the sanctions argument. I don’t buy the sanctions argument for two specific reasons. One is basically what they import. The bulk of what they import from the rest of the world is raw materials. And that’s not coming from Western Europe, Japan, or other places like that.
Then the high-tech products that they do import, let’s say very high-grade chips, are going into things like iPhones and then being re-exported right away. Okay, so they’re not on an import basis highly dependent on the rest of the world.
They’ve made two bets with that in mind. Number one is that they can convince people not to block their exports, meaning Chinese exports to their country. Number one. And then also that other countries are so dependent upon them that they can’t. Okay?
What would happen to Walmart during the Christmas season if they couldn’t buy from China? Okay.
It’s a simple example, but it does throw a monkey wrench in there.
AM: Caterpillar is another one. The Chinese have done a marvelous job of using US agricultural companies against the US political system. So they’ve got a noose around them. Buick also. GM, Buick, Caterpillar. I can name half a dozen companies. Yeah.
TN: My main focus in terms of sanctions was food. These other things, of course, they’re importing goods, really, largely to be transformed and re-exported. Food is the main issue that I would think would be damaging to China, potentially.
AM: Yeah, that was always one of my main points of contention about a war starting with Taiwan is those ports being shut down in the eastern part of China, it would be devastating. They would have food and security problems. The Chinese middle class has been growing. They don’t want rice anymore. They want noodles and dumplings. So they have a persistent food issue that just gets worse and worse every year.
TN: Right. Okay, so let’s go into this. I saw Pelosi kind of pull up into that. I think it was the Grand Hyatt she’s staying at in Taipei. And really, what is she doing there? Like official, non Official. What do you think she’s doing there?
AM: That’s a pure distraction from the midterms in the economy in the US at the moment. It’s an easy distraction. They know China is not going to do anything outlandish. They’re a pretty pragmatic country when everything is said and done anyway. So it’s like, what negative is there for them, for Pelosi and the Democrats at the moment?
CB: Here’s the only reason I’m going to disagree with you, and you said something very similar earlier, Tony. Here’s. The only reason I’m going to disagree with you is that this assumes a level of evil genius out of the White House and maniacal thinking that I just don’t think they’re capable of, okay? Okay. Again, I could be wrong.
AM: I just don’t see these guys as the evil genius that says, hey, we need a distraction, what can we do?
I don’t think it’s an evil genius. I think that’s a little bit too strong. The game of scapegoating and distractions in the beltway is as old as time itself. The professionals at it. They can see what they want to do to pull people’s eyes away from one issue onto another and they have the media under their grips so they can do anything. They want to distract people. So the evil genius part comes in what are, steps 2, 3, 4, and 5 after this? Because now the Chinese can retaliate and I don’t think the US is prepared for that.
TN: In what ways?
AM: Well, I mean if the Chinese decide to start simulating next week and commodities start ripping, inflation in, the US is going to have a ten print, 10% print on CPI come October, November, then what? You’re in the smack middle of the midterms looking at 10% inflation and you’re losing 50, 60 seats in the House and you’re losing the Senate and then you have the Republican take over and start throwing out hearings against Joe Biden every week like they did Trump. It’s chaotic.
TN: Okay, so that’s an interesting scenario. Okay, I want to ask about that and then I want to ask another question about a potential reason for visiting. But you’ve mentioned that a couple of times. So what’s the likelihood, since they’ve said that they’ll undertake serious pushback, is there a likelihood that they’ll do that? Do you put that at a 50, 60, or 70% likelihood or do you think they’ll continue to hold?
AM: I think after this visit by Nancy Pelosi, it’s a greater than 50% chance that the Chinese start stimulating a little bit earlier than scheduled with commodities ripping.
TN: Okay, so that means more oil and gas imports, more pressure on gas prices, and diesel prices. All this would hurt Europe too?
AM: Oh, of course. Europe has got massive energy issues going forward and they’re unsolvable within six months.
TN: Okay, so so far I’m hearing potentially bullish Chinese equities and potentially bullish commodities, particularly energy, commodities, and industrial metals, right?
AM: Oh, absolutely, yeah. Full discretion, I’m going into KWEB. I have Baba at this low with this Pelosi landing. So for me, it’s just like Chinese equities have been battered with no stimulus. We’re down to the point. Yeah.
TN: Okay, so on tech, you mentioned tech. Is it possible that with the chips act just passing in the US, this is the one that supports semiconductor companies for putting operations in the US? Is it possible that there is a message being passed to TSMC or any of the strategic industry guys in Taiwan by Pelosi and her staff? Is that a possibility? And if so, what do you think it would be?
CB: Absolutely. I would say that that’s one of the things I don’t know if you caught this statement from the chairman of TSMC, but he gave an interview just a day or two ago and he said, “China, if you invade, like all of our plants on the island are dust, they’re worthless. There’s nothing there.” Because I can guarantee you that. I’m sure that the US Air Force would have the coordinates for every TSMC plant that it’s like, hey, we’re going to make sure that China doesn’t get them. I’m sure that TSMC, at this point, their reputation is being a pretty well-run company, very attuned to security issues. And so I’m sure that they have multiple redundancy plans and multiple security plans to address that if China is locked in. So you have to think that TSMC, all the way down to all their key suppliers and things like that, are in some type of meeting here with Nancy.
AM: Yeah. I’m not very keen on this chip sack bill. I think it’s just fireworks and stringers and ticker tape raid. But there are EPA issues to deal with when chip-making also. So no matter what, whatever they want to throw out for legislation, as long as the EPA is hampering manufacturing in the United States, manufacturing is going nowhere, at least for the next five to ten years in the United States. So this chip act, although it gives a little bit of pressure, don’t think it’s going to be that big of a driver in the next five to ten years.
TN: Okay. I want to talk to you guys a little bit about the pushback that China may give to US companies. So China already blocked a $5 billion battery investment from a Chinese company in the US. That was just announced today, and those batteries were supposed to support Tesla and Ford, I believe. Do you think China may try to hurt US companies that are in China? Could they directly take action against, say, Tesla or GM or Ford or GE or any of the American companies that are sitting in China? Do you think they could push against, say, ex-pats in China, and US ex-pats in China and make life difficult for them?
Because if we look, for example, at what happened in Russia, we have a lot of Western companies that have abandoned their operations in Russia over the last eight months. Right? Is it possible that American companies get pushback from the Chinese government?
Because if I think of what the Chinese government did to Japanese companies in 2012 if you remember that. It was very aggressive. They were instigating protests against Japanese companies, Japanese expatriates, and Japanese government officials. Could they instigate that against the US? Companies? And could they push us Companies to just give up their operations in China?
CB: Well, the only way I would rephrase that is how would that differ from normal standard operating practice? Even within the past couple of years, there’s been a massive flood of not just Americans, but all foreigners out of China. And these are everything from journalists to just basic school teachers, English teachers. Okay? So it doesn’t even matter if you’re a sensitive national or in the sensitive industry or what China deems is sensitive.
This goes for businesses as well. You heard stories about companies saying, oh, well, I have 10 million, $50 million of profits I can repatriate. I’m going to close down my China plant and go to Vietnam. And basically what they do is they just freeze everything and said, oh, you have an unpaid tax bill, coincidentally, the same amount of money that you were going to repatriate. And so they just have to walk away from everything or sell it for one dollar or something like that.
So when you talk about that, I think that’s entirely fair. I think that’s going to happen. I think the only people that are going to effectively remain there till the end are the Shells of the world that didn’t get out of Russia until the bombs and the missiles started flying. I think it’s going to be the same with China.
TN: Are you saying that you think some US companies will in the next, let’s say, two to three years, abandon their China operations? Do you think that’s feasible?
CB: Oh, yeah.
TN: Okay.
CB: I think it’s already been happening. It’s not announced. You see a couple of announcements here and there. You hear about many more talking to people that are still there. But yeah.
TN: Albert, what do you think about that?
AM: Yes, they will. There’ll be certain companies that they go after depending on whatever political calculations they can throw at the US, for sure, without question. They’ve done this. I mean, Christopher said they’ve done this in the past. Nothing new.
TN: Right. So how would that start? Would they try to push aggressively to localize leadership? I know a lot of that leadership is already localized, but would they almost make it mandatory for leadership of, say, US companies to be Chinese and then kind of cascade that through? Or what would the early phases of that look like?
AM: I think the early phases would be phantom tax violations or some kind of fines or fees that just pop up out of Chinese mountains. Who knows? Do you know what I mean? So I think that’s the first thing you’d want to look at if they start doing it.
CB: Yeah. And again, what you’re talking about, I think, is basically what’s been happening for the past couple of years is whether it’s the phantom tax bill, whether it’s all senior leadership has to be Chinese or party members or all those kinds of things. I mean, when you’re asking about that in the future, it is like, well, how would that differ from the past two to three years?
TN: Right. It feels like we’re on the precipice of that. And some of us have been talking about kind of the end of the Asian century for probably the last five to eight to ten years. And China is what seems slow, but very rapid decline in terms of its ability to grow. Not the fact that it’s not already huge, but its ability to continue to accelerate growth. That’s gone. Those days are gone. Right.
And when growth stalls out, the opportunity becomes a zero-sum game. And it’s about market share. It’s about getting your piece of the pie. Not a growing pie, but a stagnant pie. And that’s when things get very difficult in authoritarian countries. Right?
CB: Well, I think to add upon that, they were following the Asian growth model of build, in simple terms, run large trade surpluses, controlled currency, build apartments. It’s a pretty tried, true path. But one of the things that are very different is if Malaysia runs a large fiscal surplus, nobody cares. If Taiwan runs a significant trade surplus, some people care, but whatever.
For every percentage point of GDP in trade surpluses that China runs at this point when you’re the second largest economy in the world, that is a massive, massive number, not just against your economy, but against the global economy. And that’s going to create massive, massive dislocations elsewhere.
And then the other thing is that when your only source of growth is basically building apartments, and now they’ve got like 20% to 25% of these apartments all over the country, empty and household debt that is significantly above the OECD average. It doesn’t make any sense, and this is what they’re running up against. Okay.
AM: To take that a step further, it’s like if you have low growth and your economy starts in the waiver, how do you fund a growing military to combat the United States on a global level? The math doesn’t add up. Very difficult.
TN: Okay, I want to move next on to things like cyberattacks. Chris, I know that you’re very focused on kind of the IT side of what the Chinese government is doing. Can you talk us through some of the potential, maybe aggressive moves that China could take in the wake of this?
CB: Sure. So there are all kinds of things. And one of the things, you saw today where they were looking at, they shut down the Taiwanese Prime Minister’s website. But that’s, to be honest, small potatoes.
The type of thing that you would look at, and you’ve seen this a little bit in Ukraine is where they went after things like nuclear reactors and other things like that. So if you’re looking at this, one of the types of things that you would be looking at would be, for instance, Taiwan being an island, there’s a handful of spots where cables come ashore. So what would you be looking at? Because if you wanted to make it hard on Taiwan, that might be something that you would go after.
If you had the capability, and they are very likely due to some capacity, you would be looking at putting bugs in the TSMC type of production capacity. So those would be the types of things to narrow it to Taiwan. But generally speaking, if you aren’t being hacked by China, that basically just renders your place in the universe irrelevant, almost, because they’ve pretty much gone after everybody.
TN: Right. Albert, what do you think?
AM: Yeah, I mean, the Chinese are prevalent in the cyber terrorism space. They’re out there stealing trade secrets and corporate secrets all over the place, especially in the United States. And I don’t foresee that slowing down at all. If anything ramping up, and they’re good at it, and we have lacked security in the United States, and it needs to be tightened up.
TN: Right. And we intentionally, for the viewers, did not record this on Zoom. That’s an indication of some of the thoughts around there.
Now, guys, there are some islands between Taiwan and China, and there have been some potential whispers of China taking over, say, some islands, some of Taiwan’s small islands to make a statement. Do you think that’s possible?
AM: It’s possible. I don’t understand why they would try even risking that. What if they lose a few ships?
What if they lose 1000 or 2000 troops? It’s like all of a sudden you look weak and then you’re going to be forced into a position to do something bigger. It would make no sense from my perspective.
CB: The only reason I kind of disagrees is that there’s a handful of some of these very small islands, so I doubt that they have any military hardware there. And some of them are literally, I think, as close as like 10 miles off the Chinese mainland like that. They’re just that close. And so just as a symbolic act, something like that wouldn’t surprise me at all.
AM: It won’t surprise me at all. I’m just saying anything closer to the Taiwanese actual island, I would be wary of seeing the Chinese try to take them.
TN: I spent a week on one of those islands in 2009 waiting out of typhoon, and it was an experience, but I think it’s feasible. It’s an island off of Taidong, which is no, that’s on the southwest side. They wouldn’t do that. They would do it on the I was on the southeast side. They would do it on the southwest side or the northwest side. But there are lots of islands, very small islands off of Taiwan.
Okay, good. What else I think do we need to be thinking about here? There has been talking of the Biden administration removing trade tariffs and this sort of thing on China. Do you think that could be something that the administration aggressively goes after to kind of compensate China? Or do you think this would maybe solidify those tariffs?
AM: I don’t think so. Honestly, I would rather see what the rhetoric is around the oil market price cap that they’ve been talking about with G7 and the China terrorists might fall into that realm in negotiations. I would want to see what China’s reaction is to the oil cap at the moment.
CB: I’d be very skeptical at this moment of some type of tariff rollback because for them to… The White House has very badly managed this entire situation where they created a situation where if she went or if she didn’t go, they were losers. They’re not looking bad. And so if they were to roll back tariffs at this point, I think they would get they would get slaughtered, even among the Democrats at this point. So I think that’s very unlikely.
But look, Jake Sullivan is the guy that a decade ago was proposing, what do you say we walk up to China and give them back Taiwan in exchange for peace in our time? So with these guys, anything is possible.
AM: This is the worst foreign policy cabinet I have ever seen in my life. No one’s even close second at the moment. And that kind of commentary by Jake Sullivan is just unbelievable.
