The Debt’s Too Darn Big – May 17, 2024

Wealth Management • May 18 2024
The Debt’s Too Darn Big – May 17, 2024
Morgan Lewis Posted on May 18, 2024

The Debt’s Too Darn Big

Strength in precious metals was notable this week. Gold is retesting recent highs, silver broke out to new post-Covid highs, and the gold mining stocks are now starting to more notably outperform physical. The miners still have an immense amount of catching up to do, but this week, while gold did not take out recent highs, the major mining stock indexes did break to new rally highs. 

In October of 2023, HAI began repeatedly quoting Merrill Lynch legend Bob Farrell’s observation that, “In a shift of secular or long-term significance, the markets will be adapting to a new set of rules while most market participants will still be playing by the old rules.” 

HAI sees two primary applications in play at present for Farrell’s timeless wisdom. First, financial assets benefited from the old rules; hard assets stand to prosper from the new. Second, on a more micro scale, HAI is of the strong view that while gold mining stocks languished under the old regime, they will thrive under the new. 

Why? In short, because as Western investors begin to recognize the secular change and new rules favoring gold, they will aggressively re-enter the gold stock sector as the highly undervalued leveraged play on a secular move higher in gold. 

This week, in an interview with Macro Voices, Adam Rozencwajg of HAI favorite commodity research firm Goehring & Rozencwajg offered excellent insight on the outlook for both gold and the gold stocks. In the words of Rozencwajg:

“So why aren’t gold stocks doing better?… That’s a big question we get asked a lot. And I think the answer there is that the Western speculator, in the face of high and still rising—or rather having risen and now still high—real interest rates, they’re doing what they’ve always been trained to do. They’re selling gold and gold stocks hand over fist… That’s because, real rates up, you sell your gold, but the central banks have all stepped in… And that’s put a bid under the physical gold price. But central banks don’t buy gold shares, they buy gold bars… I don’t see any signs of the central bank buying abating, I think they’re going to continue to accumulate… And as they do that, they’re going to put this huge pressure underneath the gold price. And when the Western speculator stops selling or comes back to buying, they’re just going to hit, bang up against all that central bank buying. And I think what you’re going to then see is a really sharp move higher, maybe it’s starting to happen already… [Gold] looks like it could be coming alive as we speak.”

Western investors are the key to gold mining sector performance, but they’re still playing by the old rules. They’re selling gold and gold mining stocks because they’re operating according to the old orthodoxy, as described above by Adam Rozencwajg. 

That orthodoxy was based on a world in which global policymakers could still rely on their policy alchemy to deliver Goldilocks conditions, but we’re in a new paradigm now. Inflation has escaped central bank control, the monetary policy orthodoxy previously used to subdue it is now compromised by debt spiral dynamics, and the market is slowly catching on. 

In HAI’s view, the Western investor is now beginning to get it. This week offered compelling evidence for that conclusion. Financial behemoth BlackRock may be as good a proxy for the Western investor as one can find. This week, none other than Rick Rieder, BlackRock Managing Director, Global Chief Investment Officer, and Head of Global Allocation Team offered comments that, to HAI’s ear, describe the Western investor beginning to embrace and adapt to the new rules. In an interview on Real Vision, Raoul Pal asked Rieder, “If they [the Fed] don’t [cut rates,] how do they finance the rollover of the debt?”

“They can’t,” Rieder responded. “And I think the biggest risk in the next couple of years is the debt’s too darn big.” That response could mark the unofficial changing of the guard from the old rules to the new. If a top BlackRock official is flagging the debt problem as the “biggest risk” and acknowledging the resulting effect on monetary policy (the need to cut rates despite inflation), then for all intents and purposes the Western investor is catching on!

Confirmation of this analysis will be Rozencwajg’s “really sharp move higher” in the gold price as Western investors turn from net sellers to net buyers. When that happens, the deeply undervalued gold mining sector—a sector highly leveraged to higher gold prices—is likely to launch. Perhaps its already starting. One way or another, when Western investors still playing by the old rules latch on to the new rules, the potential in all components of the precious metals sector is staggering. In HAI’s view, the most explosive potential exists in the mining stocks.

Weekly performance: The S&P 500 was up 1.54%. Gold was up 1.79%, silver surged 9.66%, platinum was up 8.22%, and palladium was up 2.96%. The HUI gold miners index gained 4.93%. The IFRA iShares US Infrastructure ETF was up 0.67%. Energy commodities were, again, volatile on the week. WTI crude oil was up 1.69%, while natural gas surged 16.61%. The CRB Commodity Index was down 0.61%. Copper continued its surge, up 8.31%. The Dow Jones US Specialty Real Estate Investment Trust Index was up 3.40%. The Vanguard Utilities ETF was up 1.53%. The dollar index was down 0.80% to close the week at 104.33. The yield on the 10-yr U.S. Treasury was down 8 bps to close at 4.426%.

Have a wonderful weekend!

Best Regards,

Morgan Lewis
Investment Strategist & Co-Portfolio Manager

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