Weekly Hard Assets Insights
By David McAlvany

Another interesting week in the wild world of markets.  All three major market indexes ended the week lower, but only modestly.  Commodities were mixed but volatile, the dollar rallied and bond yields ticked up by 2 bps.  Speaking to the volatility in Commodities, precious metals prices took a hit, copper sold off aggressively, iron ore prices sank to their lowest levels since March. On the other hand, aluminum prices topped $3,000 for the first time since 2008, oil rallied to the highest prices since early August, and natural gas continues on an upward tear.

Markets seem to be wrestling with an evolving economic phase change.

The firmly entrenched bullish trends and price momentum that have defined market structure since the Covid lows are being challenged.  What had been a straightforward dominant market narrative of surging growth in a reopening global economy, assisted by near zero interest rates and unprecedented monetary and fiscal stimulus, has become much more complicated.  We now have a shifting macro economic landscape that, while still showing some encouraging signs of strength, is increasingly churning out data points flagging significant areas of concern.   Notable concerns have increased in the areas of growth, inflation, profit margins, valuations, deteriorating market internals, and increasingly serious, potentially high impact, developments in China that continue to worsen.  Meanwhile, markets are also chewing on concerns over the US debt ceiling, stalled US spending bills, and a U.S. Federal Reserve potentially set to announce plans for tapering asset purchases as soon as next week’s FOMC meeting.  All in all, markets have a plate full of issues to contend with.

Much of the big news of this week revolved around inflation, inflation expectations, retail sales, and consumer sentiment.  On Tuesday, the August CPI print was reported and for the first time since October, the numbers came in lower than consensus expectations.  Month over month headline CPI rose 0.3% vs. the 0.4% expected, and month-over-month core CPI, excluding volatile food and energy prices, increased by 0.1% vs. the 0.3% expected.  On a year-over-year basis, headline CPI inflation ticked down to 5.3% from 5.4% last month.  Y/Y core CPI inflation eased to a still significant 4.0% from 4.3% last month.  The weaker-than-expected inflation data was met with enthusiastic cheers from the “transitory” inflation camp.  The victory lap, however, may be decidedly premature as, in addition to the fact that prices still increased in August, the factors supporting the threat for non-transitory and problematically persistent levels of inflation remain.

Since the onset of inflation concerns, it has always been clear that some component items of the CPI were likely to be of the more temporary variety, while other CPI components threatened to be more persistent.  After surging inflation all year, an easing of the CPI data at some point was to be expected as some of these more transitory factors started to resolve themselves.  The bigger issue for those dubious of the dismissive “transitory” inflation argument is the progression of price increases in the sticker CPI components likely to be more persistent.

In the month of August, the items contributing to an easing in the rate of higher prices were decidedly of the more transitory variety.  Used car prices started to decline from record levels, lodging prices started to come back to earth, and airline fares dropped significantly.  Prices for transportation services also eased.  The drop in transportation services was assisted by a decline in motor vehicle insurance rates, but, in the case of motor vehicle insurance, the decline was largely attributable to seasonal factors that are likely to reverse in September.

On the other hand, inflationary items likely to be more persistent remain concerns.  The biggest contributor to the CPI reading is housing-related “shelter” prices.  Owner equivalent rent (OER) and rent of primary residences both increased 0.3% M/M.  Despite the fact that OER is a tragically flawed measure, it historically lags the primary measures of rent increases and house price gauges by many months.  Currently the spread between the lagging OER and the other market-based primary measures for shelter inflation is well over double digit percentage points depending on which measures you use to make the comparison.  If history is still relevant in our modern moment, OER numbers are very likely to accelerate higher in the months ahead as OER closes the spread gap and increasingly catches up to the reality of what is going on in the soaring housing and rent markets.  The implications of just this one lagging factor to the “transitory” inflation thesis are potentially devastating.

Meanwhile, as chronicled in last week’s HAI, labor shortages and the likely resulting wage increases that will be needed to attract workers looms as another sticky source of persistent future inflation.  In addition, issues that were once assumed to likely be more temporary, such as supply chain disruptions, are, so far, proving to be anything but temporary, with many warnings ringing that the worst may be yet to come.  Just this week, the number of container ships waiting in cue to deliver their goods at both the port of Los Angeles and that of Long Beach in California, blew through the previous record with 61 ships now forming the line.  The congestion is growing by the day.  The situation is now at the point where a record 21 ships have been forced to drift as there is nowhere near the necessary number of anchorages for all the traffic.

At the same time, freight rates, which have already been surging to record levels, may be set to spike even higher.  Speaking to Bloomberg this week, Genco Shipping President and CEO John Wobensmith stated, “I think rates can go higher from here.  You do get to a point, and you’ve seen this in containers, where you hit a certain utilization rate, and you start to go parabolic on rates.  I think we’re getting close to that period.”  These freight rates will flow through to PPI and higher prices for producers.  Eventually, the flow through will be passed on to CPI and consumer prices.

Beating what is now becoming a very familiar drum, this week, United Postal Services’ president of UPS International Scott Price suggested that supply chain problems are so bad that they are forcing companies to reorganize their overall supply chain and logistical strategies.  In an interview with the Financial Times, Price indicated that many companies are realizing that their stretched supply chains are likely to be an ongoing problem.  The problem appears so far removed from being transitory that Price expects companies to move Asia factories back closer to home in the Americas to shrink their increasingly vulnerable supply chains.  One point to underscore here is that this is not the sort of reaction one might expect from cost conscious corporations if they felt global supply chain issues were merely “transitory.”

