The Week Ahead — 04 Jul 2022: Metals Meltdown
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We’ve all seen many chops in the markets, especially on the energy side, with the fuel and oil shortages. That was a little bit unexpected to people. Equity markets are struggling and there are a lot of talks this week about recession and trying to move the Fed into being more accommodative, which is 180 degrees from where we were two weeks ago.
Copper is hurting and down 28% since March. What is this telling us about metals, generally, and drivers of metals demand? Is this telling us that China — the largest buyer of industrial metals — won’t really bounce back? Does the market doubt China’s stimulus announcements?
We also discussed Europe, its slowing economy, rising unemployment, and gas shortages.
Lastly, is the Fed anchoring inflation?
How badly is Europe hurting?
Fed inflation anchors
What’s ahead for next week?
This is the 24th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
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1:45 Key themes for this episode
2:23 Metals meltdown — what are they telling us?
3:48 Will there be a comeback of automotive?
5:09 Does the market believe China’s promise of a stimulus?
7:25 How much is China’s manipulation be beneficial for China?
9:26 What about Japan?
12:00 Europe’s economy and inflation
15:21 Europe’s concentration risk on the sale side
19:42 Europe’s problems stem from this
20:32 Fed and anchoring inflation
25:50 What’s for the Week Ahead?
TN: Hi everybody, and welcome to The Week Ahead. I’m Tony Nash. Today we’re joined by Sam Rines and Albert Marko. Tracy is out for the long holiday weekend. Before we get started, please don’t forget to like and subscribe the video and please comment on the video. We look at them, we engage. We want to hear your feedback. Also, while you’re here, we have a promo for CI Futures. This is our markets forecasting tool. Our promotion is three months free on a twelve-month subscription. That promotion ends on July 7. So please take a look at it now and get our best promo ever.
So, key theme for this week. We’ve all seen the markets a lot of chop as we talked about. We saw a lot, especially on the energy side, kind of negative with the fuel shortages and oil shortages. I think that was probably a little bit unexpected to people. Equity markets are struggling and there’s a lot of talk this week about recession and trying to move the Fed into being more accommodative, which is 180 degrees from where we were two weeks ago. So a few things we’re talking about.
First is the metals meltdown. Second, Albert Marco, although he’s been in an undisclosed location, he has been in Europe. And we’re going to talk a little bit about how badly Europe is hurting right now. And then we’re going to look at inflation and how the Fed is potentially anchoring inflation.
So first, let’s look at the metals meltdown. If we look at copper. Copper has been a lot of buzz around copper over the last few days and copper is down 28% since March. But I think we could speak to metals more broadly. We’ve got the copper chart on the screen right now. So Albert, if you don’t mind, what are metals telling us generally about markets and the drivers of demand?
AM: Well, I mean, it’s pretty clear that the manufacturing sector across multiple industries is hurting at the moment and has taken a toll in the metals market. There just simply isn’t any demand for consumer products. There’s not going to be any demand for metals probably until the Chinese really start to stimulate.
It’s pretty clear. And then on top of that, they have pressure from the dollar that just keep on charging along trajectory to 110. So those things are really weighing on the metal market. I mean, copper specifically, like you mentioned, aluminum taken some hits just across the board.
TN: Right. So if we look at things like automotive, automotive is held up because of semiconductor supply chain issues which are working out, but automotive manufacturing slowed pretty dramatically. If we see, say, the chip issues get worked out for, say, automotive, do you expect to see more like a comeback of automotive, of car manufacturing, which will pull metal prices along?
AM: No, I don’t. And I don’t think that’s even going to be the case for the next 18 to 24 months. I mean, the auto sector is actually in a really bad shape, And it’s not specifically just because of the chips, like everyone assumes, but you have rubber shortages, you have polyurethane shortages, you have shortages across the board for the entire auto sector, for the manufacturing process. So until all of those supply chain issues get settled, there’s just no hope at the moment, which is interesting because there hasn’t been really any layoffs yet.
I know they’re artificially keeping these people on payroll and doing whatever they want to do with the shifts and manipulating that. But at some point and i’ve been arguing about this specifically the auto sector, there will be layoffs because of all this.
