Here comes the much anticipated inflation. Hyper is just around the corner. How do I know this? Because all the “smartest people in the room”, the Federal Reserve officials and buy side economists, including the big cheese, Janet Yellen, say so. That is why the long anticipated rate increase could come in September (notice I didn’t say which year).
There seems to be, however, a slight hiccup, bump in the road or fly in the ointment – commodities.
This week, Dr. Copper, plummeted to its lowest level since June of 2009. This is while the S & P 500 is hanging around its all time high.
What is so important, you ask, about Dr. Copper?
There is an old saying that “Copper is the only commodity with a PhD in economics”.
The fall in the price of Copper is (pay attention now) deflationary not inflationary. Less demand means that prices fall – meaning the dollar acquires purchasing power. Ultimately this means that worldwide growth is a thing of the past. There will be NO resurgence of the global economies. In fact, Dr. Copper says that we have only begun to see the decline. “Deflation is a bitch” and takes no prisoners. Most people think and “the smartest people in the room” know that central banks have no equal when it comes to the control of markets and economies. The premise is that sooner or later Yellen and company will succeed and not only be successful in their dual mandate of: (1) price stability and (2) full employment, but also their recent 3rd mission “growing the economy – whatever it takes, however unorthodox or reckless the measures”.
If it were a fair fight, I, like most others, would bet on the Fed. History has not only shown, but proven, that “deflation” is unchallengeable. The carnage in commodities will continue and with it all the ancillary by-products – unemployment, business failures, bankruptcies, suicides, etc.
The Central Bankers will continue to flail like a punch-drunk fighter who waves at the air and ends up on his face. The champion, deflation, will simply step over them as though they never existed.
Most recently Goldman Sachs issued a warning to their clients about the three Ds of macro-economics, Divergence, Deflation and Deleveraging and the “downward pressure being put on Chinese demand growth”.
The bloom is off the Chinese rose as the reality comes home that real growth is not simply the reconfiguration of data.
No longer is China the world’s depository for copper, iron ore or oil. There is now, in addition, the frightening reality that there is no one to take China’s place.
Over-production and over-supply, the cornerstone of deflation, has now become the order of the day. This can best be seen as West Texas crude tumbles to a price not seen in years.
Chesapeake Energy (CHK), headquartered in Oklahoma City, the second largest natural gas producer in the United States, has come from $30 in 2014 to a recent 52 week low of $8.40 (also a 12 year low). To conserve cash they took the unprecedented step of eliminating their dividend.
Operating in a zero interest rate environment, those in the energy area, primarily shale oil producers, have found leveraging a simple task. The demand for high yield paper by all the fools on Wall Street and their retail clients has been insatiable. This means that “digging, drilling and pumping gets to continue indefinitely”. Until it doesn’t.
Chesapeake’s recent fall from grace and dividend cut may be the first sign of one of the most dramatic instances of mal-investment the market has ever seen.
Morgan Stanley reports that this may be the worst oil downturn in 45 years. Most recently they have proclaimed “if oil prices follow the path suggested by the forward curve our thesis may yet prove too optimistic”.
They reached that conclusion based most importantly on two main factors (IAAM subscribers came to this conclusion awhile ago but, of course, we are not considered the “smartest in the room”) – supply and demand.
Supply – “We expect production growth to moderate following large capex cuts and the sharp decline in the rig count”.
Demand – “We anticipated that the fall in price would boost oil product’s demand”.
“There would be nothing in our experience that would be a guide to the next phases of this cycle especially over the relatively near term. In fact, there may be nothing in analyzable history”.
Au Contraire! The commodity carnage that is unfolding is analyzable if you approach it from a deflationary position. Difficult to do when everything is built around inflation.
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Till next time,