On May 4, Hong Kong stocks non-ferrous metals sector exploded, Zijin Mining rose more than 12%, Aluminum Corporation of China rose more than 9%, Jiangxi Copper rose 8%, Minmetals Resources rose nearly 10%. 2021 since, copper has risen 27%, once broke 10,000; oil rose 35%.
Betting on inflation is right on time.
1 Long-term consistency
Commodity returns are determined by their own price fluctuations, while financial asset returns ultimately come down to the (input commodities to form fixed assets) return cash flow, the difference between the return cash flow and the risk-free rate affects the discounted price of the asset.
In a financial dominated system, it is conceivable that if the return on financial assets far exceeds the return on commodities, then the gap between the two returns will stimulate companies to turn commodities into fixed asset investments, and thus the economy overheats; conversely, if the price of commodities rises rapidly, it will stimulate companies to reduce fixed asset investments and the economy stagnates (depression).
This feature dictates that, logically, commodity investment and financial asset investment should be largely consistent in terms of long-term returns.
According to Merrill Lynch data from 1973-2004, commodities returned an average of 5.8% and stocks 6.1%. Essentially the same. But from 2011-2021, copper prices remained almost unchanged and oil prices fell to 60%; while the Nasdaq doubled five times and the S&P and Dow Jones tripled.
Merrill Lynch clock different stages of various types of asset returns statistics (1973-2004)
Stocks return several times more than commodities, commodities have a very high complementary space.
2 overheating or stagflation?
From the Merrill Lynch clock, commodities soaring, will only happen in two phases, economic overheating period and stagflation period.
overheating period: due to the financial returns in the early period far exceeded the commodity, bringing a large investment demand, resulting in overheated investment, pulling the commodity to make up for the rise, investment demand with continuity, lagging, the impact of commodity returns inverse to financial assets.
Stagflationary period: commodity returns far exceed financial, compressing investment demand and leading to economic depression.
There are two broad views on what stage the economy is currently in (short cycle) in 2021, one view is overheating and one view is stagflation. However, it is not distinct in classical characteristics. The current short cycle is in a stagflationary phase, judging from the sluggishness of U.S. bonds, the big bullishness of commodities, and the negative cash returns. But the short cycle appears to be in an overheating phase in terms of rising U.S. stocks and bullish commodities.
The reason for the lack of classical features is intervention.
In the absence of intervention, when commodity returns far exceed financial, the economy overheats, investment demand is too strong to pull up interest rates, financial asset prices blast, market investment demand compresses, commodity prices fall, commodity returns fall. CPI and economic growth fall at the same time, overheating turns into a deflationary phase.
The intervention scenario, when commodity returns far exceed financial.
1) government replaces market-led investment, and government investment rises against the trend, driving the economy.
2) Market overinvestment affects higher interest rates, but central bank-led money printing affects lower interest rates. The flood of money printing funds, part of the funds involved in commodity speculation and government-led investment resonance, accelerating the push upstream prices, pushing up the PPI.
3) Lower interest rates push up the discounted price of assets, political correctness encourages big money to follow the central bank baton to push up the price of financial assets.
4) Credit easing maintains downstream capacity and suppresses PPI to CPI transmission.
Different interventions will blur the classical features, money printing-led will push up financial returns and suppress commodity performance. Investment-led will push up commodity performance and appear economic overheating. Government investment-led economic overheating and market characteristics-led economic stagflation are combined, the economy is not good, inflation is not bad, but money printing, commodities and finance fly together.
Different interventions break the regularity of the economic cycle, recession, overheating, stagflation soaring cycle, the electric fan smoke. But whether the economy is overheated or stagflationary, the commodity cycle is confirmed.
Betting on the commodity cycle is a matter of being strategically correct.
3 Cycle alignment
After World War II to 1966, the United States continued to maintain a high growth low inflation situation. 1966-1972 in recession, 1972-1981, the United States entered the stagflationary phase. 1966-1972, the U.S. government demand (war, etc.) to pull the economy. 1972-1979, the dollar decoupled from gold, printing money to fight the economic downturn. 1979-1981, tightening of monetary against inflation. The process lasted 15 years.
After 1982, the U.S. economy again entered a state of high growth and low inflation until 2008, after which the U.S. economy fell into a long recessionary phase, printing money to counteract the economic downturn. 2021, the U.S. increased fiscal stimulus. This has taken 13 years.