TN: Just for the people who don’t know. Albert is from Detroit, so he pays attention to the auto sector pretty closely, and he knows he has pretty close relationships there. So we’re talking to a man who really does kind of pay attention to what’s going on. Sam, as we see metals prices fall, we’re also seeing china become more aggressive in making statements about economic stimulus and other things. Are the metals prices right now telling us that the market doesn’t believe that china is going to put in the stimulus that they claim to be?
SR: I would say it’s a show me game with China. There’s been way too many people that have been burned way too badly, listening to the rhetoric and trying to get ahead of things on the ground, and then nothing actually happens, or they do something a little different than what they said they were going to do, and you end up with an investment profile that’s completely different.
I think that’s one of the big things to keep in mind is, yes, China is probably going to have to do something into or around the party congress this fall in terms of stimulus. They have to look at going into it. So there’s going to be some stimulus. The question is, what is it and when does it hit and what does it look like? Is it a tax cut? Because in that case, who cares, right?
It’s not going to be that big of a deal for picking up the manufacturing side in a meaningful manner. Is it going to be reopening? Right. Because if they’re sending out checks but not reopening, that’s not going to allow their manufacturing sector to get back to work, which is going to Albert’s point, going to continue to clog the supply chains for autos and auto manufacturing significantly, whether you’re us. Based manufacturer or your South Korean manufacturer, et cetera.
This is a longer term problem where I think you’re not necessarily going to have the pop and metals until people actually see the real data from either Australia or the us. Or even in Mexico. But that’s a significant amount of the auto sector assembly. You’re going to actually have to see the data before people.
TN: Right. And so what I hear about metals in China and I’ve mentioned this before, but what I’m told by people, especially in the copper sector, is that the warehouses in China are actually full, although we’re told that they’re not. They are. And words that warehouses empty out from time to time is simply to manipulate the market up. But there’s ample, say, copper and other industrial metals in warehouses in China, given the demand that the world has.
AM: Let me ask you both little question here. How much is China’s manipulation of their stimulus on and off due to them trying to force the Fed into lowering the rate hikes or putting them into a position where it’s beneficial for China overall?
TN: Sam, what do you think?
SR: I would say they definitely have a calculus instead of the ECB, instead of a certain extent the BOJ when they.. they all have to take that into account and they all have to either front run or attempt to talk their markets one way or the other. That’s why I’m saying it’s definitely part of the calculus. I don’t know how much of the fiscal side is directly related to counteracting with that and how much is directly related to keeping the people happy. I would say those are the two primary catalysts.
TN: Yeah, I think that’s right. I think any Chinese stimulus that’s going to be effective in the short term has to be cash in, say, local government accounts, people’s accounts, company’s accounts. As Sam said, that tax cuts not going to cut it, indirect payments are not going to cut it. Announcing a new rail stimulus, which they do every other year, is not going to cut it. They actually have to just churn cash out in markets. But with the US dollar and rates, I think they’re really careful right now about how quickly they devalue CNY. And I think that is one of the things that they’re being careful of. They don’t want to devalue it too quickly because Chinese exports have surged over the past six weeks. And so if they can continue to make money at the rate they have, they’ll put off the DeVal as long as they have to. But if the dollar continues to appreciate, they may have to accelerate the evaluation and they’re in a tough spot. China is not the all seeing, all knowing planner that many people think, well.
AM: Part two of that would be what about Japan? Because they devalued the Yen and they’re kind of combating whatever China is trying to try and propose and stimulus. So how does that all come into the equation?
SR: And I’ll just pop out that one of the interesting pieces to kind of throw into the puzzle is not copper sending one signal that China is maybe not going to stimulate, et cetera. But you look at Chinese Equities X, the state owned entities, and guess what? You had a plus almost 7% second quarter for those equities. So the market is sniffing something out there. There might be a little bit of a hedge of, well, if you’re not going to build a bunch of stuff, you might hand out checks, like you said. And if you hand out check, it’s going to benefit the Internet and Chinese tech companies more than it’s going to benefit the metals industry.
TN: Right. And if they want to stimulate the top echelon of Chinese society, they could just goose equities and focus on a trickle down theory, which is very anticommunist, but it’s something that they can do pretty quickly. They did it in 2015, they’ve done it at other times, and they can do that. But going back to your Japan question, Albert, it’s an interesting one because China is such a supply chain risk going forward, the uncertainty there, that Japan is selling itself as a secure alternative to China. And that’s why one of the reasons why they’re devaluing so strongly is so that it’s just a no brainer to get stuff done in Japan. Right?
