Capital Flows and Asset Markets

In recent posts, I have come to the conclusion that rising energy prices are the only thing that can break US markets (absent political change to break cartels - which probably needs higher energy prices to generate the political will for change). To be fair, one of the biggest surprises of the last eighteen months or so is how weak energy prices have been despite the Russian invasion of Ukraine. My working assumption was that energy supplies would be disrupted, and this disruption would get worse over time as sanctions bit. However after the initial spike to USD 140 a barrel, it has settled this year at around USD 80 - pretty much in line with where it was before the invasion.

As I was contemplating this, Doomberg, published a note pretty much saying cheap energy is here to stay.

I am not going to say that Doomberg is wrong here, as I suspect they are arguing from a geological point of view, i.e. that there is plenty of oil out there so prices will always be reasonable. From a geological point of view, I would agree. But market structure is beginning to change, and that can lead to much higher prices. A good example of changing market structure leasing to higher prices is iron ore. Through the 1980s and 1990s, the Japanese were the biggest buyer of iron ore. The Japanese steel buyers bought as one single cartel, and Japan funded every single iron ore mine they could find (through Mitsubishi and other trading houses). This combination of many mines, and a single buyer meant that iron ore stayed at USD 20 a tonne for 20 years. But in the early 2000s, BHP and Rio Tinto began consolidation the iron ore industry, and then Chinese steel makers suddenly became big buyers, and the sellers of iron ore were consolidated and there were many buyers. The iron ore price has stayed well supported at US 100 or higher almost ever since. Even with recent disappointing Chinese growth, iron ore prices have done well.

The rise of the US shale industry has seen a number of new entrants, and looking at US production data, we can see we have hit a new all time high. Since August, the US has added 1 million barrels a day of oil production, no doubt adding downward pressure to oil prices. This adds weight to Doomberg’s view of oil prices staying affordable going forward.

However, the EIA provides leading data (it estimates number of new wells about to be started in shale region) on oil production, and this leap in oil production from the DOE took me by surprise. The EIA data was suggestive of a slowdown in oil production growth, not an increase.

Even weirder is that drilling activity has been slowing for a while in shale region.

So where did this surge in oil production come from? Going through the DOE production numbers, there is one area that is not shale that has seen an increase in oil production - the Gulf of Mexico. Increase is probably not quite the right word, but a return to peak production.

Its been a long time since I looked at US offshore production - but thankfully Baker Hughes still provides good data on drilling activity in this region. As you would expect, shale has been a disaster for the US offshore drilling industry. From this perspective its hard to see how offshore can pull off anymore production surprises.

So offshore growth, for what it is worth is done. Lets take a closer look at onshore oil production. Outside of the Permian region, US onshore oil production has been flatlining for 10 years now

Now the Permian region has seen some consolidation. How you want to measure this is tricky - you can do production, wells, or acreage. I am going to use acreage for the simple reason that Bloomberg has already done it for me! The key here is after a number of deals have made a clear leading pack, and long list of second tier producers.

What this has been highlighting is that US producers have been spending on consolidation rather than growing production. As GS points out, total shale reserves has been falling last few years.

Goldman’s also highlights how shale has been the swing producer for oil industry. A consolidated US shale industry would raise returns across the whole industry.

High prices tend to bring about more production, and low prices tend to bring about less production. In the shale region, low capital costs and a surge for market share seemed to drive unlimited growth. My guess is the shale is close to consolidated, and supply close to being brought under control. If demand should surprise to the upside, either from a surging India or a recovering China then higher energy prices could reappear.

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One of the features of “modern” (read post GFC) markets is that volumes traded tend to be less even as markets rise. In the UK, mortgage approvals have collapsed back to close to GFC levels, after never really getting back to pre-GFC levels.

Hi guys, Russell here.

Slightly different format to the usual, also slightly different topic than usual. I'm just trying to test out some new functionality that Substack has started, namely that they can do an automatic transcript of any video that I upload directly into using their technology. So I'm probably going to try that out. I'm going to be traveling next month a bit, so it would be very useful if I could just record videos and then Substack does all the hard work for me.

