Economic Doom Loops
Recent mainstream media revelations of a more permanent type of temporary inflation are now being added to the reality of falling global GDP growth, leaving investors scratching their head as they reach for news clippings from the 1970’s for anything similar.
The word used to describe this condition is not one unfamiliar to readers of these notes, stagflation.
Stagflation, by our definition, is the unholy economic nightmare of rising inflation and falling economic growth, coupled with predictable doom loop economic policy responses from those in charge of kicking cans down roads.
As there is no constituency for short term pain in order for longer term gain by way of systemic reform, hectic inflation was always the only preferred outcome, as we’ve been outlining for many moons.
Well, inflation is here, there and everywhere. Global consumer product giant Unilever announced last Thursday that soaring commodity costs had forced it to put up prices across the board by the most in years.
“We continue to take pricing responsibly, and that’s in relation to the very high levels of inflation we’re seeing,” CFO Graeme Pitkethly told reporters. He said that inflation in the consumer goods industry is in the “high teens,” with Unilever mitigating some of the inflationary impacts due to its negotiating power.
Pitkethly warned inflation could surge even higher next year, and the company would have to deal with spot prices as its hedges expire. He said 20 billion euros in raw materials and packaging costs and 3 billion euros worth of logistical costs had been impacted by inflation.
Rivals, such as Nestlé, warned on Wednesday that “inflation costs are rising faster than we can roll forward through pricing . . . The situation has not improved. If anything, we are seeing further downsides compared to what we told you in the summer.”
The real US inflation rate, using all the “things” taken out since the 80’s, is in the teens, as per the chart below.
The rising price part of stagflation is settled, so let’s look at a one example of a falling “growth” component. The following chart comes from the current centre of the economic universe, the US:
As a side note to the above chart, if economic financialisaton and money printing were a measure of growth instead of core “productive” output then US growth would be through the roof, as some politicians believe it still is.
The stark reality of the inflationary economic outlook for any nation producing very little and consuming very much is revealing itself as we speak by way of both shortages and prices.
For those thinking China will again take up the GDP slack, this time is very different. Investor expectations of a China pulling a 2009-recent economic miracle of 6 – 8% annual economic growth are over, finished.
Veteran China analyst, Louis Gave, of Gavecal Capital notes that in face of growing “potential” civil dissention, the CCP leadership regime is in the process of pulling in the reins of property speculation and other economic excesses.
The blocking of the gigantic Ant Group IPO, Jack Ma’s seclusion and the will to prick a massive property bubble through inaction with Evergrande are a few examples of this change in direction.
The social reasons for Chinese leadership facilitating a “temporary review” of economic growth targets are wide and complex but make no mistake, it’s happening.
Investors, particularly Australian Investors, should be adjusting portfolios accordingly.
Enough on the middle kingdom, back to the broader macro picture.
The illusion of economic growth driven by central bank money printing and interest rate suppression has led to asset market speculation the likes of which the world has rarely seen – and these policies are now revealing a most sinister side effect, inflation.
The existence of this inflation continues to be vehemently denied and/or referred to by central planners as temporary, there is no other option for them as they can do nothing to combat it.
Instead, the blame for these rising costs will soon move to suppliers then to consumer “sentiment”. But we all know the blame lies at the feet of central banking planners and their desire to confront every economic problem or crisis with more of the same “fix” as those before – more handouts, more printing, more guarantees, more largesse and generally more for free.
Readers of these pages have known for years that the only acceptable solution to any systemic issues within the current financial system has been to inflate them away and hope nobody notices, leaving consumers like frogs in a slow boiling pot.
Now let’s add some Climate Change policy, lunatic virtue signalling ESG-driven energy policy and $100 per barrel oil to the mix. Since May 2021, the price of a basket of coal, oil and gas has surged 95%!!
With oil and gas driving up transport costs and thermal coal making electricity more expensive, we are now discovering the true cost of an obsession with alternate energy.
There is simply no balance in the climate change debate at all. Due to a lack of investment in new productive facilities, any industry and service that needs oil and gas will find supply lines continuing to tighten and considerably more expensive.
This is a man-made disaster of epic proportions at the worst possible time.
But not to worry, Central banks will, based on the last 12 years, continue to solve all the worlds ills, including climate change with more money printing and more jaw boning.
Unfortunately, combating inflation requires the opposite. It requires tightening of monetary policy, increase in interest rates and still more jaw boning, the other way.
The two policy responses do not go together well.
So, policy reactions look like this, Central Banks combat falling growth and over indebtedness with more “stimulus” (money printing), thus creating more debt and “temporary” inflation which then causes growth to slow even more thus leading to even more money creation “stimulus” and thus more permanent inflation, and so on and so forth, an “economic doom loop”.
For those using precious metals as part of their protection strategy – it seems the price of gold and even gold equities have awoken from a lengthy slumber over the past couple of weeks.