AM: Yeah, of course. That’s a great explanation. It’s very concise and simplistic, and I had known this, but I wanted you guys to explain this to the viewers because it’s a critical thing that most people don’t really take into account. They always see China. China. And they ignore Japan and South Korea.
TN: Yeah, Japan and South Korea have been devaluing. It’s more depreciating than devaluing. I know there’s a nerdy difference between those two, but they’ve been pushing depreciation because they wanted to be seen as a safe alternative to China. But then you also look at Southeast Asia, places like Vietnam, other places, things in Vietnam, all those exports are done in dollars, not in dong, so they can’t really play the currency card to do values.
SR: It’s also worth remembering that Japan exports a lot of machinery to China, and so if they don’t, if they strengthen their currency while China is devaluing, that puts them in there.
TN: That’s right. Great questions, Albert. Thank you for that. Okay, let’s move on to Europe. Albert, so you’ve been there. Let’s start by looking at inflation. So we’ve got on the screen right now a comparison of inflation rates in, say, the US. Europe and China. And PPI, especially in Europe, is blistering hot. It’s 40%. And CPI, of course, is accelerated as well. It’s ten plus percent, if you believe that. I think it’s higher than that. But as you’ve been there, can you walk through some of your observations of what’s happening in Europe right now and how it’s affecting companies and the way people spend and so on?
AM: Well, from the bottom up, for the general public, that’s just pure desperation. The media just doesn’t want to cover it because it’s just bad news for every single political party out there. Inflation is running rampant. Food, it’s running rampant. And every single product they have, they’re used to high gas prices to begin with, but like the United States, there’s a certain amount where the strain is just too much for families.
I believe the UK. One out of four people were skipping meals because of food inflation prices. One out of four? That’s stunning. And that will have long term health effects down the road. But we’re talking about the year now. Europe’s manufacturing sector is an absolute shambles. Their export engine into China is just nonexistent. They haven’t built out any overseas networks into Africa or other emerging markets to be able to compete. They have no military to sit there and actually push the trade issues their way. They’re secondary. Not secondary. They’re behind Russia and China in that aspect, not to Mention The United States. So, I mean, I complain about the auto sector in the United States. The manufacturing and the auto sector in Germany is absolutely dead.
TN: Okay, I want to pull that Apart a little bit. Okay, so the manufacturing in Germany is dead or dying, largely because of concentration risk in Russian gas as a feed fuel, right, for electricity.
AM: The energy prices have skyrocketed. Corporations And Private businesses are struggling to keep up with margins to cover their costs. And the governments are just like. They’re just making things worse in Germany, I believe they’re handing out money to every single person, refugee or youth person, that think that will vote for them in the future. That makes inflation worse. I can go down the list of different things that they’re doing an error, but I don’t see how Europe pulls out of this specifically in the fall and going into 2023. I mean, their gas shortages are such a problem here right now that I can’t even fathom what the problems are going to be in Germany and Italy and France going forward.
Actually, in Germany and Austria, they’re running out of wood to heat their homes because people are stockpiling that already, and this is July. So I mean, there’s going to be some serious repercussions of Europe. And this is why I targeted Europe to be a problem, possibly for financial crisis and contagion leading back into the United States. It’s just a big problem across the board.
TN: That PPI chart is just so stunning. Now we talk about concentration risk on the supply side. Let’s look at concentration risk on the sales side. Right. Europe has really over concentrated a lot of its sales requirements in China. China has been the market for a lot of European companies. Right. And outsource manufacturing. So they’re as concentrated in China or more concentrated in China than many US companies are, first of all.
AM: By far.
TN: And they’re more dependent on China as a sales market in many cases, than many US companies are, right?
AM: Yeah. This is the problem that I’ve had with Germany specifically. I want to pick on Germany because they are economic. That’s just the fact of the matter. But the Germans, they go out and they see China as a huge market, and they start pushing out their high tech trains and their windmill technology and so on and so forth. Well, the Chinese, all they did was order that stuff, buy it, piece it apart, copy it, and then they sell that to the Africans for one fourth of the cost of the Germans could possibly sell it to the Africans.