TN: Yeah. Okay, guys, so let me ask you kind of one final question, and you have to answer it with one of these two answers you can’t equivocate in between. Okay. The likelihood of China and the US in some sort of direct warfare engagement in the next, say, twelve months, is it closer to, say, 20% likelihood, or is it closer to 70% likelihood?
AM: 20% in my opinion.
CB: 20%.
TN: Oh, good. Okay, so do you think it’s greater than 20% or less than 20%?
AM: I’d say less than 20%. Okay. I would again say less than 20%,
CB: and I would say if you were to draw that out, 24, 36 months, I see it going up, probably steeper as time goes on.
TN: Okay, so that’s fair. So there’s a risk all around, right? We’ve got economic suffering globally. We’ve got inflation globally. We have whatever’s happening post-COVID trying to be figured out globally. We’ve got political uncertainty globally. So we’ve got risk and uncertainty everywhere. Adding a conflict to that mix would not be positive for anybody.
CB: And the one thing I would say is, even though I say less than 20%, that’s not like a firmly, deeply held conviction. Because if you’re talking about risk, I would have what I would call wide error bands in a lot of these situations. Look, we talk about, like, what is Xi going to do? Xi could say, hey, America is distracted by Ukraine. They got extra troops there. They’re shipping all kinds of weapons. Now’s the time to go to Taiwan. I don’t think people do that. That’s also not crazy to speculate. Yeah,
AM: I would have to agree with that because I never thought that Putin would try to take Kyiv with so few troops, but here we are, him making a vital mistake. And sometimes leaders make bad mistakes because they have a bunch of yes men around them. Yeah. Let me ask you one very quick question.
TN: Do you think there’s a possibility that China kind of takes it out on somebody else? Do they have a dust-up maybe with India to show strength at home while avoiding it with the US? Or something like that? Do they lash out to somebody else so that they can kind of flex muscles at home?
AM: Yeah, they could, but I mean, honestly, the Indians are not people to be trifled with, to be honest. They are itching to take on China if they show any kind of aggression. So I don’t see who they can pressure to say they’re big, bad China at the moment. I don’t even think they should be doing that. They should be figuring out their economic situation more than anything else.
TN: Xi Jinping’s role model is Mao. And Mao ultimately was a failure and a pariah in his own country by the time he died. Right. So I don’t think Xi has the sense to understand that Mao was a pariah by the time he died. And so that’s his role model who killed 60 million people through starvation and other things. So this is a problem. We have a guy in the office in China whose role model killed 60 million people directly.
AM: Yes, I understand that, Tony. The problem is the difference is that the CCP has wealthy families now that have almost equal footing as Xi in terms of power, and they can of them if they wanted to.
TN: Well, and that’s the reality, right? And that’s what nobody talks about. And that may be the backstop for a lot of this stuff.
CB: I’ll tell you this. The rumor mill among Chinese ex-pats, dissidents, et cetera, et cetera, are in hyperdrive this year. Look, it’s hard to know what to believe. It’s very hard to know what to believe. Okay? So I’m not about to push any theories, but there’s a lot of that discussion going around.
TN: Guys, this has been great. Thank you so much for doing this on such short notice. For anyone watching, please put comments below. We’ll take a look at them and we’ll watch them through the next week. If you have any additional thoughts, please let us know, and look forward to seeing how the next thanks a lot.
We had a pretty volatile week last week, with crude selling off pretty sharply early in the week. In this episode, we looked at energy backwardation, and Tracy educated us on what’s happening in those markets.
We also had some comments from Putin about a multipolar world. Albert talked through that.
And then on Friday, unfortunately, we saw the assassination of Japan’s former Prime Minister Abe. We talked about the Japan post-Abe and what that means for the region.
Key themes:
Energy backwardation
Putin’s Multi-Polar world
Japan post-Abe
What’s ahead for next week?
This is the 25th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
0:00 Start 0:54 Key Themes for the week 1:28 Catalyst of the energy sell-off on Tuesday 5:44 Will we see more action in energy prices? 6:57 Is it cost-ineffective to make hydrogen with natgas prices? 8:11 Diesel 9:20 Vladimir Putin’s multipolar world. 13:44 Japan post-Abe 20:29 What’s for the week ahead?
Listen to the podcast version on Spotify here:
Transcript
TN: Hi. Welcome to the Week Ahead. I’m Tony Nash. Thanks for joining us. I’m with Tracy and Albert today. Sam is away, but we are talking about a pretty volatile week this week. Before we get started, actually, please like and subscribe. Please ask any questions below, make any comments. We want to make sure this is interesting for you, so just let us know any additional info you want or comments. We’re happy to address those.
We had a pretty volatile week this week with crude selling off pretty sharply early in the week. So we’re going to look at energy backwardation, and Tracy is going to educate us all on what’s happening in those markets. We also had some comments out of Putin about a multipolar world. We’re going to have Albert talk through that. And then on Friday, unfortunately, we saw the assassination of Japan’s former Prime Minister Abe. So we’re going to talk about the Japan post Abe and what that means for Japan and the region.
So first let’s get into energy. Tracy, obviously, we had a big sell off in energy early in the week, and then we saw it come back later. What was really the catalyst for that energy sell off on Tuesday?
TS: What happened is that we started on July 5, right? We opened with low liquidity in the market in general. Then we saw a sell off in the general markets and commodities and risky assets that kind of exacerbated that trade. And then on the 6th, we saw a liquidation of a couple of very large positions in that market. And so fundamentally, basically, there is no reason for this sell off other than technicalities.
In fact, if we’re looking at this market, this spreads, the calendar spreads, which means month to month, were exploding higher during this entire move. That implies that the physical market at least, is very tight right now because you’re seeing backwardation increase significantly when we’re seeing a $10 move in ZZ, which is crazy.
TN: Can you tell us what that means? A $10 move in ZZ. What does that mean for the rest of us?
TS: If you’re talking about calendar schedule, we’re talking about monthly. So we can talk about the current front month is August. So we look at August, September, September to October, October to November, et cetera, et cetera. And once these spreads start exploding higher, that means that we’re seeing people want to dump oil in the front month market because that’s more lucrative than keeping it in storage.
So if I’m an investor and I’m looking and I want to invest in a backwardated market, I’m looking at a convex market that goes from right to left, and I’m going to invest in, say, a back month, and I want my investment to move higher…
TN: I’m investing further in the future.
TS: Right. That’s what it backwards. If you’re in a contangable market, we’re looking at the opposite situation, where you’re looking at a convex structure going from right to left, whereas if I invest in December, by the time my investment reaches Frontline X free, I’m losing money. I’m losing value in my investment.
TN: Right.
TS: And so that’s how we kind of have to look at that situation.
TN: Yes. You had a great tweet this week explaining that with visuals.
TS: I did. It’s on Twitter, if anyone wants to see it.
TN: Exactly. We saw this in crude. We also saw it in a natural gas. Right?
TS: Yes. We’re kind of seeing a major pullback in many of the commodities markets. Right. We’re seeing a little bit of a bounce this week because we’re looking at China. China has recently announced we have one last announcement with $200 billion bond sale rate. So we’re looking at a lot of stimulus out of China that’s giving commodities the boost. Right now, we have to see I think the markets are still going to wait on, particularly the industrial and base medical markets are going to wait until we actually see some action in China to really see investment back into these markets after this huge goal.
TN: So nobody believes the China stimulus story right now. It’s kind of a show me the money period. Right. But once they do start to show the money, do you think we’ll see much more action in energy prices?
TS: I think you’ll see more action in metal prices than you will equity prices.
TN: Copper’s way off compared to, say, the last 18 months. But it’s not way off, given historical copper prices. If we go back before, say, Q1 of 2020, it’s kind of where it had been previously in the ballpark, at least. Right. So we haven’t necessarily reverted back to pre-COVID, necessarily. We’re just in the start-stop manufacturing world, and that’s what’s affecting base metals like copper. Is that fair to say?
TS: Oh, absolutely. If you look at, like, a monthly chart rather than looking at a five-minute chart, and the market has kind of just been consolidating, really, for the last two years, until we see a really big break above, say, $5, a really big break below $3, we’re still kind of in that consolidation zone.
TN: 3.50 to 4.50 kind of range. Interesting. Okay. Sorry, Albert.
AM: Yeah. I got a question for Tracy. Nat gas, as we’re talking, since we discussed it a little bit, that’s used to make hydrogen, if I’m not mistaken, and since the nat gas price seems to be elevated, isn’t that going to be a little bit too cost-ineffective to make hydrogen, which causes a diesel problem, if I’m not mistaken? I’m not sure about that. That’s what I’m asking.
TS: No, absolutely. I think that would be a problem. Looking forward. I think there’s a lot of problems if we’re looking at the hydrogen market. There’s still a lot of problems when we’re talking about taking this idea to actual fruition. Right. Because if you look at the hydrogen market, there’s like a rainbow of green hydrogen, blue hydrogen, this hydrogen, this hydrogen. But we really haven’t gotten to the point that can overtake, not gas the allure of the situation is that you can take hydrogen, mix it with nat gas, you can send it down the same pipeline, and that saves a lot of money.
AM: Yeah.
TS: The situation is this is not a great idea in theory, but we’re just not there yet.
TN: Okay, got you. Albert’s, question about diesel. Diesel is not any less tight than it was a week or two ago. Right? In fact, that’s just as tight or tighter than it was, say, a couple of weeks ago or a month ago.
TS: Yeah, I think the diesel market is still very tight.
TN: Right.
AM: Maintenance season starts, isn’t it? From September to November?
TS: Yes, we will start maintenance seasons.
TN: Okay.
TS: I would actually look for some of these refineries to maybe put off maintenance season. So that’s what I would watch to the maintenance season happen. And it’s happened before. If we have it such a tight market, we could see them putting off maintenance seasons. It’s not unheard of.
TN: Okay, so hurricane season and maintenance season are upon us, but we may see at least maintenance season for all of us.
TS: Oh, not I just moved to Florida.
TN: Good luck with that. I’m in Texas. We don’t get as many of you, but it’ll be a fun season for you.
Okay, let’s move on, guys, to some comments out of Putin this week. Vladimir Putin had some comments about us, the multipolar world becoming more and more of reality. We heard this ten years ago. We heard this 20 years ago, and it came up again this week. So, Albert, can you kind of let us know what’s going on there?
AM: Tony, I’ve used this multipolar example for the US. Dollar dominance I got for years now. And the fact of the matter is, we are not in a multipolar world. We are not even going into multipolar world.
People are confusing a little bit of weakness in the US. Leadership and errors and decision making, foreign policy for multipolars, it’s just a multipolarity, and it’s just not the case for the world to be in a multipolar scenario, you would need multiple countries with equal militaries and economies. We are nowhere near that.
The Russian economy is 2.5 trillion. The American economy is pushing 30 trillion. This is just a joke by Vladimir Putin. Simply undermine the US dominance both in the world stage and the dollar.
TN: Aside from some dumpster pundits who write for The Atlantic or whatever, who believes that nonsense?
AM: A lot of Europhiles that want to see the United States take a step down, they can do it. A lot of crypto guys, a lot of gold guys. These guys have to make that argument, because without multipolarity, you cannot have a neutral reserve asset to settle trade. And that’s just the fact of the matter.
The problem becomes, if you have a multipolar world, you’re on the verge of another world war, because there always has to be one alpha that takes hold of the system. You just can’t have equal people.
TN: And the cost of the transaction? Cost? The cost of trade, everything goes up. If you have multiple rights go up, everything goes up.
AM: It’s completely unstable.
TS: Inflation from other countries to other countries.
AM: Yeah.
TN: The world is built on China exporting deflation. Has been for 15, 20 years. And it will continue. If they could just keep their ports open, it will continue. And it makes people happy. Right.
AM: No, you’re right. That’s just the way our system works right now, with the dollar underpinning all of it. It’s the lifeblood that makes trade work. And people are not going to like it. But I promise you, no one alive today is going to see anything other.
TN: So let me just take a step back. Who does he think the polls are? Russia, China and the US? Or Germany or something?
AM: He’s trying to make an assumption to say that Russia and China are the new contenders to the United States. The problem with that is they don’t have military power projection globally like the United States does. They can’t even invade Ukraine. China can’t even invade Taiwan. Otherwise they would have taken it if they’ve it could have. This is the world we live.
TN: Yeah. Russia can stir up problems in Libya or the Middle East or whatever.
AM: There’s no question that they can stir up problems and they can fill in gap vacuums that we leave right, unintentionally, unintentionally. But they cannot hold that territory. They cannot force changes in governments like the United States did.
TN: And every time I hear somebody talk about the Belt and Road as a sign of China’s dominance, it reminds me of Napoleon’s march to Russia. Right? I mean, they’re spreading themselves so thin. They can’t keep that up.
AM: They can’t. That’s perfect example to do that, to make that thing actually successful, you need to back that up to secure your trade line, trade with the military. Right. China has like, what, two military bases outside of China? Like one in Djibouti and something else. I mean, they can’t send ships over to their armor.
TN: Myanmar.
AM: Yeah. This is beyond a joke to me. I don’t take anybody seriously that even brings this part up, right. Vladimir Putin included.
TN: That’s good. So anybody watching this, if you have an alternative view, let us know in the comments. Honestly, we’d love to hear it. We just want to hear some credible.
TS: Put your notes in the comments.
TN: Yes, absolutely. Okay. Now, finally today I woke up in the US to the really tragic news of Japan’s foreign Prime Minister Abe, being assassinated.
I saw Abe in his first stint as PM in the mid 2000s. And then when he came back in, in 2013, and with the Abenomics plan, which was really difficult to pull off, ultimately successfully. The guy was smart. He was all about Japan. He’s all about Japan recovering, all about Japan being competitive. I put a picture up of Abe shaking hands with Prime Minister Modi of India. Japan and India were very tight. A lot of Japanese investment going to India, a lot of partnership across those two countries and in Africa, both to defend against China in Asia and other parts of the world. So Prime Minister Abe will be missed.
