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COMMODITY FUTURES FORECAST
Prepared by Philip Gotthelf
(September 22, 2016) Today is the first full autumn day. This fall will be particularly interesting as both the political and economic environments heat up. Even without the U.S. presidential election cycle, we are witnessing extraordinary political shifts throughout the world. For example, it is increasingly evident that OPEC has lost its grip on controlling crude oil prices. Tensions between the U.S. and Russia are increasing rather than decreasing. The "reset" button has been pushed, but the result has been a return to former cold war rivalry and tension. The latest Syrian bombing incident demonstrates how strained the relationship is. Even John Kerry admits that the U.S. is in a compromised position.
A new economic phenomenon was experienced in 1975 where the U.S. experienced high inflation with a stalled economy and low employment. Economists called the condition "stagflation." More than forty years later, central banks around the world still lack a method of dealing with stagflation. In fact, the current FED under Janet Yellen and the prior FED under Ben Bernanke did not exercise any programs that specifically addressed stagflation. Instead, both central bank leaders directed anti deflation campaigns and monetary stimulation programs. A close examination of the results reveals a lack of effectiveness. We remain in a sustained economic quagmire… the slowest recovery since World War II.
It is no coincidence that today's Wall Street Journal carries Greg Ip's story, "Central Bank Tools Losing Their Edge." The article describes how the Bank of Japan ("BOJ") wants to overshoot its former 2% annual inflation rate. Alongside the continuation of the article is a piece about Janet Yellen's denial of FED partisanship. She claims that when her FED minutes are released in five years, there will be no indication of political influence. What's the expression? Laugh out loud!
At least 50% of the FED's decision to leave interest rates alone is grounded in the election cycle. To move on interest rates would be a political gamble, indicating that the FED is willing to take a chance on the back of the Obama Administration. The prudent action is to talk rates up without actually implementing a hike until after the election. The defensive stance is politically motivated even if Ms. Yellen does not outwardly support Hillary Clinton or Donald Trump. The FED's "no action" has political consequences… PERIOD! Frankly, I must agree with Trump's assessment and Yellen's inaction. News flash... nothing about government is non-political.
This autumn brings many challenges. The war against deflation represents an important transition that will substantially impact commodity and financial markets. Clearly, inflation is an attempt to lower purchasing power and raise commodity prices. I have often raised issue with central bank inflation obsession. Why must we deflate currency and inflate goods and services? Where is the economic logic in stealing hard earned purchasing power? More importantly, consider the age and stance of the last four FED leaders. Each one brings old-time economics to the table. There has been no acknowledgement of technological progress that brings down pricing.
The Real Economic Trend
In 2008 I wrote about some economic modeling I had conducted after the FED and Treasury implemented the first round of monetary intervention with an $800 billion bond purchase. The "bailout" came on the backs of taxpayers and was facilitated through sovereign debt realignment. I pointed out that there was no attempt to use fiscal policy as opposed to monetary policy. I calculated that a sub-property tax credit combined with reinstatement of passive tax write-offs would have cost between $100 billion and $200 billion per year moving forward from 2008, but the financial crisis would have been completely avoided.
The consequential stimulation would have held real estate steady while forcing the private sector cash hoard out into the market. Consider how this worked under the Volker FED. Coming off the 1970s, the big concern was inflation. Here, too, I believe Volcker's inflation interpretation was wrong, but his aggressive interest rates policy did end up pressuring prices lower. I believe that price destiny was already established by natural economic cycles. Regardless, real estate was coincidentally protected by the tens of thousands of investors who purchased property for passive write-offs. These were known as Section 62 and 63 benefits. Savings & loans were thriving.
Of course, in Washington, DC's usual stupidity, members of Congress picked on the "write-offs for the rich" as a political scapegoat. Politicians decided to close the Section 62 and 63 "loopholes" to deny wealthy dentists, doctors, and lawyers the opportunity to shelter income. The infamous Savings & Loan collapse followed. Fast forward to 2008 when Senator Bernie Frank claimed Uncle Sam would not straighten out a $30 billion accounting discrepancy on the books of Freddie Mac and Fannie Mae. These two agencies tanked, bringing all of Wall Street and Bank Street along for the ride.
Campaign slogans designed to set the middle class and poor against the alleged 1% ignore the roll wealth plays in a capitalist system. Capital should be used rather than abused. Government policy always seems to forget how capital formation plays out in real economic trends. This ignorance and arrogance is more responsible for economic malaise than Wall Street greed or bankers' incompetence. We never hear about political incompetence unless it is tagged for either party. Thus, the political influence is not properly reported or analyzed.
There is a good reason for the lack of acknowledgement. If you criticize government, there are consequences. The IRS treatment of conservative non-profit and Jewish organizations proves the point. The further use of IRS audits and government agency intervention illustrates how the U.S. is just like Putin's Russia… albeit less obvious and less aggressive on the surface. If you think the U.S. system is innocent of harassment, ask Chris Christie what went wrong with "Bridge Gate." Translate this political reality into current economics.