So I'm going to talk about Kissinger and Munger, both very successful Americans, both very different backgrounds and very different worldviews. And I'm just going to sort of talk about how I think they fit in with the world that we're in and what they would perhaps think about the world as it was when they passed on and what that means going forward.

So weirdly they you know they both uh were born around the same time obviously Kissinger was born in Germany and Kissinger you know had a very different sort of worldview; and I think for me you know what was interesting about Kissinger. It this sort of this realpolitik view, this idea for him of trying to keep world powers in balance and as much as possible to avoid any conflict between the great powers.

I think that definitely was influenced by his more, you know, the more brutal experience of World War II, of what can happen when powers clash. His greatest success for Kissinger, I think, was separating China from the Soviet Union and not necessarily bringing China into the pro-US camp, but certainly breaking the relationship between the China and Soviet Union. And when that happened, a lot of the power of the communist bloc was broken up. And so in many ways, his greatest success was helping bring about the ultimate destruction of the Soviet Union.

Now, a lot of people hate Kissinger because of his view that the great powers matter the most. And as The Economist points out, they loved him in China because I think he treated China with the respect they wanted and their understanding of big power politics. I think we can see Kissinger's influence particularly in Trump and his attitude towards Russia of trying to break Russia away from a pro-China camp and bring them into a Western camp or a US camp in the same way that China was in a US camp.

And, you know, he probably explains his policy. Problem, of course, is that Russia has other issues. It has invaded Ukraine. And yet you can see even now, you know, this policy in the States is becoming more and more complicated. I would say for me, if Kissinger was looking at where US politics was now, he'd probably despair.

You know, what I see anyway is the U.S. is trying to keep Asia or woo Asia into the U.S. camp, but it's doing it through fear of China and offering zero free trade, zero higher tariffs and less access to the U.S. market, which is not a super attractive trade. Whereas China, of course, most of Asian Asians live in fear of China, but China is actually going down the free trade route.

It's trying to encourage more and more trade and more integrated economies into the rest of Asia, both through the Belt and Road Initiative and just through participation in regional free trade agreements. And both Biden and Trump have rejected those. And for me, that to me is a disastrous policy.

I think Kissinger would say, ultimately, this is the wrong way. It's too much more short term and too domestically focused politics, which is why I think he'd probably despair. Likewise, you know, the idea of Europe of cutting, you know, of trying to increase, get the Europeans to spend more on defence, not funding Ukraine, even though it's definitely fighting for democracy and freedom and withdrawing forces and conducting sort of industrial trade war policy of Europe. Again, it's a disastrous policy in the long term. So I think Kissinger would despair. I think the last few years have seen some, really some unwinding some of the achievements of him.

On the other hand, Munger, probably when he died, looked at American capitalism and could probably take a lot of credit for the success of American capitalism. I, for one, have been constantly surprised at how well US stocks have done and US asset prices. But when you look at what's driving that, you can see Munger fingerprints all over it.

I think Buffett and Munger have been really big pushers of the idea of companies sticking to their core areas of building moats and then rather than taking the cash that their successful businesses generate and expanding it to other businesses, returning that cash to shareholders, most particularly with share buybacks.

Now if you look at the US equity market, it's gone from a market that used to raise equity to a market now that as a whole returns equity to shareholders. And that is definitely a trademark or a success of Munger and Buffett thinking. My issue with it is I think it's gone too far. US corporates are now too powerful.

They don't pay any tax in Europe, which feeds into this negative feedback of European countries being starved of tax revenue, while at the same time being asked by the US to spend more on defence, and the US claim it's spending towards Ukraine. These are disastrous policies from a Kissinger point of view.

So when I look at Kissinger and Munger, I think Munger probably died being very happy with the world that he saw, and Kissinger died probably looking at the world and despaired somewhat. and I think the reason he despairs in some ways is driven by the success of Munger.

Anyway, some random thoughts about the world. I hope they're interesting. I hope the transcript makes sense. I might be doing more like this. I might even try some other features where I can get subtitles for what I've said underneath, which might be helpful for people who are trying to listen to me on the subway or somewhere like that.

All right, stay safe.

Talk again soon.

