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Mixed Messages

It’s pretty hard to know what’s going on out there these days.

Some things are certain. Inflation tops that list, followed closely by supply chain bottlenecks around the world. We just don’t have enough truckers and port capacity and crane operators and microchip manufacturers and and and.

The main reason: Americans are Buying. More. Stuff. COVID erased all kind of service spending; consumers rotated to goods. The inflation data doesn’t lie, as the chart here shows.

How will this play out? Well, transportation bottlenecks are the problem so the answer is to increase the throughput of the supply chain…for everything. (I exaggerate, but only slightly.) But port expansions don’t happen quickly. People don’t re-train as truckers overnight. Businesses don’t make expansion investments lightly. In other words, supply chains cannot be expanded in the short term. Such changes would take years.

So instead, to bring things into balance prices will rise until enough demand is destroyed that the supply chain is sufficient again.

This might already be underway: Q3 growth expectations are crumbling as prices soar.

And it’s becoming clear to everyone that inflation is not transitory. Grant Williams, who writes the fantastic Things That Make You Go Hmmm… newsletter, recently published this table:

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Yup, even the Fed is seeing inflation for what it is: a supply-chain driven reality with no easy fix, exacerbated by the fact that Fed essentially cannot raise interest rates (too much debt, and don’t you dare threaten the all-important stock market!).

For metals investors, the most important question is whether we are headed to inflation in a growth environment or stagflation in a struggling economy. I don’t know.

I read as many articles arguing that growth is all good as those arguing the end is nigh. On the All Good front:

  • American consumers are spending oodles of cash, way above pre-crisis levels.
  • The labour market has recovered rapidly. Yes, some recent jobs reports have disappointed but if anything businesses are struggling to find workers.
  • Stock markets are hot.
  • Household net worth surged during the pandemic by the greatest amount the US has ever seen during peacetime.
  • Manufacturers are struggling with costs, supply chains, and labour shortages. But data, such as the recent Dallas Fed manufacturing survey, shows strong measures for things like production, new orders, growth rates, and hiring.

Will all of this turn on a dime? There are a lot of pessimists out there who think so. And some things are changing: COVID stimulus cheques are disappearing, inflation is ballooning energy costs, China’s soaring real estate market is strained (the Evergrande debacle might be the coal mine canary; new construction starts fell 14% year over year in September, the third month of double-digit declines), and inflation will soon start to really squeeze margins, which would threaten high equity valuations.

I don’t know which way this will all go, let alone how quickly. I plan to watch manufacturing data, consumer spending, corporate earnings (Q3 numbers are good so far; let’s see what happens in Q4), and yields, especially when the Fed starts tapering its bond buying program next month. Such data is the only way to see whether growth is sticking or sliding.

If growth sticks, the base metal bull market will be on. Base metals always perform with growth-based inflation; supply gaps for most metals (especially those where electrification is driving new demand) will boost that performance.

If growth doesn’t stick, base metals will falter. Those needed for the electrification paradigm shift will then head back up, if in a more measured way, because there just isn’t enough metal.

As for gold – I really think it will work no matter which way the winds blow.

I question all the time whether my conclusion – that gold will perform no matter how these mixed messages resolve – is valid, or whether I’m looking through gold-coloured glasses. I might be biased. But whether we get inflation or stagflation, gold should benefit because real rates will go more negative.

Whether the stock market keeps rising or falters, gold should get attention because real rates will keep going down and because, whether it happening alongside growth or not, inflation does reduce profits and therefore will at some point hurt equity valuations. And when that happens gold miner should stand out as a safe haven in turbulent seas.

And gold miners are due for a move. They have lagged gold this year, as this chart from PI Financial shows, and it’s seasonally time for a catch up.

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