Gold and silver were two commodities that were completely tossed off portfolio managers' desks all of last year. The managers were too interested in hearing about bitcoin, cryptocurrencies and nonfungible tokens that surely would double, if not triple, in a few days.
How the tables have turned in just a few months?
This year, one can't mention gold enough times during a conference call or analyst meeting. Most will place gold's outperformance since the Russian invasion of Ukraine, but it had started outperforming much before then. The problem is that most look at absolute charts, and the price of gold earlier in the year may appear to be dull and in the same boring range as it was the last year, but it was outpricing every single asset class since the start of this year in multiples, especially against the darling technology sector. It only started taking off in absolute terms once Russia invaded Ukraine, as it broke out from $1,800 upward and headed toward $2,070, almost touching the highs of August 2020. But it has reversed since then while the war is still ongoing and even more sanctions are placed on Russia by a host of countries around the world.
Then we have other commodities. They had been in vogue all throughout the second half of last year, as inflation had been front and center in the markets. Despite the Fed's consistent denial of higher prices being just transitory, every consumer price index print inched it closer to admitting this failed position. This inflationary theme saw bonds get hit, as yields on the U.S. 10-year moved toward 2%, hurting long duration assets like technology, as they tend to be the worst performers when rates rise. The small-cap technology names have been hit the hardest. And, look at the toll taken on the famous Cathie Wood of Ark Invest and the funds like ARKK (ARKK) and ARKW (ARKW) . Large-cap names like Microsoft (MSFT) and Apple (AAPL) have all held up a lot better relatively. The Nasdaq is still down about 20%, but the smaller names are down over 80% even.
Following the $5 trillion of liquidity injected in the market since the Covid crisis began, global growth was showing signs of slowing down -- even though consumer and producer prices stayed stubbornly high. These price moves appear synonymous with stagflation, which is never a positive for risk assets, especially equities in general. We saw higher prints in oil, gold, copper and some select commodities, as these markets were selectively tight, based on strong growth and a slow supply side response. The war on Ukraine exacerbated these trends that were already in place as we saw sudden shocks in gas, oil, nickel, aluminum, and wheat -- all goods exported out of Russia and Ukraine as the world feared a total collapse of trade altogether.
Russia produces about 10% of the oil supply and more than 40% of European gas needs come from Russia. Similarly, wheat and nickel are very vulnerable to supply chain shocks from this region. We saw prices double overnight in nickel, which still remains closed as London Metal Exchange is uncertain how to settle the margin calls. This surge in select consumer-related commodities saw a bounce higher in breakeven inflation rates that took gold and silver higher. Those are the best inflation hedges -- hard assets. Commodities are all about the demand supply balance in the very front of the market.
Demand for heating or driving remain quite inelastic as price rallies hard, but there is a point that it can get to in a very short period of time, called the "tipping point," that can cause everything to collapse. That is where we are. Once nickel touched $100,000, oil almost $140 per barrel, and gasoline prices about $6 to $7 a gallon at the pump, it is a matter of when, not if, we start to see a real demand shock as this move higher in the goods basket has overshot the move higher in real wages. Factories are shutting down and production curtailed as costs to produce goods is just too high. A bull market is one that is slow and gradual. A sharp price spike is not signs of a healthy market. These spikes caused margin calls in related commodity financing deals that cannot afford to see shocks in rates, credit or financing let alone futures prices.
Most in the market are waiting for the ceasefire to then buy the market and sell commodities. But this was never about the war. The war just accelerated the path toward the tipping point, as most industries had not invested enough on the supply side over the past few years. Politicians and their "environmental, social and corporate governance investing" lobbying has made the system worse to handle such price shocks.
It's all eyes on the Fed now, as it has suggested a quart percentage point hike in rates and ending their balance sheet purchases. The big question is how will the equity market survive without this constant injection. Most expect the Fed put to be activated if asset prices fall more than 20%, but this time it is different as inflation is averaging about 7.9% year-over-year before the price spikes of March. The Fed is in a bit of a pickle as it cannot ease monetary policy until inflation comes down. But inflation or demand will not come down until it raises rates. Perhaps Vladimir Putin did the Fed a favor, as clearly the latter would never be able to raise rates so aggressively.