Ciao.

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Year end is always a time of reflection for me. What have a I learnt, what do I think will do well next year. This is particularly true in 2023, as my main trade long GLD/short TLT wen from threatening to go parabolic in October, to reversing most of its gains in November and December.

I have suffered through many punishing reversals in markets. There is always a lesson to learn from these moves, the problem for most fund managers is whether they are willing to learn or not, or even if they are open to the idea of learning. Even though GLD/TLT traded well until October, I have been caught by surprise by how well liquidity driven assets like equities and even crypto have traded. I thought 5% Fed Fund rate would have starved the market of juice. You wanted to buy the Nasdaq 100 at the beginning of the year.

I was always keen on asset flows and capital markets (hence the title of the substack). I was very keen on the concept of NIIP, but this has been bearish on US assets since 2016, when private sector NIIP hit the same extreme as 2000.

As I licked my portfolio wounds this month, I paused to think about markets. “Macro” analysis and hedge funds work best in recessions. An old market saying is that recessions are about balance sheets, while bull markets are about profit and loss. What that is saying, in good times, you want earnings growth, and in bad times you want a solid balance sheet. Where macro analysis has gone wrong in my view is that we assume dodgy lending, awful balance sheets, plainly criminal CEOs and massive retail investment are all times of a top, and all these dodgy characters are about to get the just deserts. Even I thought about shorting private equity - and idea that many subscribers endorsed. A 45% rally from recent lows makes me happy I chose not to short it.

So what is the market trying to tell us about macro, central banks and US equity markets. So first some context, I talk about GLD/TLT as they are easily traded ETFs, but I am looking at a return to very long term graph of GLD/TLT. TLT is replaced with a long dated treasury return index. Plainly the 1970s was a very different time to the 1980s and 1990s, but bares some resemblance to 2000s, but 2010s where a return to 1980s and 1990s again. What connects all this disparate eras?

The simplest way, that makes most sense to me is that US politics and society is my its very nature designed to allow people to do whatever they want. The last thing any politician or central bank wants to do is to tell American to not do something. However, from 1970 onwards, oil and energy became a constraint on US growth and politics. The modern central bank and Federal Reserve would raise interest rates mainly to counter rising energy prices until something broke, and demand collapsed. However, these days, as far as energy is concerned, it is China that is constrained, and the US is unconstrained.

What does this mean for the US? Well if energy inflation is under control, then you should expect the Federal Reserve to be accommodating, and equities to do well. Looking at US Energy CPI, buying equities when this turns lower or flat seems to be work pretty well. Early 1980s onwards you wanted to be full invested. A tactical buyer late 2008, and a big buyer in 2016 and 2020 all makes sense to me. And once again, energy CPI has turned lower.

So GLD/TLT as trade collapses down to a view on commodity markets, and particularly the price of energy. So when Russia invaded Ukraine, I assumed we were in a era of high energy prices. But oddly enough, even European natural gas prices have collapsed.

When I look at the Biden administration, I see evidence of the pro-labour tilt that drives GLD/TLT. But if I look at the policy towards Venezuela, energy supply and low energy prices are just as important. Even the release of SPR oil points to a political elite that is very sensitive to the oil price.

Coming back to GLD/TLT what does this all mean? Well as the oil import data above shows, a collapse in Chinese activity along the lines of the collapse of the Soviet Union or the Asian Financial Crisis would mean low energy prices for longer, and according to this analysis a strong equity market in the US. But with gold touching new highs this year, I think this unlikely. Gold picked up deflationary trends for commodities in 1980s and in the 2010s early on. A suddenly weaker gold price would imply long term energy oversupply I think.

The US oil industry continues to consolidate. At some point does market structure and incentive kick into see supply controlled and pricing discipline return. What I like about this analysis is that it explains why so many “macro” tools have proved useless in this bull market. The US will always want a bull market, except in oil prices. When energy prices are weak, US equities will do well, and when they are strong, there are problems. The GLD part of GLD/TLT suggest higher commodity prices will return.

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The dovish turn in Federal Reserve probably made a lot of people very happy. The US 10 Year yield has now dropped below 4%, after briefly touching 5% earlier this year.

