Commodities, China and 2012

From Art Patten, Symmetry Capital Management, LLC

A brief overview of our current thinking on the financial market and economic outlook—please see important disclosures at the bottom of this email:

Yesterday’s rally provided a reprieve from strong selling pressures, but was low-conviction judging by trading volumes and bond market behavior. I suspect it will prove temporary and that the current trend will remain negative. Normally we could ascribe that to seasonal dynamics—for example, the old “sell in May and go away” adage—but there are some really strange forces at work, and almost all of them are bearish. They may not cause much damage in the coming quarters, but at some point they will. Our current guess is 2012, but it could start earlier.

  • Recent commodity market volatility indicates to us that the trade is highly levered on the bullish side, and thus increasingly fragile. As long as there’s real demand, the investment (speculative!?) demand from developed world investors can do OK (and then some, in recent quarters). But there are now rumors of commodity supplies being used in China in much the same way that houses were used in some western countries 2005-2007, tech stocks 1998-2000, and so on here), and monetary and credit indicators from China do not bode well for commodity prices right now.
  • There are similarly fragile dynamics in Europe, where continental banks levered up on the debt of countries that now can’t pay their bills, as they surrendered monetary autonomy to join a union with no fiscal authority (and a real anti-fiscal fetish, as embodied in the Maastricht Treaty). Money and credit indicators out of Europe look absolutely horrific at the moment.
  • Either of those fragile equilibria could break hard in 2011, with the usual contagion to financial markets and asset prices. If they are not managed proactively (a serious possibility given (1) the zero-bound on central banks’ interest rate targets and (2) the prevailing deficit and debt phobias around the world) it will spread to the global economy yet again, against a backdrop of already-high unemployment and painful relative price shocks from food and fuel.
  • On a relative basis, the U.S. looks attractive. However, in 2011-2012, the proportion of young adults in the U.S. economy turns negative here), something that is strongly associated with recessions.
  • Fiscal austerity will only worsen things. In fact, we’re not surprised by the softness in U.S. leading indicators, given announcements that federal tax receipts were better than expected. Remember—today, the federal budget deficit is what gold mines were in the 19th century. In an over-levered economy slowly recovering from recession, it would have been very hard to produce too much new gold (money) back then, and the last thing you would have done is re-bury whatever gold was produced. But ‘fiscal discipline’ today amounts to the very same thing! Granted, it’s rational to worry that larger deficits will mean higher tax rates, as few politicians—and far too few economists!—grasp the reality of our monetary system and how it interacts with fiscal policy.
  • The current trajectory of the debt ceiling negotiations is depressing. The GOP believes that government spending crowds out private investment, as though money comes from somewhere ‘out there’ or is still dug out of the ground. The Dems can’t get over their beloved ‘Clinton surpluses,’ ignoring the fact that they, like every other significant federal budget surplus, were followed by a recession. For the last few weeks, a few members of the GOP have been pointing out (correctly) that the U.S. will not default. It will direct revenues to Treasury debt holders first, and be forced to make severe spending cuts elsewhere. This will further undermine an already anemic level of overall demand. In fact, fiscal authorities in most parts of the world are doing all they can to undermine global aggregate demand. The U.S. Congress is just now joining the party.
  • U.S. equity markets aren’t indicating an imminent recession, but keep in mind that they were more of a coincident than a leading indicator when the last one started in December 2007. I expect a similar dynamic this time around, with a sideways trend eventually giving way to one or more financial shocks and the eventual realization that we’ve driven ourselves into the ditch yet again.
  • Longer-term, we’re heading into an environment in which the relative impotence of monetary policy will become a new meme, a 180-degree turn from the last four or five decades. And it will probably take at least a decade for macro policy to adjust (Japan’s policymakers still haven’t, over 20 years later). More lost decades ahead? We’re starting to think it’s a wise bet.
  • The only factors that look benign at the moment are in U.S. credit markets. They imply that the employment picture should continue to improve and that the U.S. economy is not nearing recession. If we had to guess, we’d predict one or two financial market shocks ahead, but depending on their timing, there could be something of an equity market rally after the usual summer doldrums. But it might involve significant sector rotation, and our outlook for 2012 is rather pessimistic at the moment.

Finally, here’s a chart that the NYT ran in January that makes a compelling case that a 1970s-style inflation is off the table. If time allows, I’ll pen an Idle Speculator piece this summer on why that is. In the meantime:

Symmetry Capital Management, LLC (SCM) is a Pennsylvania-registered investment advisor that offers discretionary investment management to individuals and institutions. This publication is for informational, educational, and entertainment purposes only. It is not an offer to sell or a solicitation to buy securities, nor is it a recommendation to engage in any investment strategy. This material does not take into account your personal investment objectives, financial situation and needs, or personal tolerance for risk. Thus, any investment strategies or securities discussed herein may not be suitable for you. You should be aware of the real risk of loss that accompanies any investment activity, and it is strongly recommended that you consider seeking advice from your own investment advisor(s) when considering any investment strategy or security. SCM does not guarantee any specific outcome from any strategy or security discussed herein. The opinions expressed are based on information believed to be reliable, but SCM does not warrant its completeness or accuracy, and you should not rely on it as such.

