The Unite leader’s supporters are accused of harassing supporters of challenger Gerard Coyne.
China is currently modifying the terms of its oil trade with Saudi Arabia. Specifically, China is working on a deal to pay for Saudi oil using Chinese yuan. This effort poses a direct threat to the security of the dollar.
If this China-Saudi deal happens — yuan for oil — it’s another step closer to the grave for the petrodollar, which has dominated global finance since 1974. You can revisit Jim Rickards article about the Assault on the Dollar, here.
To recap, the petrodollar is weakening because the dollar is losing power as the world’s reserve currency. This is similar to the way pounds sterling gradually fell out of favor during the decline of the British Empire. The decline may take a long time, but what we’re seeing today is another step in the death march of the dollar.
Since 1974, Saudi has accepted payment for almost all of its oil exports — to all countries — in dollars. This is due to an agreement between Saudi and the U.S., dating back to the days of President Nixon.
Beginning about 15 years ago, China ceased being self-sufficient in oil, and began buying Saudi oil. As per all Saudi customers, China had to pay in dollars. Even today, China still pays for Saudi oil in U.S. dollars and not yuan, which perturbs China’s leaders.
Since 2010, China’s total oil imports have nearly doubled. According to Bloomberg News, China has surpassed the U.S. as the world’s largest oil importing nation. Here’s a chart, showing the trend.
As China imports more and more oil, the idea of paying for that oil in yuan instead of dollars becomes more critical. China does not want to use dollars to buy oil. So, China is beginning to squeeze Saudi over the form of currency in which their oil trade is conducted. China is doing this by steadily lowering its oil purchases from Saudi.
Presently, China’s three top oil suppliers are Russia, Saudi and the West African nation of Angola. Backing-up these three key suppliers are a combination of sources in Iran, Iraq and Oman, which help to diversify China’s oil-supply chain.
In the past few years, China has shifted oil purchases away from Saudi, and Russia’s oil exports have risen from 5% to 15% of the Chinese total.
China imports more oil from Russia, Iran, Iraq and Oman; less from Saudi.
Saudi’s share of Chinese imports has dropped from over 25% in 2008, to under 15% now. Meanwhile, Saudi competitors Russia, Iran, Iraq and Oman are selling more oil to China.
Saudi would like to reverse this declining trend of oil-trade with China. However, these kind of major oil flows don’t just happen in a vacuum.
There’s a good reason why Russian oil sales to China are increasing. As you’ll see in Nomi’s article, trade and financial services are often closely linked. Over the past few years, China has deepened its trading roots with Russia — now, China pays for Russian oil in yuan. Russia, in turn, uses yuan to buy goods from China.
Beyond trade in goods, within the past six months Russia has set up a branch of the Bank of Russia in Beijing. From there, Russia can use its Chinese yuan to buy gold on the Shanghai Exchange. In a sense, Chinese-Russian oil trade is now backed-up by a “gold standard.”
Looking ahead, Saudi Arabia will find itself more and more locked-out of the Chinese oil market if it won’t sell oil for yuan. But to do this, the Saudis must move away from U.S. dollars— and from petrodollars — if Saudi wants to maintain and increase access to China’s oil market.
We’ll know more about the likelihood of this after Donald Trump’s tour of the Middle East.
If Saudi begins accepting yuan for oil, all bets are off on the petrodollar. Yuan-for-oil will entirely change the monetary dynamics of global energy flows. I expect the U.S. dollar to weaken severely when that news breaks.
Much of this oil-for-yuan news is public information. Yet, for some strange reason, there’s a form of blindness within western policymaking and media circles concerning the implications of yuan-for-oil. The idea is so “off-the-wall” that many policy leaders simply ignore it.
Ignore away. But we could wake up one morning in the midst of a massive currency crisis, in which dollar values are falling and oil prices in dollars are soaring.
Michael Corleone: I saw a strange thing today. Some rebels were being arrested. One of them pulled the pin on a grenade. He took himself and the captain of the command with him. Now, soldiers are paid to fight; the rebels aren’t.
Hyman Roth: What does that tell you?
Michael Corleone: They could win.
Hyman Roth: This county’s had rebels for the last fifty years— it’s in their blood, believe me, I know. I’ve been coming here since the ’20s. We were running molasses out of Havana when you were a baby — the trucks, owned by your father.
Hyman Roth: Michael, I’d rather we talked about this when we were alone. The two million never got to the island. I wouldn’t want it to get around that you held back the money because you had second thoughts about the rebels.
? “The Godfather: Part II” (1974)
Michael Corleone is like me and every investor over the past five years who held off on an attractive investment for fear of political risk. Except he was right and I’ve been nothing but wrong.
Somehow, I think Silicon Valley got even more spun up than Manhattan. There were hedge fund people I spoke to about a week after the election.
They hadn’t supported Trump. But all of a sudden, they sort of changed their minds. The stock market went up, and they were like, ‘Yes, actually, I don’t understand why I was against him all year long.’
? Peter Thiel, in a New York Times interview (January 11, 2017)
John Wick: People keep asking if I’m back and I haven’t really had an answer. But now, yeah, I’m thinkin’ I’m back.
? “John Wick” (2014)
Me, too. Political risk, though, not so much.
If political parties in Western democracies were stocks, we’d be talking today about the structural bear market that has gripped that sector. Show me any country that’s had an election in the past 24 months, and I’ll show you at least one formerly big-time status quo political party that has been crushed. This carnage in status quo political systems goes beyond what we’d call “realigning elections”, like Reagan in 1980 converting the formerly solid Democratic Southern states to a solid Republican bloc. It’s a rethinking of what party politics MEANS in France, Italy, and the United States (and with the UK, Spain, the Netherlands, and maybe Germany not too far behind). The last person to accomplish what Emmanuel Macron did in France? The whole “let’s start a new political party and win an election in two months” thing? That would be Charles de Gaulle in 1958 and the establishment of the Fifth Republic. The last person to accomplish what Donald Trump did in the U.S.? The whole “let’s overthrow an old political party from the inside and win an election in two months” thing? I dunno. Never? Andrew Jackson?
