Wednesday, October 20, 2021

This Week's Message: Recent profit-taking notwithstanding, we remain long-term bullish on inflation, energy, and the rest of the commodities complex...

As clients and regular readers know, our under-the-surface view of global general conditions has it that inflation going forward will be, let's say, more than it's been the past several decades.

Here, once again, from our internal log is the initial synopsis of our ever-evolving thesis:

"...amid what may be a period of relatively low velocity of money, heavy debt burdens, and, we presume, further technological advancement -- I see increasing odds that we're at long last on the cusp of something meaningful (but not 1970s meaningful, mind you) with regard to structural inflation risk:

  • Increasing populism (a serious headwind for global trade -- in both goods and in labor).

  • A continual stimulating of the economy via fiscal policy (facilitated by easy monetary policy) -- demanded by a politically-powerful populist movement.

  • China maturing into a service-oriented, consumer-driven economy (while moving away from providing cheap labor and goods to the outside world).

  • The Fed's fear of bursting present asset and debt bubbles were it to implement traditional inflation-fighting measures -- thus willing to fall notably behind the inflation curve well into the foreseeable future. In fact, I personally place better than 50/50 odds that if indeed a long-term trend of rising inflation emerges, that the Fed will revert to yield curve control (buying up the price (down the yield) of longer-term treasuries) to control lending rates that, were they allowed to rise, would themselves produce a headwind to rising inflation.

  • The trillions of dollar-denominated debt sitting on foreign corporate balance sheets inspiring an active campaign by the Fed to keep the dollar at bay, in an effort to avert what could otherwise turn into a very messy global currency crises.

  • The reticence of producers in the metals space to aggressively expand capacity despite rising prices: Speaks to the devastation they experienced post the ‘08 to ‘11 China building boom.

  • The political/environmental headwinds for fossil fuel producers to expand capacity.

  • Inflation being the US’s historically-preferred mechanism to reduce heavy federal debt burdens.

Now, all that said, before we settle into that structurally rising inflation scenario (if indeed that's where we're headed), I look for a notable calming of the thrust we're presently experiencing -- as the worst of the production bottlenecks subside -- inspiring a chorus of I-TOLD-YOU-SOs from the "it's transitory" camp. 

Thereafter I suspect we'll see inflation settle into a steadily rising structural trend, and in the process fuel what will likely turn out to be the next longer-term commodity supercycle."

And here's some recent commentary from two premium macro research providers whose opinions we respect (not simply because we're on the same page with regard to inflation, btw):

BCA Research:
"Longer-term supply-chain issues will be sorted out. Still, higher costs will be needed to incentivize production of the base metals required to decarbonize electricity production globally, and to keep sufficient supplies of fossil fuels on hand to back up renewable generation. This will cause inflation to grind higher over time.

This is a classic inflationary set-up: More money chasing fewer goods. This is occurring worldwide, as supply-chain bottlenecks, power rationing and shortages, and falling commodity inventories keep supplies of most industrial commodities tight."

"Longer-term, the logic of markets – higher prices beget higher supply, and vice versa – virtually assures supply chains will be sorted out. However, the cost of energy generally will have to increase to incentivize production of the base metals needed to pull off the decarbonization of electricity production globally, and to keep sufficient supplies of fossil fuels on hand to back up renewable generation. This will cause inflation to grind higher over time."
Variant Perception:
"Structural tailwinds remain for commodity supercycle in next 3+ years given

i) fusion of monetary and fiscal policy,

ii) time lag/depletion/high-grading issues limiting supply response,

iii) investor underweight in real assets. Structural gold indicators remain bullish (surging M1 growth vs gold above ground), but we are waiting for tactical indicators to improve (seasonality, contrarian negative sentiment).

Oil producer discipline should encourage OPEC to keep supporting oil prices. Rig counts remain low even with below average inventory levels."

"The shocks associated with recessions often result in large shifts in the policy environment, causing shifting market leadership as business models shift and adapt. The pandemic brought with it aggressive and coordinated monetary and fiscal policy stimulus, which was last seen in World War II. This suggests the current change of market leadership towards inflation assets has legs."

Frankly we absolutely can't stress enough how governments the world over seem utterly clueless when it comes to energy policy these days. I mean, we totally get, and agree with, the need (the urgency even) to actively develop renewable energy sources; the thing is... well... here's from a recent episode of the always insightful Grant Williams podcast:


The human endeavor is a constant unrelenting struggle against entropy, just abandon a house for a year and you’ll see just how spontaneous disorder is. You need to continuously resupply your body and your environment with excess energy in order to impose order on your local environment, and this is a basic concept of physics. It’s the reason why time has an arrow and few people understand just how important the direct connection between our energy policy is and who gets to live and who gets to die.


For all of the arguments against fossil fuels, and I understand them, and for all of the worry about long-term damage that we’re doing to the planet, and I do understand those, there is a cost-benefit analysis to every decision that we make.
Currently, we have decided on a worst-of-all-worlds situation which is we are governed by platitude. Our politicians are untrained and the voters largely like platitudes.
Platitudes are easy. They sound great. They make for great commercials but the actual in-the-trenches decision-making around energy policy is incredibly complex, very serious, and the consequences of getting it wrong can be catastrophic, which is what we’re seeing in the UK right now, which I’ve warned our clients’ is nothing but a preview for what’s going to happen here."


I’m actually quite an environmentalist in my private life and in my work. We’ve worked on many renewable-type projects and are firm believers in them but the policy has to be sane.
You can’t be pro-renewable and anti-nuclear and consider yourself intelligent on the issue. You can’t block all new fossil fuel development in your backyard, which only has the effect of delegating your energy future to people who don’t like you.
It’s really just stunningly frustrating to watch it play out in real time.

Grant Williams:

But also completely understandable right? Because we live in that world now where it’s all about perception. It’s all about the narrative and unfortunately, it’s all about winning votes. Having a popular energy policy doesn’t really fit with having a sensible energy policy.


Yes. That’s true, except very quickly, as we’re about to find out in the UK and, will soon find out here, a crisis erupts. People get angry and then they over-correct to the other side. We’re going to see reversals of policy in the UK and a boom in the exploration of natural gas and fossil fuel plant construction eventually because it’s just unacceptable that grocery stores don’t have food and people can’t heat their homes."

Here, with a softer touch, is more from BCA: 

"Decarbonization is a strategic agenda for leading governments, especially China and the European Union. China is fully committed to renewables for fear of pollution causing social unrest at home, and import dependency causing national insecurity abroad. In the EU, energy insecurity is also an argument for green policy, which is supported by popular opinion. The US has greater energy security than these two but does not want to be left behind in the renewable technology race – it is increasing government green subsidies.

The current set of ruling parties will continue to prioritize decarbonization for the immediate future. Compromises will be necessary on a tactical basis when energy price pressures rise too fast, as with China’s latest measures to restart coal-fired power production. The strategic direction is unlikely to change for some time."

So, yes, while, as investors embrace reality, related markets will indeed get ahead of themselves (and correct [at times violently]) -- we've recently taken some profits from our rapidly rising (of late) energy and metals exposures (also rotated a bit from gold to silver) -- the intermediate to longer-term setup remains resoundingly bullish for commodities.

Thanks for reading!


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