The approximate cause of this fall in yields is that the Federal Reserve probably feels like it is “mission accomplished” in its fight against inflation. The most recent print is coming at at 3.1%

Sadly for me, my GLD/TLT trades has reversed on me, falling more than 10% since end of October.

What I find amusing about the Federal Reserve and this “pivot” is that the global macro for US inflation has been ultra deflationary. Because of the hawkish Federal Reserve policy, the US dollar has been very strong. This has also seen a reversal of more typical currency trends. When the Korean Won has weakened, this has usually meant a weakening cycle and US 10 year bonds yields tend to fall. Not this cycle. Korean Won has been weak, even as US 10 year yields have risen significantly. A strong dollar tends to be a deflationary trade.

Perhaps even more deflationary has been China’s decision to end the property speculation bubble. China has crushed the number of new houses it is building. For the decade from 2011, the Chinese residential property market was often cited as the single largest risk to markets, but the last two years, activity has been cut without any large CNY devaluation, or deflation in the rest of the world. China has taken advantage of the rest of world adopting expansionary policies to deal with domestic risk.

Why do I mention this? Well I learnt a long time ago, that the Shanghai Interbank Overnight Rate market was an extremely good lead indicator on Chinese activity. When it was rising, it was inflationary, and falling deflationary. Broadly speaking for the past 7 years it has been on a deflationary setting. But just as short rates are falling in the west, they are beginning to move higher in China. Has the government decided that enough deleveraging has occurred?

Finally, even though energy prices have been weak this year, the shale revolution in the US no longer looks like its structurally deflationary. The inventory of drilled uncompleted wells in the US has drawn down to the lowest level in nearly 10 years.

The US has also taken advantage of recent energy price spikes to get rid of the obsolete strategic petroleum reserve. Unlike other people, I agree with this. It’s a smart play, but it does reduce a significant overhang from the market.

Probably most negative for shale is that long dated natural gas markets in the US continue to indicate a much tighter outlook for natural gas than in 2020 or 2021. Here is pricing for January 2028 natural gas.

The expectations of rate cuts are really crazy in my view. In the UK, the chances that we have a Labour government next year are extremely high. The chances that the NHS will see significant funding increases and wage increases are also high in my view (NHS is the largest employer in the UK). Anyone else think that 3.7% yield is a bit low to lend to the UK government for 10 years? Anyone else think wages inflation falling back to 0 seems unlikely for the foreseeable future?

The move back in GLD/TLT has hurt my portfolio this month, and reminds me of the various times markets have gone against me. If I am right, then this should be an excellent entry point, and China, commodities and politics all are turning inflationary as investors get positioned deflationary. If I am wrong, then I can forget about this idea of launching a new fund and try and find something better to do! Both are appealing to me, so I am happy to let the markets decide. My gut feeling is that this is a good entry point. Lets see.

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In 1987 film Lethal Weapon, Donald Glover uttered the immortal line “I’m too old for this s**t”. Born in 1946, he would have been 41 when playing Murtargh to Mel Gibson’s Riggs. 13 at the time, I thought “Yeah! He is too old for that s**t!” At the grand old age of 49, and thinking of getting back into fund management, I keep thinking that I’m both too old for this s**t and too young for this s**t. Currently the no-brainer easiest trade in the world is to basically buy the Nasdaq 100.

The problem with no-brainer trades is that I have seen so many go wrong. Buying gold in 1970s, which then turned into 20 year bear market from 1980 onwards. Many gold bulls like to pretend the period from 1980 to 2000 and from 2011 to 2019 didn’t exist, but they did and wiped out many investors in gold mining companies. In hindsight, politics was turning against inflation in 1970s, and this was going to catalyse a 20 year bear market in gold.

In the 1980s, Japan was the no-brainer trade, but again by the mid 80s, politics was turning against Japan, as the US started negotiations for various free trade agreements with other nations, and the Yen was forced higher to make Japanese manufacturers less competitive.

More recently, in 2011 emerging markets and China in particular were seen as no-brainer trades. But 10 years later, you are sitting on 60% loss. I don’t need to tell you how politics has changed in relation to China.

