Increasing Inflation Prompts Selloff, but Commodities Could Just Be Getting Started

The CPI reported faster-than-expected growth in inflation which has the bond markets looking for the Fed to raise rates sooner than previously expected. Disney could be another victim of the reopening trade. Rivian makes a splash on its IPO. Commodities could be more than transitory; they could be starting a new Super Cycle.

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5 min read
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Key Takeaways

  • CPI Report Prompts Concern that the Fed Will Raise Rates Sooner 

  • The EV Market Welcomes Another Competitor 

  • Commodity Super Cycle Could Change Scope of Equity Markets 

(Thursday Market Open) First things first, I want to start with a Thank You and a Happy Veteran’s Day to all who served.

Equity index futures are pointing to a higher open as stocks try to rebound from Wednesday’s selloff. The bond market is closed today in observation of the Veterans’ Day holiday which sometimes results in lower volumes for equity markets. A few housing stocks are drawing attention to the real estate markets. However, inflation is the story and investors are trying to determine how long it will last.

The major stock indices fell on Wednesday due in part to the Consumer Price Index (CPI) reporting faster-than-expected inflation. The higher inflation numbers sent ripples throughout the bond market as Treasury yields rose noticeably across the curve. Additionally, the fed funds futures rate increased the likelihood of the Fed raising rates by June 2022 to 70% from about 50%. However, the 10-year Treasury Yield (TNX) is still 10% lower than its 52-week high which means stocks could still offer more potential to investors than bonds.  

The fear of Fed action prompted oil prices (/CL) to fall 3.47% going into the close. Additionally, Bloomberg reported that President Joe Biden said that the White House is focused on cutting energy costs, although he didn’t specify how. In recent weeks, the White House has received pressure to open the strategic oil reserves to help tame prices. Also, according to Bloomberg, other groups are now pushing the White House to ban all oil exports and focus on domestic consumption.

Gold futures (/GC) may have anticipated increased inflation because it’s working on a six-day win streak. Many investors have historically used precious metals as an inflation hedge. Today, some investors are hoping cryptocurrencies like Bitcoin will be an inflation hedge. Bitcoin futures (/BTC) created a new high on Tuesday, but actually sold off with the CPI report.  

After the close, Disney (DIS) fell 3% in after-hours trading because it missed on earnings expectations. The company reported that subscriptions for Disney+ were slower than expected, at just 1.8%. Disney’s American amusement parks are performing well with the reopening, but its European parks haven’t experienced as smooth of a reopening. These parks were also a drag on the company’s earnings.

Another stock that was trading lower before the open is Beyond Meat (BYND). Its price was down more than 19% after a disappointing earnings announcement. In response to the news, J.P. Morgan analysts cut their target price on the stock from $79 a share to $54.

Electric car maker Rivian (RIVN) climbed nearly 30% in its debut. The company’s market cap is now $98 billion, which greater than General Motors (GM) at $86 billion and Ford (F) at $77 billion. Rivian CEO Robert Scaringe said that he expects the company to deliver between 20,000-40,000 vehicles in 2021. In contrast GM expects to sell 446,997 vehicles for the year. Ford and Amazon (AMZN) are actually backers of Rivian.  

Real estate platform turned home flipper, Zillow (Z) has fallen 68% from its 2021 high due in part to its struggling house-flipping division. However, Zillow’s problems appear to be their own because competitor Opendoor (OPEN) is up nearly 18% in premarket trading on better-than-expected earnings.

Additional good news for the housing market comes from homebuilder Beazer Homes (BZH). It also rallied more than 11% before the open after beating on top and bottom line numbers.

Commodity Super Cycle

The Fed, Bank of England, and the European Central Bank rallied around the transitory inflation message last week. Supply lines improvements, people getting back to work, and seasonal consumer shifts away from products and toward services are some of the reasons central bankers are favoring the “transitory inflation” narrative. However, some analysts believe that the commodity issue will be with us for a while because of an emerging Commodity Super Cycle.

The Commodity Super Cycle is an investment theory where commodities come in and out of favor over long periods of time. It often starts with an equity market boom driven by cheap money and inexpensive raw materials. However, over time, cheap money and high demand for raw materials result in rising prices. During these times, commodities become more expensive and form commodity bull markets. When commodities become even more scarce, equity growth will slow while commodity production will ramp up. It can take years, if not decades, for commodity production to meet demand, which is why it’s called a “super cycle”.