Now don’t get me wrong. Do I think Emmanuel Macron, a former Rothschild investment banker whose “ambition was always two steps ahead of his experience”, is the second coming of Charles de Gaulle? Do I think Donald freakin’ Trump is a modern day Andrew Jackson? Bwa-ha-ha-ha-ha-ha … good one!
But here’s what I do think:
- Something old and powerful is happening in the real world to crush the status quo political systems of every Western democracy.
- Something predictably sad is happening in the political world to replace the old guard candidates with self-absorbed plutocrats like Trump and pretty boy bankers like Macron.
- Something new and powerful is happening in the investment world to divorce political risk and volatility from market risk and volatility.
The old force repeating itself in the real world is nicely summed up by these two charts, the most important charts I know. They’re specific to the U.S., but applicable everywhere in the West.
First, the Central Banker’s Bubble since March 2009 and the launch of QE1 has inflated U.S. household wealth far beyond what the nominal growth rate of the U.S. economy would otherwise support. This is a classic bubble in every sense of the word, with the primary difference from prior vast bubbles being its concentration and focus in financial assets — stocks and bonds — which are held primarily by the rich. Who wins the Academy Award for creation of wealth inequality in a supporting role? Ladies and gentlemen, I give you the U.S. Federal Reserve.
Source: Bloomberg LP and TCW, as of 12/31/16. For illustrative purposes only. Past performance is no guarantee of future results.
And as the second chart shows, this central bank largesse has sharply accelerated the massive shift in wealth to the Rich from the Rest, a shift which began in the 1980s with the Reagan Revolution. We are now back to where we were in the 1930s, where the household wealth of the bottom 90% of U.S. wage earners is equal to the household wealth of the top one-tenth of one percent of U.S. wage earners.
For illustrative purposes only.
So look … I’m not saying that the current level or dynamics of wealth inequality is a good thing or a bad thing. I’m just saying that it IS. And I understand that there are insurance programs today, like social security and pension funds, which are not reflected in this chart and didn’t exist in the 1930s, the last time you saw this sort of wealth inequality. I understand that there are a lot more people in the United States today than in the 1930s. I understand that there are all sorts of important differences in the nature of wealth distribution between today and the 1930s. I get all that. What I’m saying, though, is that just like in the 1930s, there is a political price to be paid for this level of wealth inequality. That price is political polarization and electoral rejection of status quo parties. I won’t give the whole history lesson here, as it’s a good excuse for readers to immerse themselves in Wikipedia for half an hour or so and read about guys like Father Coughlin, but the rhyming of political history in Western democracies between the late-1920s/early-1930s and today, particularly in the way that status quo political parties were subverted or overthrown or just plain eliminated throughout Westworld is … pretty amazing.
Western democracies, mixing a healthy dash of popular political representation with a big dose of capitalist economic structures, are extremely good at the most important driver of social stability: co-opting the more talented members of a mass society into the status quo system, bringing new blood into that top two percent socioeconomic club who might otherwise apply their talents in more subversive ways. Maybe not the top one-tenth of one percent on a purely financial wherewithal scale, but definitely the top two percent on a more broadly defined socioeconomic scale of wealth, stability, and influence. That co-opting process is the steam valve for Western societies, and it has two components, particularly in the most successful Western society, the United States — educational mobility (move to where the good intellectual jobs are) and labor mobility (move to where the good physical jobs are). Educational mobility, spurred in the U.S. by more than $1 trillion in government-backed student loans, is in high gear, and the importance of an educational pedigree to get into the 2% Club has NEVER been greater. Labor mobility, on the other hand, crushed by globalization and the housing crisis, hasn’t been this broken since … yep … the 1930s.
As a result, the composition of the 2% Club of wealth, stability, and influence is changing. Today it’s almost entirely a Club of the educationally mobile and accomplished, the people who deal with symbols for a living — words and tickers and numbers and code — and whose language and lingo is similarly abstracted. And because our status quo political institutions, like political parties, are in all nations and in all times the top-down creations of the 2% Club, our political parties themselves speak a different language today than they did even 10 or 20 years ago. No political party is immune, regardless of where it sits on the traditional left/right spectrum. This isn’t a Republican vs. Democrat thing. It’s not a rich vs. poor thing, either, because there are plenty of rich people who aren’t symbol manipulators and are feeling less and less at home in the 2% Club. It’s a who’s-dominating-the-2%-Club thing, and in Westworld that’s the educationally accomplished symbol manipulators.
Our status quo political parties speak well and clearly to the 2% Club and their educationally mobile circles, not so well to the guy who didn’t go to law school and whose kids don’t have a prayer of getting into Stanford. Not so well to the guy who, to be honest, kinda hates lawyers and the professional symbol manipulators, and definitely hates anyone who went to Stanford. Not so well to, as Amity Shlaes titled her seminal history of the 1930s and the Great Depression, the Forgotten Man, citizens who — today and in the 1930s — are well and truly stuck. Stuck because labor mobility is broken. Stuck because their wages are flat and their debt is up. Stuck because they’re getting older. Stuck because, like the sailors on the Battleship Potemkin, they are served disgusting, rotten meat but are told by the well-spoken professionals that these are dead fly larvae, not live maggots, and so they can simply be washed off with salty water. Stuck because the entire political system is rigged for the educationally mobile and the symbol manipulators. Not rigged in a cartoon evil sense, but rigged in the same way that the German system is rigged in favor of people who speak German and the Chinese system is rigged in favor of people who speak Chinese. Don’t speak Symbol Manipulation? Sorry, but the status quo Western political system is rigged against you. And you know it.