So my problem, and why I am too old for this s**t, is that the politics for US large cap tech has also turned negative, and did so quite some time ago. Lina Khan head of the FTC basically made her name by calling out Amazon for its anticompetitive behaviour. Biden went out of his way to try and increase market competition in the US, and yet the biggest and best stocks, the ones most at risk have continued to climb. And that is because the biggest companies are the biggest buyers of their own shares, regardless of valuation.

If I had to explain the bull market of the the last ten years to some distant future young analyst, I would say it was a bull market driven by the tolerance of extremely pro-capital policies. Rather than try and let market forces work their magic, governments stepped in early and often to maintain friendly market conditions. Corporates were allowed, and even encouraged, to seek tax friendly policies. Corporates have benefited from government largesse and reduced taxes. This has led to the strange situation in the US net worth being 600% of GDP, and US Federal Debt to GDP being over 100%, and life expectancy actually falling. How can a country be rich, broke and dying at the same time? What is clear to me is that pro-labour policies are very effective at reducing debt to GDP levels. Rising nominal GDP with high inflation and high interest rates is the incentive structure needed to reduce debt - and importantly in my view, win elections here.

The problem is that political change can only change markets with a significant lag. For example, I see devaluation of the currency as a pro-capital policy (it reduces real wages). With this understanding, you wanted to buy stocks when Nixon abandoned the gold standard, but US stocks did not take off for another 8 years. If you bought stocks at the 1974 low, you did buy a generational low, but only from the 1980s onwards did stocks really outperform. Perhaps it was the confirmation of pro-capital policies with the landslide election of Reagan that markets needed.

The Plaza Accord of 1985 led to a surge in the value of the Yen, and was a clear sign that the mercantilist policies of Japan had reached a natural political end. And yet the Nikkei quadrupled over that period before entering a prolonged bear market. These days, a strong yen and weak Nikkei is almost axiomatic - but back then people rationalised it away.

So coming back to today, for me the 40 year bull market in bonds is done. And for me its a clear market signal.

So I think we are heading back to a long period of gold outperforming treasuries. Below is the a long term chart of gold versus treasuries. For me, we are still in the foothills of this trade.

My problem is that while I am too old to play along with the “no-brainer” trade of Nasdaq 100, I am too young to just sit around buying gold and selling treasuries while waiting for it to happen. I still have the fire in the belly to go out and short businesses that will struggle in the world we are going to. So strangely, I feel both too old for this s**t, and too young for this s**t.

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I have been bearish on TLT for a while now. But since October it has had a big bounce, but still in a downtrend in my view.

Back in the summer, I took a long look at Irish tax policy. In essence, Irish tax policy is basically set in consultation with large US corporates. The OECD is trying to introduce a new policy that allows governments like the UK to tax large multinationals like Apple on where they generate the revenue, rather than were they book the profits. In a recent budget, the Exchequer (UK treasury) estimated a GBP 2bn uplift from the OECD tax changes.

In response to this change, the Irish introduced a tax policy - Capital Allowance on Intangible Assets (CAIA). This removed the need for US corporates to send profits to tax havens, and pay tax in Ireland at a rate that they can set themselves. They merely need to transfer intellectual property to Ireland at cost, then get a subsidiary to buy it at “market value”, and then can depreciate this assets to generate a tax shield.

This policy was implemented after the details of the OECD tax plan were largely known, so I suspect have been shaped in a way that makes them very legally robust. My feeling is that tax take in Europe from large US corporates (Apple for example) will remain low. This creates huge problems for European corporates and governments. First of all, the Irish tax scheme only works for US corporates. That is a German company can not set up an Irish subsidiary, and then avoid paying tax on its US operations. Secondly, US politicians are not incentivised to change the system, as it technically increases the US tax take from US corporates. Thirdly, it gives US based companies a huge advantage when competing with non-US corporates. In essence, the UK tax base is continually eroded. This is leading to some strange macro outcomes. The UK tax take is at 50 year highs.

Despite this, the UK runs a 5% of GDP budget deficit.

