Falling FAANG Forecast

I see the bad moon rising
I see trouble on the way
I see earthquakes and lightning
I see bad times today
--Creedence Clearwater Rivival

Couple of interesting charts. First (Chart 3) presents a ratio of resource vs biotech ETFs alongside the yield on the German 5 yr bund since 2010. The relationship is readily apparent. Lower yields favor biotech ETFs (a proxy for speculative risk taking in 'tech') relative to price of resource ETFs (a proxy for inflation and conservative positioning in 'stuff' stocks). 

Now, as rates climb higher, the ratio is moving in favor of resource ETFs. Note that the ratio has lots of room to move higher, as suggested by the previous peak in 2010-2011.

The second chart plots central bank liquidity (presumably the aggregate assets on central bank balance sheets mostly due to asset buying programs associated with quantitative easing) alongside the market cap of the FAANG+ group which, due to their immense size can be seen as proxies for the overall market--particularly the tech side. This can be seen a slightly different take on this important chart.

The relationship could not be more obvious. The trillion$ of money printed out of thin air to fund central banks asset purchases has goosed stock prices higher.

With central banks now signaling a reversal of QE programs as they address surging prices of goods and services, the ramifications of doing so are ominous for stocks--particularly those of the speculative FAANG variety.

Off the Charts

When explanations make no sense
When every answer's wrong
You're fighting with lost confidence
All expectations gone
--Swing Out Sister

Strongest beginning to a year for commodities since 1915.

Note that the bar for this year is broken, since the 100%+ change would literally be off the chart otherwise.

Manufactured Chaos

"I want this country to know that we stand on the edge of oblivion! I want every man, woman, and child to understand how close we are to chaos! I want everyone to remember why they need us!
--Sutler (V for Vendetta)

Article questions whether Russia is truly the target of recent sanctions. The thought has crossed my mind as well.

If the West truly wanted to hurt Russia, then it would increase production of oil and flood the world with supply. Not only would this crush prices and cripple the Russian economy, but it would provide relief for consumers struggling with inflationary concerns.

But Western countries have not done so. In fact, they have acted in manners that squeeze oil prices higher.

Sanctions that restrict Russian food exports also make little sense. Because Russia is a net food exporter, restrictions on trade mean Russia has more food and its trading partners have less.

Consequently, the sweeping sanctions ostensibly meant to cripple the Russian economy are driving up prices in the West and increasing risk of shortages in economies already facing inflationary pressures not seen in generations.

On the other hand, higher prices and economic disruptions play into the hands of proponents of the Great Reset. The thinking is that higher oil prices will motivate more investment in green energy. And that economic turbulence will increase dependence on 'enlightened' one world government--while trimming some population deemed to be 'excess' in the process.

Because the Great Resetters believe that they assimilate power in times of crisis, they are endeavoring to create them. Elections, Covid, Ukraine. 

Manufactured chaos.

Stock to Flow Ratio

I don't know why
You treat me so bad
Think of all the things
We could have had
--Talking Heads

Nice point about stock to flow ratio differences between gold and other commodities. Stock to flow ratio is measured here by taking above ground inventory and dividing it by annual production.

Unlike most commodities, gold's stock to flow ratio is high. Nearly all gold mined over thousands of years still exists in its stand alone, elemental form. Because physical gold is durable and inert, it remains with us. On the other hand, annual gold production is relatively low, constituting only 1.5% or so of above ground stock. Consequently, gold's current stock to flow ratio is above 50.

Compare this to wheat. Above ground wheat stocks are rapidly consumed. Wheat put in storage is subject to decay. In order to meet demand, about 3x the amount of wheat inventory must be produced annually. Inventory turnover is high, resulting in wheat's low stock to flow ratio below 0.5.

Of course, the properties of gold that elevate its stock to flow ratio, e.g., durability, scarcity, etc, make it attractive from a monetary perspective. In fact, it seems to follow that commodities with high stock to flow ratios would constitute a nice short list of plausible monies.

The article stresses that stock to flow ratio helps explain pricing differences between gold and other commodities. Whereas the price of wheat is driven largely by supply/demand dynamics of its stock to flow ratio components, the price of gold is less subject to short term volatility. Above ground inventories are high compared to new supply and consumer demand.