There’s no attachment to a political party that from your perspective is speaking gibberish. The attachment is to change and reversion. The attachment is to Something Else. The Something Else will not have a well-considered or coherent policy wrapper. It won’t look smart. It didn’t in the 1930s and it doesn’t today. Why not? Because if it did, it would be co-opted as part of the status quo! Words like “well-considered” and “coherent” and even “policy” are the abstracted words of the modern status quo. They are the language of the 2% Club, particularly of an educationally mobile 2% Club, and it’s a very different language than that spoken by anyone hailing from the world of physical construction and manipulation rather than symbol construction and manipulation.
So what is this other language? Importantly, as Joan Williams describes in her phenomenal article, “What So Many People Don’t Get About the U.S. Working Class,” it’s not a soak-the-rich language (in fact, it’s more disparaging of the poor than the rich). It’s a non-abstracted language of direct, physical involvement in localized social behaviors (what Nassim Taleb calls “Skin in the Game”), because that’s the language that has meaning for anyone who depends on labor mobility and physical construction to make a better life for themselves and their kids. It’s an uncomfortable language for the educationally mobile 2% Club, because it doesn’t abstract away the racist, sexist corners of real world, localized social behaviors and beliefs in a carefully constructed linguistic architecture. That doesn’t mean that the Forgotten Man is necessarily racist or sexist (doesn’t mean that he’s not, either). It means that these are not behaviorally motivating or politically meaningful words to a major sub-population. It means that our language defines and constrains our thoughts and behavior, not the other way around. It means that we ARE our grammar, at least in our lives as social animals. It means that the Confusion of Tongues is not just a quaint Old Testament story with cool Gustave Doré engravings about some apocryphal Tower of Babel.
It is THE political story of this or any other age, and it always leads to a radical restructuring of the political order, because you cannot have a stable political equilibrium where a critical mass of national sub-populations speak different social languages.
But that’s where we are in every Western nation in 2017. The politically ascendant sub-population on the educational mobility track hear the language of the Other and say “Unacceptable people. Must resist. Zero-sum game.” The politically stuck sub-population on the labor mobility track hear the language of the Other and say “Bad hombres. Must fight. Take no prisoners.” The center cannot hold. More accurately, there is no center, no cooperation. Competition is all, and that’s no way to run a country.
Unfortunately and unsurprisingly, the new political leaders who emerge from a collapse of the Tower of Babel are rarely the champions of the Forgotten Man that you might think would emerge. Both in the 1930s and today, there’s no shortage of non-status quo political entrepreneurs who speak the language of the politically stuck and are willing to put themselves out into the political arena. But to be successful in their political entrepreneurship it’s almost essential that these new candidates be card-carrying members of the 1/10th of 1% Rich Club. Why? Because it requires an insane amount of money and sheer notoriety to replace the machinery of a status quo political party in a mass society. A political party is a media company. By joining a status quo party and toeing that party line, you communicate an enormous set of signals to potential voters for free. But by toeing that party line, you lose your Forgotten Man authenticity and any hope of being the champion of Something Else. Want to be a “change candidate”? Better make a couple of billion dollars first, or have plenty of billionaire friends, so you can afford to bypass the status quo political party.
Little wonder, then, that Donald Trump, a billionaire TV star, succeeds in overthrowing the Republican Party. Little wonder that Emmanuel Macron taps a vast banker network from across Europe to fund his campaign. Little wonder that zillionaire Mark Zuckerberg has embarked on a nationwide “listening tour”, complete with equal zillions of photo ops — none of which are with educationally mobile symbol manipulators — as he prepares for a political life. Good old-fashioned mustachioed fascism may work in Turkey, but here in the U.S. you need a smiley-face with your Panopticon. Sharing is caring!
So that’s my political take: the old and powerful Tower of Babel process is starting up again, and status quo political institutions are not long for this world. As we move to the Something Else to come, we’ll have to endure a parade of billionaires wielding political power in unprecedented ways, aided by unprecedented technologies of social control. That’s the Big Risk for everyone reading this note, regardless of your politics, regardless of your social language, regardless of your vision of the life well lived. That’s the Big Risk we have to manage, as investors and as citizens.
So how do we do THAT?
For today’s note, I’m focusing on the investor side of that question, and that means focusing on the one Big Question: as the Western status quo political system collapses into Something Else, how is it possible that our capital markets are not similarly gripped by volatility and stress? What is responsible for breaking the transmission mechanism from political risk to market risk?
I’ve got a macro answer and I’ve got a micro answer.
The macro answer is that you need status quo political parties to govern a country effectively. Thankfully, there are only enough billionaire candidates of Something Else to fill the top of the ticket, and even if there were more, a party of independently wealthy and independently popular mavericks isn’t a coherent party at all. There’s not less gridlock with an essentially party-less American president or an essentially party-less French president, there’s MORE gridlock. And that means that any sort of fiscal policy — whether it’s a clear-the-decks debt assignment or a classic stimulus program or whatever — is more difficult under this sort of independent political regime than in a status quo regime.
Sure, there’s a lot of excitement when the Stranger comes to town. Take a look at what happened to the U.S. 10-year bond after Trump was elected.
Source: Bloomberg LP, as of 04/10/17. For illustrative purposes only. Past performance is no guarantee of future results.
But excitement fades as fiscal policy promise fades to fiscal policy deadlock. When I look at Washington today, or London or Paris or Rome or wherever, it sure looks for all the world like a return to our regularly scheduled entertainment. Nature abhors a vacuum, and politics is no exception. In the absence of an active and effective fiscal policy authority, global monetary policy authorities will fill the policy void. And what is their policy? Refer to chart 1 at the start of the note, please. Low growth. Financial asset inflation. Low volatility. Wash, rinse, repeat. The new Goldilocks, now eight years old. Could go for another eight years, easy. Wheeee!
