Weekly rollup | Dec 19-25 2022
Stocks Mentioned: Canfor Pulp Products Inc. (CFX), West Fraser Timber (WFG), SPDR S&P Homebuilders ETF (XHB), Japanese stocks (EWJ), Grayscale Bitcoin Trust (GBTC), VanEck Vietnam ETF (VNM), South Korea ETF (EWY), China Large-Cap ETF (FXI), Invesco China Tech ETF (CQQQ), Singapore ETF (EWS), Abrdn Platinum ETF (PPLT), Biotech stocks (XBI), Teucrium Wheat Fund (WEAT), Graphite India (NSE:GRAPHITE)
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December 20 2022
The Bank of Japan maintained yield curve control and the yen strengthened from a pre-announcement low of 138.18 to 133.1. I closed out the fx position. Moves of 2.5% in a day aren't normal in fx land. When all other central banks are busy trying to destroy their economy, the market cheered BoJ's surprise dovish stance. My thinking that the central bank which dares to maintain an independent monetary policy (and not follow the Fed off a cliff) will be rewarded with a stronger currency has been validated.
I expect the Nikkei to start reflecting this soon.
Canfor Pulp Products Inc. (TSX: CFX) is announcing the immediate curtailment of its Intercontinental Pulp Mill, which is expected to be in place for four weeks. The curtailment is due to the lack of available economic fibre as a result of sawmill curtailments. The downtime will remove approximately 24,000 tonnes of market kraft pulp.
Inflation leads to demand destruction which cures the inflation problem automatically. With Fed hikes thrown in, you get supply destruction which leads to higher inflation in future as existing capacity and capex projects get shelved.
USD.JPY is down 3.1% today (yen appreciating). In any other year, that would be the financial news headlines, not Avatar. Futures point to a broad based collapse in US assets. Gold and bitcoin are holding steady. All major stock indices are down, including the Nikkei. The Nikkei should be a key beneficiary of this shift from US assets, so I expect that to change soon.
When the pound went into free-fall, the Bank of England interfered. The UK government changed their policies. I think the Fed doesn't care what happens to the dollar or to asset prices. Powell isn't going to stop until he gets inflation under 2%, even if that means mass layoffs, a Great Depression style collapse in asset prices, and a run on the dollar. "Operation successful, patient dead" as we colloquially say in India. The speeches of the various Fed governors read as if they are gleeful about the effect they are having on asset prices. Almost as if they are measuring success based on the amount of misery and fear they are causing.
A few days ago, I wrote that American exceptionalism was dead. The Greenspan-Bernanke-Yellen put which put a floor under asset prices has morphed into a Powell sledgehammer which puts a lower ceiling on asset prices. I'm sure there are pockets of value left in US equities, but it's time to start looking elsewhere.
The treasury market was under pressure on Monday as traders expected a hawkish pivot from the BoJ. That would have reversed flows from Japanese investors, causing capital rotation out of US bonds and into Japanese fixed income. Even though there was no such pivot, treasuries continued to sell off. I believe this is an opportunity to go long the 10Y and 30Y. In a deflationary collapse, bond yields will fall. The Fed is propping up short term rates by raising the Fed Funds rate, which forces banks to hold excess reserves at the Fed and contracts the availability of credit for short-term borrowing. The resulting squeeze makes it harder for financial market participants to finance their "inventory" (all balance sheet assets held as trading positions). Treasuries are the best collateral, making them a beneficiary of a flight to safety. Then yen moving 3% tells me we're in for a hell of a move into safe-havens at the expense of all risk assets.
Stay long gold and treasuries. Yen too, but there should be a better entry following the short liquidation.
In India, farmers and small businesses can access 1Y gold-collateralized loans from state owned banks at 7%. In the US, small businesses are paying 7.9% for short term borrowing. The sell-off in US real assets is only getting started.
The National Association of Home Builders (NAHB) is expecting weaker housing conditions to persist in 2023, after homebuilder sentiment fell for 12 consecutive months in 2022. If the Fed is serious about destroying the housing market, there's a long way down for home prices, and construction should be in a bear market for the foreseeable future. Sell West Fraser Timber (WFG) and XHB.
Dollar selling off. Treasuries selling off. Stocks selling off. Central banks are really in control of markets today. Gold and bitcoin are higher amidst all the uncertainty and fear. Bitcoin could go either way but gold is definitely in a bull market.