I think what Abe did partly was bring back Japan’s ability to defend itself by passing a constitutional change that allowed the Japanese military to defend itself where previously it wasn’t even allowed to do that. So there’s a lot of dignity that Japan kind of got back, and we can rub Japan’s nose in World War II for eternity, but it’s not going to be constructive. What happened, happened. They’ve paid their dues, and that’s kind of what Abe said, look, we paid our dues, we’re going to move on now and join the 21st century. And that’s what Japan did.
So I’m just curious to get your thoughts, guys, on Japan post Abe. What do you see as of course they moved on to another prime minister. Japan has already moved on from the Abe government. He wasn’t a sitting prime minister. But what do you see kind of the challenges of Japan’s role in Asia particularly, but also in the world post Abe?
AM: I think the most pressing issue for Japan would be contending with China, both militarily and economically. Abe was, like you said, brilliant statesman and patriot for the Japanese people. So he’s going to be sorely missed. And it’s not just he’s going to be missed, but his cabinet and the people that his network is going to be missed because they’re losing a big part of what he brought to the table in terms of strategy and ideology. It was a big shift.
I think that the Japanese are probably going to struggle for strategy in the next five to ten years. And it’s a sad thing, but I’m sure the Japanese, they’re resilient people and they’ll move on and they’ll recover.
TN: Tracy?
TS: No, I absolutely agree with what Albert said. I think the thing is that people are painting him, the media right now, in particular the Western media, painting them with some villain, which is very interesting to me. And I think that people should really just look at his legacy and respect what he’s done instead of jumping on the bandwagon.
TN: So they’re portraying him as some ultra nationalist, but he’s as ultra nationalist as Modi as in India, or Jokowi is in Indonesia, or Lee is in Singapore, you name it. Tsai Ing-wen in Taiwan. It’s an Asian direction now. Right. And has been for the last ten to 15 years.
AM: Yeah. The media also, Tony, is desperate to not allow any center right or even right nationalist figures be murderers or looked up upon. They just can’t stomach it. They just can’t help themselves to demonize a person that is absolutely unjustifiably demonized by being called an ultra-nationalist and even worse, by the NPR.
NPR had two other headlines that they had to delete because it was just so atrocious. This is a.. And Modi, Abe, I don’t want to put Victor Orban into that, but all these right leaning leaders just get attacked and the media can’t help it.
TN: Right, yeah. I think from an economic plan, if we look at what Abe did with Abenomics, of course, the Japanese Central Bank is kind of “independent,” right. But they really took the JPY from kind of 76 to the dollar to, say, 120 to the dollar, and it really allowed Japanese manufacturing to be competitive again. Right.
And it took somebody with that clarity of economic vision, as well as the clarity of, say, the military vision and political vision, to be able to pull off what they did. And in terms of, say, energy sustainability under Abe, they also created much deeper relationships in the Middle East with places like Qatar, UAE.
TS: And they also looked forward to nuclear, where you looked at the west was looking to shut things down, Abe was looking to invest in nuclear projects. You’re looking for energy security, energy going forward. There are a lot of things that he did to advance that sector in Japan, which is admirable.
TN: Right. Albert if we take a US perspective on this? The US has worked hard to kind of hold a line against China. Do you think with the mediocre leadership we have in the US right now, do you think it’s possible that some of that US say coalition falls apart a little bit? Or do you think we just kind of take a breather and then it resumes based on the institutional stamina of parts of the Japanese government?
AM: That’s a great question, Tony. That’s actually a really good question. And I think where we have to look for we have to separate the Biden foreign policy cabinet with the Pentagon. Because the Pentagon is actually leading this charge for the Pacific with Japan and Australia in charge. I really don’t think that the Japanese are going to take a step back or the US is going to take a step back. I think the system is pretty much, the train has already left the station and it’s rolling.
There might be an argument from the opposition in Japan, but I don’t think. That it’s going to take hold to derail this new initiative by the US and the Pacific.
TN: Great, that’s good to hear. Okay, guys. Hey, on that somber note, we’ll end it, but let’s look at the week ahead. Guys, what are you looking for in the week ahead? We’ve had this real turnaround this week. What do you see going into next week? Do you see things calming a bit?
We saw it coming into Friday. Things really turn up in US markets and in commodity markets. Do we see things stabilizing a bit going into the Fed meeting after we’ve had some Fed comments late this week?
AM: I want to see the comments of where they might signal a 50 basis point rate hike versus a 75. I absolutely believe 75 points is coming just from the jobs data that they posted. It was obviously massaged a little bit.
TN: Just a little bit.
AM: Of course it is. Yeah, but this was a good one. And then the revision too, and it just seems to me that they want another 75 basis point rate hike.
TN: To really kill it?
AM: They got to tackle inflation. I mean, they’re looking at 8.8 on the next CPI, which is just.. And you’re staring on the barrel at 9% and 9.2 and 9.3 in the coming months, which is absolutely a political nuclear bomb that goes off.
TN: Okay, Tracy, what are you looking for in the next week especially in commodities?
TS: Yeah, I mean, I agree we probably will see 75 after non farm payroll this week, which I was looking for a clue kind of are we going to get 50, are we going to get 75? It looks like 75 for sure.
So looking in the coming weeks, I’m really looking to China right now and to see what comes to fruition with these sort of stimulus plans. What does that do to the base in industrial medals markets? And I think those are the two things that you should be focusing on right now, particularly if you’re invested in commodities markets.
TN: Very good. Okay. Yeah. I’m kind of hoping they give in to 50, but I’m not hopeful. I do think they’ll on the kind of conservative hawkish side and go 75. But if they can pick up the bat phone and talk to China, and the China guys will unload a dump truck of cash over the next week or so, then I think they’ll be a little bit lighter and do 50 basis points. But I think a lot of it depends on China ECB. They can’t get their act together, so there’s nothing ECB can do to really help.
And Europe is in so much trouble that it doesn’t really matter what they do. They have huge problems anyway. So. I think you’re right. And tell me what you think about this. But I don’t necessarily think we see massive chop. I think we see just a lot of fairly sideways moved for the next week or so.
AM: I would be wary if we jumped up to 4000 or even, like, 3970. I think a rug pull would be in an order right after that. That’s what they do. They bowl everybody up and then pull the rug out.
TN: Tracy?
TS: Yeah. After this big move down in the oil market, in particular, because we did have sort of a flow event coupled with a couple of large funds kind of workforce to liquidate. So I could see that we still could go a little bit higher next week. Sideways to higher next week.
TN: Very good. Okay, guys, be interesting to see. Thanks for joining us. Thanks very much. Have a great weekend. And have a great week ahead.
TN: Very good. Thank you, guys.
AM: I struggle with the headache through that whole thing.
MG: The Lead Lag Report joining us for the hour here is Tony Nash of Complete Intelligence has found a lot of people that I respect following. Tony, I saw a few people saying they were excited to hear what Tony has to say. So hopefully we’ll have a good conversation here.
Tony for those who aren’t familiar with your background talk about who you are how’d you get involved in the data side of markets and forecasting in general. And what you’re doing with Complete Intelligence.
TN: Sure, Michael. First of all, thanks for having me. I have followed you for probably 10 or 15 years.
MG: I am very sorry for that I am very very sorry for that.
TN: But yeah so, I got involved in data way back in the late 90s when I was in Silicon Valley and I built a couple of research firms focused on technology businesses. I then took about probably eight years to become an operator. I did a turnaround in Asia of a telecom firm. I built a firm in Sri Lanka during the Civil War and then I started down the research front again. I was the Global Head of Research for the Economist and I was the Asia Head of Consulting for a company called IHS Markit which is now owned by S&P and then after that I started Complete Intelligence.
So, you know my background is really all about data but it’s also all about understanding the operational context of that data. And I think it’s very hard for people to really understand what data means without understanding how people use it.
MG: Okay. So that’s maybe a good direction to start with that point about context with data because I think part of that context is understanding what domains data is more appropriate for forecasting and others. Right? So, I always made this argument that there are certain domains in particular when it comes to, I would argue investing that have sort of a chaotic system element to them. Right? Where small changes can have ripple effects. So, it’s hard to necessarily to sort of make a direct link between a strong set of variables and the actual outcome because there’s always a degree of randomness. Whereas, something that’s more scientific right that doesn’t have that kind of chaos theory element is it’s clearer.
So, talk about that point about context when it comes to looking at data. And again, the kind of domains where data is more appropriate to really have more conviction in than others.
TN: Yeah. Okay. So, that’s a great place to start. So, the first thing I would say is take every macro variable that you know of and throw it out the window. It’s all garbage data 100 of it. Okay? I would never trade based on macro data.
We’ve tested macro data over the years and it’s just garbage. It doesn’t matter the country. You know we hear people saying that China makes up their data. Well, that may be true you can kind of fill in the blank on almost any country because I don’t know how much you guys understand about macro data. But it is not market clearing data. Okay? Like an equity price or a commodity price.
Macroeconomic data is purely academic made-up data that is a proxy for activity. It’s a second or third derivative of actual activity by the time you see, say, a CPI print which is coming out tomorrow. Right? And it’s late and it’s really all not all that meaningful. So, I wouldn’t really make a trade or put a strategy together based on macro data even historical macro data. Every OECD country revises their data by what four times or something.
So, you see, a print for CPI data tomorrow that’s a preliminary print and that’s revised several times before it’s put on quote-unquote actual. And so, you know, you really can’t make decisions using macroeconomic data beyond a directional decision. Okay? So, if you follow me on Twitter, you see I’m very critical macro data all the time. I’m very sarcastic about it.
I think the more specific you can get… You know if you have to look at say national data or macroeconomic data, I would look at very low-level data the more specific you can get the better. Things like household surveys or you know communist and socialist countries. Chinese data at the very specific level can be very interesting. Okay? Government data the high-level data in every country I consider it garbage data in every country. So, you’re looking at very low-level very specific government or multilateral data, that’s interesting.
The closer you get to market clearing data the better because that’s a real price. Right? A real price history on stuff is better and company data is the best. And of course, company data is revised at times but that really helps you understand what’s happening at the kind of firm level. And what’s happening at the transaction level. So, you know, those are the kind of hierarchies of data that I would look at.
MG: So, okay this is a great. That’s a great point you mentioned that it’s you said very these variables is macro variables they’re proxies for activity. Right? They’re really more proxies for narratives. Right? Because and that’s where I think… You mentioned sarcasm almost 99 of my tweets at this point are sarcasm because when Rome is burning, what else I’m not going to do except joke about it. Right? Because I can’t change anything. Right?
So, and to that point I share a lot of that cynicism around data that people will often reference in the financial media that sounds really interesting, sounds like it’s predictive but when you actually test it to your point, you throw it out because it doesn’t work. Right? There’s no real predictive element to it.
So, we’ll get into some of the predictive stuff that you talk about but I want to hit a little bit on this market clearing phrase you kept on using. Explain what you mean by market clearing.
TN: Data is where there is a buyer and a seller.
MG: To actual prices of some asset class or something like that.
TN: Yep. That’s right.
MG: Okay. So, that makes sense. Okay. Now again I go back to the certain domains that data is more clear in terms of cause and effect and getting a sense of probabilities the challenge with markets. As we know is that the probabilities change second by second because not only does that mean meaningless data change second by second but the market clearing data changes second by second. Right? Going back to that point.
So, with what you do with Complete Intelligence, talk us through a little bit. What are some of the variables that you tend to find have some predictive power? And how do you think about confidence when it comes to any kind of decision made based on those variables?
TN: Sure. Okay. So, before I do that let me get into why I started Complete Intelligence because if none of you have started a firm before don’t do it. It’s really really hard so…
MG: From the people in the back because I got to tell you I’m an entrepreneur, I’m going through. And all you got is people on Twitter kicking you when you’re down when it’s the small sample anyway.
TN: Absolutely. So, I was where I had worked for two very large research firms The Economist and IHS Markit. And I saw that both of them claimed to have very detailed and intricate models. Okay? Of the global economy industries, whatever. Okay? For all of the interior models. And I have never spoken with a global research firm a data firm that is different from this. And if I’m wrong then somebody please correct me. But at the end of that whole model pipeline is somebody who says “no that’s a little bit too high” or “a little bit too low” and they change the number. Okay? To whatever they wanted it to be in the first place. So, and I tell you 100% of research firms out there with forecasts today have a manual process at the end of their quote-unquote model. A 100% of them. Again, if there’s somebody else that doesn’t do that, I am happy to be corrected. Okay? But I had done that for a decade and I felt like a hypocrite when I would talk to clients.
So, I started Complete Intelligence because I wanted to build a 100% machine driven forecasts across economics, across market, across equities, across commodities, across currencies. Okay? And we’ve done that. So, we have a multi-phase, multi-layer machine learning process that takes in billions of data items. We’re running trillions of calculations every week when we reforecast our data. Right? Now the interval of our forecast is monthly interval forecast. So, if people looking at daily prices that’s not what we’re doing now. Okay? We will be launching daily interval forecasts. I would say probably before the end of the year to be conservative but we’re doing monthly interval forecasts now.
Why is everything I’ve said is meaningless unless we measure our error. Okay? So, for every forecast that we do. And if you log into our website, you can see whether it’s the gold price, the S&P 500, USD, JPY, molybdenum or whatever. We track our error for every month, for everything that we do. Okay? So, if you want to understand your risk associated with using our data it’s there right in front of you with the error calculations. Okay? It’s only fair, If I’m gonna say sell you a forecast, you should be able to understand how wrong we’ve been in the past, before you use that as a decision-making input.
MG: Well, maybe just add some framework on that because I think that’s interesting. So, what you call error I call luck. Right? Because luck is both good or bad. I always make that point that with any equation any set of variables you’re going to have that error is the luck component that you can’t control. And that doesn’t necessarily mean that the equation is wrong. Right? It’s just means that for whatever reason that error in that moment in time was higher or lower than you might otherwise want. Okay?
TN: There is no such thing as zero error. And anybody who tells you that they have zero error is obviously they’re an economist and they don’t understand how markets work. So, there is always error in every calculation.