What is really odd about this, is that the usual drivers of a fiscal deficit - falling asset prices or rising unemployment are not present. UK house prices are at all time highs.

And unemployment is low.

One possible thought I had was that the UK as it is now outside of the EU, could unilaterally “denounce” the tax treaty with Ireland. The treaty allows this with 6 months notice. The main purpose of this would be to try and bring Ireland to it senses, and stop reducing EU tax take while its funding a war in Ukraine. Other options would be to list Ireland as a tax haven (non-cooperative tax jurisdiction) and this would then subject to businesses operating out of Ireland with various onerous checks and regulations.

The problem with this, is that if Ireland, is shut down as a tax haven, another nation would probably be willing to step into the breach. This leaves the UK with implementing policies that reduce the incentive to shift assets overseas. This might be seen as extreme, but the tax structure of Apple has been copied wholesale by US corporates, and more and more businesses are being subsumed in to the tax free operations of these corporates. Advertising industry is dominated by Google and Meta (and tax free), retail is dominated by Amazon (and tax free), television is dominated by Netflix, Disney and Amazon and is tax free. Payments by Visa and Mastercard and is tax free. The logic of tax take, and the US of Ireland as a tax haven points to only one option - a tariff on all imports that make payments to offshore intellectual property.

What I am trying to say is that the UK could impose a tariff on any product that pays royalties to non-UK intellectual property. For example, Apple takes a 30% cut on all transactions through its iStore. This will be carried out through Irish based Apple subsidiary, and subject to Irish tax. As the intellectual property rights are not based in the UK it should become subject to a IP tariff, of say 10%. This would discourage base shifting, and would act to counter the unfair advantage that US based corporates have. As Apple has no IP based in the UK, my guess it would raise something like US 1bn of revenue for the UK, and similar amount from Microsoft and probably more from Google. As a policy, I admit it is not ideal, but experience leads me to believe that dealing with US corporates requires carrying a big stick.

Should the OECD tax reform fail, which I think is likely, I hope the UK has the courage to implement tax policy to level the playing field. Given the US has implemented across the board tariffs on China, this seems only fair.

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I have always been a big fan of the late historian, Eric Hobsbawm. Reading his classic trilogy, Age of Capital, Age of Empire and Age of Extreme, made me acutely aware that much of the world that we take for granted is relatively new. Capitalism as a way of organising society only really has a history of 200 years or so. Its benefits are manifold. Efficient use of assets and resources. Decentralised decision making, that allows supply to meet demand without government intervention. A largely meritocratic society. However, the negative side of capitalism, the concentration of power in fewer and fewer hands, and the rise in income inequality is a well understood downside. Capitalism’s weaknesses are purely political, as more and more members of society are disenfranchised, it creates a political pool upon which enterprising politicians can feed upon. I think politicians are aware of this, and have focused on trying to keep unemployment low. Using the UK, as an example, politicians have succeeded on this front. Policy seems focused on avoiding spikes in unemployment.

While the large pool of unemployed during the Great Depression led to disillusionment with capitalism and the rise of fascism and socialism, we can also see that rising inequality is another obvious way to disenchant the voting public of the merits of capitalism. Ever more expensive housing costs is a political problem.

I understand the political decision to avoid a Great Depression after the GFC, and the focus on raising asset prices. But in a democratic political system, at some point workers would rebel against this system. So far this rebellion has presented as “populist” outcomes such at Brexit and Trump. For me, the “best possible outcome” would be rising wages and rising interest rates that would allow economic imbalances to be reset - without a political breakdown. Unfortunately, 2023 has shown a reversal, with wages in the UK falling when rebased to food inflation.

The US shows a similar trend when wages are looked at terms of food inflation, 2022 and 2023 has seen wages fall.

Similar analysis shows that Japanese wages in food terms are collapsing.

The flip side of falling wages in real terms, is that asset prices have also begun rising. MSCI World has recouped most of the losses form 2022. That is we are seeing falling wages and rising assets prices. This is the opposite of what I expected to see. Housing prices in the UK and the US have also been strong, recouping losses from 2022.

There is one market where the pro-labour trade has worked in terms of rising real wages and falling asset prices - China. The Chinese stock market is back to 10 year lows.

