Cross of inflation

Weekly Comment – February 7, 2021

Two great interviews this week: 1) Goldman’s head of commodity research Jeff Currie on Bloomberg’s Odd Lots and 2) Stanley Druckenmiller, interviewed by Tony Pasquariello also of course, from Goldman.

I’m summarizing a couple of main points from Druckenmiller, crystalized from his observations: 1) in three months the Federal Gov’t increased the deficit by more than the sum of the last five recessions combined and 2) in the span of six weeks, the Fed bought more treasuries than they did in TEN years under Bernanke and Yellen.  He says now is the “wildest cocktail” he has ever seen and expects much higher inflation and a continued boost to commodities.  I have linked the 30-minute interview at bottom

Jeff Currie argues for a bull market in commodities, which he has been doing for some time.  In that connection, I start with a couple of updated charts, one short term and one which covers the past twenty years, of the ratio of SPX to BCOM (Bloomberg Commodity Index).  Top chart is the one-year horizon.  Since April, as monetary and fiscal authorities stomped on the gas pedal, this ratio has gone sideways.  In other words, even with the speculative fervor in stocks and a growing tech wfh economy, commodities have kept pace.

The next chart is over a twenty year horizon, and this of course shows the massive outperformance of stocks over commodities.  Since the GFC low in 2008, the ratio has gone up 9 times from 5.3 to current 47.1.  From 2008 to 2013 it doubled.  From 2013 to 2015 it doubled again.  From 2015 to 2020 it doubled again, and kept on going.  Until this year.

Podcast on Bloomberg’s Odd Lots with Joe Weisenthal and Tracy Alloway with Jeff Currie, Global Head of Commodities Research at Goldman. 
One of the initial topics concerned the short-lived speculative burst in silver early in the week. Interestingly, Currie mentioned that silver has always been the “populist” metal, and he referred to William Jennings Bryan “Cross of Gold” speech at the 1896 Democratic Convention which is widely hailed as one of the greatest political speeches ever.  The issue of the time pitted the free money silver advocates against the east coast elites in favor of the gold standard.  The miners and farmers and labor of the west wanted silver included in a bi-metalism monetary standard, which would in effect loosen financial conditions, and make it easier to pay back loans made by eastern bankers under the hard-money gold standard in place since 1873.  There are obvious parallels to today’s populist sentiment, though there is no question that loose monetary and fiscal standards have carried the day, now in the form of monetary transfers raised from government borrowings and issued directly to individuals, from Biden’s $1400 stimulus checks to the possibility of the cancellation of student debt, to Romney’s $3000 per child credit.  

Here is a short summary of Currie’s arguments that commodities are in a super bull cycle.  I would of course encourage you to listen to the source podcast on Odd Lots (for those without access I have linked a GS 2021 outlook interview below). The points are that volatility is starting to rise across commodity markets.  He notes that inventories are generally low, making this a structural story.  Every market with the exception of [zinc??] and cocoa is in deficit (meaning that demand exceeds supply).  He goes on to make an interesting point about green energy initiatives ironically supporting oil in the medium term.  The reason has to do with structural long term UNDER-investment in supporting production of ‘old-economy’ commodities.  The NEW economy has sucked capital away from the OLD economy and has left inventories low.  He doesn’t really mention things like M2 money supply growth or pinpoint deficit spending, but does refer to USD weakness as an underpinning factor of his thesis.  He highlights three themes that result in policy driven demand.

1) redistributive policies

2) environmental policies

3) versatility in supply chains and security of supply (redundancy).

He calls attention to income and wealth transfers to lower income individuals and their higher propensity to spend.  Higher income people spend about 3 cents per extra dollar on things that are not very commodity sensitive.  Lower income spends 100% of transfer funds in more commodity intensive ways.  Green initiatives have contributed to underinvestment in old energy.  In the ‘outlook’ interview he said that in the first half of 2020 there was an unheard of 40% decline in oil capex (and has a $65/bbl target for 2021).  Another interesting stat, 20% of the industrial demand for silver comes from the manufacture of solar panels.  In terms of supply chains (though not in Currie’s presentation) semiconductor chips have become the hot topic, with shortages (most are supplied by Taiwan) leading to factory shutdowns in autos and widespread inventory hoarding, beginning with Huawei and now spreading to Apple and others.  An analyst cited by Bloomberg notes that key chip component prices “have risen as much as 15% in the past three to six months.”  