So, the reason we track error is because that serves as a feedback loop into our machine learning process. Okay? And we have feedback loops every week as we and what we’re doing right now is every Friday end of day. We will download global data process over the weekend have a new forecast on Monday morning. Okay? And so all of that error whether it’s near-term error, short-term error or say medium-term error, we feed that all back in to help correct and understand what’s going on within our process. And we have like I said, we have a multi-phase process in our machine learning platform. So, error is simply understanding the risk associated with using with using our platform.
MG: Right, which is basically how apt is a thing that you’re forecasting to that error which is again luck good or bad. I’m trying to put in sort of a qualitative framework also because I think… Yeah, there’s errors in life obviously, too. Right? And so, when they’re good or bad. But you know those elements.
TN: Right. But here’s what I would and I don’t know, I don’t want to dispute this too much but I think there is. So, you use the word luck and that’s fine but I think luck has a bit to do with the human element of a decision. Okay? We’re using math and code there’s zero human interaction with the data and with the process. And so, I wouldn’t necessarily call it luck. I mean, it literally is error like our algorithms got it wrong. So, if you want to call luck that’s absolutely fine but I would say luck is more of a human say an outcome associated with a human decision. More than something that’s machine driven that’s iterating. Again, we’re doing trillions of calculations every week to get our forecasts out there.
MG: Yeah, no that’s fair and maybe for the audience, Tony. Explain what machine learning is now.
TN: Sure.
MG: I once developed an app called “How Edition”. I was having dinner with the head developer once and he said he just came back from a conference about machine learning and he was just basically well, having drinks with me laughing and joking saying everybody use this term machine learning but it’s really just regression analysis. Right? So, talk about machine learning what is actual machine learning? How important is recent data to changes in the regression? Because I assume that’s part of the sort of dynamic nature of what you do just kind of riff on that for a bit.
TN: Okay. So, when I first started Complete Intelligence, I was really cynical about AI. And I spoke to somebody in Silicon Valley and asked the same question: what is AI? And this person said “Well AI is everything from a basic I say, quadratic equation upward.” I’m not necessarily sure that I agree that something that simple would be considered artificial intelligence. What we’re really doing with machine learning is there are really three basic phases. Okay? You have a preprocess which is looking at your data to understand things like anomalies, missing data, weird behavior, these sorts of things. Okay? So, that’s the first phase that we look at to be honest that’s the hardest one to get right. Okay?
A lot of people want to talk about the forecasting methodologies and the forecasting algorithms. That’s great and that’s the sexy part of ML. But really the conditioning and the pre-process is the is the hardest part and it’s the most necessary part. Okay? When we then go into the forecasting aspect of it, we’re using what’s called an ensemble approach. So, we have a number of algorithms that we use and let’s say they’re 15 algorithms. Okay? That we use we’re looking at a potential combinatorial approach of any individual or combination of those algorithms based on the time horizon that we’re forecasting. Okay?
So, we’re not saying a simple regression is the way to go we’re saying there may be a neural network approach, there may be a neural network approach in combination with some sort of arima approach. We’re saying something like that. Right? And so, we test all of those permutations for every historical period that we’re looking at.
So, I think traditionally when I look back at kind of quote-unquote building models in excel, we would build a formula and that formula was fairly static. Okay? And every time you did say a crude oil forecast you had this static formula that you set your data against and a number came out. We don’t have static formulas at all.
To forecast crude oil every single week we start at obviously understanding what we did in the past but also re-testing and re-weighting every single algorithmic approach that we have and then recombining them based upon the activity that happened on a daily basis in that previous week. And in the history. Okay?
So, that’s phase two the forecasting approach and then phase three is the post process. Right? And so, the post process is understanding the forecast output. Is it a flat line? Right? If it’s a flat line then there’s something wrong. Is it a straight line up? Then that there’s something you know… those are to use some extremes. Right? But you know we have to test the output to understand if it’s reasonable. Right? So, it’s really an automated gut check on the reasonableness of the outcome and then we’ll go back and correct outliers potentially reforecast and then we’ll publish. Okay?
So, there are really three phases to what we do and I would think three phases to most machine learning approaches. And so, when we talk about machine learning that’s really what we’re talking about is that that really generally three-phase process and then the feedback loop that always goes back into that.
MG: Yeah. No that makes sense. Let’s get…
TN: That’s really boring after a while.
MG: No, no, no but I think that’s it’s part of what I want to do with these spaces is try to get people to understand you know beyond sort of just the headline or the thing that is thrown out there. As a term to what does that actually mean in practice you don’t have to know it fully in depth the way the that you do. But I think having that context is important.
TN: I would say on the idea generation side and on the risk management side right now. Okay? Now the other thing that I didn’t cover is obviously we’re doing markets but we also do… we use our platform to automate the budgeting process within enterprises. Okay? So, we work with very large organizations and the budget process within these large organizations can take anywhere from say four to six months. And they take hundreds of people. And so, we take that down to really interacting with one person in that organization and we do it in say less than 24 hours. And we build them a continuous budget every month.
Once accounting close happens we get their new data and then we send them a new say 18-month forward-looking forecast for them. So, their FPA team doesn’t have to dig around and beg people for information and all that stuff. So, some of this is on the firm event could be on the firm evaluation side, as well. Right? How will the firm perform? Nobody’s using us for that but the firms themselves are using that to help them automate their budgeting process. So, some of that could be on this a filtering side and the idea generation side, as well.
So, we do not force our own GL structure onto the clients. We integrate directly with their SAP or Oracle or other ERP database. We take on their GL structure at whatever levels they want. We have found that there is very little deterioration from say, the second or third level GL to say the sixth or seventh level GL, in terms of the accuracy of our forecast. And when we started doing this it really surprised me. We do a say a team level forecast for 10, 12 billion organizations, six layers down within their GL. And we see very little deterioration when we go down six levels than when we do it at say two levels. Which is you know it really to me it speaks to the robustness of our process but would we consider Anaplan a competitor not really, they’re not necessarily doing the kind of a budget automation that we’re doing at least, that I’m aware of. I know that there are guys like Hyperion who do what we’re doing but again their sophistication isn’t necessarily. What we’re doing and they do a great job and Hyperion is a great organization. I think Oracle gave them a new name now but they’re not necessarily using the same machine learning approaches that we’re using. And our clients have told us that they don’t get the same result with using that type of say ERP originated or ERP add-on budgeting process.
Yep. So, I would say we can’t we can do company-specific information for a customer if that’s what they want. Okay? We don’t necessarily have that on our platform today aside from say individual ticker symbols. Okay? But we’re not forecasting say the P&L of Apple or something like that or the balance sheet of Apple. Something we could do in a pretty straightforward manner but we do that on a customer-by-customer basis.
So, what we’re forecasting right now are currency pairs, commodities about 120 commodities and global equity indices. Okay? We are Beta testing individual equity tickers and we probably won’t introduce those fully on the platform until we have our daily interval forecast ready to go to market. But those are still we’re still working some kinks out of those and we’ll have those ready probably within a few months.
MG: Okay. So, let’s talk about commodities here for a bit tonight. Obviously, this is where a lot of people’s attention has gone to. What kind of variables and I know you said you have a whole bunch of variables that are being incorporated here but are there certain variables in particular when it comes to oil and other commodities that have a higher predictive power than others.
TN: There are I think one of the stories that I tell pretty often and this really shocks people is when we look at things like gold. Okay? I’m not trying to deflect from your oral question but just to you know we’ve spoken with the number of sugar traders over the years. Okay? And so, we tell them that say the gold price and the sugar price there may not necessarily be a say short term say correlation there but there is a lot of predictive capability there and we talk them through why. And I think the thing that we get out of the machine learning approach and we cast a wide net. We’re not forcing correlations is that we’ll find some unexpected say drivers. Although drivers implies a causal nature and we’re not trying to imply causality anywhere. Okay?
We’re looking at kind of co-movement in markets over time and understanding how things work in a lead lag basis with some sort of indirect causality as well as say a T0 or current state movement. So, with crude oil you know there are so many supply side factors that are impacting that price right now, that I can’t necessarily point to say another commodity that is having an impact on that. It really is a lot of the supply side and sentimental factors that are impacting those prices right now.
MG: That makes a lot of sense. And I’m curious how did you mention it’s I think the intervals once a month. Right? So, given the speed with which inflation has moved and yields have moved how does a machine learning process adapt to sudden spikes or massive deltas in in variable movement. Right? Because there’s always a degree of randomness going back to error. Right? And you can make an argument that the larger move is the that may actually be more error but I think that’s an interesting discussion.
TN: So, I’ll tell you where we were say two years ago when 2020 hit versus today. Okay? So, in March of 2020, April 2020 everything fell apart. I don’t think there were any models that caught what was going to happen. It was an exogenous event that hit markets and it happened very quickly. So, in June, I was talking with someone who is with one of the largest software companies in the world and they said “Hey has your AI caught up to markets yet because ours is still lost” And you guys would be shocked if I told you who this was because you would expect them to know exactly what’s going to happen before it happened. Okay? I’ll be honest I think it was all of them but the reality is you know Michael you where you were saying that ML is just regression analysis.
I think a lot of the large firms that are doing time series forecasting really are looking at regression and derivatives of regression as kind of their only approaches because it works a lot of the time. Right? So, we had about a two-month delay at that point and part of it was because… So, by June we had caught up to the market. And we had started in February to iterate twice a month, we were doing once a month; I hope you guys can understand with machine learning two factors are we’re always adjusting our algorithms. Okay? We’re always incorporating new algorithms. We’re always you know making sure that we can keep up with markets because you cannot be static in machine learning. Okay? The other thing is we’re always adding capacity why? Because we have to iterate again and again and again to make sure that we understand the changes in markets. Okay?
So, at that time we were only iterating twice a month and so it took us a while to catch up. Guys like this major technology firm and other major technology firms they just couldn’t figure it out. And I suspect that some of them probably manually intervened to ensure that their models caught up with markets. I don’t want to accuse any individual company but that temptation is always there. Especially, for people who don’t report their error. The temptation is always there for people to manually intervene in their forecast process. Okay?
So, now, today if we look for example at how are we catching changes in markets. Okay? So, if I look at the S&P 500 for April for example, our error rate for the S&P 500 for April I think was 0.6 percent. Okay? Now in May it changed it deteriorated a little bit to I think four or six percent, I’m sorry I don’t remember the exact number offhand but it deteriorated. Right? But you know when there are dramatic changes because we’re iterating at least once a week, if not twice a week we’re catching those inflections much much faster. And what we’re having to do, and this is a function of the liquidity adjustments, is where in the past you could have a trend and adjust for that trend and account for that trend. We’re really having to our algorithms are having to select more methodologies with recency bias because we’re seeing kind of micro volatility in markets. And so again…
MG: So, kind of like the difference between a simple moving average versus like an exponential moving average. Right? Where you’re waiting the more recent data sooner.
TN: It could be. Yeah.
MG: Right.
TN: Yeah. That’s a very very simple approach but yeah it would be something like that, that’s right. Yeah. What so when we work with enterprise customers that level of engagement is very tight because when we’re getting kind of the full set of financial data from a client obviously, they’re very vested in that process. So, that’s different from say a small portfolio manager subscribing to RCF futures product where we’re doing forecasts and they have their own risk process in place. And they can do whatever they want with it. Right? But again, with our enterprise clients we are measuring our error so they can see the result of our continuous budgeting process. Okay?
So, if we’re doing let’s say, we launch with a customer in May, they close their mate books in June get them over to us redo our forecast and send it over to them and let them know what our error rate was in May. Okay? So, they can decide how we’re doing by department, by team, by product, by whatever based upon the error rates that we’re giving at every line item. Okay? So, they can select and we’re not doing kind of capital projects budgets we’re doing business as usual budgets so they can decide what they want to take and what they don’t want to take. It’s really up to them but we do talk through that with them and then over time they just start to understand how we work and take it on within their own internal process.
MG: So, back a little bit Tony. So, you mentioned you do this machine learning forecasting work when it comes to broad economics, markets and currency; of those three which has the most variability and randomness in other words which tends to have a higher error? Whenever you do any kind of machine learning to try to forecast what comes next?
TN: I would say it depends on the equity market but probably equity markets when there are exogenous shocks. So, our error for April of 2020 again, we don’t hide this from anybody it was not good but it wasn’t good for anybody. Right? And so, but in general it depends on the equity market but some of the emerging equity markets, EM equity markets are pretty volatile.
We do have some commodities like say rhodium for example. Okay? Pretty illiquid market, pretty small base of people who trade it and highly volatile. So, something like rhodium over the years our air rates there have not necessarily been something that we’re telling people to use that as a basis to trade but obviously, it’s a hard problem. Right? And so, we’re iterating that through our ML process and looking at highly volatile commodities is something that we focus on and work to improve those error rates.
MG: Here, I hope you find this to be an interesting conversation because I think it’s a part of the of the way of looking at markets, which not too many people are themselves maybe using but is worth sort of considering. Because I always make a point that nobody can predict the future but we all have to take actions based on that unknowable future. So, to the extent that there might be some data or some conclusions that at least are looking at variables that historically have some degree of predictive power. It doesn’t guarantee that you’re going to necessarily be better off but at least you have something to hang your hat on. Right? I think that’s kind of an aspect to investing here.
Now, I want to go a little bit Tony to what you mentioned earlier you had lived abroad for a while in Europe. And when I was starting to record these spaces to put up on my YouTube channel the first one, I did that on was with Dan Arvis and the topic of that space was around this sort of new world order that seemed to be shaping up. I want you to just talk from a geopolitical perspective how you’re viewing perhaps changing alliances because of Russia, Ukraine. And maybe even dovetail that a little bit into the machine learning side because geopolitics is a variable. Which is probably quite vault in some periods.
TN: Yeah, absolutely. Okay. So, with the evolving geopolitical order I would say rather than kind of picking countries and saying it’s lining up against x country or lining up with x country or what country. I would say we’ve entered an era of opportunistic geopolitics. Okay? We had the cold war where we had a fairly static order where people were with either red team or blue team. That changed in the 90s of course, where you kind of had the kind of the superpower and that’s been changing over the last say 15 years with say, China allegedly becoming kind of stronger and so on and so forth. So, but we’ve entered a fairly chaotic era with say opportunistic macroeconomic relation or sorry, geopolitical relationships and I think one of the kinds of top relationships that is purely opportunistic today is the China-Russia relationship.
