Wow! What a blast!
- Equities up to new highs
- Bonds down sharply
- Commodities up
- Iron ore hits US$80/t!
- Infrastructure to further surge
- Technology to soar
- And yes, Gold, at major support, still looks brilliant in a rising wealth world.
- You have been well prepared for all of this
Thanks for joining me on this fascinating journey into what should be the greatest period of Prosperity the world has ever known! The broad market responses over the past year have been very close to the projections made in Dawes Points. Equities up, bonds down and commodities moving higher. This is very pleasing. The markets seem to be pointing to a full vindication of the Great Bifurcation concept.
I hope this approach has helped you survive the uncertain world of the past few years and to also make good returns on your investments.
If so, let me know. If it hasn’t, then I have communicated my ideas poorly.
The point is also made that while the outlook seems so challenging on so many fronts, the markets themselves are pointing to this outcome that would appear otherwise unthinkable: – a very simple outcome of continuing Global Prosperity.
Writing this newsletter has itself been a great journey as it allowed me to analyse the underlying features of a very broad resources sector and its various upstream and downstream related industries.
One of the more significant observations made of global economies over the past 50 years is that recessions have generally been quite short and the declines in local GDP growth and then global GDP have typically been quite modest yet the falls in prices of equities and commodities have been savage.
Much of this can be connected to inventory changes everywhere and then the re-allocation of capital. If you can understand this then your hopes of doing better than the pack are greatly improved.
The Global Boom has been steadily unfolding over the past three years and after just a short slowdown in 2015 is now picking up momentum and providing opportunities everywhere. Changes in inventory can be seen everywhere.
Here the discussion is not just on LME metals warehouse levels or China steel mills iron ore stocks, it is about the allocation of capital. Over allocation to financial instruments in bonds and cash and under allocation to the productive economy. The flow of capital to determine inventory levels from and to each sector will be the key to understanding it all.
Clearly some major things are changing in this Global Boom roll. So……..
- Where to start with all this?
- Where will it go to?
- When will we get there?
- When will it end?
Where to Start is with the reality that the world has become beholden to a bureaucracy of theoretical academics who have pontificated on matters championed by a myriad of special interest groups, unelected NGOs and that cabal of politicians, bureaucrats, central bankers, financiers and media all tied up with keeping interest rates down to benefit borrowers. And a special interest in issuing more debt. It may be all that simple and it certainly has tied up massive amounts of capital.
Unwitting (witless?) media commentary also rails against anything that might increase interest rates and tries to deny a realistic return to the providers of capital.
All seem to be concerned that rising interest rates will cause grief to owners of indebted balance sheets. But we all know that these entities are mostly sovereign governments and now generally not individuals or corporates.
What also characterizes this current period is the build up of massive cash positions and defensive portfolios everywhere.
It is not just investors being defensive in their portfolios. Corporates are too, showing few takeovers and little new capex, and individuals have risk averse strategies and major reserves of cash. All made up by the mass psychology of fear over almost a decade. Think of it as inventory.
Logically therefore, the equity markets are not overextended. They are not awaiting a major downward re-adjustment. They are under weighted in portfolios. Note also that the various market indices are over represented by highly priced defensive stocks and underweighted by cyclicals.
Recall the earlier Dawes Points breakdown of the rear-visioned ASX Gold Index into domestic and overseas producers. Look at Caterpillar, Boeing, General Dynamics and Microsoft. Rising earnings and re-ratings. Look at the rerating underway of the US banks after years of underperformance and that cheeky graphic a few weeks ago in Dawes Points #55pp.
US equities making new highs after 15 year bases are not saying a bear market is yet to come!
But the bond markets are the ones that are grossly overpriced while commodities are severely underpriced.
The actions of the markets over the past six months and particularly over the past couple of weeks or so are giving strong confirmation that the Great Bifurcation is now a reality and the performance of commodities has been a sight to behold.
What is the fundamental difference between Monday 7 November when the Chicken Littles dumped stocks prior to the US election and Wednesday 9 November when the XAO was up 3.4%, iron ore above US$75/t and copper at US$2.45/lb.
Nothing. Pure sentiment.
And what are those investors with gargantuan holdings in T Bonds thinking now that they are sitting on major (already down 13.6 % for 30 Year T Bonds since the highs in July 2016 and 6.3 % for 10 Year), that will become gargantuan, capital losses.