In the 1970s, the U.S. fought against the economic downturn by first government investment and then (after the de-anchoring of gold) central bank lending, and after 2008, it fought against the economic downturn by first central bank lending and then government investment.
The current stage is nothing new compared to the 1970s, the means of fighting the economy is only a little different in order. As the only long-wave cycle of the economy under the dominance of fiat (dollar) currency, the 1966-1982 stagflationary cycle, can be compared to the 2008-2008?
While the short cycle was stimulated by money printing as if by a fan-like rotation, the long cycle is very definitely facing a stagflation to depression switch. The most distinctive feature is negative real interest rates on the dollar.
4 Long-wave stagflation and short-wave overheating
In periods of economic overheating, it is investment demand that drives commodity prices up. The very term overheating indicates the exuberance of investment, which (market-based) investment needs to be driven by earnings expectations. This characteristic dictates that nominal interest rates will be higher during the overheating period, and nominal interest rates will generally outperform inflation, basically without the phenomenon of negative real dollar interest rates.
This is not the case in stagflationary periods, where the rise in commodities stems from preservation of value (or speculative demand for commodities), but the poor returns from converting commodities into fixed assets and the low nominal interest rates lead to negative real interest rate problems as nominal interest rates do not outperform inflation.
The long-wave stagflationary period is closely related to the turn of negative real dollar yields.
The U.S. CPI reached 2.6% in March and the 10-year U.S. bond yielded 1.6%. The real interest rate is -1%. This feature of negative real interest rates on the dollar determines that the long-wave economy is currently in a stagflationary period. However, the short-wave economy is also characterized by some investment overheating, led by global government investment (ignoring earnings).
Overheated investment can drive commodity explosions.
5 On gold again
Compared to the US dollar, gold has a small application and no interest, a feature that determines its relatively poor long-term returns. Gold will only explode when the dollar is at negative real interest rates, and gold is the demon mirror of fiat currencies. The main influencing factor for gold to outperform other assets is the negative real dollar return.
The real dollar yield is determined by two factors, one is the inflation trend (refer to CPI or PPI); the other is the nominal yield of the dollar, refer to the ten-year US bond yield. It is important to note that inflation expectations and inflation trends are not the same.
In terms of the information that can be received, more than 99% of the information has no impact on the long-term trend, it is useless information for the long term, it is all noise. Market expectations, however, are affected by noise.
Financial asset prices are dominated by expectations, but their prices jump up and down. This in itself shows that market expectations are very variable. Such variable expectations can only mean that expectations are highly influenced by noise.
Why is the credibility of many economic data getting worse and worse? Because there are always people trying to create noise to influence market expectations. The funny thing is that these people always succeed and can always influence the market expectations. In that sense, inflation-protected bonds (TIPS) imply that inflation expectations will be more affected by noise. Whereas long-term inflation trends are dominated by those useful information (signals), in terms of inflation trends, there are two important signals that are of great interest.
1) Commodity trend. Long-term trends are consistent with PPI and CPI. since 2021, copper has risen 27% and oil 35%. This will continue to drive the PPI up, which is a bellwether for inflation.
2) The reservoir problem. 1960s the ratio of real assets to financial assets was at a record low and money was stored inside the reservoir. 1970s the financial reservoir burst and inflation soared in 1970s. Since 1985, inflation has been on a long-term downward trend, having fallen from 15% to about 2%, while the global financial reservoir has been expanding, and money is being stored inside the financial again, exactly as it was in the 1960s. By now, the global ratio of real assets to financial assets is at another record low. However, since 2021, commodities have clearly outperformed stock markets (copper has risen 27%, oil 35%; Dow Jones up 11%, NASDAQ up 7.8%). The horse-trading effect will spur a shift of capital from equity markets to commodity markets, and once the financial reservoir storage drops, inflation will accelerate upward.
Whether observed from commodities or from the reservoir, the inflation trend will be more certain, inflation will accelerate the run-up of ten-year U.S. bond yields, deepening the negative dollar interest rate. Accelerate the gold explosion. And whether you are betting on gold or betting on commodities, you are betting on inflation and are fighting against money printing.
Summary.
On the long 5-10 year horizon, betting against inflation is a matter of being strategically correct. But in the short term, as betting on inflation will pressure U.S. stocks, a larger downside in U.S. stocks will induce panic to depress all asset prices, betting on inflation should be appropriate to retain some cash to pick up the opportunity.
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