And so, there’s a lot of talk about China and Russia having this amazing new relationship and they’re deep. And they’re gonna go to war together or whatever. We’ve seen over the past say three, four months that’s just not the case. And I’ve been saying this for years just for a kind of people’s background. Actually, advised the Chinese government the NDRC which is the economic planning unit of the central government on a product or on an initiative called the belt and road initiative. Okay? I did that for two years. I was in and out of Beijing. I never took a dime for it. I never took expense reimbursement just to be clear, I’m not a CCP kind of pawn. But my view was, if the Chinese Government is spending a trillion dollars, I want to see if I can impact kind of good spend for that. So, I have seen the inside of the Chinese Government and how it works and I also in the 80s and 90s spoke Russian and studied a lot on the Russian Government and have a good idea about how totalitarian governments work.
So, I think in general if we thought America first was offensive in the last administration then you really don’t want to learn about Chinese politics and you really don’t want to learn about Russian politics because they make America first look like kindergarten. And so, whenever you have ultra-ultra-nationalistic politics, any diplomatic relationship is an opportunistic relationship. And I always ask people who claim to be China experts but say please tell me and name one Chinese ally. Give me one ally of China and you can’t, North Korea, Pakistan. I mean, who is an ally of China there isn’t an ally of China. There is a transactional opportunistic relationship with China but there is not an ally with China.
And so, from a geopolitical perspective if you take that backdrop looking at what’s happening in the world today it makes a whole lot more sense. And a lot of the doomsayers out there saying China is going to fall and it’s going to have this catastrophic impact. And all this other stuff, the opportunism that we see at the nation-state level pervades into the bureaucracy. So, the bureaucracy we hear about Xi Jinping. And Xi Jinping is almost a fictional character. I hate to be that extreme on it but there is the aura of Xi Jinping and there is the reality of Xi Jinping, just a guy, he’s not Mao Zedong. He doesn’t have the power that supposed western Chinese experts claim that he has. He’s just a guy. Okay?
And so, the relationships within the Chinese bureaucracy are purely transactional and they are purely opportunistic. So again, if you take that perspective and you look at what’s happening in geopolitics, hopefully you can see things through a different lens.
MG: Now, I’m glad you’re framing that in those terms because I think it’s very hard for people to really understand some of these dynamics when it’s almost presented like a like the story for a movie. Right? For what could be a conflict to come by the media because and it’s almost overly simplified. Right? When you hear this type of talk. So again, I want to go back into how does that dovetail into actual data. Right? Maybe it doesn’t at all. When you have some of these dynamics and you talk about market clearing data, you’re going to probably see mark movement somewhat respond off of geopolitical changes. Talk about anything that you’ve kind of seen as far as that goes and how should investors consider geopolitical risk or maybe not consider geopolitical risk?
TN: Yeah, I think, well when you see geopolitical adjustments today all that really is… I don’t mean overly simplified but it’s a risk calibration. Right? So, you know Russia invades Ukraine, that’s really a risk calibration. How much risk do we want to accept and then what opportunities are there? Right?
So, when you hear about China, you have to look at what risk is China willing to accept for actions that it takes? Keeping in mind that China has a very complicated domestic political environment with COVID shutdown, lockdowns and all of this stuff. So, having worked with and known some really smart Chinese bureaucrats over the years, these guys are very concerned with the domestic environment. And I don’t although there are idiot you know generals and economists here and there who say really stupid stuff about China should take over TSMC and China should invade Taiwan, these sorts of things. My conversations over the years have been with very pragmatic and professional individuals within the bureaucracy.
So, do I agree with their policies? Not a lot of them but they are well thought out in general. So, I think just because we hear talk from some journalist in Beijing who lives a very sheltered life about some potential thing that may happen. I don’t think we necessarily need to calibrate our risk based on the day-to-day story flow. I think we need to look at like… so there’s a… I’m sure you all know who Leland Miller is in China beige book like?
MG: Yeah, he’s not too long ago.
TN: Yeah. He has a proxy of the Chinese economy and that’s a very interesting way to look at an interesting lens to look through China or through to look at China or whatever. But so, I think that the day-to-day headlines, if you follow those, you’re really just going to get a lot of volatility but if you try to understand what’s actually happening, you’ll get a clearer picture. It’s not necessarily a connection of a collection of names in China and the political musical chairs, it’s really asking questions about how does China serve China first. What will China do to serve China first and are some of these geopolitical radical things that are said do they fit within that context of China serving China first? So, that’s what I try to look at would I be freaked out if China invaded Taiwan? Absolutely. I think everybody would right but is that my main scenario? No, it’s not.
MG: In terms of the data inputs on the machine learning side how granular is the data meaning? Are you looking at where geographically demand might be picking up or is it simply this is what the price is and who cares the source? Because again with hindsight if you knew that the source of China and kind of had a rough sense of the history of Russia-Ukraine maybe that could have been an interesting tell that war was coming.
TN: Yes or No. To be honest it had more to do with the value of the CNY. Okay? And I’ll tell you a little bit about history with the CNY. We were as far as I know, the only ones who called the CNY hitting 6.7 in August of 2019 with a six-month lead time. And so, we have a very good track record with USD-CNY and I would argue that China’s buying early in 2022 had a lot more to do with them from a monetary policy perspective needing to devalue CNY. So, they were hoard buying before they could devalue the CNY and I think that had a lot more to do with their activity than Russia-Ukraine. Okay? And if you notice they’ve made many of their buys by mid-April and once that happened you saw CNY, go to 6.8. Right? It’s recovered a little bit since then but China has needed to devalue the CNY for probably at least nine months. So, it’s long overdue but they’ve been working very hard to keep it strong so that they could get the commodities they needed to last a period of time. Once they had those commodities, they just let the parachute go and they let it do value to 6.8 and actually slightly weaker than 6.8.
MG: The point of the devaluation is interesting. I feel if I had enough space but we were talking about the Yen and what’s happened there. And this observation that usually China will start to devalue when they see the end as itself going through its own devaluation.
How does some of those cross correlations play out with some of the work that on machine learning you’re doing? Because there’s a human element to the decision to devalue a currency. Right? So, the historical data may not be valid I would think because you might have kind of a more humanistic element that causes the data to look very different.
TN: Well, they’re both export lab economies. Right? And we’ve seen a number of other factors dollar strength and we’ve seen changing consumption patterns. And so, yes when Japan devalues you generally see China devalue as well but also, we’ve seen a lot of other activities in on the demand-pull side and on the currency side especially with the US dollar in… I would say over the last two quarters. So, yes, that I would say that the correlation there is probably pretty high but there are literally thousands of factors that contribute to the movement of those of those currencies.
MG: Is there anything recently Tony in the output that machine learning is spitting out that really surprises you? That you know… And again, I understand that there’s a subjective element which is our own views on the world and of course then the pure data. But I got to imagine it’s fascinating sometimes if you’re sitting there and seeing what’s being spit out if it’s surprising. Is there anything that’s been kind of an outlier in in the output versus what you would think would likely happen going forward?
TN: Yeah. You know, what was really surprising to me after we saw just to stick on CNY for a minute because it’s the first thing that comes to mind, when we saw CNY do value to 6.8. I was looking at our forecast for the next six months. And it showed that after we devalued pretty strong it would moderate and reappreciate just a bit. And that was not necessarily what I was hearing say in the chatter. It was kind of “okay, here we go we’re going to go to seven or whatever” but our data was telling us that that wasn’t necessarily going to happen that we were going to hit a certain point in May. And then we were going to moderate through the end of the year. So, you know we do see these bursty trends and then we see you know in some cases those bursty trends continue for say an integer period. But with CNY while I would have on my own expected them. I expected the machines to say they need to keep devaluing because they’ve been shut down and they need to do everything they can to generate CNY fun tickets. The machines were telling me that we would you know we’d see this peak and then we would we would moderate again and it would kind of re-appreciate again.
So, those are the kind of things that we’re seeing that when I talk about this it’s… Oh! the other thing is this: So, in early April we had a we have people come back to us on our forecast regularly who don’t agree with what we’re saying and they complain pretty loudly.
MG: So, what do you say I talk when I hear that because whenever somebody doesn’t agree with the forecast, they are themselves making a fork.
TN: Of course. Yeah. Exactly. Right? Yeah, and so this person was telling us in early April that we’re way wrong that the S&P was going to continue to rally and you know they wanted to cancel their subscription and they hated us and all this other stuff. And we said okay but the month’s not over yet so let’s see what happens this was probably a week and a half in April. And what happened by the end of April things came in line with our forecast and like I said earlier we were like 0.4 and 0.6 percent off for the month. And so that person had they listened to us at the beginning of the month they would have been in a much better position than they obviously ended up being in. Right? And so, these are the kind of things that we see on a… I mean, we’ve got hundreds of stories about this stuff but these are the kind of things that we see on a regular basis. And we mess up guys I’m not saying we’re perfect and but the thing that we when we do mess up, we’re very open about it. Everything that we do is posted on our on our website. Every call we make, every error we have is their wars and all. Okay? And so, we’re not hiding our performance because if you’re using our data to make a trade, we want you to understand the risk associated with using our data. That’s really what it comes down to.
MG: It reminds me of back in 2011 and in some other periods I’ve had similar situations, where I was writing and I was very adamant in saying the conditions favored a summer crash. Right? I was saying that for the summer and the market should be going up and people would say oh where’s your summer crash and I would say this summer hasn’t started. Like it’s amazing how people, I don’t know, what it is, I don’t know if it’s just short-termism or just this kind of culture of constantly reacting as opposed to thinking but it is it is remarkably frustrating.
Going back to your point at the very beginning being entrepreneur don’t do it, that you have to build a business with people and customers who in some cases are just flat out naïve.
TN: That’s all right though. That’s a part of the risk that we accept. Right?
MG: Yeah, the other thing right now that happens with every industry but from the entrepreneur’s standpoint. It’s what you’re doing the likely outcome of your product of your service. You’re trying to communicate that to end clients but then in the single role of the die the guy the end client who comes to you exactly for that simply because they disagree with you know the output, now says I want out.
TN: Oh! Yeah! Well, your where is your summer call from 2011 the analogy today is where is your recession call. Right? So, that’s become the how come you’re not one of us calls right now. So, it’s just one of those proof points and if you don’t agree with that then you’re stupid.
So, I would say you never finish with that there is always a consensus and a something you’re you absolutely, must believe in or you don’t know what you’re talking about.
MG: Yeah, well, thankfully. What you’re talking about so appreciate everybody joining this space Tony the first time you and I were talking. I enjoyed the conversation because I think it said on investing and I encourage you to take a look at Tony’s firm and follow him here on twitter. So, thank everybody. Thank you, Tony and enjoy.
Millions of Australians decide whether or not to vote back in the Conservatives after nine years under the party’s rule. BBC’s Katie Silver and Australian economist Tim Harcourt tell us more. Rising fuel prices have led food delivery drivers to strike for days in the United Arab Emirates, where industrial action is banned. BBC’s Sameer Hashmi explains their struggle from Dubai. Adi Imsirovic from the Oxford Institute for Energy Studies gives us his views on the former German chancellor Gerhard Schroeder’s recent resignation from the board of directors of Russia’s state-owned oil company, Rosneft. In Korea, president Joe Biden begins his five-day Asia trip with a visit to a Samsung semiconductor plant. We talked to Carolina Milanesi, president of analyst and market research firm Creative Strategies, about this. Vivienne Nunis is joined throughout the programme by guests Tony Nash, Chief Economist at Complete Intelligence in Houston, Texas, and Karen Percy, Senior freelance reporter in Melbourne.
Show Notes
VN: Tony Nash, who’s the chief economist at Complete Intelligence in Houston, Texas, is one of them. Welcome back to the program, Tony.
TN: Hi, Vivian. Thank you.
VN: Thanks for joining us again, Tony Nash. Listening to that. It’s interesting, isn’t it? It doesn’t matter where you are in in the world. The energy crisis triggered by the war in Ukraine is forcing drivers to fill the pinch wherever they are.
TN: Yes. I live in Texas, and we produce a lot of oil here.
VN: What’s the situation there?
TN: Oil is rising pretty quickly. The price of gasoline is rising pretty quickly. So both regard to the UAE. I spent a bit of time in the region, and the prices are always lower. They’re very cheap. But what’s interesting about the delivery business is if the cost of petrol is impacting the delivery business, that could be a real issue for that business model. I think we’ve been in an era of relatively low petrol prices, and if those prices remain high, it could be a real challenge for that business model at some point.
VN: So you’re saying that fuel prices are already cheaper compared to, say, global averages in the US, and I guess they are in the US as well. They’re heavily subsidized, aren’t they? I guess the question is, should governments be stepping in where they can to ease that pressure on drivers and everyone facing various cost of living pressures?
TN: Well, with UAE, actually, the prices in May for fuel are lower than they were in April. They’re still elevated, but they have come down a small amount, like 2% or something. But I think if the government is to help people, all that will do is I think we’ll only have higher crew prices or higher sorry, fuel prices. So it’s a hard thing to say, but I think more money toward it will only make those prices higher as more people consume kind of at the same levels, but with the subsidies. So it’s a very hard time. And I think it’s something that maybe the companies should help their drivers with, not necessarily the governments. These people are working on behalf of the company. And so perhaps the company should help their drivers a little bit with fuel.
VN: Tony, this story is moving all the time, isn’t it? We’ll get to some of that in a moment. But firstly, it was rather extraordinary, wasn’t it, that Gerhard Schroeder didn’t resign from that position on the board of Rosneft until today?
TN: Yeah. It’s weird that he took up the position in the first place. I remember when it happened 20 or so years ago, and it just seemed like a strange appointment at the time. But it took him 20 years to make the decision. So, yeah, it’s well overdue and it seemed fishy from the start. And I think Germans have been extraordinarily patient in putting their pressure on him to get it done.