The backdrop outlined above could well prove to be the perfect storm for precious metal investors.
Before we move into the precious metal space, a quick comment on cryptos. Although we’ve owned some Ethereum and BTC in the crypto space for some time, we’ve always wondered how this market might behave in a financial crisis – it’s yet to be tested.
Gold, on the other hand…………….
John Hathaway, Senior Portfolio Manager, Sprott Asset management described it best in his most recent note :
“Despite lacklustre third quarter and year-to-date performance for gold, the fundamental backdrop for precious metals and related mining share prices continues to strengthen in our opinion. Here’s why we believe this:
- Inflation has become increasingly problematic and more persistent than previous sanguine assessments by Federal Reserve Board (Fed) Chairman Jay Powell and other Fed officials.
- Real interest rates remain deeply negative, a positive for gold. The average annual return on gold during periods of negative real interest rates has been a stellar 21.12%.
- Monetary policy continues to be highly accommodative. The bearish case for gold rests on the deteriorating probability of the Fed tapering asset purchases in November.
- The global economy is beginning to sputter. Spreading economic weakness will make any tightening moves by central banks difficult to implement without broader repercussions.
- Physical gold buying centred in India and China has risen dramatically. Indian demand alone is 500 tonnes greater than it was in 2020, more than enough to absorb current mine supply.
- Net buying of gold bullion by central banks is likely to continue and may possibly increase.
- Positioning by commodity traders is at negative extremes and is usually followed by short-covering rallies. The selling of paper gold on the thesis of Fed tightening is already priced into the market.
- Gold mining equities are trading at deep value while generating record cash flow.
A Near Perfect Environment for Gold and Gold Miners?
Since mid-June, gold and related mining stocks have been over-sold, shorted or ignored. The bearish thesis for gold and gold mining stocks has been that the Fed will slay inflation by “tapering” asset purchases, in stark contrast to their general dovishness over the past several economic cycles.
Now the rubber hits the road; the bear case for gold depends on the following fantasies:
- Tapering is different than raising interest rates.
Our Counter: They’re the same thing — both restrictive monetary policies are designed to accomplish similar outcomes. - The global economy can withstand a small increase in borrowing costs.
Our Counter: It can’t. Excessive leverage will result in spreading defaults of marginal borrowers. - A 2022 slowdown is not in the cards.
Our Counter: It is. Multiple signs of weakness are already showing up, including weak employment reports, poor consumer sentiment and negative China Caixin Manufacturing PMI (purchasing manager’s index). - Nosebleed financial asset valuations are impervious to rising interest rates.
Our Counter: They’re not. There are plenty of signs of market averages topping. - Inflation is transitory.
Our Counter: Evidence is increasing that it is intransigent and unlikely to be stemmed by tapering.
In our opinion, the number one reason for disinterest in gold has been the seemingly endless equity bull market. However, it would seem that things can hardly get better for equity bulls. The rosy economic outlook, super easy monetary policy and bullish crowd psychology are not immutable. Odds suggest that future changes are more likely to be negative at the margin than positive…
As noted by Bob Farrell, “Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.” Risks unperceived at market peaks can begin to multiply faster than investors can react. An unravelling of the current speculative euphoria, at a time when precious metals fundamentals have rarely been more solid, would constitute a near perfect environment for gold and gold miners.
Expectations for rising interest rates seem to be moving into high gear (see Cornerstone Macro). Somehow, these expectations are deemed to be harmful to gold but no threat to financial asset valuations in general. Perhaps this inconsistency can be explained (1) by the consensus belief that economic growth and strong earnings will be sufficient to offset the damage from rising rates and (2) that interest rates will rise just enough to put a lid on inflation but not economic growth and thereby render more draconian monetary tightening unnecessary. To us, this view ignores the yawning mismatch between the incremental supply of deficit-driven Treasuries and the lack of demand at ultra-low interest rates. As recently noted by Macromavens (10/12/2021):
‘The point being that, as troubling as the recent backup in rates has been, it is FAR worse than surface-scanning investors dare imagine. The fact that $20 billion in foreign purchases, $38B in bank purchases, $8B in spec buying (and $40B in purchases by the Fed!) — which annualize to roughly $2.8 trillion in Treasury demand — failed to arrest the backup in rates (much less send them tumbling downward) SHOULD send ice cold shivers down the market’s spine. For, unless one imagines that the pace of Treasury issuance is about to slow big time, (and that requires one hell of an imagination!) the recent action in the Treasury market reveals how impossible our financing situation has become.‘
Precisely. The financial markets have not taken into account the magnitude of supply or the distortion of interest rate price discovery caused by quantitative easing. The impending attempt at balance sheet normalization could prove far more disturbing to financial markets than the failed 2018 episode.“
Peace.
