A New Era – June 28, 2024

Wealth Management • Jun 29 2024
A New Era – June 28, 2024
Morgan Lewis Posted on June 29, 2024

A New Era

Writing of the period just before the Great Depression’s guillotine dropped in the late 1920s, Dr. Benjamin Anderson, in his tour de force Economics and the Public Welfare, wrote that “Every era of speculation brings forth a crop of theories designed to justify the speculation, and the speculative slogans are easily seized upon. The term ‘new era’ was the slogan for the 1927-1929 period. We were in a new era in which old economic laws were suspended.”

Today we find ourselves in another bold new era, and once again, old laws are presumed suspended as the imaginative mind of the investor feeds emotions already captured by fear of missing out (FOMO) turned panic of missing out (POMO). This is a great time to “keep your head when all about you are losing theirs.”

Of course, today’s new era may be the boldest of them all. We have a bone-fide big-tech spending-arms-race in pursuit of Artificial General Intelligence (AGI). AGI is a field of theoretical AI research that attempts to create software with human-like intelligence. An AGI system, in theory, is a complete artificial intelligence that will solve problems in various domains, like a human being, without manual intervention, and will self-teach and solve problems it was never trained for. As we all know, chip maker Nvidia is at the center of the big tech feeding frenzy as they provide the advanced chips needed to run the AGI race. 

Earlier in June, Leopold Aschenbrenner, a former member of OpenAI’s Superalignment team (the department responsible for figuring out how to control super intelligent AI), authored a white paper titled “Situational Awareness: The Decade Ahead.” In the paper, Aschenbrenner describes himself as one of just a “few hundred people, most of them in San Francisco and the AI labs, that have situational awareness” of what the AGI race is set to deliver. In short, his message is that “Everyone is now talking about AI, but few have the faintest glimmer of what is about to hit them.” What does he see?

According to Aschenbrenner, “AGI by 2027 is strikingly plausible. GPT-2 to GPT-4 took us from ~preschooler to ~smart high-schooler abilities in 4 years… We should expect another preschooler-to-high-schooler-sized qualitative jump by 2027. I make the following claim: it is strikingly plausible that by 2027, models will be able to do the work of an AI researcher/engineer.” Aschenbrenner further claims that “AI progress won’t stop at human level. Hundreds of millions of AGIs could automate AI research, compressing a decade of algorithmic progress into ≤1 year. We would rapidly go from human-level to vastly superhuman AI systems. The power—and the peril—of superintelligence would be dramatic.”

Not exactly easing the tension in the room, Aschenbrenner then admits that “Reliably controlling AI systems much smarter than we are is an unsolved technical problem…things could easily go off the rails during a rapid intelligence explosion. Managing this will be extremely tense; failure could easily be catastrophic.” 

This author is not enamored by tech that could easily go off the rails with catastrophic consequences. Real assets, real people, and reality in general are far more appealing. No surprise, then, that HAI has absolutely no interest in Nvidia stock, especially not at the absolutely unheard of and absurd multiple of over 40 times price to sales! That’s a valuation that makes peak bubble multiples look downright cheap by comparison. 

That said, every market participant must contend with what is happening to Nvidia, all other AI bubble darlings, and with the state of the AI bubble itself. After all, the AI bubble is currently helping to prop up an even larger, decade-old bubble in the broad stock market. A breakdown of the AI bubble would almost certainly risk putting the pin to the larger stock market bubble as well. While that would spell disaster for financial assets, like a hurricane out at sea, the storm would send its destructive waves far and wide. Those waves could also impact hard assets.

So, is the AGI arms race going to deliver the new era promised? Will it suspend economic and market law, and avoid the fate of all previous bubbles? Or is the AGI bubble the latest example of the triumph of Wall Street hype over real world reality? In short, if you’re not one of the few hundred people claiming “situational awareness” of the future of AGI, it’s impossible to say. 

What’s much more certain is that big tech is spending money on this race hand over fist. As Aschenbrenner wrote, “The most extraordinary techno-capital acceleration has been set in motion… Over the past year, the talk of the town has shifted from $10 billion computer clusters to $100 billion clusters to trillion-dollar clusters. Every six months another zero is added to the boardroom plans.” So, the money is being spent. That much is certain. 

Whether those trillions ever turn a profit is a very serious question that will impact the fate of all AI bubble stocks, as well as the broad market in the future. On that profitability question, some serious cracks emerged in the bullish AI thesis this week. Famed MIT economist Daron Acemoglu said that, at present, it looks like “truly transformative changes [justifying the AI spend] won’t happen quickly, and few—if any—will likely occur within the next 10 years.” Furthermore, Acemoglu estimates that only a quarter of AI-exposed tasks will be cost-effective to automate within the next 10 years. He forecasts AI will increase US productivity by only 0.5% and GDP growth by only 0.9% cumulatively over the next decade. 