So not only is Germany losing out long term with Chinese trade in the market, because that’s stagnating, but now they have no chance to go into the African market because it’s flooded with Chinese parts.
AM: They made such critical errors for the years, and they were just so drunk on cheap money out of China that now for the next decade or two, they’re going to have problems.
TN: Yeah, but my overarching points are that Europe is over concentrated on the energy side with Russia, and they’re over concentrated on the manufacturing and then market side with China. And aside from that, they’re kind of out of bullets. They don’t have a lot. And I think that is a lot of the basis for the reason we’re seeing PPI just explode in Europe.
AM: Yes, of course. The only country that even has the only country… The French are smart. I don’t want to hear anything from the Americans be like, Oh, the French are weak and put up the white flag on the Eiffel Tower, whatever these jokes are. But the French have nuclear power and they have food security for their entire nation.
Two of the biggest problems right now in Europe, France has a grasp on. The rest of Europe is total chaos. But those two issues in France are absolutely secure, and the French are smart and they’re looking for long term gains to push the Germans out of the way and take over the EU, and that will actually end up happening. But in the near term, inflation is almost worse there than it is here. Their housing market is mainly cash based, so it’s not as bad of a bubble, but everything else.
TN: So you don’t see much let up in Europe for the rest of 22. You think it continues to be pretty dire in Europe for the rest of 22?
AM: Oh, absolutely. I think the only reason that it’s even somewhat stable at the moment is the tour season has kicked up, and then that’s created other problems where you’re going to cancel flights and overbooked hotels.
TN: Right. Sam, do you have a similar view on Europe at least for the remainder of the year? It continues to be really difficult for the remainder of the year.
SR: Oh, yeah. And the only other place that I would point out is Italy. I mean, Italy is in a pretty rough spot here too. Even with Mario Draghi at the helm, they’re still in a pretty tight spot, and part of it is natural gas and pretty tight there. But the other part is that when it took Legarde about 35 seconds of saying, we’re going to tighten up a little bit here, from negative rates to maybe zero to almost blow up the bond market in the BBB market, it was insane what was going on, and it was a very small move, and you still had yields blow out across the Italian government deck. It’s one of those situations where things move very quickly, things break very quickly, and it doesn’t have a whole lot of bullets in the site.
TN: It’s not like they can go to their version of the permian and drill again. Just to bring this back to something really basic. A lot of Europe’s problem stems from the fact that it has a very old population. So they don’t have young, productive people to keep up with the commitments to very old people in very simple sense. Does that make sense? Is that right?
AM: Oh, absolutely. Looking at just the Italian demographic, all those young Italian guys have bolted for the UK, London, and New York and Miami. They’re gone.
TN: So until they either have a lot of babies, automate, or have a lot of new immigrants, Europe continues to have the same issue?
TN: Okay, good.
SR: Demographics don’t change quickly.
TN: No, they don’t.
SR: It’s about 18 years.
TN: That’s right. Okay, so let’s move on to the Fed and inflation anchoring. Sam, you had a great piece in your newsletter, which I’ve referenced many times, and people always ask me how they get their hands on it. So it’s one of the most exclusive newsletters you can get in America. But you had a great piece on Fed Anchoring. Now, I put a chart up on five year inflation expectations. The only reason I put this up is because they really peaked back in late February. Okay? And after that, the five year inflation has really broken down a lot, almost to normal ranges. Okay. So I know you’re looking shorter term, but can you walk us through a little bit about the Fed Anchoring inflation and what you expect? Kind of the near term impact?
SR: Sure. So kind of the point of what I was trying to get across. There’s really two things that you needed anchored for markets to begin to find some footing in the US. At least. And that was you needed to have inflation expectations begin to become anchored. And I think we’ve seen that. Right. You see that chart and it peaked in March, give or take, and has fallen back towards call it normal ranges, if not slightly below what you would expect in this type of environment. That makes sense, right?
In five years, we’re not going to have this type of solution. I’ll be willing to accept that no problem unless we have another flare up somewhere. But I think that’s a fairly reasonable thing to do. But also you have to have the expectations for the Fed anchored as well, because you had two unanchorings that were really happening side by side that was highly problematic for markets.
