State of the inflation/reflation trade - Focus on Commodities
For several months I've been talking about the issues with the reflation trade. First it was the Dollar and some stocks topping, then it was bonds going higher, then Crypto crashing and others markets topping a few weeks later. We saw the cracks on Copper, Oil and so on. But is it over? Will the Fed actually tapper and that create issues to the market? Will the inflation keep running hot? So far what we've had was markets getting really far ahead of themselves. The risk on trade made massive moves in just 8-14 months since the crash and so things started slowing down. Bonds fell a lot (25-30%), the USD fell a lot (10-15%), Global stocks rose a lot (~100%), Commodities (30-300%) and of course Crypto skyrocketed (1500-6000%). These moves came after a period of stagnation and from extreme lows after the crash, but they are massive moves nevertheless and a break is healthy. Personally I believe a bigger correction isn't far away, but I could be very wrong as my long term picture indicates much higher prices for many of these markets.
I'd like to clarify that many of the reasons that have led to this huge expansion across all markets since March 2020, aren't what most people think they are. Passive investing, excessive speculation/gambling since lockdowns, evolution of technology, Fed narratives & low rates, eviction moratoriums - postponing debt repayments, supply constraints & underinvestment in key material/commodities which are coming out of a brutal bear market... are all way more important to me than what the Fed or Central banks are doing. First of all QE isn't money printing and the Fed doesn't create money. The treasury has created that in combination with the Fed, but it hasn't been as much as people think it is given how big the issues are globally, especially with banks not creating new loans. And the funny thing is that over the last few months banks are using the reverse repo facility indicating strong demand for safe and liquid instruments which is 1. Indicating QE isn't really working 2. Something isn't right in the markets.
So are all the above stronger than the deflationary/disinflationary pressures? So far they have been and the truth is that the situation could remain the same for years. Actually I can easily see higher prices for 1-2 years, especially on Oil and Copper. These are the two commodities that will have steady or increasing demand despite all the environmental concerns. In reality its the environmental concerns that are the exact reasons why I am bullish on these two. Why? After a decade of underinvestment there won't be enough production to keep up with the demand. Even if demand goes down, if supply goes down even more that could create a very strong imbalance that could send oil much higher. For copper I can see an even more bullish case because it is actually needed in the ESG movement. Of course government spending also playing a role into this, but this doesn't mean we will get 1970s style of inflation.
Now let's get into the charts. As you can see on the main chart of this idea (USOIL), you can see how bullish oil is. I don't believe this high will hold and it has actually found perfect support at the 64-66$ range. No idea how long it takes to break out, but I doubt the 77$ resistance will hold for much longer. Above 77$, 90$ will come easily in my opinion and later even higher prices with 100$/barrel not being out of question. OPEC announced that it would allow some production to come back, but no idea how much and how fast could it come back. Gasoline seems to be leading the way here and prices could go even higher, meaning oil will probably follow. Clearly after 1.5 year in this pandemic people have saved money and want to travel, so the pend up demand is playing a role (at least in the short term).
When Copper reclaims the first red zone, it means it has reclaimed its 2011 ATH. That would be pretty bullish in my opinion and a very valuable signal overall. Copper is already showing a lot of strength after a significant pullback and consolidation and that could be the confirmation for more upside.
Bonds even after such a rally, along with the USD haven't been able to do much damage. Bonds found resistance when retesting some key lows from below and they seem pretty weak at the moment. The DXY found resistance at its March top and is looking a lot weaker. Actually it has fully broken down. That makes me think this USD rally was potentially a bet on tapering (buy the rumor, sell the news) and the drop is normal as negative real yields in the US are getting very deep. One thing that might be playing a role on this dip for Bonds & USD is the announcement of some the new Repo facilities outside the US for foreigner Dealers and Central banks, with the potential to expand to others too in order to avoid stresses in the markets. Part of the drop in the USD might be attributed to this because many who are expecting the dollar shortage to get worse might be closing positions. So in the short term at least we might see bonds & the USD pullback, but this doesn't they will go much lower. For now most markets seem to be range bound and we are essentially waiting for some clarity as to which direction they will take next.