Yes, there’s enormous political risk associated with the collapse of status quo political institutions and the rise of the Trumps and the Macrons of the world. But …
- for financial markets, these new leaders are familiar, encouraging faces. They’re members of the 1/10th of 1% Rich Club, because they had to be to sidestep status quo political parties. Moreover,
- there’s going to be a hope and a promise of fiscal policy initiatives, and that’s a tailwind for markets, too. And finally,
- don’t worry, Mr. Market, when that hope and promise of pro-growth policy fades into the realization of anti-growth gridlock, our old friends Janet and Mario will be there to pick up the slack with more liquidity.
That’s my macro story for the divorce of political risk from market risk, and I’m sticking to it. Where does it break down? Not with a funky German or Italian election, but with Janet and Mario declaring victory and taking away the punchbowl. That’s what will bring political risk back to markets.
On the micro side, it’s the triumph of Communication Policy, just as far as the eye can see. I’ve written a lot about Communication Policy in the past, here, here, here, and here. It’s what the Fed calls their use of words and public statements for effect, as a specific policy tool designed to influence investor behavior rather than to communicate truthful information. You know … what we would call lying in other circumstances. As Ben Bernanke said in one of his last speeches as Fed Chair, Communication Policy (“enhanced forward guidance”) has been the star of the show since quantitative easing lost its mojo with the QE2 program. Making up narratives and telling them convincingly has worked for politicians for, oh, several thousand years. I suppose the only surprising thing is that it took central bankers so long to get in on the act. Today it’s their primary shtick.
But now that politicians and central bankers have demonstrated the incredible efficacy of what game theory calls Missionary Statements — the intentional construction of common knowledge through highly mediated statements — everyone wants in on the act. Everyone wants to be a Missionary for their own institutional ends. And that Everyone definitely includes Wall Street.
Here’s what I’ve noticed in the past two major political risk events in Western markets — the Italian referendum on December 5 and the French first round election on April 23. In both cases, the most political risk-impacted equity markets began to rally sharply three or four days BEFORE the vote.
Source: Bloomberg LP, as of 05/03/17. For illustrative purposes only. Past performance is not indicative of how the index will perform in the future.
The index reflects the reinvestment of dividends and income and does not reflect deductions for fees, expenses or taxes. The indices are unmanaged and are not available for direct investment.
The top chart is the European bank equity index before and after the French vote. Below is the price chart of the broad Italian equity index before and after their referendum.
Source: Bloomberg LP, as of 05/03/17. For illustrative purposes only. Past performance is not indicative of how the index will perform in the future. The index reflects the reinvestment of dividends and income and does not reflect deductions for fees, expenses or taxes. The indices are unmanaged and are not available for direct investment.
In both cases the bottom was reached well before the actual event. Why? Because in both cases the sell-side research machine — all the chief economists and chief strategists and acolytes of all the big Wall Street firms — began churning out a flood of Missionary Statements designed to create a positive narrative around a potentially very negative (for markets) political risk event. Ditto with the U.S. election, where the positive narrative around Trump began a full week before the election (see “American Hustle” for the full Narrative Machine description).
I mean, the effort to create a positive narrative out of whole cloth would be comical if it weren’t so seriously impactful. My personal fave on the Wednesday before the French vote was a bulge bracket strategist who shall go nameless, writing to say that a Le Pen victory wouldn’t really be that bad of a thing for markets in general and the banks in particular, because if she won there could well be a massive run on the French banks, which means that Le Pen would have to backtrack on her anti-euro stance to prevent a complete economic collapse. So buy now!
My first reaction to this avalanche of positive Narrative construction was indignation, tinged with a little anger. Give me a break! Markets are getting a little squirrelly going into the vote, and so you’re going to start pumping out this drivel? My reaction was what John Maynard Keynes, who was at least as good a game theorist and investor as he was a macroeconomist, would have called a first level response to a Missionary statement — I’m right and the Missionary is wrong! This is the human, natural response. It’s also a losing response if you want to play the game of markets successfully.
As Keynes explained so smartly with his parable of the Newspaper Beauty Contest, you don’t make money by holding firm to your personal opinion of who’s the prettiest girl or what’s the most attractive stock. You don’t even make money by identifying the consensus view of who’s the prettiest or what’s the right answer to a market question, because all of us are smart enough to be looking for the consensus view. No, you make money by getting ahead of the formation of the consensus view through Missionary statements, even if your personal view is that the Missionary is dead wrong in their assessment of pretty girls or attractive stocks or market outcomes. Would you rather be right or would you rather make money? Back in my younger days I didn’t think there was a conflict between the two. Now I know better. Once the Wall Street Missionaries started their Narrative blitz, it didn’t matter that I believed (and still believe!) that an anti-status quo Italian referendum creates a systemic risk for the European banking system. I wasn’t going to get paid for that view, even if the anti-status quo vote won (it did) and even if I’m objectively correct about the risk (we’ll see). Frustrating? Sure. But in the immortal words of Hyman Roth, this is the business we have chosen.
It’s this micro explanation of the divorce between political risk and market risk that I think will prove to have the most long-lasting impact on investor behavior. You know, I started writing Epsilon Theory because Mario Draghi kicked me in the teeth in the summer of 2012 with the pretty words of his mythical OMT program. I couldn’t believe that mere narrative could be so powerful. But it is. It’s the most powerful thing in the world. Bad enough that politicians have wielded this power for centuries. Worse that Central Bankers have recently proven to be such adepts. Now that Wall Street and the global banking synod have fully embraced the dark narrative arts? Katy bar the door. Even when the androids of Westworld knew it was just a story, they were hard-wired to respond. So are we.