Chinese CPI has been much lower, implying any wage growth has been kept by workers.

It should be noted that China has done a far better job of raising wages than any other Asian nation.

So one possibility is that we are in a world where ONLY China has gone pro-labour, and the rest of the world is still pro-capital. China is a such a big player in gold and in treasuries it could definitely be causing GLD/TLT to trade well.

Why does this fill me with dread? When the political system is captured by one group, it can only be resolved through revolution, and the destruction of the system. You can already see the outlines of this collapse. Trump has a good chance of being re-elected despite leading the capitol invasion. You have to wonder who will stop him next time? Large cap US corporates evade taxes on their operations in rest of the world, starving European allies of tax revenue, while Congress is considering cutting military aid to Ukraine.

Eric Hobsbawm in his Age of Extremes argued that the threat of the Soviet Union and Socialism made sure the elite in the US ran a system that benefitted everyone. That is capitalism that broadly worked for everyone. He feared that the collapse of socialism would allow greed and the profit motive to run unchecked. I fear that he is being proven correct - and that this will usher in an age of conflict and revolution. The optimist in me hoped for a rising wages and rising interest rates to correct the economic and political imbalance within the existing system, but I fear that the evidence this year might be saying this is impossible. I am filled with existential dread.

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The basic view I have is a world that is moving pro-labour and away from capital friendly policies. De-globalisation, anti-immigration, anti-free market are all pro-labour policies in my view. One observation is that rapidly rising food prices tend to cause political change. US food prices remained under control until 1970s. This caused a big political change from the 1980s onwards. We seem to have entered a new era of rising food prices.

To capture the change, I have a a core trade that is long gold, short treasury trade. This has worked well. The idea is that WITHOUT much higher interest rates, inflation will run amok. That is if TLT rallied, then GLD will rally. This part has worked.

I had assumed the bear market in bonds would lead to a change in leadership in markets. There are definite signs of this. The bear market in bonds has seen Japanese banks outperform the broader Japanese market for the first time in 14 years.

The Eurostoxx 50 has also seen banks make up 3 of the best performers this year, Unicredit, BBVA and Santander.

US stocks HAVE struggled with a rising rate environment. The equal weighted S&P 500 has been sideways since 2021. And US banks have underperformed Japanese and European banks for the first time in a long time.

Where I have been wrong is thinking that we might see the underperformance of “growth” stocks versus value stocks. This has not happened, largely driven by large cap tech.

Where I have been wrong has been the willingness of companies to carry out share buybacks at valuations that make little economic sense. If Microsoft’s earning yield had followed its bond yield, the stock would be much weaker.

I had also assumed that the Chinese example of regulating tech would be followed by the US. This has been plainly wrong. One argument in favour of US tech is that US elections are so expensive, politicians in the US cannot afford to take on big corporations.

I have also been wrong that wage inflation would drive commodity inflation. Grain prices for example have been incredibly weak. US corn prices have given up almost all the gains seen in 2020 to 2022 period. So commodity price increases are not necessary to drive inflation. Wage increases are sufficient. That is I have been wrong to be bullish on other commodities, other than gold.

On currencies, I have been surprised by the strength of the Mexican peso. It would seem that the size of trade flows seems to determine economic power. Trade policy determines who gets the benefits. US is still by far the largest importer. This seems to allow the US to set the terms of trade.

US trade policy benefits Mexico over China in recent years, which has reversed a decade long trend of a weaker Peso versus the Chinese Yuan. Historically I would always have chosen Yuan or Yen over Mexican peso - but US policy seems to be the dominant driver.

Structurally I am bearish on bonds. I think inflation is going to be entrenched, Where I could be wrong on bonds is the but I am sympathetic to a politically bullish argument for lower interest rates. That is the US government cannot afford higher interest rates. The interest bill on the government debt it already closing in on social security as the biggest expense.

Politically in a pro-labour environment austerity is dead. Hence, I have to think that corporates are the most likely source of tax revenue. Both right wing and left wing governments have shown their antipathy towards large corporates, so I am going to continue to avoid them, and stick to my long GLD, short TLT trade.

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