Also this week, speaking to ongoing and intensifying price pressures, U.S. supermarket giant Kroger said grocery prices are set to climb even higher as inflation is proving to be stronger than the company’s previous expectations.  The Kroger news echoes comments made earlier in the week by 3M’s CFO, who, in preparing markets for a greater than expected inflation driven hit to Q3 margins, said that “…despite taking price up, getting to positive, we are seeing inflation outstrip price.”

The CPI report notwithstanding, arguably the biggest inflation-related news of the week came out on Monday, when the Federal Reserve Bank of New York released their latest survey of consumer expectations.  Consumer inflation expectations are a key factor towards future inflation.  Consumers and businesses that expect higher future inflation will act in accordance with that expectation.

The circular logic is powerful, as the actions taken by consumers and businesses expecting higher future prices are actions that in themselves drive higher prices.  This week, the NY Fed reported that inflation expectations for the one year ahead period jumped to a new all-time high at 5.18%.  In addition to being an all-time high, it was also the tenth straight month of increases.  The three-year median inflation expectation also hit a new all-time high, coming in at 4.0%, up sharply from the previous 3.7%.  This is a troubling development.  If a widespread inflation psychology is setting in, which appears to be the case, it threatens to instigate a much more significant and lasting inflationary spiral than would otherwise be the case.

Also out on Friday was the University of Michigan’s Survey of Consumers.  Preliminary consumer sentiment rose modestly by 0.7 points in September to a 71.0 reading, while expectations were for a reading of 72. After last month’s dramatic plunge and recent positive developments on the Covid delta variant front, a larger rebound would have been welcomed.  According to Richard Curtin, the chief economist of the survey, “The steep August falloff in consumer sentiment ended in early September, but the small gain still meant that consumers expected the least favorable economic prospects in more than a decade.”

Curtin also points out that since the dramatic weakening of consumer confidence showed up in August, “Many other sources of economic data have since shifted in the same direction, and point toward slower growth in consumer expenditures….”  Speaking of the inflation problem and its negative impact on sentiment, Curtin pointed out that “although declining living standards were still more frequently cited by older, poorer, and less educated households, over the past few months, complaints about rising prices have increased among younger, richer, and more educated households.”  The observation is supportive of the increasingly widespread awareness and impact of inflation throughout the population.

Mr. Curtin further suggested several potential reactions by consumers to inflation. “Consumers have initially reacted by viewing the rise in inflation as transitory, believing that prices will stabilize or even fall in the future. As a result, postponing purchases is seen as a viable strategy. This implies a slowdown of spending in the months ahead and a more robust rebound later in 2022.”  Positive retail sales data released earlier this week along with the above-mentioned rise to record high levels of inflation expectations may suggest that another interpretation of the consumer reaction to inflation is in play.

As to an alternate interpretation, Curtin goes on to say, “the main alternative is that inflation will not be transient, but will rise further due to an unprecedented expansion in fiscal and monetary policies. The resulting rise in inflationary psychology will lessen resistance to rising prices and stiffen demands for increased wage gains.”  In other words, if expectations are not for “transitory” inflation, then the inflation genie explodes decisively out of the bottle.

On the verge of next week’s FOMC meeting, the Fed will reveal its next preferred policy step.  Unless the Fed can thread the needle perfectly, it would seem that challenges and serious risks are present in any potential direction.  If they announce their taper plans, they will be moving in a direction that eventually reduces the sugar this bull market seems to be increasingly dependent upon.  That path runs the risk of exposing the economy and a vulnerable market to a hornet’s nest of risks.  

Hall of fame investor Jim Rogers, in an interview this week, offered thoughts on where that path might end.  Referring to the record levels of ultra-accommodative stimulative policies, Rodgers said, matter-of-factly, “when it ends, we are going to have the worst bear market of my lifetime.” On the other hand, if they delay action on taper plans, they only pick the other poison.  A further delay of tapering risks to seriously perpetuate and intensify inflation.  This might buy some time for markets and the economy, but only in exchange for an even more devastating array of problems, magnified in both size and scope, in the ever-approaching future.  This has been, and may continue to be, a remarkably resilient market, but with the minefield surrounding the Fed’s current positioning, we are hoping for the best, considering the worst, and planning and preparing for all potential outcomes.

As for weekly performance:  The S&P 500 closed the week down 0.57%.  Gold was off by 2.27%, while silver lost 6.53% on the week. Platinum dropped 2.71%, while palladium was the hardest hit PM again this week, dropping 6.70%.  The HUI gold miners index fell 2.30%.  IFRA, the I Shares US Infrastructure ETF, was down 2.50% for the week.  Energy commodities were higher.  WTI Crude Oil gained 3.01%.  Natural gas rallied again by 3.34% on the week.  The CRB Commodity Index was up 1.59%, while copper was hard hit, down 4.58%. The Dow Jones US Real Estate Index ended the week down 0.61%, while the Dow Jones utilities index lost 2.73%.  The dollar was bid higher this week, gaining 0.63% to close the week at 93.18.  The yield on the 10-year Treasury gained 2 bps to close the week at 1.37%.

Have a great weekend!

Best regards,

David McAlvany
Chief Executive Officer
MWM LLC