So put it all together and what do we have? As a citizen I’m on high alert. Political volatility is only going to get worse in Westworld. But as an investor my systemic risk antennae are pretty quiet. Is there stuff to do, long and short? Sure, particularly away from Westworld. But until and unless Draghi starts to taper and Yellen looks to hang a recession around the Donald’s neck with beyond-tapering balance sheet reduction, I don’t see how political risk translates into market risk. And even then you’ve got a powerful volatility reducer in the self-interested Narrative creation of every Wall Street Missionary. Will it last forever? Of course not. The Missionaries, both on Wall Street and in Central Banks, are only human. Inevitably they will disappoint us. Let’s just try not to have a gun pointed at our heads when they do.
President Trump ditches the Paris accord, but almost all big firms say pulling out is an error.
After a poor March jobs report, followed by an April scorcher, the May payrolls report due at 8:30am on Friday will be the tiebreaker, not only for the current state of the economy where both soft and hard data have been deteriorating in recent weeks, but perhaps also for the June rate hike decision, which as the Fed noted in its May FOMC minutes, may not take place without “evidence” that the recent “transitory weakness” in the economy is over. Here are the consensus expectations for tomorrow’s report:
- May Nonfarm Payrolls Exp. 185K (Range 140K to 235K) vs April 211K
- Unemployment Rate Exp. 4.4% (Range 4.30%-4.60%) vs April 4.4%
- Average Hourly Earnings M/M Exp. 0.20%, vs April 0.30%; Y/Y Exp. 2.60%, vs April 2.50%
In terms of overall expectations, the consensus is looking for 185k nonfarm payrolls to be added to the US economy in May – the same as the April consensus – compared to 211k actual jobs added in April. That according to RanSquawk would be in line with the 185k/month pace seen in 2017 thus far. On one hand, there is potential for upside surprise, as per today’s stellar ADP report which came in at 253K, far above the 185K expected. On the other, Goldman believes a favorable swing in the weather between the March and April survey periods boosted last month’s hiring pace, and suggests the 211k pace of April job growth “likely overstates the near-term underlying trend”, as such there will be payback in the May report. Also, Goldman cautions that the ADP measure has been running above official private payroll growth so far this year, by 60k per month on average, so take it with a grain of salt.
The unemployment rate is forecast to hold steady at 4.40%, matching the lowest reading recorded since 2001, and beneath the FOMC’s NAIRU projection between 4.70% and 5.00% (made in its March forecasts). A 4.4% print would be stronger than the Fed’s own year end forecast of 4.50%. If May unemployment stays at or near that level, it would be further evidence the economy has reached full employment and is at full capacity, meaning virtually everyone seeking work has found a job, even if that doesn’t explain why wage growth remains anemics. If the rate dips lower, that could put upward pressure on wages and inflation, or alternatively it will prompt questions about the quality of jobs added.
As a result, most of the attention is likely to fall on the earnings data for signs of inflationary pressures. Average hourly earnings (AHE) are seen rising by 0.20% M/M, easing a touch from the +0.30% pace seen in April. On an annualised basis, the pace of AHE growth is seen rising by 0.10 ppts to 2.60%. In its latest Beige Book, the Fed stated that “most firms across the districts noted little change to the recent trend of modest to moderate wage growth,” though many firms reported offering higher wages to attract workers “where shortages were most severe.” According to RanSquawk, HSBC notes that though wage growth has picked up, as of late, it remains sluggish when compared to previous cycles. Looking at the May wage number in particular, Goldman warns there may be a negative surprise pointing out that the May payroll period ended on the 13th, which is associated with meaningfully below-average wage growth.
We estimate nonfarm payrolls increased 170k in May, a moderate slowdown from April’s +211k pace and modestly below the three-month moving average of +174k. While labor market fundamentals remained broadly stable – featuring a further decline in continuing jobless claims – recent deterioration in service sector employment surveys suggests hiring may be slowing at the margin. We also believe a favorable swing in the weather between the March and April survey periods suggests the 211k pace of April job growth likely overstates the near-term underlying trend, which we believe is closer to 175k (and should slow further as the economy moves beyond full employment). Relatedly, May is also an important hiring month, and labor supply constraints in some geographies and industries suggest some additional downside risk. On the positive side, both jobless claims and the ADP report suggest more favorable labor market fundamentals, and the end of the federal hiring freeze suggests scope for above-trend growth in federal employment.
On wages, Goldman warns there may be disappointment:
We estimate average hourly earnings increased 0.2% month over month and 2.5% year over year in May, reflecting the interaction of firming wage growth with negative calendar effects. The May payroll period ended on the 13th, which in our model is associated with meaningfully below-average wage growth. However, we are more constructive on wage growth generally, exemplified by the acceleration in the employment cost index to a cycle-high pace in Q1.
Factors arguing for a stronger report:
- Jobless claims. Initial claims for unemployment insurance benefits declined, averaging 241k during the four weeks between the April and May payroll survey periods, a new cycle low. Additionally, continuing claims dropped by an encouraging 63k from survey week to survey week, roughly the same pace as in the prior month.
- ADP. The payroll processing firm ADP reported a 253k increase in private payroll employment in April – above consensus expectations – suggesting a solid underlying pace of job growth. The ADP measure has been running above official private payroll growth so far this year (by 60k per month on average), and we believe the May ADP reading received a boost from the net strength in the financial and economic indicators also used in their model. These considerations make the task of teasing out the underlying signal from the report more difficult.
- End of federal hiring freeze. The administration’s hiring freeze n for federal workers (excluding defense and public safety) went into effect on January 23 and concluded on April 11 – the Tuesday of the April survey week. Its impact on overall payrolls appears fairly limited, with average monthly payroll growth in these categories slowing from +3k in 2016 to -4k during the three months of the freeze. The impact also seems minor when compared to federal job growth during the 1981 federal hiring freeze at the start of the Reagan administration (see Exhibit 2). Assuming the 2016 trend in labor demand growth continued this year, the cumulative impact of the 2017 freeze was approximately -20k (on the level of federal payrolls). Accordingly, we see some scope for an above-trend reading in tomorrow’s report, reflecting pent-up labor demand (we assume +10k for total government payrolls).