 
One other fascinating point was that he cited 1979 to 1980 as another period of high real commodity prices, but also the time of the lowest wealth and income inequalities.  I think it might be a stretch to connect those two features of the era.  I will note however, that CPI accelerated through the late 1970’s of the Carter years, and posted a yoy high of 14.8% in 1980 before plunging under Volcker. Reagan was elected in 1980.  He was born on February 6, 1911, so would have been 110 yesterday.  At the time he took office he was 69 and there was widespread concern that he was too old.  Hmm.  In August 1991 he fired the air traffic controllers who would not return to work, thus busting the PATCO union.  It’s an interesting comparison with today’s loose money Fed, borrow-and-spend Treasury and an administration focused on wealth and income redistribution.  Do populist movements give rise to inflationary environments? 

Here’s an excerpt of Bryan’s 1896 speech:

More than that; we can tell them that they will search the pages of history in vain to find a single instance where the common people of any land have ever declared themselves in favor of the gold standard. They can find where the holders of fixed investments have declared for a gold standard, but not where the masses have. Mr. Carlisle said in 1878 that this was a struggle between the “idle holders of idle capital” and “the struggling masses, who produce the wealth and pay the taxes of the country,” and, my friends, the question we are to decide is: Upon which side will the Democratic party fight; upon the side of “the idle holders of idle capital” or upon the side of “the struggling masses”? That is the question which the party must answer first, and then it must be answered by each individual hereafter. The sympathies of the Democratic party, as shown by the platform, are on the side of the struggling masses who have ever been the foundation of the Democratic party. There are two ideas of government. There are those who believe that if you will only legislate to make the well-to-do prosperous, their prosperity will leak through on those below. The Democratic idea, however, has been that if you legislate to make the masses prosperous, their prosperity will find its way up through every class which rests upon them.  

And the bombshell conclusion:

Having behind us the producing masses of this nation and the world, supported by the commercial interests, the laboring interests and the toilers everywhere, we will answer their demand for a gold standard by saying to them: You shall not press down upon the brow of labor this crown of thorns, you shall not crucify mankind upon a cross of gold.

Bryan was nominated for President on the strength of that speech.  He lost to McKinley.

OTHER MARKET THOUGHTS/ TRADES

This week beginning on Tuesday, the treasury auctions $58 billion 3’s, $41 billion 10’s and $27 billion 30’s, for a total $126b raising $62 billion in new cash.  There will come a time when these auctions go badly.  On Wednesday, Powell speaks about the State of the Labor Market to the Economic Club of NY.  It’s likely he will continue to emphasize needed accommodation to help the 10 million unemployed.  Will that create a concession for bond buyers?  During the week I mentioned 3EH 9900/9875ps for 0.75 ref 9924.5.  Expires 3/12.  While it’s not likely to finish in the money, the large open interest in 3EH puts makes this part of the ED curve more vulnerable to large swings. 

In terms of a broad play in commodities, the Bloomberg Commodity Index trades on the CME/CBOT under Bloomberg ticker DNA.  While volume isn’t great, it’s worth noting that total open interest has recently doubled from last year, to around 42k. The index is up 39% since March.

	1/29/2021	2/5/2021	chg
UST 2Y	11.3	10.5	-0.8
UST 5Y	44.1	46.6	2.5
UST 10Y	109.1	116.7	7.6	w/I 118.7
UST 30Y	185.4	197.2	11.8	w/I 197.0
GERM 2Y	-73.3	-71.1	2.2
GERM 10Y	-51.8	-44.8	7.0
JPN 30Y	65.7	65.3	-0.4
CHINA 10Y	318.5	322.1	3.6
EURO$ H1/H2	1.0	2.0	1.0
EURO$ H2/H3	11.0	12.5	1.5
EURO$ H3/H4	42.5	45.0	2.5
EUR	121.38	120.50	-0.88
CRUDE (active)	52.20	56.85	4.65
SPX	3714.24	3886.83	172.59	4.6%
VIX	33.09	20.87	-12.22

https://www.youtube.com/watch?v=rgtkq5vS5OE    -Druck
https://www.youtube.com/watch?v=y9yuyAAn5Dc  -Currie

http://www.let.rug.nl/usa/documents/1876-1900/william-jennings-bryan-cross-of-gold-speech-july-8-1896.phphttps://millercenter.org/bryans-cross-gold-and-partisan-battle-over-economic-policyhttps://en.wikipedia.org/wiki/Cross_of_Gold_speech#:~:text=The%20Cross%20of%20Gold%20speech,Chicago%20on%20July%209%2C%201896.&text=He%20decried%20the%20gold%20standard,upon%20a%20cross%20of%20gold%22

https://blinks.bloomberg.com/news/stories/QO14VSDWLU6I

• ABOUT:
  Former member of the CME specializing in interest rate options and yield curve strategies.