Jeff Currie, the Global Head of Commodities Research for Goldman Sachs, sees certain elements that could feed a commodity bull market. Frist, decarbonization is the attempt to remove the use of fossil fuels in favor of cleaner and more climate friendly green energy sources. Despite the tremendous progress in green energy, alternative green energy suppliers like wind and solar haven’t been able to keep up with energy demand. 

Additionally, government policies around the world have made business difficult for drillers and miners to get their products out of the ground and to market. This has led to increased shortages for oil, gas, and coal. Energy companies are afraid to put out the capital expenditures for increased drilling and mining because they’re unsure if policies will change. An unexpected change in policy could lead to large losses if capital is laid out and projects are shut down.

Another issue Mr. Currie cited is de-globalization or the desire to make business local. While these policies can help protect some jobs and businesses, they also cut off certain countries and communities from potentially cheaper sources of energy found outside their borders. Cutting off foreign supplies also deters energy companies from drilling or mining because they don’t know if there will be a market for their products.

A third issue is the increased amount of money in the system. Inflation is caused when too many dollars are chasing too few goods. In response to the COVID-19 pandemic, central banks and governments flooded economic systems with money to avoid a severe recession or even a depression. However, now there is a lot of money in the system but not enough goods—in other words, there’s high demand for energy but low supply. 

Commodity super cycle
CHART OF THE DAYCOMMODITY COMPARISON. The S&P GSCI Index ($SPGSCI—candlesticks) attempts to track commodity prices. From 2000 to 2011, the GSCI Index showed greater relative strength (green) than the S&P 500 (SPX—pink). In 2012, the tables turned, and the S&P 500 strengthened relative to the commodity index. . Data Sources: ICE, S&P Dow Jones Indices. Chart source: The thinkorswim® platformFor illustrative purposes only. Past performance does not guarantee future results. 

Bicycling: The cycle between equity markets and commodity markets has a long history. During the Great Inflation from 1965 to 1982, the Dow Jones Industrial Average ($DJI) couldn’t sustain a break above 1,000 for the entire time frame. However, a Commodity Super Cycle doesn’t mean stocks won’t rise. Instead, certain sectors would likely assume market leadership like energy and basic materials.

While most equities tend to do better in a commodity bear market, many stocks will still perform well. However, investors may have to become better stock pickers because they must identify companies that can manage expenses and still grow their businesses under those conditions.

Oiling the Chain: If a Commodity Super Cycle occurs, oil, oil derivatives, and oil-producing countries will likely be among the beneficiaries. According to the Hinrich Foundation, the oil supply chain made up 12% of the global trade in 2018. The largest oil-exporting countries at that time were Saudi Arabia, Russia, Iraq, Canada, United Arab Emirates, and Kuwait. In all, just 15 countries account for 80% of crude exports.

Petroleum derivatives like chemicals and plastics make up another 12% of global trade. These products come mostly from the United States, Russia, Netherlands, Singapore, India, and South Korea.

However, there are political risks here. You may remember that in March 2020, just as the economic ramifications of COVID-19 pandemic policies were being felt, Russia and Saudi Arabia sparked an oil production war. The production war and lower demand from lockdowns took oil prices down to $15 per barrel.

Nuclear Option: The move toward de-carbonization has given rise to ESG investing. ESG investing is analyzing and investing in companies that are conscientious about their impacts on the environment, social consequences, and corporate governance. Depending on the type of ESG grading and investing a person ascribes to, ESG energy companies may be few and far between. However, there is a movement among ESG investors to include nuclear energy.

Nuclear energy is clean energy, although it comes with some obvious risks. However, Bill Gates and Warren Buffett are partnering to build a new kind of nuclear reactor in Wyoming. Rising energy prices could help the nuclear industry group grow as investors look for a cleaner alternative. 

Good Trading, 

JJ

@TDAJJKinahan

Historical data should not be used alone when making investment decisions. Please consult other sources of information and consider your individual financial position and goals before making an independent investment decision. 

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Key Takeaways

  • CPI Report Prompts Concern that the Fed Will Raise Rates Sooner 

  • The EV Market Welcomes Another Competitor 

  • Commodity Super Cycle Could Change Scope of Equity Markets 

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