One, you had inflation unanchoring very quickly, and that’s problematic for markets generally. But you also have the Fed expectations becoming unanchored, and the market was pushing, pushing, pushing for whatever it could get in terms of hikes. Right. It was 75–75–50–50–50. Adding an item to somewhere around four and a quarter percent at the peak. And as of today, you’re back to having the terminal rates or where the Fed raises interest rates to happen by December of this year, and it’s 3.25% 3.5%, and then it cuts next year, is the expectation.
So you’ve begun to have, call it a pricing that’s similar to 1994 hike and then cut style of Fed. That is pretty interesting. That’s a pretty anchored expectation for the Fed. It’s a reasonable expectation of the towards neutral. You’re probably somewhat towards real rates at that point being somewhat positive just because you have inflation of about 3.2 and you have a Fed funds rate a little bit above that. nThat’s why I think that’s a fairly reasonable place for it on the inflation expectations front, that’s largely specifically going to call it close in inflation expectations under a year.
Those are largely call it oil and gasolated and groceries.
TN: Very much energy.
SR: Yeah, this is US. This is not Europe. But as long as in the US, you don’t continue to have those rise in a dramatic fashion, people tend to stop extrapolating. Those forward in their inflation expectations either stabilized or declined back to what they call it normality. And that normality would be somewhere between two and a half and two so that we could spot.
TN: So if gas prices, gasoline prices in the US stopped at, say, 490 or whatever they’re selling at now as a national average, let’s say we plateaued there for three or four months, people would adjust and it would be livable?
SR: It would be livable, yeah, it would be livable. So long as the not accelerating higher.
TN: As long as what, sorry?
SR: As long as they’re not accelerating higher.
AM: Yeah, Sam is right. The risk is as long as they stabilize, I completely agree with Sam. We have one hurricane in the Gulf of Mexico. We have a problem, like a real problem, looking at like $5.50 to $6 gas, and then inflation becomes absolutely just insane.
Going back to the inflation number that they printed out last time, they’re using this ridiculous 5% for housing and shelter and the CPI equation. It’s a little bit hard for me to swallow, but if they can do some kind of magic and keep inflation somewhat steady over the next few months I agree with Sam.
TN: It’s kind of a short at that point.
SR: The interesting part about that is you create an interesting duality in calling risk markets, where the US risk market looks very attractive. If you’ve peaked on Fed pricing, if you peaked on the PE killing. PEs are down 35% year over year. That’s a bigger drop than we’ve seen for several corrections.
You can have a really interesting US risk market going into the back half of the year across markets. The curve, on the other hand, that could be two spends to get very interested very quickly.
TN: Very good. Okay, good guys. What are we looking for for the week ahead? We’ve got a holiday here on Monday. We’ve started to see, say, gasoline prices perk back up in markets on Friday. Are we going to start to see potentially in the near term gas prices rise post July 4?
AM: I think so. One of the things that’s not being said, I don’t think we touched upon, I think last time we did, but the Saudis come in with lower than expected barrels per day, lower capacity, and this must have been stemmed from McCrone and Biden trying to price cap them. Come on, you do that to us, we’re going to do this to you. It’s a game at this point. And the Russians are certainly pulling strings of the Saudis and the Iranians to make this a little bit more chaotic for the US. So I think gas does go does start to trend a little bit higher over the next two weeks.
You’re certainly going to hear noise from people with July 4 prices for barbecues coming up. So that’s going to be all over the news.
TN: Okay, interesting. Sam, what are you looking for during the week ahead?
SR: To build on what Albert was talking about? I think it’s really interesting that spare capacity from OPEC just doesn’t appear to be there whatsoever. But at the same time, you’re also probably going to have at least somewhat of a call, a permanent impairment of Russian oil fields if you continue to have sanctions, that puts a floor long term in global energy prices, period. And if you don’t have US service firms keeping those fields going, we’ve seen what happens when you send Chinese and Russian oil services firms to Venezuela just before you destroy the oil industry.
So look forward to that. On the other side, I’m really looking forward to the conversations that a bunch of millennials have to have with their parents, the crypto markets this July 4.
TN: You are a millennial.
SR: But I am looking forward to some glorious Twitter cons that Tuesday.
TN: Fantastic. Okay, guys, thanks very much. Have a great holiday weekend and have a great weekend.
AM: Thanks, Tony.
SR: Thanks, Tony.
This Week Ahead is originally published at https://www.completeintel.com/weekahead/the-week-ahead-4-jul-2022.