And those with massive cash positions of over US$70 trillion (I saw a number from a reliable source suggesting US$70tn might be better to use than my US$80tn cash estimate but what is US$10tn nowadays!)?
So where do we go now?
Surely now it will be straight up!
The US equity market made new highs this week.
In the S&P 500, where a major long term base coincides with mostly oversold momentum.
NASDAQ has achieved new highs above the 2000 peak!
And the Russell 2000 Small Caps making new highs.
Short Term Dow Jones 30 Industrials – Look at this action. Another 1000 points to be added very soon?
These say a massive new up leg is starting as millions of bears cover their short positions (and probably change their shorts!).
So where to start.
The US election gave us an excellent insight into the powerful financial intertwining amongst the political and welfare sectors and the financial market participants themselves who have all benefitted from the large bond selling programmes at the expense of the economy and most of the middle and working classes. Massive expenditures, ever higher tax burdens, entangling red and green tape and little to show for it.
Margaret Thatcher expressed it well with words to the effect of `Socialism is wonderful. Until you run out of other people’s money’.
And the US and Europe (and Australia) are running out of other people’s money. That is, the money that wouldn’t be better used elsewhere.
To me, this is best explained by considering the ending of the 35 year bull market in bonds.
In a bubble like no other.
The Trump victory was just saying `Enough’! Call it what you will.
But the markets have been indicating this all along.
Consider the strategy as pointed out by the markets over the past two years.
- Gold is leading. Correcting now, but still is leading. Strong performance by ASX gold equities.
- Industrial metals are following. Commitments made to small caps and midcaps.
- China is rising steadily. Steel in China guided us through the dark days and it is guiding us through to very bright sunshine for the next decade.
- Iron ore is over US$75/t and I have hit my US$80/t target. Commitments made to BHP, RIO, FMG and also MGT. Dawes Points #52
- Bonds are peaking. Move out of bonds and into equities and commodities.
- China with its One Belt One Road (now, `OBOR’) will underpin Eurasian infrastructure and now Trump’s American infrastructure promises even more. Great for steel, iron ore, copper, zinc and nickel.
Global bond markets are now hurting and the pain is going to get a lot worse.
While equity markets are soaring!
I hope you didn’t fall for that higher bond yields would collapse share prices waffle.
Prices of most resources commodities have had good jumps recently and well ahead of the US Election so the forces were well intrain then.
Table. Price changes in June Half and Dec Half 2016
Prices have broken the 2011 downtrend as suggested in the last Dawes Points after eight years of bear market from 2007.
The evidence has been so clear and the perspective has allowed confident assessment of markets and opportunities.
The mix of strongly performing gold stocks coupled with the move into the large cap resources in mid year has been wonderful.
A general Resources Portfolio was set up for 1 July picking up recommendations on the major resources stocks BHP, RIO, FMG, S32, WSA, WPL and STO together with three small stocks, MGT, ASP and PNX, that MPS was raising capital for.
Look at these.
So where will it all go?
In my experience, breaks in long term downtrends in markets, commodities and stocks typically lead to eventual new highs. Typically.
Downtrends of recent years have been long and often ugly. But typically the longer the trend the longer the period for underlying human spirit to absorb the stress and adapt to the new environment. The response then can be a powerful break of the downtrend and can run for years as a new uptrend.
So starting with the bond market we have some useful time scales. From 15% highs 1981, bond yields have declined for 35 years. But note that they rose from 2.25% in 1942 for 39 years until 1981.
So now with all the QE and global debt it is probable that bond yields will rise for the next 30 years and make new highs above 15%.
And all those negative yields are now positive.
Note that during the 1940-1980s period there was good economic growth and many happy times so don’t despair.
With gold, we have its own history. Gold peaked in Jan 1980 at US$875 then had a 20 year bear market to US$248 in 2000. The current gold market took 11 years to get to US$1923 and declined for five years to US$1080.
Another five years should see gold above my US$5,000/oz.
In the very short term, gold has rapidly declined from a pre US Election US$1340 spike, down US$160 (12%) to major long term support at $US1180. Note gold is oversold and MASSIVE volume passed through as some big players covered short positions. A reasonable possibility of a major low is being formed here after a five month decline. Don’t get despondent about gold.