Instead, gold price should be driven more by changes in institutional demand. The more institutions demand gold, the higher the price--regardless of inventory levels or annual production.

While institutions are often regarded as large financial entities such as money center or central banks, in a broader sense institutions represent societal rules and norms.

Stated another way, when it becomes more 'societally correct' to own gold, then price will go up.

Stated another way again, changes in institutional rules are likely to coincide with changes in price of high stock to flow ratio commodities such as gold.

Petrodollars to Petroyuan

When situations never change
Tomorrow looks unsure
Don't leave your destiny to chance
What are you waiting for?
--Swing Out Sister

Courtesy of the 1944 Bretton Woods Agreement, the US dollar has enjoyed reserve currency status for the better part of a century. A reserve currency is a money that circulates extensively internationally. It is deemed the standard used to price and execute financial transactions. As such, it is constantly in demand. Banks worldwide must keep piles of reserve currency on hand.

Strong international demand for the USD has been a boon for the federal government. Money can be printed and debt can be issued without having to worry about destroying the value of the currency. 

It is safe to say that the financial position of the United States would be in a much different place were it not for the USD's reserve currency status.

No market demonstrates USD reserve currency privilege more than the international oil market. For decades, Saudi Arabia has priced barrels of crude in USD. Any non-US entity seeking to buy crude from the Sauds has to pay in USD, which lights a fire under dollar demand in forex markets.

Plus, the US gets an extra kicker. Because it can print gobs of USD with little penalty, the US can do so to buy oil on the international market. Let's see...paper dollars printed out of thin air versus a barrel of crude. 

Who gets the better deal? 

The USD's use in oil trade has led to the term 'petrodollar.' The US has reaped huge gains from the petrodollar.

However, the age of the petrodollar may be coming to an end. Financial system warfare currently being waged as part of the Ukraine conflict is awakening countries to their vulnerability, and prompting them to investigate ways to reduce dependence on the USD. By doing so, these nations could sidestep crushing sanctions that might be hurled toward them in the event that they cross the US in some manner.

Seeking alternatives to petrodollars in oil markets would constitute  a significant step in that direction. 

It should not be surprising, then, to learn that countries are experimenting with pricing oil in yuan rather than in USD. In an uncertain world, it makes sense to diversify--even more so when some of that uncertainty involves a country that might decide to weaponize its currency against you.

By engaging in financial warfare the United States appears to be looking the proverbial gift horse in the mouth. The gift of reserve currency status may be rescinded as countries scramble to increase their sovereignty in a sanction-heavy world.

Movement from petrodollars toward petroyuan demonstrates.

Sanctions

"You arrogant ass. You've killed us!"
--Andrei Bonovia (The Hunt for Red October)

Over the past couple of weeks, Western governments have levied countless sanctions on Russia. In this context, sanctions are trade restrictions against a foreign country meant to punish that state for behavior deemed undesirable or bad. Russia's invasion of Ukraine sparked a deluge of sanctions ranging from curtailing or banning trade of particular commodities to freezing Russian bank accounts.

Sanctions aim at achieving various political objectives. One is to make the sanctioned country's population hurt to the point where it demands that its ruling regime cease enacting policies that outsiders find objectionable. Another objective is to weaken a country economically and financially so that it depletes resources for conducting belligerent activities. A third objective might be to weaken a state to the point where it can be overthrown by direct attack.

Despite their popularity, sanctions have marginal track records of success. One reason for this is that sanctions require solidarity among outside states in order to be effective. If only a few countries honor the restrictions, then the targeted state can reconfigure its supply chains toward other countries open to trade. The economic strain of sanctions can therefore be mitigated by developing alternative trade channels.

Sanctions also fail because they commonly strengthen resolve in sanctioned states. When freedom to trade with outsiders is forcibly restrained, then nationalistic tendencies increase among a country's population. Rather than creating animosity toward a domestic regime, sanctions often unify nations behind that regime.

It also seems lost on politicians that the economic penalties imposed by sanctions work both ways. When trade is restricted, the productivity benefits of specialization decline as countries diversify to become more self-sufficient. Less output is produced, and standard of living falls--not just for the sanctioned target, but for all countries--even for those who decline to honor the sanctions. In this manner, sanctions behave like tariffs. 