VN: Well, we don’t know there was anything fishy, of course. I mean, perhaps the pressure only really came on to him since this invasion by Russia into Ukraine, given that before that, Russia and German energy relations were pretty tight.
TN: Sure. Yeah. But Germany had at some point looked at, say, taking LNG from other parts of the world, Qatar, US, other places, and they chose not to do that and really have Russia as their only source, I believe, largely because of lobbying that Schroeder participated in. So had Schroeder not worked with Gasprom, there’s a feasible scenario that Germany would have multiple sources of natural gas and oil and not really just looking at Russia.
VN: I mean, Tony, I guess what is fairly obvious that it was a very lucrative position there, and that’s probably one of the reasons why he stayed so long.
TN: Sure. And as a former Prime Minister, it is awkward for him to lobby to single source energy from one country. I get it. Of course, it’s lucrative and everybody has to pay the bills somehow. But this was particularly odd.
VN: Okay. Let’s leave it there. Thank you both for your thoughts on that. Tony. It was interesting, wasn’t it, how President Biden almost made a beeline to that Samsung plant straight off the plane after he landed in South Korea, obviously underlining that relationship with South Korea, but also the importance of semiconductors in today’s economy.
TN: Sure. So I live in Texas, and Samsung last year announced a $17 billion chip Fab investment just north of Austin, Texas. And Texas Instruments is also building a new chip Fab in North Texas. So there are three new chip fabs that have been announced or major new chip fabs that have been announced in the US over the past couple of years. And two of them are in Texas. And so that $17 billion of investment that Samsung is making is really the reason for the trip. So that chip Fab that’s in Texas, there’s got to be a lot of thank yous to Samsung for making that investment in the US.
VN: So it’s not a wider move then by the US to really try and encourage that kind of thing in its own shores. We talk about onshoring we’ve seen so many delays in global supply chains throughout the pandemic. We’ve seen shipping crises. Is this an idea to try and prevent any of that from happening in the past and get those made in the country closer to some of those big companies like Apple and intel, for instance.
TN: That has been underway for probably five years. The movement to getting technology firms, particularly semiconductor and defense related technology firms, building more either in the US or in the NAFTA or the North American Trade Agreement area. So that started particularly after the 2016 election, and it’s continued in the Biden administration trying to get more of that technology development and technology manufacturing in the US.
VN: And right where you are in Texas. Well, not exactly where you are, but somewhere in Texas we’re hearing not just about these semiconductor plants, but also, of course, Tesla moving a Gigafactory there as well, out of California and into Texas.
TN: Right. Tesla, Oracle, HP, many firms have decided to relocate to Texas. It’s a great workforce. I’m here. I run an artificial intelligence company here, and people here like to work. And so it’s a really good location for technology companies.
VN: It’s not just the hard work, though, isn’t it? Also about tax rates, if I recall.
TN: It’s about tax rates. It’s about research dollars. So the universities here get a massive amount of research dollars and spend a lot of money on research. And it’s the quality of education that’s here. So all of those things combined, of course, Samsung got subsidies for building its Fab and Taylor, but I think they could probably get subsidies from anybody. They’re kind of really looking at the whole environment that they plant their business in.
VN: It’s interesting because we always think, well, originally we thought about California dominating the tech industry. Now we’re hearing about Texas, as you’ve just mentioned. I spoke to Carolina, who we heard from earlier. She’s actually moved out of California into Atlanta. And she told me that’s a growing tech hub, too, used to be a kind of base for telecoms companies, but now it’s attracting some of those tech firms, too.
TN: Yeah, I think there are a lot of kind of mini tech hubs around the US, and you can find them in different clusters around the US. And so it’s really just a matter of what critical mass can you get and what specialization can you get, and then how do you build around those specializations? So, for example, Tesla moves to Austin, and their vendors are then required to move to Austin as well. Right. And that creates a cluster around what Tesla does. So really getting those bigger fish to move their vendors and build that whole system is pretty critical. And the Texas governor, Greg Abbott, has actually done a really good job of recruiting those firms here because it’s only the last four or five years that a lot of that’s happened.
VN: Okay, well, thank you, Tony, for all of that insight from Texas. Do you take ketchup and mustard on your hot dogs?
TN: You’re supposed to only eat mustard on hot dogs. I’m sorry, but this is the law of the land.
KP: It’s an abomination. I have a Canadian Hudson who does the same thing.
VN: Okay, so just mustard, you said. Okay, Tony asking you in watching along in the US. I mean, Boeing getting into this private space race. Now, Boeing has been in the news for all the wrong reasons over the last few years. Those two very serious fatal crashes. There’s a lot riding on this venture, Tony. Have I still got you there?
TN: Yeah, I’m here. Can you hear me?
VN: Yeah. So just talking about Boeing, they’ve had a pretty rough ride, given those two facial crashes. A lot riding on this venture into space.
TN: Absolutely. And they need some good news stories. And if this is a good news story for for them, that’s great. I hope it ends up well.
VN: Okay. Thank you, Karen Percy in Melbourne and Tony Nash in Texas. You’ve been listening to business matters with me, Vivian Nunes. Thanks for the team in Manchester here as well. Bye for now.
Russian company Gazprom says it will halt gas supplies to Poland and Bulgaria from Wednesday morning. Poland currently depends on Russian imports for around half of its gas. The country’s deputy foreign minister Marcin Pzydacz tells us his government was already been prepared for this move. Plus, the World Bank’s latest commodities report makes sobering reading, suggesting that high food and fuel prices could blight the global economy for years to come. We hear from its author, World Bank Senior Economist Peter Nagle. With Elon Musk poised to take over at Twitter, the European Union’s Commissioner for the Internal Market Thierry Breton tells us that the firm will be welcome to operate in the EU under new management, providing it adheres to the bloc’s rules. As Delta Air Lines reveals that cabin crew will be paid for boarding as well as flight time in a landmark announcement, the president of the Association of Flight Attendant Sara Nelson says unionization efforts by airline staff forced the company’s hand. And the BBC’s Ivana Davidovic investigates urban mining, the process of reclaiming raw materials from spent products, buildings, and waste. Throughout the program we’re joined live by Zyma Islam, a journalist with The Daily Star newspaper in Bangladesh, and by Tony Nash, chief economist at AI firm Complete Intelligence, based in Houston, Texas.
Show Notes
EB: Joining me today to help discuss all of this to guests from opposite sides of the world, Tony Nash, chief economist at the AI firm Complete Intelligence in Texas. Hi, Tony.
TN: Hi, Good Evening.
EB: Good to have you with us. Tony Nash in Texas, what do you think is interesting, isn’t it, because this could I don’t know, it could go two ways, just politically. It’s an interesting move from Moscow to, if you like, preempt European sanctions against Moscow by cutting off the supply to Europe.
TN: Yeah. I think the further this goes along, the more I like people buying oil and gas from Texas, since that’s where I live. So we’ll take that. But for Poland, less than I think, about 10% of their electricity mixes from gas. So it wasn’t a majority gas driven market anyway. So they were very smart to put resources in place, alternatives in place. And, of course, it hasn’t been cost free. It’s taken a lot of resource to get that in place, but it’s good for them. And being on the border with Russia, they have to be prepared for anything.
EB: Yeah. I mean, gas is obviously very important during the winter months and we’re entering spring. So maybe European countries are feeling the crunch a little bit less strongly. Nonetheless, the question does remain, is Germany especially willing to cut off the oil? The oil is by far the bigger element, isn’t it, in terms of Russian revenue from its energy exports? And that’s the thing that Europe is resisting so far. Do you think we are pushing in that direction?
TN: I think if the fighting continues, they’ll have to. The problem is they don’t really have alternatives right now. And so that’s their dilemma is Europe did not diversify when they should have, and now they’ll pay much, much higher prices. So that will eat into European economic growth and it will really hurt consumers. So I think Europe is in a very difficult position. That’s obvious. But a lot of it is on some level, I wouldn’t say completely their own making, but they had opportunities to diversify, which they didn’t take.
EB: Yeah. I mean, Tony, everyone wants to get their LNG from Qatar and they all from the United States. There are going to be some pretty wealthy Qatari and American exporters of LNG, even if they can meet the demand next year.
TN: All of my neighbors in Houston are benefiting. I’m not in the oil and gas sector, but they are certainly benefiting from this.
EB: Let me bring in Tony there. I mean, we saw a story this week, Indonesia, for instance, banning the export of some palm oil food protectionism could be a thing. We’re not really talking about that yet. But those countries I mean, Bangladesh neighbor, India, will it start cutting off its exports when it starts to see global prices rising and perhaps being more pressure on its domestic supply?
TN: Yeah, it’s possible. And we also have a situation where the US dollar is strengthening and emerging market currencies are weakening. So these ad commodities are becoming more expensive in US dollar terms for sure. But it’s an accelerated inflation rate in emerging market currencies. So one would hope that, say countries like China, who are suffering with this, who devalued their currencies in a big way over the last week, would start to put pressure on Russia to resolve the conflict so that both Russia and Ukraine can start exporting food commodities again.
EB: Tony Nash, what do you think? I’m forgetting the unicorn thing. Could officials come down that hard on Twitter, a new, less regulated Twitter platform under Elon Musk?
TN: Well, let’s assume that he obviously doesn’t understand the technology is regulating 100 million Europeans could turn on their VPNs tomorrow and access Twitter from a pop outside of Europe in 5 seconds. It would be no problem at all. So Twitter could unilaterally shut down in Europe and they’d still have 100 million customers on the European mainland. So he has a fundamental misunderstanding of the technology that he’s supposedly regulating. But what I don’t think he also understands is Twitter has people like Rouhani from Iran and Vladimir Putin and Chinese people who deny that they have a million Muslims in prison and all this other stuff. So why is he not cracking down on Twitter for allowing those guys to have a voice when he’s worried about Elon Musk, who is a loud guy, but he’s a pretty middle of the road guy, seemingly. So I just don’t understand why there’s so much hyperventilating about Elon Musk. I don’t get it.
EB: So you’re along with, I guess certainly a large number of Republicans in Congress right now who are saying bring it on. We’re delighted that this takeover is happening because we imagine we’re going to see a much less regulated platform.
TN: Let’s take another view. Let’s take Jeff Bezos, who owns The Washington Post. Right. It’s a media platform, and it’s had some really questionable practices over the past few years. So why aren’t media regulators in Europe looking at The Washington Post? They’re just not. And so I think if Musk is really going to have Twitter be in the center and not moderate except for things that are illegal, then more power to them. It’s in the spirit of the US law from the 1990s that said that internet content publishers can’t be sued because they’re not Editors. They’re only publishers. So I think it’s more in the spirit of the 1990s Internet regulation than anything that’s out there today.
EB: Tony Delta in Atlanta, that’s not a million miles from where you live, is it? Do you have sympathy for the flight attendants here?
TN: Yeah. It’s insane. I never knew about this. So no wonder the flight attendants are less than cheerful when we arrive on board.
EB: Especially for the check in bid, right?
TN: Exactly. It’s just insane. They’re in uniform, they’re working. Why they’re not paid. I just think that’s insane.
EB: The unionization drive does seem to be gathering a bit of pace in America, doesn’t it, right now. And we mentioned we’ve referenced all those other companies. It’s the mood of the moment. Yeah.
TN: Well, labor has the strong hand right now, and wages are rising. And when labor has the strong hand, you see more unionization. So it’s just a natural course.
EB: But it has been decades during which Union participation in the state certainly has gone down, isn’t it? I mean, since I’m in the 70s wasn’t right.
TN: But if we look at the rate of baby Boomer retirement, we have a lot of people going out of the workforce right now. And so we do have tight labor markets because of it. And that’s really part of what’s pushing the strength on the side of labor. And so this stuff is demographic.
EB: And it’s typical when it comes to technology. I mean, I have a personal take on this. I went to Acra in Garner in 2015 to the famous Agbog blushy central dump there, which is an extraordinary place. It’s one of the largest of its kind in the world. Miles of waste, all kinds of things. They’re burning cables just to extract the copper from the tubing and the wiring. But the air, I mean, it took me 24 hours just to feel my lungs clear from that place. It’s an extraordinary thing, isn’t it, Tony Nash, don’t you think it’s strange that the market around the world, the free market, hasn’t found a system whereby the value of old units is recycled efficiently?
TN: Yes. So if I want to recycle electronics here in my local town, I take it to a center and I have to pay them to take it. So they’re taking gold and platinum and other great stuff out of there, but I have to pay them to take my recyclable electronics.
EB: Is that why? I mean, do you understand the economics of that? Because you’d think that supply and demand would suggest that if there were a competitive value in the goods that they’re extracting, there would be competition and therefore there would be people offering lower prices or perhaps even paying you for your old stuff?
TN: Yeah, I understand the competition of it, but I think I just want to get rid of the stuff. And I think that’s what they realize is they can charge people just to get rid of old computers or phones or whatever, and then they get money on both sides.
EB: The big corporations, Tony, have a bigger responsibility here. I mean, they’re the ones producing the stuff. They’re the ones, I guess, I don’t know, paying for the extraction of some of these rare Earth metals and everything else. Some of the toxic stuff coming from places like Russia, Latin America, the DRC, and those are the things that are then being spat out and causing all kinds of pollution.
TN: Sure. I would think, for example, the phone manufacturers and the mobile carriers would have an incentive to collect the old phones from people.
EB: Yeah, but do you think regulators should be doing more here?
TN: I don’t really know. I think regulation tends to kind of contort things like this, And I think for something like this would potentially create an unintended economic opportunity. So we heard about the person in Bangladesh who collects used items in Singapore. I lived there for 15 years. We had somebody called a Karen Gunn person who would collect used electronics and other things and buy our house. So whether it’s that local person or whether it’s an Assembly Or a disassembly location, say, near my house, Those are people who are focused, who are specialized on what they’re doing. I do think, though, that the people who create this actually should have some sort of incentive, not from government, but from their customers to collect this stuff Once they’re finished with it, because it’s costing me money to get rid of it, but I’m paying them for it.