Note, too, bullish sentiment is very low indeed and ready for a surprise upside surge.
The industrial metals bottomed in 1998 then rallied for 9 years and the last downtrend of eight years has bottomed at a much higher level. Expect at least ten years of uptrend to much higher prices. Relentlessly rising Asian consumption, high capacity utilisation, no inventory and exploration expenditure cutbacks make this an easy projection.
This graphic on copper looks magnificent. The 4 year downtrend from 2011 has also been broken.
What will be the effect of renewed infrastructure spending in the US?
The US economy that everyone dismisses has a mind of its own. How’s this for housing starts as at 1 October 2016! Highest level since mid-2007. There must be ten more years yet in this upcycle. Wonderful for copper.
Iron ore has had an interesting journey as seaborne trade expanded to meet Chinese demand that just keeps growing. Steel output is still strong and high cost domestic Chinese magnetite output has been declining. India, ASEAN and the US are depend on Chinese steel exports and increased US infrastructure spending can only increase demand. US steel production at 80mtpa (and about 60% steel scrap-fed Electric Arc Furnaces(EAF)) and consumption at 120mtpa means more imports. From China. Not a lot of serviceable unused steel making capacity in the US so I think high tariffs on Chinese imports will be just another thought bubble.
The now-achieved US$80/t end 2016 target for iron ore wasn’t just starry eyed optimism. This is developing into a long term tight market and, if it does, the technical pattern referred to in an earlier just might give the eventual and currently inconceivable new highs in iron ore several years out. Note the long lead times for most new mines (not too many FMGs around) and the declines in Pilbara reserve and ore grades as well as the closure of 170mt pa of Pilbara Yandi ore capacity over the next few years. Could we get US$95/t next year?
Note too, the rise of magnetite ores and concentrates and MGT.ASX is the preferred play here.
Energy is fascinating.
Total energy demand is still rising and with Non-OECD consumers making up almost 60% of demand and growing strongly it is unlikely to slow soon. The keep this graphic mind. Energy demand share by fuel type.
Coal is the dominant fuel. Gas is the fastest growing and nuclear has the greatest potential. Renewables are just another thought bubble.
The most interesting is oil.
Opec, Non-Opec and NGLs give us 94mbblpa and growing at 1.5%pa. Non OPEC oil is fascinating. Keep in mind Peak Oil for conventional reservoirs. Tight oil should now be considered petroleum mining. Conventional oil and gas fields have large capital upfront and low operating costs. Tight oil has short life rapid decline fields so capital costs now current operating costs.
The crosswinds within the oil market are enormous and often unfathomable. OPEC is almost a spent force with each player driving its own agenda. The national budgets of most OPEC members are irretrievably linked to oil revenues so the post 2013 oil price has reduced budgets severely Bonds are now being issued and state assets being sold.
It is of interest that most of the monthly OPEC bulletins report higher demand levels and lower output levels than immediately previously given. This market is now in balance so expect higher prices.
So we know now this will all last a long time.
How will it end?
Don’t quite know just now. But whenever it is and in whatever way it happens you can be sure it isn’t soon.
Of course something else happened a week or so ago.
Donald Trump won the US Presidential Election.
It is interesting how Donald Trump with his ‘draining the swamp’ to describe the cabal was so similar to the Great Bifurcation although his other fork in the road, whilst expressed and emphasized differently, will give impetus to commodities and world growth through promised major infrastructure.
The Trump victory was strongly hinted at in the statistics and analytics within social media Face Book, Twitter and Instagram where Trump was followed and `liked’ by far more than Clinton and the overflowing halls were in great contrast to the tame Clinton gatherings. Take non compulsory voting and you have a very interesting range of dynamics which the `cabal’ had ignored. You also saw the difference between Trump rallies and the Clinton gatherings.
The biggest question is whether then the US$ will rise because capital will be attracted to the booming stock market and active economy or will capital see that US imports will rise giving greater leverage to the economies of Asia, Europe, Sth America … and Africa?
The stock markets of most of these we follow have done well.
BSc F AusIMM MSAA
27 November 2016
I own or control in portfolios BHP, RIO, FMG, MGT, STO, PNX, S32 and ASP mentioned here.
Contact me now – email@example.com or +61 2 9222 9111