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13 Responses to Commodities, China and 2012

  1. macrosam says:

    What drove the higher than expected tax receipts, however? Was it related to unemployment assumptions used? State tax receipts also appear to be stronger than expected as well (and in Meredith Whitney’s case, too strong). I realize many states increased taxes, but increased tax receipts could also be a byproduct of the increased spending that occurred earlier (which then could have cajoled out some of the hoarded savings).



    just the modest top line growth- 1.8% gdp q1, for example. enough to muddle through with a too wide output gap


  2. Crake says:

    In the chart titled, ‘Change in Population Share of Young Adults in the U.S.’, the declining young population periods were all robust economic periods. Those periods also were met with rising government deficits, so the latter was probably the driver and was able to offset the demographic trend. So this is telling us that in the past, negative US consumption demographics were offset by government demand and we had booms, situations reinforcing the power of government spending to offset demadn loss, but this time the negative demographic consumption trend is going to be met by austerity (at least it looks that way) – so we are entering uncharted territory and it looks to be a pretty stormy forecast.


  3. SethM says:

    Thought I’d share this great little 1933 pro-inflation, pro-FDR, short by MGM short. Very simple and very timely.


  4. pebird says:

    A interest payment holiday would be a bad thing, and it would be construed as a default, but after the political dust settled, bond holders would be made whole. The settlement systems, repo and money markets would be screwed up for a while.

    Unless Obama decides to issue US Notes – the tea party crowd would have a field day.


  5. Dan F says:

    Additionally, if the government defaults I would assume that the interest rates on future bonds would have to be substantially higher due to the incurred risk.

    Being the cynical person I am that may be the reason why Bill Gross got out of treasuries? The inner circle wants a default and will then reenter the market knowing after the dust settles a second default will be nill.


  6. MamMoTh says:

    I have a question unrelated to this story…

    If I have $10K in my bank plus $5K in Tsy bonds.

    Then if the government chooses to default on its debt I end up with only $10K in my bank and the government with no debt. But I am really pissed off.

    But if the government is responsible and runs a surplus in order to repay its debt collecting in net $5K extra taxes from me, which it uses to redeem my bond. So I end up with $10K in my bank and the government with no debt. But I am really pleased the government did what it had to do.

    So, oversimplifications apart, is it right to say that defaulting and repaying the debt running a primary surplus are both the same thing?



    Yes, in that it’s a tax either way


    MamMoTh Reply:

    ok, so the only difference would be who is taxed. in case of default bond holders are taxed, in case of surplus it’s basically the domestic private sector.

    I know this might be obvious to you, but don’t you think it’s not for most people even if they are familiar with basic MMT?

    I think with all this argumentation could be more effective at least from a marketing point of view, given all the nonsense about the debt ceiling and deficit reduction…


    Save America Reply:

    “But if the government is responsible and runs a surplus in order to repay its debt collecting in net $5K extra taxes from me”

    No, you move to the USVI like Warren and pay 3% in taxes instead of what the other sheeple are paying right? And while you are at it, might as well do like Bill Black said, the only way to rob a bank is to own one and open up a bank like Warren did too! On my bumper sticker, instead of WWJD (what would jesus do) I have WWWD shortened to W3D, what would warren do, do as warren does and the government will always be playing catch up. ;)


    art Reply:

    @Save America,

    That’s cute, but don’t presume that Warren’s down there simply to lower his federal tax rate, or that there’s no real benefit from those tax incentives to the USVI. The effect of that lower tax rate is essentially to have the private sector pick up the federal govt’s ‘slack’ of investment/involvement.


  7. SethM says:

    Great stuff, always enjoy reading more from the Symmetry Capital. One way for MMT to gain more awareness is if they manage to pull a Paulson.


  8. leja says:

    Is it just me or is the whole world trapped in gold standard mentality? They treat money as if it were limited resource like pieces of gold. And how absurd it is that bankrupt eurozone states can own institution like IMF that can create money out of thin air, and then lend it back to them? IMF’s lending capacity was expanded to 750 billion with a flick of a pen. How come no-one in the media is not questioning how bankrupt states can own a facility with a unlimited lending capacity. They should just take out loans of 100%, 150%, 200% percent of GDP, whatever they need and keep that debt in their portfolio. Interest payments come back to the owners, right? What are they thinking? That loans have to be paid back because money is somehow tied to the gold and therefore it’s quantity is limited?


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