Jim Covello, Head of Global Equity Research at Goldman Sachs, shares Acemoglu’s skepticism. This week, Covello told a panel, “My main concern is that the substantial cost to develop and run AI technology means that AI applications must solve extremely complex and important problems for enterprises to earn an appropriate return on investment (ROI). We estimate that the AI infrastructure buildout will cost over $1tn in the next several years alone… So, the crucial question is: What $1tn problem will AI solve? Replacing low wage jobs with tremendously costly technology is basically the polar opposite of the prior technology transitions I’ve witnessed in my thirty years of closely following the tech industry.” 

In response to a question of whether Covello was just concerned about the cost of AI technology or also skeptical about its ultimate transformative potential, he responded, “I’m skeptical about both.” He added, “Many people seem to believe that AI will be the most important technological invention of their lifetime, but I do not agree.” He added, “The big tech companies have no choice but to engage in the AI arms race right now given the hype around the space and FOMO, so the massive spend on the AI buildout will continue. This is not the first time a tech hype cycle has resulted in spending on technologies that don’t pan out in the end.”

So, who’s squaring up this ball correctly? Aschenbrenner, our fearless techie with insider knowledge from the Artificial General Intelligence frontier, or Acemoglu and Covello? As previously stated, unless you can definitively confirm or deny the hype, it’s impossible to say. Perhaps the AI spend and possible arrival of AGI will be truly transformative, maybe not so much. What is clear, however, is that, transformative or not, if it’s not sufficiently profitable to justify the massive spending binge, the AI stock bubble beneficiaries run the risk of imploding every bit as spectacularly as the darlings of yesteryear. Again, that carries broad consequences to the larger stock market bubble—the financial asset bubble the AI bubble binge has helped to prolong.

In his white paper, Aschenbrenner added another comment that should be of interest to HAI readers. He added that, “Behind the scenes, there’s a fierce scramble to secure every power contract still available for the rest of the decade.” All the spending by big tech in pursuit of AGI is useless without the energy and energy infrastructure needed to power the push toward AGI. Whether or not that push toward AGI ever rewards AI bubble stock shareholders, the spending spree will no doubt benefit shareholders of energy and copper producers over the coming years. Ultimately, that’s where the profitability may manifest. Both commodities are scarce, and both commodities are essential if even the smallest dreams of AI grandeur are to come to fruition. In short, energy and copper may be the best valuation and risk adjusted ways to play the IA capex boom. Those are bets likely to pay off regardless of whether AGI is a profitability boon for the AI bubble stocks or not. 

While on the topic of new eras, there’s another one HAI has been watching closely; the paradigm shift of global central banks diversifying reserves away from US dollars and into gold. Last week, we got important confirmation that we have an investable new era for the yellow metal. In an article titled, “Central Banks expect to snap up more gold this year amid USD pessimism,” the WSJ reported that a World Gold Council (WGC) survey of global central bank reserve managers found that, “More than four in five respondents expect reserve managers to increase global holdings of bullion, the highest proportion on record since the annual survey began.” 

The record pace of central bank gold buying over the last two years has been fueled mostly by emerging market central bank demand specifically. Crucially, however, according to the latest WGC survey, “Banks in Emerging Markets kept their positive attitude toward gold’s future in reserves, but were now joined in this view by 57% of Advanced Economy central banks, up from 38% in 2023.” That’s a very big shift in a very short time for a very important cohort of the central bank universe. Central bank gold buying is no longer a peripheral Emerging Market phenomenon, it’s now quickly become a reality in the Advanced Economy core as well. 

Furthermore, the survey also found that simultaneously, “Advanced Economies have grown increasingly pessimistic in the outlook for the U.S. dollar’s share of global reserves, with 56% believing the greenback’s share will fall, from 46% a year prior. Nearly two-thirds of emerging-market central banks share the same view.” Double whammy for the dollar, twin support for the new era of gold. 

Western investors hang on every word out of the mouth of Advanced Economy Western central bankers. Will the Western investor soon listen to central bank actions as well? In HAI’s view, it’s just a matter of time. 

Given current valuations, the best probability of profiting from AI hype is the reality of an AI capex-fueled demand boom for energy and copper into tightly supplied markets. At the end of the day, however, the best “new era” opportunity is the one in which the old economic laws are not suspended, but respected. That’s gold.

Weekly performance: The S&P 500 was nearly flat, off 0.08%. Gold was up 0.36%, silver was off 0.18%. Platinum was up 1.78%, and palladium was up 5.76%. The HUI gold miners index was up 0.24%. The IFRA iShares US Infrastructure ETF was nearly flat, down 0.05%. Energy commodities were volatile and mixed on the week. WTI crude oil was up 1.00%, while natural gas was off 8.29%. The CRB Commodity Index was off 0.94%. Copper was off 1.14%. The Dow Jones US Specialty Real Estate Investment Trust Index was up 0.36%. The Vanguard Utilities ETF was down 1.64%. The dollar index was up 0.10% to close the week at 105.54. The yield on the 10-yr U.S. Treasury was up 14 bps to close at 4.40%.

Have a wonderful weekend!

Best Regards,

Morgan Lewis
Investment Strategist & Co-Portfolio Manager

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