Who is hurt the worst? The world's poor. Because those at the bottom of the economic pyramid have the most to gain from specialization and trade, they become 'collateral damage' when prosperous countries impose trade sanctions. 

Consequently, sanctions themselves may be seen as acts of war. Although they are often levied in response to violence, sanctions are also violent in nature. They forcibly restrict trade--often in manners aimed at hurting others--particularly civilians. In this sense, trade sanctions bear similarity to wartime policies such as the Allied bombing of German and Japanese cities during WWII. 

While sanctions seem to satisfy popular urges to 'do something,' they possess capacity to do more damage than the bad behavior that those restrictions purportedly aim to punish.

Plugged Nickel

Well, it's midnight
Damn right
We're wound up too tight
--Nickelback

First of several posts seeking to record some of the craziness in commodity markets. This one follows up on the short squeeze in nickel.

After moving over 80% higher at one point yesterday, nickel outdid itself today.

Trading was halted after the squeeze jacked nickel prices to over $100,000/ton.

This action seems the mirror image opposite of what we saw at the depth of CV19 market craziness where crude futures dipped below zero...

Risky Hedges

Past the church and the steeple, the laundry on the hill
The billboards and the buildings, memories of it still
Keep calling and calling, but forget it all, I know I will
--Squeeze

We're seeing some eye-popping moves in commodities with chatter that many commodity producers are getting margin calls on their hedges. 

Why should producers face problems with commodity prices going thru the roof? Commodity producers sometimes short futures to lock in prices. In fact, futures markets came about mainly for this purpose years ago.

The problem is that producers' 'long' positions are usually physical ones that have yet to be sold, meaning that producers lack liquidity (cash) to cover margin calls when their short hedges move higher.

Nickel is up over 80% today as producers feel the squeeze.

Peabody Energy (BTU), a major coal producer, announced today that they had secured a facility from Goldman Sachs to cover temporary cash requirements for their hedges. After hitting a 52 week high yesterday, the stock was off more than 10% on the announcement. 

Although hedging is generally considered a risk management tool, the current situation demonstrates that this is not always the case. 

no positions

Backwardation

Don't look back
A new day is breaking
It's been too long
Since I felt this way
--Boston

Backwardation is an unusual situation in futures markets where front month contract prices exceed those of out-month contracts. Usually futures curves slope in the other direction, with out-month prices higher than front month prices (due to carrying costs, etc). This condition is known as 'contango.'

Commonly, backwardation occurs when demand exceeds supply in the near term, leading to shortages. Shortages cause traders to bid up prices of front month contracts but leave farther out futures contracts relatively unaffected. This lends an atypical downward sloping shape to forward futures contract curves, and positive price spreads (i.e., the difference between front month contract prices and out month prices).

As this article reports, backwardation is happening in spades across commodities. While energy-related commodities have been the big headline grabbers, the phenomenon is occurring among other commodity groups. For example, most industrial metals have been in backwardation since late last year.

The glass half full interpretation is that backwardation-causing events are often acute situations that resolve themselves relatively quickly.

The glass half empty interpretation is that backwardation juices prices higher on the upstream ends of supply chains. If they remain persistent, then those pressures tend to work their way downstream to consumers.

Say it, Fed heads: backwardation rhymes with _____.

Stagflation and Gold

You're calling my name
But I gotta make it clear
I can't say, baby
Where I'll be in a year
--Aerosmith

Stagflation is a period of economic malaise the combines stagnant economic growth with rising prices. The last major period of stagflation in the US occurred in the 1970s. Some will recall those gas lines.

Chatter about pending stagflation is getting louder.

Here is an interesting analysis that considers gold in a prospective stagflationary environment. The basic thesis is that, in a stagflationary environment, gold is one of the last commodities bought. As inflation picks up, businesses and speculators first buy consumable commodities that they need (e.g., oil, ags, base metals). 

However, as business prospects dim (the 'stag' part) and there is still worry about inflation, buyers turn to gold.

What about Bitcoin as an alternative to gold? As proposed in the piece, Bitcoin is likely to benefit more from 'risk on' environments with ample central bank money printing. In 'risk off' situations with tighter monetary policy, then the focus turns to gold.

