Up? Down? What Now?

March 21, 2022

It has been over a month since this space has been updated, and the markets continue to be very volatile. On February 24th, Russia began their invasion and at that time the market had worked its way down to about 4,150 based on the fear of what would happen.

Since then the market has rocketed up about 7.5%. Back in the day (like 3 years ago) that would have been a great annual return. Perhaps it isn’t such a bad idea to increase your cash position or perhaps diversify into something less overvalued.

One of the things that this might bring to mind is that war is good. War is really, really good… for rich capitalists. That is until it isn’t. Major war causes significant reshuffling of economic circumstances and they are anything but predictable. Russian oligarchs, most of whom obtained their wealth due to a very lopsided, often violent reordering of Russian society are learning that lesson (read ‘Red Notice’ by Bill Browder, not the movie, which is entertaining but not enlightening at all).

Currently NATO remains on the sidelines, but to do so is a humanitarian catastrophe, it also encourages bullying and the rise of the wealthy state actors and politicians being able to control policy for average citizens. It is hard to say if Ukraine will be sacrificed, but betting on it is probably a mistake. The market looks to be making that bet as it bounces nicely.

It is difficult to identify enough times, in enough ways, the risks facing our current asset prices. On the investment front, stocks, bonds, real-estate and more are significantly overpriced based on a reasonable return on investment. That is allowed to happen because bonds and treasuries pay almost nothing. This is due to massive debt burdens by governments who are using their credibility to force interest rates down and keep budgets in check.

That underlies a population that is also burdened with debt, and a far too large percentage is having trouble paying for the necessities of life in a wide variety of countries where collapse seems like the only answer. That is a strong statement, but if you saw Greece after their collapse you might be less sanguine. If you know anyone living in Cuba or Venezuela or South Africa, it might not seem so far fetched.

So this might cause you to consider what is next? I think interest rates will be the answer. The Federal Reserve met recently in the US and raised the key lending rate by just 0.25%, and this small raise is likely due to the pressures caused by the war in Ukraine. But many of the members of the Federal Reserve continue to talk about the need to raise rates by 0.5% soon. They expect to raise rates 10-11 times in the next two years. Things are going to be more expensive, for governments, for corporations and ultimately for you. Because you, your income pays ALL of those bills.

The thing central bankers and governments around the world are trying hardest to avoid is for people to stop consuming. It all falls apart if people don’t consume. If people consume a little less things can be protected with price hikes. If you consume a lot less, then the system starts to collapse. People who stop consuming now, will almost certainly be protecting their personal interests. There is no telling what people will do. Post COVID, there is a massive build up in demand and private wealth for the top 50% of society.

For those who have significant debt burden’s the picture isn’t good. Here is a chart of the US ten year treasury. As war in Ukraine broke out, traders forced the yield down to about 1.7% (17 on the chart below), since then it has become clear that the US will raise rates no matter what, and more importantly that investors want more for the risk they are taking. Rates have jumped by 33% since the war started. They may move around a bit, but rates are still likely to rise substantially in the next 2 years.

One of the things mentioned in this space over the last two years or so is that commodities were the play to go for. Here is a look at the Goldman Sachs Commodity Index which tracks major commodities for the past two years. (Diversification is always good, but sometimes you wish you went all in on a particular idea.) Oil and base metals have been the suggested ways to play these market dynamics and the returns have been generally very good.

GSCI Total Return – What a run!

Oil is probably fairly valued at around $85/bbl (WTI), but the war could cause oil to stay in the $120-$150 per barrel range for a significant amount of time. Meanwhile many metals have gone crazy (Nickel broke the LME last week, and Aluminum is enduring madness as well) and while that may calm down, the reality is that many of the most necessary things we need for society to function (let’s not forget food) cannot be adequately obtained, grown, replaced, for the prices they are trading at. There is a lot of commentary about windfall profits (true) that ignores the bankruptcies of the past 3-5 years when prices were down. It was just two years ago that Oil traded below zero.

Of course not every market is the same. Farmers have been suffering for decades, particularly smaller farmers who can’t plant 10,000 acres. Meat and egg prices are held low with (sometimes inhumane) farm factories. These things probably can’t continue this way and prices will need to rise to accommodate the dreams of the people.

It is sometimes difficult to see this clearly, however in this modern world we have a specific case that bears watching. The electric car (EV) boom is happening in real time and while the economics don’t make any sense, it is roaring ahead through excess wealth, government incentives and marketing star power.

There is broad evidence that EV’s do little to improve the environment overall, however the boom is in full swing (and one of the reasons betting on base metals is a very, very wise choice), but it is leading to massive price surges in various commodities such as Lithium, Cobalt and Nickel and to a lesser extent other metals like Copper. The impact of ‘everyone’ chasing a single commodity is evident. This month, the Chinese government urged players in the Lithium business to keep prices ‘rational’. There was little information about ‘how’ that could happen, but the 400% gain in the last two years, and over 100% higher than the last peak in 2017, when the EV boom was starting seems to be causing some strain on the EV supply chain.

Ultimately, investing involves a lot of risks, and currently the risks are very, very high for a typical investor. Investors have piled into markets at or near the peaks, cost structures are under stress due to inflation, debt burdens, rising interest rates and soon, rising taxes. Risks to markets have been evident for some time with supply chain constraints due to COVID and now a pretty major war effort. Perhaps soon we will see even more stress as ‘globalization’ difficulties become more evident due to differences in expectations between democracies and autocracies.

Overall, caution is probably not a bad approach. The news is generally not good and that should cause some concern.

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