I know of a guy who sold bitcoin at $26k in December 2020 thinking January profit taking would be the end of the bull run. He made over 200% in a few months, which is a pretty good trade by any metric. Except, come January and bitcoin shot up to $42k. And suddenly, a 200% return looked like a terrible trade. After exiting my JPY position in the ~134 range today, I understand his emotion. It certainly feels smart to take a profit thinking that's the end of the move, but the really smart move would have been just sitting on my hands and letting my winners run. Note to self for the next trade.
December 21 2022
The US Energy Information Administration expects US crude production to come in at 11.7 million b/d in 2022 and add another 600,000 b/d next year to reach an all-time high of 12.3 million b/d.
US crude exports have averaged 3.4 million b/d this year, reaching the annual peak in November, with almost 60% of all departures going through Corpus Christi, TX.
Buy Japanese stocks (EWJ)
My working theory is that the coming US recession is going to cause a run on the dollar and US real assets, which should benefit the rest of the world. Not Europe, which is in a recession of its own making. Not the UK, which is permanently in a political and financial mess ever since the elites decided not to give the plebs the Brexit they voted for. Not Canada, since it is too dependent on the US in terms of trade relations. Not Australia, at least not until the Chinese demand picture becomes clearer. That leaves Japan, New Zealand, South Korea, Taiwan, LatAm and rest of Asia Pacific.
I like Japan for being bold enough to continue yield curve control and not follow the Fed's footsteps. I like the yen strength. Even though Kuroda's term expires next April, I doubt his successor will change the BoJ's approach if it proves to have been the right move - and it will. While other countries central banks are busy following the Fed in hurling their economies off a cliff, the Bank of Japan is telling Mr. and Mrs. Watanabe that they should bring their capital home because it's going to be the safest place to be. Tokyo real estate over New York real estate. Nikkei 225 rather than the Nasdaq 100.
Ever since the 1990 stock market crash, Japanese capital has been moving to the US. Since US tech took off following the collapse of the commodity bubble in 2011, the rest of the world has been parking its capital in the US because the US uniquely offered both safety of capital and strong growth. Safety of capital because the Eurozone crisis made the dollar appear to be the cleanest shirt in the dirty laundry. Strong growth because low interest rates financed innovation of a magnitude not seen since the birth of the automobile, radio and other disruptive technology in the Roaring '20s. Cheap capital made the US not just a leader in tech. It enabled the country to become the world's No. 1 oil producer, overtaking Saudi Arabia for the spot. The deflation created by QE, QE2, QE3, Operation Twist, whatever you call it, made the US the place to be. Immigration, real estate, financial services, crypto - everything benefited from the decade of low interest rates. It turned out that capex booms created economies of scale that made everything cheaper, much to the chagrin of the gold bugs and hyperinflation crowd.
That golden decade is now well and truly in the rear-view mirror. The CPI will come down in 2023 due to the wealth destruction caused by the Fed's rate hikes, but it's going to stay above the 2% target over the long-term as capital flees the US. If landlords need to finance housing at 8% interest, pay higher property taxes, and suffer capital losses, you can bet they will raise rents enough to compensate. Rig counts in the Permian will keep going down as funding for exploration will dry up. Goods will disappear off the shelves when business owners figure out that they're better off sticking their capital in T-bills for a low risk 5% return than running a business with all the uncertainty.
Everything we've taken for granted due to a decade of prosperity will go for a toss as the Fed stubbornly sticks to a prohibitively high rate of interest in a recession. The natural rate of interest is determined by investors' time preference - it is a measure of consumption given up in the present for more future consumption.
A deflationary bust means prices go down. Even at a 0% interest rate, deferring present consumption will mean higher future consumption. Fed Funds at 5% while businesses can't even afford to borrow at 0% because prices (revenues) are falling means people voluntarily shutting up shop in order to enjoy the free money given out by the Fed. The Fed's balance sheet is full of long duration assets which pay out less than the Fed funds rate. The Fed will be technically insolvent soon enough if they continue down this path, adding to further stress on the dollar.
The US government is set to pay out ~$700 billion a year in interest on its current debt outstanding. That number is going much higher if the Fed continues to bleat about inflation instead of pivoting back to QE.
A situation like this does not bode well for the dollar's role as a reserve currency. Goodbye, safehaven demand. Hello, run on the dollar. Remember Carter bonds? When the US had to finance its deficit by borrowing in Deutschemarks and Swiss francs because foreigners didn't want to own dollar debt? That can happen again.
