2. Points To Be Covered Today:
• A Fog of Confusion
• Inflationary Pressure
• Capex : New Economy Vs. Old Economy
• BHP’s Forward Guidance
• 10-Year Treasury: Goldman Sachs Doubles Down
• PMs Remain In No Man’s Land
• Gold: There Is A Minor Support Near $1,770
3. A Fog Of Confusion
• With investors’ manic mood swings whipsawing the U.S. yield curve in-and-out of
hysteria, gold suffered another dose of reality on Jul. 21. And with inflation
surging and the U.S. 10-Year Treasury yield still extremely oversold, the yellow
metal could be dodging even more bullets in the coming weeks.
• Case in point: while over-positioning, the U.S. Federal Reserve’s (FED) hawkish
shift, unprecedented reverse repos (another $886.206 billion sold on Jul. 21) and
the Delta variant have rocked investors’ boats, the reality on the ground is
much different.
• To explain, with Canadian National Railway (CN) SVP James Cairns telling
analysts on Jul. 20 that “during Q2 we saw the more balanced demand
recovery that we expected,” the U.S. 10-Year Treasury yield is still
underestimating the strength of the U.S. economic recovery.
• For context, CN is a leading North American transportation and logistics company
that transports more than C$250 billion worth of goods annually across a rail
network of approximately 20,000 route-miles spanning Canada and mid-America.
5. “Labor And Fringe Benefit Expense
Was Up 28% Versus Last Year
• Moreover, another excerpt from the conference call read:
• “Labor and fringe benefit expense was up 28% versus last year.
This was mostly driven by increased wages due to a 9% higher
average headcount and higher incentive compensation. Fuel
expense was up 86% driven by a 76% increase in price and a 14%
higher workload, partially offset by another solid fuel efficiency
improvement of 2%.”
• On top of that, with CEO Jean-Jacques Ruest noting that “there is
rail inflation [and that] eventually you will see it in the all-inclusive rail
index of AAR because there is a bit of a lag in that index,” how is the
company responding to the inflationary pressures?
8. Inflationary Pressure - I
• “On the raw material, you're right. The headwinds we now
see moving forward are stronger than what we assumed so
far.
• We said, I think, at the beginning of the year, we could probably
have on the full year 0.5% in terms of cost headwind.
• I mean, now you could hear us, I mean, saying 1% in the
second half.
• And actually, I mean, we can see that all in all, in cars and vans,
as well as in trucks and buses.”
9. Inflation And Commodities – Do We
Still Fight For Lumber?
• Furthermore, while I’ve been warning for months that inflationary
pressures will likely force the FED’s hand in September, cost-push
inflation remains alive and well.
• For example, while crude suffered a freak-out on Jul. 19 and lumber
has fallen off a cliff, steel remains in the clouds and coal isn’t far
behind.
• In addition, with commodity producers still skittish over the wreckage
that occurred during the global financial crisis (GFC), the group has
been extremely cautious this time around.
• And with a lack of capital investments severely constraining
production, the supply/demand equilibrium remains completely
out of whack.
12. Capex : New Economy Vs. Old Economy - I
• The black line above tracks capital investments made by technology-
related firms in the S&P 500, while the blue line above tracks capital
investments made by commodity producers in the S&P 500. If you analyze
the right side of the chart, you can see that commodity cap-ex is at a 40-
year low.
• On the flip side, technology-related firms are expanding at a pace that
exceeds the dot-com bubble. As a result, not only could a Big Tech tirade
upend the PMs, but realigning U.S. interest rates with the economic
realities could be just as damaging.
• To that point, BHP Group, the world’s largest mining company, released its
full-year operational review on Jul. 20. For context, CEO Mike Henry said
back in March that “there’s really no point in chasing production.
• The industry has a good track record of being quite a pro-cyclist, and it
has ended in tears quite often.”
14. BHP’s Forward Guidance - I
• If you analyze the red box above, you can see that BHP’s
“FY22 guidance” includes lower-to-roughly-flat production.
• If you turn to the first column from the right, you can see that
petroleum, copper, iron ore, coal and nickel could experience
negative year-over-year (YoY) production growth (on the low-
end) to low/mid-single digits production growth (on the high-
end).
• The bottom line? While cost-push inflation has been the main
driver of the inflationary surge and the bond market is all-in on
the FED’s “transitory” narrative, fresh commodities supply is
not coming to the FED’s rescue.
15. 10-Year Treasury: Goldman Sachs Doubles Down
• Finally, while the U.S. 10-Year Treasury yield continues to weigh
the FED’s likely taper (which would slow economic growth and
reduce inflation) with the effects of the supply chain disruptions
that continue underwriting the inflationary surge, Goldman
Sachs has doubled down on its year-end forecast.
• Despite the recent malaise, the U.S. investment bank expects
the U.S. 10-Year Treasury yield to end the year at 1.90% (the
dark blue line above).
• Moreover, with the futures market implying a year-end target of
roughly 1.40% (the light blue line above), Goldman Sachs still
sees upside risk to the consensus expectation.
17. PMs Remain In No Man’s Land
• The PMs remain in no man’s land, as the front-end and the back-end
of the U.S. yield curve have the potential to push them over a cliff.
• Regarding the former, with the FED likely to announce its taper
timeline in September, rising short-term interest rates reduce the
PMs’ relative appeal.
• Regarding the latter, if the vaccines prove effective and reduce the
impact of the Delta variant (which data shows that they already
have), long-term interest rates are massively underestimating the
inflationary pressures and the prospective strength of the U.S.
economy.
• Thus, any way you slice it, the medium-term outlook for the PMs
remains profoundly bearish (the long-term outlook is bullish, though).
18. Gold: There Is A Minor Support Near $1,770
• Gold prices extended the weekly leg lower on Wednesday and now
challenge the key $1,800 mark.
• Wednesday’s downtick was on the back of rising open interest and
volume, allowing for the continuation of the move in the very near term.
• That said, there is an interim support near $1,770, a Fibo level of the
March-June rally.