Macro-Economic Environment
Much like her famous buzzkill namesake from the 70’s Three’s Company sitcom, our own Janet threw shade at the Chinese recently warning them to avoid exporting their excess capacity abroad in such things as solar panels and steel. Some may find this ironic as the IRA resembles something coming straight out of a central party planning manifesto. Perhaps, Secretary Yellen should pay particular attention to how this excess capacity was generated, with most of the affected industries once the focus of the party’s Five-Year Plan.
While most of the narrative around China has focused on the weakness in the property sector and the ensuing potential fallout, manufacturing in China continues to be quite strong as evidenced by their investment in such since the pandemic. It is also important to note that profitability is seemingly driving this CAPEX rather than party diktat.
As China continues to bulk up its manufacturing, we are doing much of the same domestically as a drive towards redundant manufacturing is being driven by those private sectors that need to ensure stability of supply. While the IRA tends to capture most of the headlines with promises of new chip plants and data centers, the bulk of this new domestic manufacturing construction will involve industries outside the government’s focus.
Although all governments generally do a bad job of picking winners and losers, it turns out that the U.S. Government is also working from a playbook that is decades old. Recently, the Biden Administration commented that they will be looking into Chinese dominance in the shipping industry. Combine this with their intrusion into the U.S. Steel/Nippon Steel takeover and it’s unclear why they are so focused on industries that have been dominated by the Chinese and the Koreans for decades.
While Janet hypocritically rips the Chinese over product dumping, they are retaliating for some blatantly stupid politics being played out in Arkansas. China has been actively shifting its soybean purchases away from the U.S. over the past several years, however they have recently amped up that transition in response to the Arkansas Governor forcing Syngenta (controlled by China’s Sinochem) to divest 160 acres of farmland in the state. It’s this type of non-tariff warfare that will continue to create friction and, as we know, this friction has an economic cost.
Takeaways: The war between East and West that we have written about is being fought on a number of fronts, some of which are not always so overt. While attempts to bulk up our chip making capabilities may come under the guise of national security, much of the political games and false flags that are being displayed will only cause further distrust. This distrust will come with a high price tag however, something that politicians on both sides fail to understand.
Commodities/Energy
I-banks are finally coming around. As we’ve been saying for quite some time, the most advantageous risk/reward dynamics (especially in an inflationary and higher interest rate environment) currently favors select commodity exposure at the expense of the highest flying tech names. Goldman Sachs is the latest in recommending taking profits on tech and placing them elsewhere - primarily energy - as an inflation and geopolitical hedge.
One of the most counter-intuitive moves in the commodity space recently has been gold, which has risen ~11% this year (+26% since October) despite rising interest rates and gold ETF outflows.
Who’s driving this move? Central Banks and international (primarily Asian) buyers. Investors' willingness to gain more exposure in “stuff” is a global phenomenon and moving into all sorts of SOP-focused areas, including copper, silver, PGMs and all-things energy. There was a recent WSJ Op-Ed titled “What if the Federal Reserve is Wrong” concerning the rationale behind the much anticipated rate cuts amid a continued rise in commodity (input) prices. Our counter-question is: When has the Federal Reserve been Right?
Speaking of energy, the Middle East is the closest it’s been to a major, multi-national escalation in years. Iran is widely expected to retaliate against Israel over its attack on an Iranian Consulate in Damascus, which killed 12. Iran has reportedly informed the U.S. to “step aside” as it readies its response. Lebanon, Syria, the West Bank and Gaza (all with Iranian support) threaten Israel from virtually all sides, with the exception of the south. A strike from Iran directly into Israel would up the stakes and open a new, more volatile chapter in the Middle East’s conflict(s). The impact has moved well beyond oil prices, as everything directed away from the Red Sea (Europe/Asia trade route) has come with higher shipping costs.
Takeaways: We’re witnessing the investment implications and sector rotation of what SOP has been advocating since our inception - a secular-led environment involving both higher inflation and interest rates. Add in the very real elements of geopolitical conflict, and you have all the necessary ingredients for hard asset/commodity outperformance.