We've certainly seen Bitcoin bid higher over the past few years of gargantuan central bank money printing. More recently, we've seen 'usable' commodities bid to the moon while gold has languished.

All of this is consistent with the above propositions, and suggests that gold's time is approaching.

This is an interesting thesis--one that I might put to work.

position in gold  

Correction Territory

I'm sick and tired of you setting me up, yeah
Setting me up
Just to knocka, knocka, knocka
Me down
--Bruce Springsteen

Futes melted in the hour or so before the open, leading to a weak open. SPX now in 'correction' territory.

Pretty oversold in near term. Snapper (snapback rally) around here to relieve some selling pressure would be intuitive.

Meanwhile am picking away at pockets of perceived value. Also continue to build miner positions as it feels like opportunities to do so are becoming, uh, precious...

Crack-Up Boom

"It's just money. It's made up--pieces of paper with pictures on it so we don't have to kill each other just to get something to eat."
--John Tuld (Margin Call)

Ludwig von Mises coined (!) the term 'crack up boom' to refer to people swapping out of money and into real goods out of fear that purchasing power was being destroyed by ever increasing monetary creation--either through expansion of bank credit or through monetization of debt. 

As supply of money ever increases, demand for money (i.e., desire to hold cash rather than spend it) collapses. People buy stuff even if they don't need it because anything tangible is better than holding cash which is deemed worthless.

Mises witnessed this phenomenon first-hand during the marquee hyperinflation of the 20th century in 1920s Weimar Germany. He saw children playing house with piles of worthless currency, and men pushing around infamous 'wheelbarrow wallets.'

Ron Paul wonders whether we're on the verge of another crack-up boom. Trillion$ in new money have been created with no end in sight. Inflation measures are printing multi-decade highs. Asset prices have followed suit.

He thinks that re-kindling the spirit of liberty would stop progress of a crack-up boom. Why? Because liberty-minded people do not tolerate massive government spending nor central bank intervention in financial (and social) affairs).

That's a worthy cause to pursue.

Positioning for Retirement

Doing the garden
Digging the weeds
Who could ask for more?
--The Beatles

With retirement coming up fast I've been doing a few things w.r.t. personal finance. I've been saving more and spending less in order to build cash. Have also been selling some stuff on ebay and elsewhere to collect extra 'juice.' Also helps thin things out at the house--much needed.

Preparations are being made to rollover my 401(k) from work. I'm looking forward to allocating this capital among far more choices than those available thru the current fund administrator.

In both my brokerage and IRA accounts, I've been buying dividend paying stocks. Dividends are real cash that can provide a significant, and perhaps under-appreciated, income replacement in retirement.

Inflation is particularly bad for retirees as it erodes purchasing power of savings. To hedge against the prospects of Big Inflation, I've been building stock positions in the oil complex (e.g., ENB, XOM) and miners (e.g., AEM, AGI, PAAS). 

The miners appear particularly attractive. The financial strength of many in this group has perhaps never been better. Solid balance sheets and cash flows. Many are paying significant, and increasing, dividends (which helps me kill two birds with one stone). The sector has been pounded down to attractive valuation levels--particularly given the growing inflationary environment.

I've been swapping funds out of precious metal ETFs such as PHYS and into the miners to more fully express my perception of this situation--albeit at a slightly higher risk profile. 

positions in AEM, AGI, ENB, PAAS, XOM

Green Light District

Red light
Yellow light 
Green light
Go
--Def Leppard

Hedge fund legend Paul Tudor Jones follows his compadre Stan Druckenmiller in discussing the recklessness of current Fed policy and its ramifications on his investment approach. He points out that the Fed is being way more aggressive now than in 2013 (QE time) when monetary policy backdrop was much more benign (i.e., friendlier toward being aggressive). 

With the economy heating up and employment much more in balance now--not to mention the trillion$ already dumped into the system over the past year in CV19 'relief,' there are glaring inconsistencies in current Fed actions.

He also notes that the Fed's mandate, at least as policymakers discuss it, has shifted completely away from inflation-related 'price stability' to focus exclusively on 'full employment.' Talk about mission creep.

Or mission migration...