What I've just painted is the end outcome of the current Fed policy. Obviously, it won't be allowed to get that bad. Either Trump comes back in power in 2024 and kicks Powell out, or Congress steps in and revokes the Fed's charter before they go too far, but at whichever point this destruction is arrested, the damage would have been done. I believe the 50 bps hike this month crossed the Rubicon.
Monetary policy works with a lag. I don't see things getting better for the US. It's going to get infinitely worse absent an immediate U-turn on rates and more QE.
Which brings me to Japan. Sure, they've widened the band on their yield curve control but are not in the least inclined to raise rates or adopt policies with an explicit goal of causing unemployment and destroying asset prices. They've dealt with deflation for 30+ years and know how to handle it. They are leaders in industrials and advanced technology. They're going to fill in the vacuum created by the collapse in US innovation.
Buy EWJ. Best case, we get a decade of Japanese outperformance. Worst case, set a stop loss at $50.8 for a risk of 7.8%.
EWJ sector weightings tilted towards industrials and tech.
A counter-argument against QE and ZIRP is that it benefited borrowers at the expense of savers. This is textbook economics, which was thoroughly debunked by empirical evidence. As a saver, you benefited from the Fed's QE and ZIRP by seeing capital appreciation in your home and IRA. The Case Shiller home price index compounded at ~6% per year since 2009. If you financed your home with 100% equity, that appreciation equaled a CD ladder. If you borrowed at 2%, you made a killing. Savers don't just hoard cash under the mattress, they invest. Even bonds benefited from capital appreciation as interest rates went down.
What about those without assets? Say, pensioners or those living off social security? Did they have 2-day Amazon delivery or the convenience of Doordash and Uber earlier? No. They saw their living standards go up as they got more bang for their buck. Young people without assets? If they were smart enough to pick STEM courses, they landed high paying jobs and moved up the income ladder. And whatever assets they managed to accumulate compounded far faster than the CD era pre-2008.
As an aside, back in the 1960s, the communist government of India wanted to cap growth at 3%. They called it the "Hindu rate of growth". They didn't want a productivity and economic miracle, just a slow plod where nothing changed from one year to the next. Those with savings invested it in fixed income schemes at the Post Office or bought whole life insurance policies from a government owned insurance monopoly. It was an era with no growth and no capital appreciation. But hey, you got 4% interest, which was above the GDP growth rate! Any Indian would trade the current 3% deposit rate and the last two decades of prosperity for that horrible time in the country's history. It's not the rate of interest so much as the rise in living standards that people actually care about.
Coming back to the US. Easy money worked, not in defiance of the laws of economics. The missing variable is that it enabled innovation, productivity, and brought in capital from all over the world, which was massively deflationary and more than offset the inflation created by the Fed's money printing. The dollar can go down even as the money supply contracts, and go up even if the money supply expands. Forex rates aren't determined based on a single variable. QE wouldn't work in Argentina since nobody wants to have their capital stuck in Argentina. QE in Venezuela would only cause hyperinflation. The US was a special case.
The unwinding of QE will be the unwinding of this virtuous cycle of cheap money fuelling innovation, productivity growth and rising asset prices. It will mean the dollar losing its over owned status and becoming just another freely floating currency. While the yen strengthened following a deflationary bust, the dollar will depreciate.
Macroeconomics is not like arithmetic where 1+1=2. Sometimes, money printing leads to inflation. Sometimes it doesn't. In 1929, debt deflation caused the Great Depression. Maybe it doesn't in 2023. I am just putting out my current thinking on why the era of US outperformance is ending, knowing fully well things can change in a heartbeat.
Buy Grayscale Bitcoin Trust (GBTC)
The math is simple. Each Grayscale share represents 0.00091342 btc. You can check each day's value here
At $7.98 per share, that implies a bitcoin price of $8736, a full 48% discount to spot bitcoin price. GBTC is not bitcoin - it is a closed end trust charging a 2% management fee just to (purportedly) hold bitcoin on Coinbase. Coinbase says the bitcoin is indeed held in custody, but they refuse to show proof on the blockchain. If there is no underlying bitcoin backing the share value, the whole thing is a fraud and it goes to zero when it all comes out. That's the worst case scenario.
The best case scenario is that they do hold all the bitcoin they say they do, and they decide to sell that bitcoin and liquidate the trust, closing that 48% discount and giving shareholders a near 100% return.
