Everything gets hit in a bus crash but gold is going to outperform in reflation cycle

Local market bashed from the start and finished near the lows of the day despite a mini-recovery that couldn’t be sustained. There weren’t many places to hide as all sectors were in the red - with tech and retail hit the hardest. You know things are looking ugly for asset prices when RBA jumps in to save the corporates again. Alas, this may prove to be another short reprieve from the structural problems in the economy. As we have been saying since late 2019, Western economies are living in the past and were headed for recession while the Eastern economies were making massive reform towards the future. 

Australia and US were heading into a recession pre-pandemic and the structural problems have not been fixed. The RBA proved our point by cutting rates below inflation ahead of the pandemic. Since then the RBA has mainly been irrelevant in the global scene but continues to blow extreme bubbles in the local scene. If the US Fed and ECB stand aside and allow the inflation to run hot as they have said for months, we may be starting a pullback cycle in the range of 20-30%. Like the RBA, the top end of town will be putting pressure on Central Banks to save their bacon with taxpayer-funded balance sheet expansion again. 

Thankfully, we now have a limiting factor in reflation. The reflation cycle is not being driven by demand inflation but cost inflation. If the Central Banks try to curb the bond market selloff, they create a situation where real yields will collapse as inflation runs hot. In simple terms, Central Banks will have to steal more from the savers and retirees to bail out zombie business to pay bigger bonuses and dividends. Like the RBA, if they go further down that track, inflation may go hyper and then it all goes wrong. 

Already US treasury auctions overnight were a disaster as there was no demand. The US continues to issue Treasuries at historic high levels in a bond market selloff. They have no choice as a fiscal mess and weak economy means endless deficits are feeding the debt boom. The US Fed will have really go “full metal jacket” to get this back in control and even that will cost massive balance sheet expansion and USD debasement. Just this week US Fed chair spoke clearly that they were not going to do that. Not yet anyway…when the 10-year gets to 2.50%, we may start seeing them hyperventilate and then we have another taper tantrum for the markets. The Aussie 10-year bond yields touched 1.91% when RBA jumped in and that finished at 1.88%. Given the RBA’s track record and what is happening in the global macro, we may be looking at 2% as early as tonight.

In all the red today, it is easy to discount the need for risk management as part of any investment cycle. Everyone says they have one but the real test of a model or process is in real time. Something as simple as liquidity test may sound good logically but it fails in the real world. Liquidity exists till it doesn’t. The only green category today was gold miners. Markets were selling gold under the impression that rising yields are negative for gold but ignored the reality of the reason the yields were going up. Reflation cycle is very positive for gold as central banks and bond markets always underestimate inflation. The second upside is the margins of the gold miners are expanding again as the USD bounces on risk off-trade. Everything gets hit in a bus crash but gold is going to outperform in reflation cycles with or without a central bank bailout. You can’t say that about any other sector…maybe Bitcoin, but let’s leave that for another day.

Comments on US market last close

US market was hit hard overnight with bond yields going wild. US 10-year yields got to 1.55% before sliding back on recovery at the close. NASDAQ and RUSSELL are down over 3.5% with USD higher, all sectors red and metals getting bashed. Oil surprising holding flat but that makes no difference to the energy sector today. Growth fund managers are out of cash to hold up dream. Multiples and Treasury auctions were a mess overnight with weak demand. AUD/USD fell from above 80 to below 79 cents. Last day of the month and it's going to be hard to window dress performance today. Crowded trade into a new month with weak fundamentals is going to be tricky with the US Fed bailout...and I don't think Fed is coming soon. Funny how the market is rolling over in sync with the pandemic crash cycle as we expected. We may see more pain in March. We have yet to see this month end asset allocation adjustment... and this one likely to be out of equities and into bonds.

Remain nimble, contrarian and cautiously pragmatic with elevated global macro risks!!! Buckle up...it’s going to get bumpy!!!

Full SUNSET STRIP report with end of day market stats are on the attached link/pdf.