Jones suggests that if the Fed does not signal that they are treating recent data indicating hotter inflation with seriousness, then he'll take it as 'a green light to bet heavily on every inflation trade.'  

The latest FOMC statement will be released this afternoon. What will the rhetoric suggest?

Letting It Fly

Time keeps on slippin,' slippin,' slippin'
Into the future
--Steve Miller

The always insightful Stan Druckenmiller zooms with the USC student investment fund group. In the first 20 minutes he offers prepared remarks, primarily concerning his current macro view, while the remainder is Q&A.

Druck lets it fly in part one. After unprecedented monetary and fiscal intervention in response to CV19 last spring, he contends that both the federal government and the Fed are being reckless on a historic scale by continuing to pump stimulus into the system after indicators show that the economy no longer needs assistance. Debt has exploded and prices are rising. He is preparing his family trust fund (a few $billion large) for Big Inflation with bets against the US dollar and on commodities. 

Although he remains long stocks, Druck says that he'll be surprised if he isn't out of equities before year end. I'm not sure whether he thinks inflation will hurt stocks or whether he believes prices are too high (he mentioned that he sees bubbles in nearly all assets classes).

Several interesting notes from the Q&A. On lessons learned from his mentors, Druck highlighted the advice he received about envisioning what things will look like in 1-2 years rather than where things are today. Today has already been priced in. Also enjoyed the Soros story about sizing positionss accordingly. Attractive opportunities should be well funded.

Re digital currencies, he suspects that the dollar et al will be headed electronic. However, he isn't keen on Bitcoin or its brethren being the chosen one.

On unequal wealth distribution, Druck suggests there has been no greater facilitator than central banks--a point these pages has made before.

In prepping for inflation, was surprised there were no questions or comments on gold. I'll take that as a bullish contrarian indicator...

His remarks on shorting also surprised me. While the last 10-12 years have been 'miserable' on the short side, Druck said that recently his shorts have been doing better than his longs. Moreover, given the historic macro situation, he suspects that upcoming years may be very friendly to shorting assets that are wildly overpriced. 

This inspired me to start thinking about setting aside modest short side space in my taxable account for some put projects. Also set up a short candidate watch list. 

position in gold 

Time to Shine

There used to be a graying tower
Alone on the sea
You became the light 
On the dark side of me
--Seal

Stocks continue to outpace commodities. Ratio of $SPX:$CRB hitting new highs on a daily basis.

Ratio of US Stocks to Commodities continues to hit new all-time highs. $SPX $CRB pic.twitter.com/uqKs9432UI

— Charlie Bilello (@charliebilello) January 23, 2020

From the graph, the two previous periods where commodities outperformed weren't economically similar. The early-mid 70s were times of classic 'stagflation' while the mid 2000s saw commodities and stocks both run for a while--commodities just ran hotter. Oil peaked at ~$150/barrel in 2008.

What will it look like when it's once again commodities' time to shine?

Gold Over Copper

Sarah Connor: What did he just say?
Gas Station Attendant: He said there's a storm coming in.
Sarah Connor: I know.
--The Terminator

These pages have often observed that gold is a bet on disorder. As gold price rises, those bets increase. Stephanie Pomboy presents another way to look at what's going on by plotting the ratio of gold to copper prices.

at the risk of piling-on,the canary in the financial crisis coalmine has been singing loudly. the relationship btw the metallic barometer of financial insecurity (gold) and the metallic barometer of economic activity (copper) has been a reliable predictor of trouble in the past. pic.twitter.com/K6rjNSpRcB

— steph pomboy (@spomboy) August 7, 2019

When the ratio goes up, it tends to correspond to crisis.

The ratio is going up.

Primary Asset Classes

"The most valuable commodity I know of is information. Wouldn't you agree?"
--Gordon Gekko (Wall Street)

Investors generally choose from four primary asset classes:

1) Cash. Cash is the fundamental asset class upon which other asset classes are based. It is denominated in units of currency (e.g., dollars). Cash is liquid, meaning that it is easily exchanged at its nominal value (e.g, 'one dollar'). It carries low short-term risk, meaning that its value is unlikely to decrease over the next few days or weeks. Over longer periods of time, however, the value of cash can decline in inflationary environments when the creation of additional money (typically by government) causes the purchasing power of cash to go down.