Arguing for a weaker report:
- Service sector surveys. Service-sector employment surveys n have deteriorated somewhat in recent months, with the ISM non-manufacturing survey falling to 51.4 in April (from its recent high of 55.2 in February) and available May surveys weakening on net. Our overall non-manufacturing employment tracker fell to 53.4 in May from 54.4 in April, with declines in the Philly Fed and Richmond Fed employment subindices but improvement in the New York Fed and Dallas Fed measures. More encouragingly, the key labor market subcomponent of the Consumer Confidence report remained strong, rebounding 0.8pt to 11.7, not far from its cycle-high reading. Service sector payroll employment grew 173k in April and has increased 129k on average over the last six months.
- Labor supply constraints. We view the labor market as close to full employment, with the unemployment rate roughly 0.3pp below its structural rate and yesterday’s Beige Book referencing increased reports of labor supply constraints. As slack diminishes further, this should exert both upward pressure on wages and downward pressure on job growth. From a hiring perspective, May is a particularly important month, with non-seasonally adjusted payroll growth averaging 838k over the last five May reports. As shown in Exhibit 3, we find that payroll growth tends to slow during late spring in years with relatively tight labor markets, as defined by an above-median Q1 employment gap (i.e. 2017).1. Labor constraints appear particularly binding in May (and August) in these years. One potential explanation is that the May payroll period occurs after much of the start-of-year seasonal slack has been wound down (earlier in the Spring hiring season) but before the entry of students and recent graduates into the labor force (in late May and June).
- Continued retail weakness. Retail employment growth has fallen n from its historical trend of 15-20k per month to -2k on average over the past six months. We believe the structural shift of retail sales from brick and mortar stores toward less labor-intensive e-commerce firms will continue to weigh on payrolls growth in that industry, with the impact on the order of 10k per month relative to its previous trend. This drag on retail employment has appeared particularly pronounced recently – with a 50k cumulative drop in retail payrolls over the last three months – and we note the possibility that weak brick and mortar sales trends in Q1 may be accelerating the pace of this structural shift. Similarly, we note the possibility that the weakness in April home sales and housing construction may have weighed on hiring in that industry.
- Seasonals. Since 2010, May payroll growth has surprised negatively relative to consensus in four of the seven instances. While this is only slightly more than half the time, the average surprise has been fairly sizeable at -50k over this period. This may suggest downside risk to the extent the BLS seasonal factors have not fully evolved to reflect this tendency.
- Job cuts. Announced layoffs reported by Challenger, Gray & Christmas after our seasonal adjustment rose sharply (+28k to 59k, a one-year high). Over half of the increase reflects a 20k layoff announcement at Ford Motor that was announced after the May payroll survey period. After taking into this account, the increase in May job cuts was more modest
- Return to Normal Weather. We believe the early-March winter storms likely exerted a meaningful drag on March payroll growth and provided a boost to April. Winter Storm Stella hit the Midwest and East Coast at the beginning of the March survey week, with the level of population-weighted snowfall during a March survey week at its highest since at least 2005. This suggests the April employment report may have benefitted from workers in the establishment survey returning to their jobs in some industries. Our preferred aggregate of weather-sensitive industries (construction, retail, and leisure and hospitality) also rebounded, to +66k from -17k in March. Accordingly, we believe headline job growth in April likely overstates the near-term trend, suggesting scope for moderation in May.
- Manufacturing sector surveys. Employment components of manufacturing n sector surveys were mixed in May, with improvement in the ISM manufacturing employment component (+1.5 to 53.5), but deterioration in several regional surveys, including the Philly Fed, New York Fed, and Dallas Fed employment components as well as the Markit PMI subindex. Our overall manufacturing employment tracker pulled back to 0.6pt to 55.7, still a healthy level. Manufacturing payroll employment rose 6k in April, its fifth consecutive increase, and has increased 12k on average over the last six months.
- Job availability. The Conference Board’s Help Wanted Online (HWOL) report showed a rebound in May online job postings (+4%) following April’s 1% pullback. However, we continue to place limited weight on this indicator at the moment, in light of research by Fed economists that suggests the HWOL ad count has been depressed by higher prices for online job ads.
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Impact on Fed policy:
- With the implied probability of a June hike at around 96%, it would likely take a horrific report to stop the Fed from lifting rates by 25bps. With the rate of joblessness below the Fed’s estimate of NAIRU, as well as its end-2017 target, it would likely look through a big headline miss, so long as wages don’t collapse.
- Many Fed speakers have been paying particularly close attention to wages, observing that they have been a notable weakness.
- Fed’s Kashkari (voter, dove) last month said there may be more slack in the labour market, arguing that stronger wage growth may pull more people back into the labour market, helping participation to rise.
- Fed’s Evans (voter, dove) points out that across the board wage growth has not proceeded as quickly as the Fed would have thought. A sentiment that has also been touched on by the Fed’s Kaplan (voter, slightly hawkish) too.
- Fed’s Williams (non-voter, centrist) went further, and described wages as “stubbornly soft.”
- In terms of Fed hikes, even if wages missed, it may still not be enough to derail the Fed’s hike plans. Pantheon Macroeconomics has argued that in the previous cycle, the Fed lifted rates when AHE were running at 2.60% Y/Y, and it then accelerated sharply to 4.00% within five quarters.
- Given rate changes operate with a four/five quarter lag, Pantheon says the Fed will be aware of the dangers of leaving it too late to raise rates.
Possible market reaction
- The market is pricing in just one full hike in 2017, with the implied probability of two hikes slightly better than a coin flip.
- An upside surprise in the Employment Situation Report may contribute to a repricing where the market converges towards the Fed’s forecasts, though with clear doubts about whether inflation can sustainably pick-up towards the Fed’s inflation goal (PCE has been easing as of late), it is unlikely the market and Fed’s view will converge.
