Risk-Taking Cracks

The president told us elections
Were filled with some lethal infections
He’s unclassified
More docs to help guide
The courts to start making corrections

Meanwhile in Iran more attacks
Has led to some risk-taking cracks
Thus, oil is higher
While semis look dire
Have we seen the market climax?

A few words on the president’s speech last night as it was widely touted. In it, he explained he declassified a trove of documents offering proof that there have been many election irregularities over the past six years, naming China as a major player in the process. These documents are available online for all to see and ostensibly refute (I have not read them, nor am I likely to do so) that our elections have been secure in the US. In fact, the same government analysts that have declared there to have been no issues are the ones who these documents purport to show were interfering. My only observation, especially on this topic, is that no matter the proof available, minds have long been made up, and this will not change opinions, at least until arrests are made and trials are held.

Which takes us to more relevant market issues. Arguably, the poster child for semiconductor stocks is the Korean KOSPI (-6.4%), where just two companies, both major players, Samsung and SK Hynix, represent some 40% of the index value. As you can see from the below chart, it has been tough sledding for the past month, with that market closing lower by nearly 28% from its highs on June 22^nd.

Source: barchart.com

And while that may be extreme, if we look across major markets in Asia, there was some rough times last night almost everywhere. Tokyo (-4.0%), HK (-1.8%), China (-3.6%) and Taiwan (-6.5%) all had serious dislocations downward. And, of course, the thread running through them all is the tech exposure. There has been much discussion of a rotation out of tech and AI stocks into other areas, with financials and energy amongst the beneficiaries, and certainly, last night’s price action supports that thesis. Interestingly, India (+1.25%) completely bucked that trend, but then, India is perceived to be a major loser from the AI story, so if that is unwinding, I guess it’s no surprise that India benefits. Elsewhere in the region, things were far less volatile.

As to Europe, despite a glaring dearth of technology companies, equity markets there are also under pressure this morning (DAX -0.9%, CAC -0.9%, IBEX -0.5%, FTSE 100 -0.1%) although that is more likely to be a response to the fact that oil prices have picked back up as the US resumes more aggressive military activities against Iran. As to US futures, at this hour (6:45), they are all lower led by the NASDAQ (-1.8%) although both the SPX and DJIA are down by -0.7%.

Which takes us to oil. The black, sticky stuff is higher by 2.0% this morning, although, as you can see from the chart below, it is still hovering right around $80/bbl, the level I described as its new home earlier in the week.

Source: tradingeconomics.com

The key question here remains just how much of an interruption in economic activity has been caused by the Iran conflict. Not dissimilar to the election question at the top, it seems the two sides of this argument are dug in and will countenance no discussion that they are misreading the situation. There are still analysts who discuss tank bottoms and the idea that now that so many reserve inventories have been released, we are quickly approaching a situation where their much mooted $200/bbl is right around the corner. And yet, despite the tick higher overnight, the market continues to price a relative lack of concern over future supplies. As always, I go with prices as the best arbiter, but that’s just me. The massive production increases from the US and Canada, as well as Brazil and Guyana, increases from Venezuela and the workarounds by the Gulf nations to get their oil to market continue to demonstrate that supply is available.

One wild card that is very difficult to completely understand is China, where things are always opaque, and where their imports have fallen sharply, thus reducing demand. Was that demand “destroyed” in the sense that it will never return? Seems unlikely. Rather, my best guess, and it is just a guess, is that China tapped into their own SPR and has been using that, rather than importing. Whatever the situation, there appears to be no shortage of oil available.

One other thing weighing on the price has been Ukraine’s success in attacking Russian refining capacity. If the Russians cannot refine their oil, they need to sell it as crude rather than products, and that is adding to the inventories available for sale. It is also part of the explanation as to why products prices and the crack spread remain so high, more oil, less refining.

Looking at precious metals, gold (+0.4%) closed below $4000/oz yesterday for the first time since last November as per the below chart.

Source: tradingeconomics.com

Silver (-0.4%) also remains under pressure and this morning copper (-1.9%) is suffering alongside the precious space. But perhaps a few words on what gold really represents are in order.

As J.P. Morgan said in 1912, before the Federal Reserve was created, “Gold is money, everything else is credit.” Certainly, the second part of the statement is correct as your bank deposits rely on your bank standing behind them, making you a creditor of your bank. Federal Reserve Notes are paper obligations of the US government, so again, represent purchasing power, but as we have learned, a decreasing amount of it every day. Meanwhile, gold has a 5000-year history of being accepted as a thing of inherent value. Now, the widely accepted definition of money these days is it must have three characteristics; it serves as a medium of exchange, a store of value and a unit of account. Gold historically has served as the first two, although rarely as a unit of account. Rather, gold holdings were always converted into whatever the unit of account was at the time.

Which takes us to the present, why does gold continue to represent a part of the financial markets, and over the past several years, an increasingly important part. I would contend this is all of a piece with the broader changes in the global community, notably the end of the Pax Americana, where the US no longer chooses to (or can) guarantee the peace of the post WWII and Cold War worlds. Instead, we have seen a constant increase in debt by every nation as governments around the world seek to placate their own citizens and are unable to pay for all the goodies they offer, thus borrow the difference.

However, the freezing of Russian reserve assets by the West in the wake of the invasion of Ukraine has altered many views about what is safe and represents value, and what is paper and doesn’t represent value and central bankers, charged with maintaining a nation’s wealth, have gone back to gold as the one thing they know will retain value given it is nobody’s liability. The chart below shows activity in May, which is similar to what has been happening virtually every month, that central banks are relatively price insensitive, buying the stuff as a strategic asset. And the sellers, were selling because they needed the money!

One last chart to make the point about gold and purchasing power. The below chart from the FRED database demonstrates just how much purchasing power the dollar has lost since the Fed came into existence; i.e. just how much inflation has destroyed the real value of the dollar. For reference, that opening level is 1021 compared to today’s 29.9, a 97.1% devaluation in 113 years of the Fed. It can be argued that the Fed has failed catastrophically in their effort to maintain the value of the dollar.

Ok, quickly elsewhere bond yields have edged lower, with Treasuries (-3bps) leading the way and European sovereigns either unchanged or having slipped by -1bp. JGBs overnight also slid -2bps, but overall, while there is a lot of discussion about yields, they are not moving very far.

Finally, the dollar is a bit firmer this morning with the pound (-0.3%), Aussie (-0.4%) and euro (-0.1%) all slipping although NOK (+0.2%) is benefitting from oil’s move. In the EMG bloc, though, there is more trouble with KRW (-0.5%), ZAR (-0.6%) and MXN (-0.3%) representative of more anxiety there. Ultimately, I still have a hard time getting too bearish the dollar in the current world.

On the data front this morning brings Housing Starts (exp 1.31M) and Building Permits (1.40M) as well as IP (0.2%) and Capacity utilization (76.2%). Finally, at 10:00 we see Michigan Sentiment (51.0). There are no Fed speakers scheduled, and they are entering their quiet period, so we won’t hear from them until the meeting on the 29^th. (Perhaps we won’t hear from them anymore after that too!).

Summing up, Iran and oil are still key drivers, equity market rotation is happening, although given how far it has moved, we may be near the end of that process, and yields have no direction. Regarding yields, we may have reached the point where the issue is not inflation concerns, per se, but rather the sheer volume of debt that is going to be issued going forward, and the fact that private investors want more yield to be persuaded to buy it. As to the dollar? Like I said, I just don’t see the bear case over any longer-term horizon.

Good luck and good weekend

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