That said, the primary objective of cash is capital preservation. In uncertain times, or as a parking place for investment capital until better opportunities arise, cash can be an attractive asset class.

2) Fixed income. Fixed income includes a variety of investment vehicles ranging from bonds (both government and corporates) to certificates of deposit (CDs). Fixed income securities usually pay predetermined streams of income to their owners over the life of the investment. The timing of these payments is nearly always pre-set as well (e.g., monthly, semi-annually, annually, at maturity). This predictability is an attractive feature of fixed income instruments. A primary risk for owners of fixed income is 'credit risk,' meaning that it is possible that the borrower who sold the debt may default on some or all payments. To compensate, investors demand higher interest rates from debtors deemed to be riskier.

The primary objective of fixed income is predictable income or cash flow.

3). Equities. Equities, also known as stocks, are investments in for-profit companies. Partial ownership of a company is obtained by purchasing its shares either directly or via funds (mutual funds or exchange traded funds (ETFs)) that hold its shares. Equity shares can commonly be purchased on a stock exchange such as the New York Stock Exchange (NYSE) or the National Association of Securities Dealers Automated Quotations (commonly called the 'NASDAQ').

Stocks entitle the owner to participate in future wealth-building activities of the company that can result in share price appreciation (a.k.a. 'capital gains') or dividend payouts. Of course, owners also face risk that the company may not perform well in the future, thereby causing share prices to drop or dividend payouts to decline/terminate. The risks associated with stock ownership generally exceed those associated with either cash or fixed income. However, the rewards are generally greater as well. (Remember that risk and reward are related: the higher the risk, the higher the prospective reward, and vice versa. If that was not the general rule, then markets would have trouble functioning)

The primary objectives of equity ownership are capital appreciation and dividend income.

4) Alternative assets. The three asset classes discussed above--cash, fixed income, and equities-- are considered 'conventional' asset classes and comprise the bulk of investment portfolios. However, over the past few decades, financial market innovations have enabled investors to gain exposure to another group of assets called alternative assets. Alternative assets, sometimes termed 'hard assets' because they typically involve tangible goods, include commodities (such as oil, farm products, and gold), real estate, and even collectibles such as art. In the old days investors wishing to own alternative assets had to buy the tangible property and hold it in physical form. Today, many alternative assets have been 'securitized,' meaning that investors can readily buy exposure to them through ETFs and related vehicles. Many of these securities carry idiosyncratic risks, however, and investors must understand these risks before getting involved with this group.

Alternative assets can be attractive from two standpoints. Owning hard assets such as real estate or gold can be an effective way to hedge against inflation and other forms of financial or social disorder. If the value of the dollar goes down, for example, then the price of land or gold typically goes up. Another feature of alternative assets is that their value often moves up and down in a manner that is weakly or even negatively correlated to stocks and bonds--making this asset class an attractive way to diversify an investment portfolio.

The primary objectives of alternative assets, then, are inflation/disorder protection and diversification.


One of the major decisions facing investors involves 'asset allocation,' or how to divide their capital among the four above asset classes. We'll discuss in a future post.

position in gold

Current AA

I never wanted another
Come over to me and discover
--Orchestral Manoeuvres in the Dark

Current asset allocation in securitized (paper) form:

Stocks  13%
Fixed income. 1%
Alternative assets  28%
Cash  58%

Alternative assets mostly include precious metal ETFs and stocks are primarily in PM miners.

Primary goal this year is to broaden equity exposure to include a stable of dividend payers. Not too much too fast, though, given elevated valuation levels and field position. Hoping to use lower prices to my advantage.

Gold and Disorder

And so we turn on the TV one more time
And we see that everything is fine
--Flesh for Lulu

WSJ observes that, with gold up nearly over the past three months, the yellow metal is outperforming stocks on a quarterly basis for the first time in years.

When it really gets its groove on, financial analysis of gold is likely to look more like this:

And perhaps people will suddenly remember gold's historical position in the monetary hierarchy:

This 'golden rule' is grounded in the primary thesis for owning gold. Gold is a bet on disorder--whether that disorder is narrowly monetary or broadly social in nature.

Sadly, people tend to figure this out only after this disorder is well underway.

position in gold