This risk/reward closely resembles a binary option. A double or nothing in betting circles. The extra 2% you pay is for a call option on the bitcoin price, on top of the double or nothing bet. I like how cheap the call option is. I'll skew this slightly in favor of taking the bet by noting that if Grayscale has been lying about the collateral in this trust, they stand to lose their fat management fees on ~$15 billion in AUM, not to mention the cost and liability associated with lawsuits. Plus, they are suing the SEC to allow them to convert GBTC into an ETF.
It would be an incredibly stupid move to ask for ETF conversion if they actually hold no bitcoin. It would also be a reputation hit to the parent company Digital Currency Group. That makes this a double or nothing, but with the odds highly tilted toward the outcome being a double rather than a nothing.
It's a high risk bet, but I like the upside enough to take the bet.
[Existing home] sales have now declined for 10 straight months, the longest such stretch since 1999. Reports this week showed confidence among homebuilders dropping for a record 12th straight month in December, while single-family homebuilding and permits tumbled to a 2-1/2-year low in November.
While stocks can sometimes bottom when the news flow is terrible, and that's something I'll be on the lookout for, I don't think this is one of those times. The full impact of Fed rate hikes hasn't even begun to be felt. It's going to get worse, and worse, and worse as the leverage gets sucked out of the system. Negative homeowners' equity is going to become a buzzword like in 2009.
December 22 2022
Buy VanEck Vietnam ETF (VNM)
In keeping with my thesis on dollar dominance fading, I've been looking for opportunities outside the US. Japan is the top choice. I looked at South Korea (EWY) but Samsung Electronics accounts for nearly a quarter of the ETF holdings, so pass. The Chinese ETFs FXI and CQQQ look interesting chart-wise, but I'm not comfortable with the tech heavy portfolio allocation.
I looked at Singapore (EWS) as a China proxy, and that would be my third pick if I was looking to add more risk (I'm not). Singapore is extremely banking and financials focused, with the top 3 holdings (DBS, OCBC, United Overseas Bank) accounting for 37% of the portfolio. If a Chinese recovery really kicks off, Singapore would be a good buy. But not yet.
That brings me to Vietnam. The ETF has a PE of 10, is diversified among real estate, staples, consumer cyclical and financial services. The currency is down ~4% ytd vs the dollar, and the ETF is down 42.6% ytd. The time to invest in emerging markets is when things turn from extremely terrible to slightly less so. I think we're in that moment. The dollar cooling off should make things slightly less awful for Vietnam. The ETF is at an all-time low if you exclude the covid bottom. I expect a sharp bounce within a month if I'm right on the dollar, so I'm bottom fishing.
Stop loss at $10.5, below the 52-week low, for a risk of ~13% with an initial target of $16. Timeline: by Jan 2023.
It's time to get defensive, and that means buying precious metals. We've already got exposure to gold via the miners. Silver is both an industrial and a precious metal, plus it's too volatile for my taste. Palladium is too tied to automobile demand. That leaves platinum and rhodium, and I'd much rather go with the former given it's easily tradeable.
Buy Abrdn Platinum ETF (PPLT)
The expense ratio is 0.6% and tracking error is minimal. The metal is in a choppy uptrend, arguing for patience, a wide stop (3 ATRs), and a smaller position size than you'd normally take.
Bonds, agriculture, Brazil and carbon credits. That's the list of everything that's up today, with the biggest winner being the KRBN ETF with a 0.9% gain. Powell has done great in his role as the Christmas Grinch, nixing the usual Santa Class rally and turning the mood somber on Wall St going into the holidays.
Biotech stocks (XBI) have been stuck in this channel for 3 months. Chances are, this breaks lower given how weak the bounces are. I've been wanting to recommend buying biotech stocks but the repeated failure to bounce to near the top of the channel makes me cautious.
December 23 2022
If you're a non-US person holding popular futures linked ETFs or ETPs, SELL. I know I recommended Teucrium Wheat Fund (WEAT) earlier and I know several people don't always follow through on my exit recommendations. If you don't sell before Jan 1 (trade settlement is T+2 days), you will be taxed at 10% of gross proceeds. Applies to several energy cos, UUP, SOYB, etc as well. Full list here
Stopped out on the Graphite India trade. Three consecutive down weeks for stocks tends to do that.
I've tried both approaches - using stops to get out, and stubbornly holding on to value and waiting to be proven right. This trade just happens to belong to the former camp, so I don't mind getting stopped out.
PCE increased 5.5% yoy and 0.1% from October levels. Spending on goods took a hit, but spending on rent and utilities increased 23.4% yoy. The more the Fed hikes, the more this component will go up. Although spending on lifestyle is rapidly collapsing, we'll continue to have inflation in the statistics.