Hard Currency Choices
Back in early January (seems like a long time ago) we penned a view https://aurumecho.com/from-dusk-to-dawn/ that decisions have been made in the non-Western alliance world to move away from the US dollar as the default trade currency in favour of more local “flavours”. Since then, even we’ve been stunned with the pace of change, not that you would read or hear anything of it in the “Western Alliance” news streams.
In this note we will try to share some views on the challenges facing asset allocators/investors in this rapidly shifting (deteriorating) geopolitical climate. The not so new investing challenge that is inflation in a massively over indebted world, now has war added to it, throw your fiscal models out the door.
Actual war now means that any falling inflation numbers are transitionary and the possibility of USD150 per barrel oil due to supply “blockages” combined with the China reopening look more likely by the day, adding fuel to the inflation fire. In a world with extremely tight energy supply, only a global recession of a nature so serious as to severely scrimp energy demand will change the course. The investing backdrop in a serious recessionary scenario would change the outlook for many an asset class, especially Gold, as Central Banks dial the printing up to 11 in response. In fact, they may dial to 11 just on fear alone, leaving those investors waiting for a “bargain event” horribly underinvested.
At this stage, a severe recession is not our base case (barring a credit event) but we do believe Central banks and policy makers will act decisively at the first hint of systemic pressure, therefore, we are maintaining our allocations to old school hydrocarbon investments to a level of 10%+ of portfolios with a high level of conviction.
The irony of hydrocarbon demand increasing on the back of woke energy policy is outstanding. To see what happens in the real world, just look at German energy policy since “the war” started. They’ve rapidly moved back to coal, reversed their nuclear policy, started burning wood for heat and provided massive fiscal assistance to the population to “alleviate” energy cost pressures. Effectively, the German GOVT has been massively subsidizing fossil fuel demand, putting enormous sums of money in the hands of “EVIL” bad energy producers!! Oh, the irony!! Let this German situation be a lesson to investors as to how pragmatic climate change virtue signallers can be when populations face real energy issues!
On the matter of war in the Ukraine, it should be clear from the build-up of military forces on both sides that the Ukrainian conflict may soon escalate and potentially spill over into broader borders. We suggest caution in underestimating the preparedness of Russian forces and leadership. Western media attempts to present Russia as a country with leadership in disarray may well be just wishful propaganda.
From a Russian perspective, security of its borders has long been its motivation (and protecting Russians in East Ukraine), particularly in face of technological advances in hypersonic weapon systems with NATO boarders creeping closer. For NATO (the US), a loss in the battle over Ukraine would lead to many countries outside the Western alliance to view the US as no longer Omnipotent, leading to many of these countries jumping to join the BRICS+ alliance (a definite USD negative).
In addition to this, the US has always been concerned at a pivot East by Germany. We wonder if some in Germany may be viewing the Nordstream pipeline sabotage as a war act, by a “friend”. So, it’s on for the young and old, Russia clearly underestimated the NATO military build-up in the Ukraine since 2014 but now understands and has been preparing on a massive scale over the last 6 months to “take the gloves off”. We may not have to wait weeks for the next chapter in this geopolitical saga as we sift through aftereffects on investment portfolios.
On the matter of the US dollar and investment positions, after a strong 2022 for the US dollar, what might the opportunities be if one takes a view that 2023 sets rather poorly for the USD? Make no mistake, de-dollarisation is a central theme in many countries outside the Western alliance, and, believe it or not, as are discussions on the role of Gold moving forward.
Reserve confiscations and sanctions applied by the US on Russia have not only had very little effect on Russian trade (as evidenced by Russian trade balance and currency) but have led to many other countries to now trade oil and other commodities in non USD currencies, particularly China and India with their energy suppliers. Adding downward pressure on the USD (and Euro) are massive debt and inflationary issues in an unsustainable “free shit for all” bureaucratic system, putting serious pressure on the financial system, even without a war!
It was Oscar Wilde who opined “The bureaucracy is expanding to meet the needs of an expanding bureaucracy”! To maintain “things” in the US, the country well on track to a 4 trillion dollar deficit spend this year.
Think about this pile debt below and the fact that most of it was accumulated over the last 13 years at very, very, 3000 year low interest rates!!
Out of control spending is not just a US phenomenon, government spending in numerous EU countries is above 50% of GDP. It is hard to imagine a more stupid or more dangerous way of making decisions than by putting those decisions in the hands of people who pay no price for being wrong.
Central Banks now find themselves wedged between two evils. The evil slow burn (for now) of inflation or collapse of Sovereign Bond markets due to high interest rates, taking the entire system with it.
Which do you think they’ll choose?
We think the risks rising rates pose to an over indebted financial system are well covered, as should be your precious metal insurance positions. Should geopolitical and economic events manifest to a weaker US dollar, we have been considering increasing allocations to the following: (These are ideas, not advice).
- Commodities and Precious Metals.
- Emerging Market Equities
- Emerging Market Bonds
- Real Estate Investment Trusts, Telecoms and High Yielding infrastructure of rapidly Emerging Asian markets, including Singapore.
As stated above, the most important consideration for investors through 2023 will be whether central banks will “Pivot” in the face of worsening economic conditions, driven by higher interest rates,
Or,
Wait for “something” to happen in credit markets as per the chart below.
So,
Does one keep much dry powder (and continue to suffer eroding purchasing power) in preparation for the “event”,
Or,
Do Central banks stay in front of it all with massive stimulus as they’ve done since 2009, accelerating inflation to an uncatchable speed?
Do you feel lucky?
It has surprised many analysts how the Gold price has held up in the face of rapidly increasing interest rates.
With interest rates now near, or close to their peak for this cycle, the outlook for the Gold price over the next year has never been better.
Amazingly, many profitable Gold producers trade like Gold is $1,100 per ounce and quality explorers are in the midst of a prolonged bear market. Rising costs and outright collapse of some producers have created bargain prices for the better quality, lower cost producers. Central Bank Demand for Gold remains robust across the globe as does domestic demand in the World’s most populace nations.
2023
Peace!