EB: Okay. A couple of minutes left in the show. I’m going to ask you both now for a quick thought about the things that have caught your eye most in the area, the news stories that have caught your attention. Tony, tell us in Texas what’s catching you up there?
TN: It’s really hard to follow that. So in Texas, one of the things that’s happening and this is not new, but it’s becoming more and more common is if you take your car out somewhere, Even in just a normal neighborhood, to, say, a shopping Center, It’s pretty common for someone to come even in the middle of the day and steal the catalytic converter off of your car. You go into a restaurant or a shop and you come out and someone has taken the catalytic converter off your car, which is a key part to muffling sound, and they do it for the precious metals in that piece. So that’s becoming very common here again. It’s happened for years, but it’s becoming much more intense Because of the prices of precious metals.
EB: Yeah, unauthorized recycling. We can full circle Tony Nash and Zimmer Islam in Texas and Bangladesh, respectively. Thanks to you both and thanks to you all for listening. This has been business matters as my name’s Ed Butler. Take care. Bye.
Fed Chairman Powell was out this week all but assuring a 50bp hike in May, also implying we may see a burst of quick hikes. Then everyone who said “it’s all priced in” two weeks ago panicked on Thursday and Friday. Mike Green shares what’s new here and why are we seeing the reactions now?
We’ve spoken before about Q2 earnings, expecting them to generally be weaker, partly on inflation, which every company is blaming for shortfalls.
– Snapchat missed earnings but it reported 64% revenue growth, with daily active users up 20%.
– Netflix lost subscribers. They’re now the tech cautionary tale.
– FB is falling in anticipation of an earnings shortfall next week.
– Tesla reported a 42% earnings surprise and they’re about even on week
We keep hearing about commodities getting smoked this week. What happened this week and what should we be thinking about right now? We’ve got a bunch of housing metrics out on Tuesday (Case-Shiller, etc). Do the guys expect to see an impact on house prices already or will it take a couple of months/another rate rise to have a noticeable impact?
Key themes from last week:
1. Powell’s Wrecking Ball (Dollar Wrecking Ball)
2. Tech Earnings
3. Commodities getting smoked?
Key themes for the Week Ahead
1. Housing
2. France election
3. Geopolitical lightning round
This is the 15th episode of The Week Ahead in collaboration of Complete Intelligence with Intelligence Quarterly, where experts talk about the week that just happened and what will most likely happen in the coming week.
TN: Hi and welcome to The Week Ahead. My name is Tony Nash. Today we’re with Albert Marko and Mike Green. Before we get started, I’d like to ask you to like and subscribe to our YouTube channel. Thanks for doing that. I also want to let you know our CI Futures promo ends on April 30th. This is CI Futures, about 3000 assets forecast every month for $50 a month. That promo will end on April 30th. So if you’re interested, please go to completeintel.com/promo and check it out.
So this week we’ve got some key things from the past week. First of all, Powell’s wrecking ball and rate rises and the dollar wrecking ball that comes with that very important item. Tech earnings. We’ve seen a collapse in tech equities over the past couple of days. Not a collapse, but some really interesting activity. We’re going to talk through that. And then commodities. We’ve seen commodities, heard some people say commodities are getting smoked late this week. So let’s talk through that.
So Mike, first let’s look at Fed Chair Powell is out this week, all but assuring a 50 basis point hike in May. And a lot of people think it may be stronger for a longer period of time, maybe June and July even. I hear a lot of people saying a few weeks ago, it’s all been priced in yet we’ve seen kind of some panicking markets on Thursday and Friday. So we’ve got the 10-year on screen right now. So what is new here from your perspective and why are we seeing the reactions now?
MG: So the point that I would argue on this is that we’re in a feedback loop effectively where the market tries to price the Fed’s indications the Fed is in turn responding to the market. And so it’s leading to a dynamic where the Fed is saying, well, look how interest rates are rising, particularly at the back end. Clearly, we’re behind the curve. Therefore, we need to hike more and we need to convey to the market that we’re going to hike more. The market mechanically has to respond to that because you just can’t ignore it. Right.
You have to effectively think of it in a binomial tree type framework. The Fed has told you they’re going to hike more aggressively. Therefore, you need to shift the whole system up. Right. And that feedback loop, I would argue, is what we’re kind of captured in right now. And it’s part of the reason why the market is forced to respond to it in a risk off fashion, et cetera. We just don’t know if the Fed really actually knows what the underlying signal is and how much of it is us and how much of it is their insights onto the economy.
The second thing that I would just highlight is that the Fed has put themselves into the very uncomfortable position of last year, arguing that inflation was transitory. And this has been one of these really frustrating things for those of us that actually agreed with them that it is largely transitory in inflation rate. Right. So the rate of inflation is transitory, but the price level, I don’t expect oil to go back to negative $37 a barrel. That would be absurd. Right, right. So when you talk about the transitory dynamic, it’s typically thought of as the rate. But I think the perception had broadly been the prices themselves were going to somehow come back down and not adjust to the realities of accommodating the difference.
So I think that is sitting at kind of the core of the issue is that the Fed is now in the same way they were trapped in that transitory framework that people began to increasingly malign and make fun of. Now they feel this overwhelming need to come out and tighten and show that they’re actually serious about inflation and reestablish credibility, even as it’s very clear that the economy is starting to slow. And they’re then forced into the mantra of now saying, well, we see no signs of the economy slowing. And so they’re going to have to maintain that for a period of time or they sound like fickle policymakers.
TN: Right.
MG: I think the market is understandably concerned and scared at how far they’re going to have to go to prove to us that they’re really serious.
TN: Right. And Yellen was out saying there will be no recession this year, which I mean, I hope she’s right.
MG: There’s a recession. Yeah.
TN: Exactly. So I was roasting coffee yesterday, and my coffee guy was telling me that coffee prices will stay elevated because of the buying cycle from the farms and so up and down the commodity supply chain, across, it seems, across metals, across crude, across ags. That timing has a real impact on the change in levels. The rate may not change much from here, but it seems like the level will remain elevated, as you’re saying.
MG: I think that’s right. And again, that’s why the transitory, I think, was so toxic and confusing to people because they were thinking, oh, we’re going back to $1.75 gasoline as compared to the $6 in chains that we’re currently paying in California. Right?
TN: Right.
MG: That’s very hard to accomplish under the current framework. And the coffee example is a really good one. It’s not so much the level. The adjustment to the level is painful. Once that level has been reached, all sorts of changes in relative purchasing activity can occur. Right. You can decide you’re going to roast your own beans because it’s cheaper than somebody else’s beans. You can decide that you’re not going to go to Starbucks, you’re going to do your coffee at home and put it into a travel mug to save money.
Whereas the Wall Street Journal highlighted you can reduce your consumption of beef and chicken and increase your consumption of lentils. And yet another example that just pisses people off because it feels completely disconnected from the reality that they’re in. But those are all true statements, right. Those are adjustments that people make once the level settles down. Where the real problem occurs is the uncertainty about the level.
Is it going to be 20% higher next year? Is going to be 20% lower next year? That makes it very hard for me to plan. And that’s really what we’ve experienced. And now what your feedback, what your contacts are telling you is no, prices are going to stabilize at a higher level because that’s what’s required to induce the supply response.
TN: Right.
MG: Okay. It sucks. Coffee is more expensive now, but at least it will be in the stores.
TN: Right. So going down the path of, say, your Wall Street Journal saying you need to eat lentils instead of beef. With interest rates rising, it seems like consumers would utilize more credit during that adjustment period. With rates rising, it seems like it would make things much more difficult. So there’s a double whammy on consumers. Are we seeing that impact right now?
MG: I don’t think we’re yet at the point that the higher interest rates are feeding through in a way that matters. Right. So the vast majority, something like 95% of outstanding mortgages are no longer adjustable rate. They’re fixed rate. And so that is going to be very slow to adjust. We’ll see that the marginal purchasing behavior. And we are absolutely seeing that. We’ve seen a dramatic reduction in refinancing and purchase applications. We’re starting to see traffic deteriorate. We’re starting to see new orders roll over. We’re starting to see consumer spending intentions begin to plummet.
And there’s two reasons why people can use credit cards. Right. You can use credit cards to smooth over effectively saying, hey, guess what? I’m getting paid my bonus next week. Therefore, I’m going to make the purchase now and I’m going to repay it. Or you can see people start to tap credit because they are so strained that they can’t do anything else.
And unfortunately, the evidence that I’m seeing suggests it’s the latter, that it’s the lower income households who are now taking advantage of high cost financing choices in order to sustain a level of consumption that they’re having difficulty retreating from.
If your rent goes up and you don’t want to be homeless and their coffee prices have gone up, at some point, you need to expand your purchasing capacity. And that means using credit.
TN: In basic terms, what we’ve been talking about on this show is demand destruction. The Fed is aimed at demand destruction. And that means that demand curve actually moves in, right?
MG: Yeah.
TN: So people are going to have to rein in their behaviors because we’re likely at new pricing levels for many things. And so that consumption is going to have to decline a bit to adjust to the new environment. Albert, you had a comment?
AM: Yeah, two comments, actually. The thing about the demand destruction and the supply, from the Fed’s point of view, they think that getting rid of demand involves eliminating supply. Right. So that a little bit has to do with the rates, but also what Mike said about doom loop. I mean, that’s very interesting because that’s exactly what we were talking about in multiple areas, not just for bonds, but Yellen herself, she’s had her minions go out in the bond market and just straight up lie to bondholders, saying, oh, they’ll recover, they’ll recover while everyone keeps buying, and they just keep butchering the long bond.
The 30 years just been 3.1 today or 3.5. It’s crazy. She did this in 2013 where she had this little ploy where she has preventing capital flight, leaving the United States in order to prop up the US equity markets. And that’s what we’re seeing today. And this doom loop between the Fed and the treasury, because they’re not on the same page. They’ve got different policies, different ideas of how to keep the market, and it’s causing problems.
MG: I would actually add to that and just highlight that this is, of course, the downside to not having people who actually have ever traded or negotiated a swap or done anything else along those lines in positions of decision making. You don’t want to put a fox in charge of the hen house. But the reality is it is somewhat useful in terms of understanding what’s actually transpiring. It doesn’t surprise me at all that Janet Yellen says something along the lines of, well, there’s no sign of a recession because they’re working very first order, first derivative type dynamics. It’s that second and even potentially third derivative that ultimately conveys the dynamics of what’s really happening.
And the second part is that the Fed operates under a model in which negative real interest rates, which is basically a function of inflation expectations and the current level of yield. Some people roughly approximate it with trailing inflation and current yield, which is completely insane. But at least if you’re doing it in a structural fashion, they tend to presume that the only reason why markets move is due to information.
The market has some insight, and this has been one of the huge policy innovations. And I use “innovations” over the last 20 years has been this dynamic of, okay, well, if we’re trying to figure out market expectations, let’s use market inputs. But those market inputs in turn respond to the policy makers. Right?
TN: Right.
MG: And there’s all sorts of structural features to markets. If I happen to short a pay or swap shop, for example, and my risk manager is forcing me to cover that risk, it has no economic signal to it. It’s simply a market feature that they are then trying to interpret as indicative of underlying demand. That’s just wrong.
TN: Right.
AM: On top of that, you have a political component where Yellen tied to a certain party or not just Yellen but others tied to a certain party are going to do things beneficial to that party.
I know economists and financial guys don’t like to hear that, but that’s just the reality of it.
TN: That’s the reality of national accounts. We also mentioned the dollar wrecking ball. We’ve seen over the past week, Yen devaluation or Yen depreciation. We’ve seen CNY devaluation. CNY has gone from, I think, 6.34 to 6.49, which is a dramatic deval of CNY. How much of an impact does the dollar have on those markets, particularly because we’ve heard about the dollar losing influence for the past, I don’t know, 50 years. But talk to us, Albert, what’s going on there?
AM: Like I said, Yellen wants to restrict capital flight, and a strong dollar does that. It’s killing the emerging markets. They gave Japan the go ahead to devalue the yen in order to offset anything that China does asymmetrically against the United States, because they have been. They’ve been in a little bit of a tit for tat for quite some time now.
So the dollar at 110 just absolutely annihilates emerging markets, except for the markets that are commodity based, like Canada. I’ve been in Canada. I love the Canadian economy right now. It’s strong oil based, gold based. So that’s where I’m coming from on the dollar right now.
TN: Great. Okay.
MG: I would just broadly highlight but by the way, I don’t know if you saw the CNY today, but it moved huge again today. So it’s actually now 6.50. Well, fantastic in the same way that like a root canal is fantastic. Right. But yes, it’s a wonderful technology. Nobody wants to experience it.
But just to put this in context, this is a move now that is equivalent in terms of devaluation of what we saw in August of 2015, in terms of the much-heralded… Right. And I would just highlight that I think this is an important move. I think it’s telling you that there’s all sorts of stuff that’s going on. I tend to fall into the category of terms of trade dynamics, more so than interest rates or even anything, those dynamics.
Japan allowing its currency depreciate, leading to depreciation for the Chinese currency or contributing to depreciation for the Chinese currency. They want a competitive in global export markets. Right. So there’s an element of China needing to respond and maintaining competitiveness versus a significant devaluation that’s occurred in the Japanese yen, which is basically, if you think about it from an American perspective, means I can buy 30% more of what a Japanese worker produces today than I could a year ago. Not quite exactly. Right. But somewhere in that range.
The second part of it, though, is that the terms of trade have just turned so ugly for these countries where the things that they need to import, they have incredible food insecurity, they have incredible energy insecurity, and those are the things that are rising in price. And we’re seeing no signs that those are going to retreat, whether it’s LNG that Japan now has to compete with China in Europe or from the United States and elsewhere or whether it’s wheat or rice or corn.
I believe, Albert you may know this better than I do but I believe Malaysia just announced export restrictions on palm oil, worried about their own food security. This is the way the system breaks down. And the irony of course is the US, are we going to get unlimited palm oil imports? Of course not. But can we use soybean oil or canola oil in lieu of palm oil for frying our Twinkies and our food? Of course. Right. We can do that. The US can survive almost anything from a food or energy shortage standpoint. It’s the rest of the world.
