Macro Matters (but I promise more mining talk!)

From The Maven Letter | June 29, 2022

A reader emailed me this morning asking why I spend so much time writing about macroeconomics. The reader noted that he reads my work for my expertise in exploration and mining; these days there isn’t a lot of that to find in The Maven Letter.

It’s a very fair question. The thing is…I wish I could focus on exploration and mining. But there is no point in investing in a sector unless the macro picture is supportive. Right now, sentiment in metals and mining is terrible. Trading volumes are non-existent, stock prices are suffering almost across the board, and outlooks are dim.

Does that mean this is a buying opportunity? In a way. Given how bullish I am on metals over the medium term, buying favourite stocks in this weak period certainly makes sense. But this weak period Is. Not. Over.

I write newsletters to try to help fellow investors understand opportunities in metals and mining. A huge part of that is finding good stocks. But timing is also critical. Even most of the best explorers, developers, and miners out there will get sucked down in the downdraft that this recession will create. So buying now is, in my opinion, not the best idea.

Since my job is really to find stocks with strong potential, in periods when I don’t believe in buying I have to explain why. That’s the reason for all the macro: if I thought the bottom was in or, better yet, if I thought we were on an upswing, I would ditch all the macro talk in a 3 heartbeat to discuss rocks and management and fund flow in the sector and all the things that help me find the best stocks to ride in a good metals market.

I certainly think that the metals market is coming. But it cannot happen until central banks have finished tightening us into a recession because no one is going to buy investment ideas based on growth right now. That’s the base metals situation boiled down to one sentence.

Gold is always more complicated – it is holding up well but not moving up, mostly because more rate hikes from the Fed vs the ECB and the BOJ are keeping the US dollar strong – but the outlook for gold stocks can be distilled down: there will no run on gold stocks until the stock market bottoms. It doesn’t matter that gold as an investment makes sense before the market bottoms – when markets slide, most investors sell. And they sell everything.

And so there is downside ahead for metals and mining stocks. That’s the story I’ve been trying to sell, though looking back it’s possible I didn’t say it clearly enough; I may have emphasized the reasons to the detriment of highlighting the conclusion.

The conclusion: there is yet more downside ahead for stocks. Of all varieties, and certainly including metals and mining stocks. I am not buying anything right now.

I think I have made clear that I am incredibly bullish on the metals opportunity on the other side of this storm but we haven’t got there yet. Let me provide some of the latest data supporting that statement.

The most obvious is that tightening is already causing demand destruction. That is the point – it’s by reducing demand that tighter monetary conditions ease inflation – but it also means slowing, and if taken too far then negative, growth. That is where we are now heading.

The chart below shows the volume of puts (bets on price declines) linked to the S&P 500 energy sub-index. Lots of people are suddenly betting on a massive move down in energy.

Commodities are also moving down, despite little respite on supply bottlenecks. The Commodities Research Board Raw Industrial Material Index covers a range of well-traded industrial materials that are not part of the futures market. That means they move on supply and demand, not on sentiment. The sustained gain on this index through 2021 was clear evidence of inflation. Over the last three months that has clearly reversed, which might be good for inflation but is happening because demand is down.

Then there is the slew of recent strong statements from people like Bill Dudley, the former governor of the New York Fed and now a regular contributor to Bloomberg Opinion. He started his latest article, published last week, with this statement.

If you’re still holding out hope that the Federal Reserve will be able to engineer a soft landing in the US economy, abandon it. A recession is inevitable within the next 12 to 18 months.

For a more numerical version of the same thing, here’s the latest forecast on what getting inflation down will do from the New York Fed (I added bolding for emphasis).

This disinflation path is accompanied by a not-so-soft landing: the model predicts modestly negative GDP growth in both 2022 (-0.6 percent versus 0.9 percent in March) and 2023 (-0.5 percent versus 1.2 percent). According to the model, the probability of a soft landing—defined as four-quarter GDP growth staying positive over the next ten quarters—is only about 10 percent. Conversely, the chances of a hard landing—defined to include at least one quarter in the next ten in which four-quarter GDP growth dips below -1 percent, as occurred during the 1990 recession—are about 80 percent.

The stock market surged out of the last two recessions, which were the Great Financial Crisis and COVID. Both were…unusual, in the speed at which they unfolded and the response they provoked from governments and central banks.

The most important question to consider today is: what will happen after this recession? There are several possibilities:

• A recession pulls markets down but inflation eases enough that governments and central banks feel they can support growth without risking the return of inflation. Rates go down, and infrastructure spending programs are announced. This would be ideal – investors would look for the sectors most likely to perform with some growth and moderate inflation and metals would stand out, especially given the supply shortages facing so many. Gold would likely also perform, alongside rate cuts and persistent, if lower, inflation.

• Inflation does not ease notably despite growth grinding to a halt. That’s stagflation. In stagflation, nothing works other than precious metals. The Fed would continue raising rates to fight inflation, which would spiral growth downward because debt loads are so high. It’s hard for any stocks to perform in such dire circumstances.

• • By some magic, inflation eases and growth persists. This is the dreamy ‘soft landing’ that is very unlikely. The Fed takes rates to a reasonable level. Risk-taking returns to the market and metals have to compete for attention.

As I’ve said, it’s all about when investors return to the market and how they feel about risk when they do. The best is likely a short recession that doesn’t fix everything (inflation is still around, just lessened), which has cautious investors looking for opportunities that make fundamental sense.

This path is very possible, though I’m not laying any bets just yet. Instead, we just have to get through the doldrums of summer, which this year will be extra boring because market sentiment is so terrible, and then see how things look on the other side.

Since no one wants to spend the summer reading endless macro musings on how crappy things are, and I miss talking about mining companies and projects, and since preparing for the upswing on the other side is the most useful thing to do during a boring period – it’s time to get back to mining! I have a few ideas – and I’m open to others! If you have a topic you’d like me to explore, email and let me know.

One idea is that I plan to return to my Catching Up With… series, which I have completely abandoned. I used to catch up with a company in the portfolio almost every week, doing a deep dive into their latest accomplishments and ideas. Seems like a good moment in time to return to that project.

I’ll also spend more time answering Mailbox questions, as those are often about exploration or mining or specific stocks. The first such offering is below…

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