- Given past market reactions, a likely expression to an upside surprise may be a flattening of 2s10s, a sell-off in the long-end, which could help to lift the dollar.
- Stocks are almost guaranteed to go up no matter the actual data.
Every year, the world’s richest and most powerful business executives, bankers, media heads and politicians sit down in some luxurious and heavily guarded venue, and discuss how to shape the world in a way that maximizes profits for all involved, while perpetuating a status quo that has been highly beneficial for a select few, even if it means the ongoing destruction of the middle class. We are talking, of course, about the annual, and always secretive, Bilderberg meeting.
And just like last year’s meeting in Dresden, the primary topic on the agenda of this year’s 65th Bilderberg Meeting which starts today and ends on Sunday, is one: Donald Trump.
Ironically, this year “the storm around Donald Trump” as the SCMP puts it, is not half way around the world, but just a few miles west of the White House, in a conference centre in Chantilly, Virginia, where the embattled president will be getting his end-of-term grades from the people whose opinion actually matters: some 130 participating “Bilderbergs”.
The secretive three-day summit of the political and economic elite kicks off Thursday in heavily guarded seclusion at the Westfields Marriot, a luxury hotel a short distance from the Oval Office.
As of Wednesday, the hotel was already on lockdown and an army of landscapers have been busy planting fir trees around the perimeter, to try protect “coy billionaires and bashful bank bosses” from prying lenses and/or projectiles. Perched ominously at the top of the conference agenda this year are these words: “The Trump Administration: A progress report”.
So is the president going to be put in detention for tweeting in class? Held back a year? Or told to empty his locker and leave? If ever there’s a place where a president could hear the words “you’re fired!”, it’s Bilderberg.
Sarcasm aside, the White House was taking no chances, sending along some big hitters from Team Trump to defend their boss: national security adviser, HR McMaster; the commerce secretary, Wilbur Ross; and Trump’s new strategist, Chris Liddell (curiously, neither Gary Cohn nor Steven Mnuchin will be there although the controversial new Chairman of Goldman Sachs International, Jose Barroso will be present). Could Trump himself show up to receive his report card in person: we are confident he will tweet all about it… which is probably why he will never be invited.
Stil, none other than Henry Kissinger, the gravel-throated kingpin of Bilderberg, visited the White House a few weeks ago to discuss “Russia and other things”, and certainly, the Bilderberg conference would be the perfect opportunity for the most powerful man in the world to discuss important global issues with Trump.
Sarcasm aside, what are among the “Trump agenda” items to be discussed? The publicly list is as follows:
- The Trump Administration: A progress report
- Trans-Atlantic relations: options and scenarios
- The Trans-Atlantic defence alliance: bullets, bytes and bucks
- The direction of the EU
- Can globalisation be slowed down?
- Jobs, income and unrealised expectations
- The war on information
- Why is populism growing?
- Russia in the international order
- The Near East
- Nuclear proliferation
- Current events
The US president’s extraordinary chiding of NATO leaders in Brussels is sure to be first and foremost on the Bilderberg discussing panel. The Bilderbergers have summoned the head of Nato, Jens Stoltenberg, to give feedback. Stoltenberg will be leading the snappily titled session on “The Transatlantic defence alliance: bullets, bytes and bucks”. He’ll be joined by the Dutch minister of defence and a clutch of senior European politicians and party leaders, all hoping to reset the traumatised transatlantic relationship after Trump’s galumphing visit.
As the Guardian puts it, the guest list for this year’s conference is a veritable “covfefe” of big-hitters from geopolitics, from the head of the IMF, Christine Lagarde, to the king of Holland, but perhaps the most significant name on the list is Cui Tiankai, China’s ambassador to the US.
According to the meeting’s agenda, “China” will also be discussed at a summit attended by Cui, the US commerce secretary, the US national security adviser, two US senators, the governor of Virginia, two former CIA chiefs and any number of giant US investors in China, including the heads of the financial services firms the Carlyle Group and KKR. And for good reason: as last night’s PMI numbers showed, the Chinese economy – the global growth dynamo – is finally contracting. If China goes, the rest of the world will follow.
Additionally, the boss of Google Eric Schmidt, who warned in January that Trump’s administration will do “evil things”, is expected to attend, too. The executive chairman of Alphabet, Google’s holding company, has just come back from a trip to Beijing, where he was overseeing Google AI’s latest game of Go against humans. He declared it “a pleasure to be back in China, a country that I admire a great deal”. It’s possible three days spent chatting to the Chinese ambassador could even be good for business.
Several journalists are participating in this year’s forum, including London Evening Standard editor George Osborne and Cansu Camlibel, the Washington bureau chief for Turkey’s Hurriyet newspaper. But per convention, news outlets are not invited to cover the event.
“There is no desired outcome, no minutes are taken and no report is written,” the group stated. “Furthermore, no resolutions are proposed, no votes are taken, and no policy statements are issued.”
Ex-deputy secretary of state William Burns and former deputy assistant secretary of defence Elaine Bunn, both Obama-era officials, will also attend. Burns, the current president of the Carnegie Endowment for International Peace, has warned that Trump “risks hollowing out the ideas, initiative and institutions on which US leadership and international order rest.”
With one of the agenda items titled simply enough “can globalisation be slowed down?” it is no surprise that anti-globalisation protesters have already descended on the location of the meeting.