Albert referenced the emerging markets. I mean man, if you are a cash crop producing emerging market that is now struggling with issues around food and energy security, this is going to get bad. It’s really bad.
AM: It’s really bad. It’s causing political uncertainty in many regions of the world. And again use the phrase doom loop because politicians over Covid policies have created a doom loop in trade.
TN: But let me ask you and we need to wrap up this topic but I want to take this full circle because it’s fascinating. With the currency devaluation depreciation in China, Japan and the food issues could that potentially push, say, North Asia to put more pressure on Russia to wrap up the conflict so that the commodities out of Russia and Ukraine can alleviate some of this price pressure on emerging markets. Is that a possibility?
AM: It’s a possibility, but I think it’s a small possibility. Things have changed because of the Ukrainians sinking that battleship. They got bears at that point.
But Interestingly though, now that you mentioned, I just thought of it. Japan and China have always competed for the fishing rights and then sea Japan. So you could see a future. Want to say naval skirmish but a couple of boats taking some live firearounds.
TN: Sure. Yeah. Or a mistake. Right. You could have a mistake that results in something like that. Okay, let’s move on to tech. I think we can talk about this issue for hours.
AM: Yeah.
TN: Let’s move on to tech. Robert, we’ve spoken about key to earnings for a while, expecting them generally weaker, partly on inflation and other pressures. But this week we saw Snapchat miss earnings, but they reported 64% revenue growth and their active users were up 20%. So their business seems to be going well. Netflix lost subscribers and we saw them kind of as the tech cautionary tale. Facebook is falling in anticipation of their earnings for next week. On the bright side, Tesla saw a 42% earnings surprise, but their stock, after moving up a bit, really hasn’t moved much.
So on screen, we’ve got Facebook and Snapchat kind of showing their downward trajectory over the past month. So can you talk us through kind of what’s happening with tech earnings? Is that a rotation? Is tech really out of gas? What’s going on there?
AM: I believe tech is out of gas. A lot of it has to do with inflation and rates and whatnot. But I think tech earnings had gone into the stratosphere when Covid was just blazing because of the lockdown. People stayed at home, got on Snapchat, got on Facebook, got on Google and whatnot. Right.
The Tesla earnings. Those are a joke. It sounded like Tesla is the most efficient automaker in the world, which is absolutely a joke when they’re making cars intense. And it took the market up like 70 points. And then as soon as some of the better analysts started digging through the information, immediately sold off again. And then that actually triggered, I think that triggered the market to sell-off a little bit because people are worried about tech earning. I think Google’s going to miss big because their brick and mortar advertising scheme is hurting. Last month and this month it doesn’t look pretty.
But I want to take some caution here because everyone’s going to get beared up on these tech earnings as everyone’s seen the Huawei, big puts coming out there and whatnot. But we’ve seen time and again these tech earnings missed on revenue. And then the guidance is fantastic and the market rips 200 points in a week. I don’t want to be short tech at this level right now.
TN: Right. Mike, what are your thoughts?
MG: The obvious component is that we’ve got extraordinarily difficult compares for most of the tech companies. Right. So you go into a pandemic and every kid needs a computer, every kid needs a cell phone, every kid needs that. And I’m speaking to you over a microphone that was purchased during the pandemic and a computer that was purchased during the pandemic and a video camera that was purchased during the pandemic. Right. And I upgraded my software and my kids got new phones and all this sort of stuff that all occurred. Well, guess what? It’s not happening now. That’s harder.
And when I think about the reinvestment that needs to occur as we talk about going back into the office and into work, et cetera, it’s much less on the soft side. It’s much more on the simple dynamics of how do we restock a pantry at a company cafeteria. Right. Which hasn’t had to happen for a while.
TN: Right.
MG: So I am generally skeptical of it. I’m particularly concerned about the consumer side of it. One of my friends many years ago had highlighted that the emergence of cell phones as a consumer good had by and large, replace lots of other types of spending. So it reduced clothes, reduced spending on everything else. People are now tapped out on buying those phones. Right? They’re out of money and they’re using their credit in one form or another. So I’m skeptical on particularly Apple.
I agree with Albert, by the way, on Google. I think people are underestimating the importance of the bricks and mortar, and they’re also underestimating. I think this is one of the challenges for the Netflix. I’ll be 100% straight with you in terms of my household’s reaction to it. I mentioned it to my wife. She’s like, well, we’re obviously switching to the advertising supported model as soon as that becomes available because, candidly, I don’t even like watching Netflix to begin with. I could care less. If I have to watch ads and get it for $10 as compared to $20, then I would argue that this is happening broadly.
As we move back to an advertising supported model, the inventory of advertising space is about to explode at the exact same time that demand is relatively weak. So who thinks we’re going to get premium prices for advertising anymore? These models are screwy in terms of how badly they could deteriorate. If you simultaneously have a boom in advertising space at the exact same time that demand is relatively short.
TN: But lucky us, we get more campaign ads until November.
Okay, great, guys. Moving on to commodities. We saw commodities pretty much get smoked in the last half of this week. We’ve got one month history of WTI and copper up on the screen. So what happened this week, and what should we be thinking about right now with respect to commodities?
AM: I think that in terms of commodities, I think the biggest component right now is to see what happens in the Ukraine war, whether Russia stops because the Europeans and the Biden administration is using that as like the Putin price hike and whatever. But that’s what they’re blaming it all on. And a lot of people are worried about this being an extended war. I don’t think it’s going to last more than another month or two.
But for commodities, especially wheat and fertilizer, the moment that Ukraine comes back online, those things are just nosedived. And the Fed wants that to nose dive because they’re trying to kill supply in order to tackle inflation. So that’s from my perspective, there.
TN: So a lot of this at this point, you think depends on Russia, Ukraine.
AM: Yeah. That and the dollar. That and the dollar. So the dollar goes up, prices will come down.
TN: Okay. So appreciated dollar, did that hurt commodity prices this week?
AM: I think so. Go ahead, Michael.
MG: Yeah. So they’re not quite inverse. But remember, when we see prices, we’re seeing our prices, we’re not seeing the rest of the world’s prices. And exactly to the point that we were raising before with Japan and everything else on a year to day basis, as much as you may think, oil prices are up in the United States, they’re up maybe 50% in the United States. They’re up 100% if you’re in Japan. Oil prices 100% on a year to day basis.
AM: Wow. Right.
MG: I mean, that’s just an extraordinary outcome. You’re looking at these kind of underlying characteristics, and you have to say to yourself, the rest of the world is going to start to experience significant declines in aggregate demand.
Forget the supply component that Albert is highlighting. Focus much more on the demand. And when we think about commodities, developed world demand is extraordinarily efficient. We don’t throw copper on the ground. We don’t discard it into landfills. We recycle copper. Right. We recycle aluminum. We clean up the sludge off of our factory floors. That doesn’t happen in most places around the world. Right. Scrap found out in the open is still a significant fraction of aggregate supply. So we just use it more efficiently.
As things shift back here, we’re going to become more efficient at it. And I got a lot of heat earlier this week for posting a chart that said, look, I’m not seeing this commodity super cycle. I’ll say I’m not seeing this commodity super cycle. I don’t see the underlying outward shift in aggregate demand in almost any commodity that says we’re going to have truly sustained high levels of inflation and need for significant additional production other than effectively the disaggregating of supply chains. And you’ll hear things like huge copper demand because of electric vehicles. Right. That is selling human innovation so short, it’s just ridiculous.
If copper prices go higher, we’ll figure out how to use less copper wiring. That’s the history of the world.
TN: Right.
AM: That’s absolutely correct. That’s when they started using, like, gold flakes and sprays and different types of adhesive made out of whatever.
TN: But it generally takes a big demographic change to enter a commodity super-cycle or some sort of supply cut-off, right?
AM: Yeah. I can see a super-cycle within one or two commodities peaking and then coming back down and another one peaking and coming back down. But this insane super cycle that people were expecting, I don’t think it can happen. I agree with Mike.
TN: Okay, great. Let’s switch gears and look at the week ahead. Guys, we talked a little bit about housing, but we’ve got a bunch of housing metrics coming out next week with Case Shiller and a few other things. Because of rate rises, do you guys expect to see a near term impact on house prices? Are we kind of in a wait and see mode? What do you think is happening there.
AM: Politically? The Democrats want housing to come down. Right. And I think some of this bond action is meant to do that to be honest with you. I think they want houses down in the 30 year up. These prices, these housing prices are insane. It just stuns me to see some of these homes going for 150% of what they were two years ago.
And at some point the buyers are going to dry up. I mean, these cash buyers are going to dry up. And the credit now, I think in Tampa, it’s like over 6% for a 30-year mortgage. It’s going to make it even more unaffordable.
TN: But how much does that have to do with housing supply? Are we seeing more supplies coming on the market?
MG: Well, we are seeing more supply of new homes because the delays in completion means that homes that were ordered 18 months ago are finally starting to show up on the market. And that’s been one of the challenges. Unlike what we saw in 2005, 2006. This is not a function of massive amounts of new housing being built in areas that previously did not have housing.
So the character of 2004, 5, 6 was effectively converting farms and semi rural environments into subdivisions of endless numbers of homes that look identical so that people could have a home and then drive an hour to their work or an hour and a half. I mean, that was just crazy.And that was killed by the spike in oil prices that occurred with Hurricane Katrina and Ivan.
This time around, you just have a shortage of supply in terms of people willing to move. And unfortunately, the increase in interest rates, paradoxically, can exacerbate that. Right. Because I don’t want to leave my house and buy a new house because I have to enter into a new mortgage. Right. Of the mortgage. So, perversely, this could end up preventing supply from coming onto the market because when I go to look to replace my home, I can’t do it. And so it’s not clear to me that prices are going to take the hit that people are looking for.
I think at the low end, you’ll see certainly some pressure on new homes. You’ll see some pressure. But perversely, that just exacerbates the problem. Right. If new homes get hit more than existing homes, guess what? We’ll get less new homes.
TN: Okay, great. So far, it’s a very positive show, which is fantastic. End of a rough week into a rough show.
Let’s talk a minute about the French election, guys. It’s next week, what do you expect to happen in markets, say, with the Euro and French equities.
AM: Yeah, actually, we ended up buying the Euro today, looking for Macron to win reelection. Everyone that sees my Twitter feed knows I’m a conservative. Le Pen is a disaster for France, for Europe, transatlantic relations with the United States. She just can’t win and she won’t win. But the thing is, a lot of people think that she’s going to win.
So I think the Euro is going to probably pop half percent, maybe even percent, come Sunday into Monday. And then the dollar might actually come down and the market might actually rally a little bit crazy.
MG: I’m certainly sympathetic to that. I mean, the degree of sell off that we have seen, everything ranging from the yen to the Euro, et cetera, it’s hard to sustain this type of momentum. Ultimately, I’m exceptionally bearish on Europe. I’m exceptionally bearish on Japan for reasons that are largely unrelated to the immediacy of it.
I agree with Albert, and I actually would highlight something that he said that is really important for people to understand. When you describe yourself as a conservative, most people would say, okay, Marine Le Pen is a conservative. Right. Because she represents anti immigration and she represents behave more like French people. Right. But the reality is conservatism is all about let’s not break the system and try to replace it with some utopian vision. Right. Let’s try to work within the existing system to make it better.
When you enter into periods of uncertainty like what we’re experiencing, there’s a reason why the incumbent almost always wins, because people don’t want radical change in their lives. It makes it far more difficult. And so I just am not seeing any evidence that Le Pen has the chance that she’s claimed to and not that I want to join Albert on the potential tinfoil hat conspiracy standpoint, but I agree with them. I don’t think she’d be allowed to win.
TN: Okay, interesting. So a little bit of stability in Europe, which is great.
Guys, let’s have a quick geopolitical lightning round. I know there’s a lot going on in Russia, China, Ukraine, elsewhere. What’s on your mind, Albert, when you talk to your politics, what are you talking about the most?
AM: Honestly, China. The civil unrest in Shanghai, that’s actually looking like it’s spreading is kind of really concerning. For years, Xi’s been holed up in bunkers and can’t go.
You know, China, Tony. I mean, you have 1.3 billion people mad at you. You just don’t go out. Xi has this problem at the moment. So for me, it’s the civil unrest in Shanghai spreading to Guangdong and even outwards.
MG: Wait a second. So XI has 1.3 billion people mad at him? Did he say something against Bitcoin? Sorry.
AM: That would be 2.3 billion people because all of India is there too.
MG: 1.4 billion people. But yeah, exactly. You get really mad about that, as I’ve discovered.
Now, listen, I completely agree with Albert that, and this is again, part of the great irony of everything that’s been going on and I’m somewhat guilty of this myself looking at the dynamics of Russia and the moves that they were making and I think both Albert and I would still come to the conclusion says they’re going to take Ukraine and they’re going to take it in a much more violent fashion because now they’re really pissed.
TN: Yes.
MG: But the simple reality is that I think most people had described a degree of competence to Putin and Russia that has now become very clear that the authoritarian and central planning tendencies associated with that style of governance has its flaws. People are slowly waking up to this.
They’re now beginning to see this in China where it’s like well, wait a second. Maybe Xi’s not planning for the next 100 years. Maybe XI’s planning for the next two days to figure out where… without getting killed.
TN: That’s exactly it, Mike and I’ve been saying that to people for years. China does not think in centuries these guys are making it up as they go along. I’ve been inside the bureaucracy. I know it. They’re making it up as they go along.
So you hit it right on the head. They’re planning for the next two days or two months. They’re not planning for the next 200 years.
AM: Yeah. And the Chinese, they’re quite practical but it’s just too big of a country. I mean, there’s so many different regions and dialect. How do you keep something that big cohesive manner? You don’t.
TN: It’s hard. It’s a collection. It’s like the EU or four of the EU. But it’s very complex for one guy to manage. So guys, thanks very much for that. I really appreciate it and have a great weekend. Thank you very much.