There are two striking demographic realities working against a more powerful economic recovery. The second largest population bulge in history is retiring while the largest generation in human history is entering the labor market. The simplistic view is that Millennials will replace Baby Boomers and the larger youth population will fill any workforce gap attributed to economic growth. We see this analysis from the "economic experts" and we believe it. This viewpoint is outrageously shortsighted. It gives no consideration to the fact that Baby Boomer jobs are retiring right along with the boomers.
This has been my clarion call even as recently as my last Special Report that highlighted the potential impact of driverless cars in the new "Sharing Economy." Slow employment growth is partly the result of technological job displacement; a/k/a disruption. We do not need as many window glazers (workers who install glass into window frames) because machinery pre-glazes window panes to reduce labor. Pre-fabrication has evolutionized construction, reducing labor. Automated banking has reduced the need for bank tellers. Hybrid seed has increased crop yields and quality. Process control has impinged upon human quality control personnel.
Millennials are entering a shrinking job market for manufacturing, construction, and other blue collar trades. Equally important, Millennials don't like "those kinds of jobs." They see a different picture of what they want on their cell phones, computer tablets, and television sets. Labor unions have been so busy soliciting political favors that they have failed to promote membership. It is a sad and economically dangerous situation. The U.S. is in bad shape, but Europe is worse.
The political failure to recognize economic and demographic trends has caused a huge human vacuum. Thirty years ago, Western Europe believed they had a looming unskilled labor crisis. Population growth had slowed to the point where idiot PhD economists warned of a disastrous labor shortage. The solution was to open up borders and accept supplemental labor from less prosperous countries affectionately called the "Third World." For Western Europe, the importation came from the Middle East. Now, autonomous unemployed Muslim youth threaten the very foundations of European society. This is more the case with the recent refugee influx.
Forget the Trump position for a moment and look at the real reason politicians have ignored illegal immigration. The U.S. was running out of cheap unskilled and low-skilled labor. California farmers were happy to use Mexican migrants to service fields. Everyone in Washington turned a blind eye because they believed illegal immigrants were a solution rather than a problem. Despite all the warning signs provided from Census 2000, Congress and our Presidents allowed illegal immigration to continue. For Democrats, immigrants are prime voting blocks. For Republicans, immigrants are cheap labor. For the U.S. eco-political structure, illegal immigration displaces entry level labor for legitimate citizens. This is why we see Trump's message taking hold among low skilled and even middle skilled labor.
The real economic trend is based upon the clash between retiring Boomers and Millennials as technology rapidly modifies labor markets and raw materials. I have presented arguments covering all these components, but I believe much extrapolation remains to be done if we are to extract a real economic picture and create eco-political models moving forward. Not everyone can be an app developer for Google or Apple. Not everyone can be a systems analyst. We need to elevate the less technical jobs like construction trades, manufacturing, and services.
The Current Picture
We are about to reap record breaking or near record crops. Farm prices are allegedly depressed. The world is awash in crude oil. Energy prices are challenged. Huge natural resources are coming online as technology advances discovery and recovery. Efficiency and the Green Movement reduce demand for power while creating entirely new fields of ecological management. Hello Ms. Yellen! The FED cannot change the direction of production and progress.
I have called commodity deflation "normalization." I am shocked and dismayed that the FED has no room in their deliberations for evaluating the normalization process. Yet, this progressive fact of life is constantly in the news. Every day there is a new innovation that improves everything from farming to medical care. Why do we innovate? Cost reduction is one of the leading innovation drivers. When platinum prices soared, car companies turned to palladium catalytic converters. When palladium prices advanced, car companies worked on reducing the amount of metal required to achieve pollution reduction. It was all about cost and it remains about cost.
I am sorry to inform the FED that unless it can increase transaction velocity and halt technology, prices are going to remain in consolidation. No amount of printing money will drive away normalization or disruption. The old formulae don't work. However, there is one dreaded possibility that can take all central banks by surprise. This was alluded to by former FED Chairman Alan Greenspan. In a word, GOLD. The one commodity central banks can effectively stimulate and inflate is gold and perhaps the sister metal, silver.
The FED faces a Catch 22 since promoting inflation also promotes an inflation hedge. At $1,350/oz, gold is in the picture. At $999/oz, gold is in the background. Too much inflation promotion could spook investors into a gold stampede. That would pull control away from central bankers and reposition monetary dependence away from paper and into hard assets. Even now, the gold chart shows a dangerous sideways consolidation extending from July. A bust below $1,300/oz represents a bearish signal and a pop above $1,390 spells trouble. There is considerable technical "congestion" on the chart.
Gold is likely to act like T-Bonds. We saw how the 30-year bond remained in a trading range after the British exit. The recent bust on the heels of FED rate rhetoric how vulnerable these consolidations can be. If the FED, BOJ, and ECB all promote inflation, it wouldn't take a very big spark to ignite a huge surge in gold and silver. A flight from currency into gold represents a huge problem if the objective is to coax money into circulation. As I said, they are not exhibiting much intelligence from my perspective. Hopefully I am wrong and "they" are smarter than their actions imply. We shall see as the election approaches.
September 22, 2016
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