Although we are waiting for some direction, such negative real rates are beneficial to several markets, and Gold could be one of them. Gold hasn't performed very well recently and technically it is neither bullish nor bearish, however if the current negative real rates persist I think gold could do well. Like with Copper, a reclaim of the 2011 ATH (1920$) would be very bullish for Gold. It's interesting how many markets are below some key highs and just chopping below, which could lead into a bullish expansion. Just to be clear again, the ones that look the best are Copper and Oil, while Gold and Silver aren't. The real shortages and real demand is more likely to come on the first two than the latter.
Finally, overall stocks don't look bearish. They really don't. There are some bearish scenarios and I do think we might get a strong dip at some point soon, but before the dip we might get a 5% increase and then go lower.
I'd like to clarify that many of the reasons that have led to this huge expansion across all markets since March 2020, aren't what most people think they are. Passive investing, excessive speculation/gambling since lockdowns, evolution of technology, Fed narratives & low rates, eviction moratoriums - postponing debt repayments, supply constraints & underinvestment in key material/commodities which are coming out of a brutal bear market... are all way more important to me than what the Fed or Central banks are doing. First of all QE isn't money printing and the Fed doesn't create money. The treasury has created that in combination with the Fed, but it hasn't been as much as people think it is given how big the issues are globally, especially with banks not creating new loans. And the funny thing is that over the last few months banks are using the reverse repo facility indicating strong demand for safe and liquid instruments which is 1. Indicating QE isn't really working 2. Something isn't right in the markets.
So are all the above stronger than the deflationary/disinflationary pressures? So far they have been and the truth is that the situation could remain the same for years. Actually I can easily see higher prices for 1-2 years, especially on Oil and Copper. These are the two commodities that will have steady or increasing demand despite all the environmental concerns. In reality its the environmental concerns that are the exact reasons why I am bullish on these two. Why? After a decade of underinvestment there won't be enough production to keep up with the demand. Even if demand goes down, if supply goes down even more that could create a very strong imbalance that could send oil much higher. For copper I can see an even more bullish case because it is actually needed in the ESG movement. Of course government spending also playing a role into this, but this doesn't mean we will get 1970s style of inflation.
Now let's get into the charts. As you can see on the main chart of this idea (USOIL), you can see how bullish oil is. I don't believe this high will hold and it has actually found perfect support at the 64-66$ range. No idea how long it takes to break out, but I doubt the 77$ resistance will hold for much longer. Above 77$, 90$ will come easily in my opinion and later even higher prices with 100$/barrel not being out of question. OPEC announced that it would allow some production to come back, but no idea how much and how fast could it come back. Gasoline seems to be leading the way here and prices could go even higher, meaning oil will probably follow. Clearly after 1.5 year in this pandemic people have saved money and want to travel, so the pend up demand is playing a role (at least in the short term).
When Copper reclaims the first red zone, it means it has reclaimed its 2011 ATH. That would be pretty bullish in my opinion and a very valuable signal overall. Copper is already showing a lot of strength after a significant pullback and consolidation and that could be the confirmation for more upside.
Bonds even after such a rally, along with the USD haven't been able to do much damage. Bonds found resistance when retesting some key lows from below and they seem pretty weak at the moment. The DXY found resistance at its March top and is looking a lot weaker. Actually it has fully broken down. That makes me think this USD rally was potentially a bet on tapering (buy the rumor, sell the news) and the drop is normal as negative real yields in the US are getting very deep. One thing that might be playing a role on this dip for Bonds & USD is the announcement of some the new Repo facilities outside the US for foreigner Dealers and Central banks, with the potential to expand to others too in order to avoid stresses in the markets. Part of the drop in the USD might be attributed to this because many who are expecting the dollar shortage to get worse might be closing positions. So in the short term at least we might see bonds & the USD pullback, but this doesn't they will go much lower. For now most markets seem to be range bound and we are essentially waiting for some clarity as to which direction they will take next.
Although we are waiting for some direction, such negative real rates are beneficial to several markets, and Gold could be one of them. Gold hasn't performed very well recently and technically it is neither bullish nor bearish, however if the current negative real rates persist I think gold could do well. Like with Copper, a reclaim of the 2011 ATH (1920$) would be very bullish for Gold. It's interesting how many markets are below some key highs and just chopping below, which could lead into a bullish expansion. Just to be clear again, the ones that look the best are Copper and Oil, while Gold and Silver aren't. The real shortages and real demand is more likely to come on the first two than the latter.
Finally, overall stocks don't look bearish. They really don't. There are some bearish scenarios and I do think we might get a strong dip at some point soon, but before the dip we might get a 5% increase and then go lower.