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Below is a full list of this year’s participants:
- Castries, Henri de (FRA), Former Chairman and CEO, AXA; President of Institut Montaigne
- Achleitner, Paul M. (DEU), Chairman of the Supervisory Board, Deutsche Bank AG
- Adonis, Andrew (GBR), Chair, National Infrastructure Commission
- Agius, Marcus (GBR), Chairman, PA Consulting Group
- Akyol, Mustafa (TUR), Senior Visiting Fellow, Freedom Project at Wellesley College
- Alstadheim, Kjetil B. (NOR), Political Editor, Dagens Næringsliv
- Altman, Roger C. (USA), Founder and Senior Chairman, Evercore
- Arnaut, José Luis (PRT), Managing Partner, CMS Rui Pena & Arnaut
- Barroso, José M. Durão (PRT), Chairman, Goldman Sachs International
- Bäte, Oliver (DEU), CEO, Allianz SE
- Baumann, Werner (DEU), Chairman, Bayer AG
- Baverez, Nicolas (FRA), Partner, Gibson, Dunn & Crutcher
- Benko, René (AUT), Founder and Chairman of the Advisory Board, SIGNA Holding GmbH
- Berner, Anne-Catherine (FIN), Minister of Transport and Communications
- Botín, Ana P. (ESP), Executive Chairman, Banco Santander
- Brandtzæg, Svein Richard (NOR), President and CEO, Norsk Hydro ASA
- Brennan, John O. (USA), Senior Advisor, Kissinger Associates Inc.
- Bsirske, Frank (DEU), Chairman, United Services Union
- Buberl, Thomas (FRA), CEO, AXA
- Bunn, M. Elaine (USA), Former Deputy Assistant Secretary of Defense
- Burns, William J. (USA), President, Carnegie Endowment for International Peace
- Çakiroglu, Levent (TUR), CEO, Koç Holding A.S.
- Çamlibel, Cansu (TUR), Washington DC Bureau Chief, Hürriyet Newspaper
- Cebrián, Juan Luis (ESP), Executive Chairman, PRISA and El País
- Clemet, Kristin (NOR), CEO, Civita
- Cohen, David S. (USA), Former Deputy Director, CIA
- Collison, Patrick (USA), CEO, Stripe
- Cotton, Tom (USA), Senator
- Cui, Tiankai (CHN), Ambassador to the United States
- Döpfner, Mathias (DEU), CEO, Axel Springer SE
- Elkann, John (ITA), Chairman, Fiat Chrysler Automobiles
- Enders, Thomas (DEU), CEO, Airbus SE
- Federspiel, Ulrik (DNK), Group Executive, Haldor Topsøe Holding A/S
- Ferguson, Jr., Roger W. (USA), President and CEO, TIAA
- Ferguson, Niall (USA), Senior Fellow, Hoover Institution, Stanford University
- Gianotti, Fabiola (ITA), Director General, CERN
- Gozi, Sandro (ITA), State Secretary for European Affairs
- Graham, Lindsey (USA), Senator
- Greenberg, Evan G. (USA), Chairman and CEO, Chubb Group
- Griffin, Kenneth (USA), Founder and CEO, Citadel Investment Group, LLC
- Gruber, Lilli (ITA), Editor-in-Chief and Anchor “Otto e mezzo”, La7 TV
- Guindos, Luis de (ESP), Minister of Economy, Industry and Competiveness
- Haines, Avril D. (USA), Former Deputy National Security Advisor
- Halberstadt, Victor (NLD), Professor of Economics, Leiden University
- Hamers, Ralph (NLD), Chairman, ING Group
- Hedegaard, Connie (DNK), Chair, KR Foundation
- Hennis-Plasschaert, Jeanine (NLD), Minister of Defence, The Netherlands
- Hobson, Mellody (USA), President, Ariel Investments LLC
- Hoffman, Reid (USA), Co-Founder, LinkedIn and Partner, Greylock
- Houghton, Nicholas (GBR), Former Chief of Defence
- Ischinger, Wolfgang (INT), Chairman, Munich Security Conference
- Jacobs, Kenneth M. (USA), Chairman and CEO, Lazard
- Johnson, James A. (USA), Chairman, Johnson Capital Partners
- Jordan, Jr., Vernon E. (USA), Senior Managing Director, Lazard Frères & Co. LLC
- Karp, Alex (USA), CEO, Palantir Technologies
- Kengeter, Carsten (DEU), CEO, Deutsche Börse AG
- Kissinger, Henry A. (USA), Chairman, Kissinger Associates Inc.
- Klatten, Susanne (DEU), Managing Director, SKion GmbH
- Kleinfeld, Klaus (USA), Former Chairman and CEO, Arconic
- Knot, Klaas H.W. (NLD), President, De Nederlandsche Bank
- Koç, Ömer M. (TUR), Chairman, Koç Holding A.S.
- Kotkin, Stephen (USA), Professor in History and International Affairs, Princeton University
- Kravis, Henry R. (USA), Co-Chairman and Co-CEO, KKR
- Kravis, Marie-Josée (USA), Senior Fellow, Hudson Institute
- Kudelski, André (CHE), Chairman and CEO, Kudelski Group
- Lagarde, Christine (INT), Managing Director, International Monetary Fund
- Lenglet, François (FRA), Chief Economics Commentator, France 2
- Leysen, Thomas (BEL), Chairman, KBC Group
- Liddell, Christopher (USA), Assistant to the President and Director of Strategic Initiatives
- Lööf, Annie (SWE), Party Leader, Centre Party
- Mathews, Jessica T. (USA), Distinguished Fellow, Carnegie Endowment for International Peace
- McAuliffe, Terence (USA), Governor of Virginia
- McKay, David I. (CAN), President and CEO, Royal Bank of Canada
- McMaster, H.R. (USA), National Security Advisor
- Micklethwait, John (INT), Editor-in-Chief, Bloomberg LP
- Minton Beddoes, Zanny (INT), Editor-in-Chief, The Economist
- Molinari, Maurizio (ITA), Editor-in-Chief, La Stampa
- Monaco, Lisa (USA), Former Homeland Security Officer
- Morneau, Bill (CAN), Minister of Finance
- Mundie, Craig J. (USA), President, Mundie & Associates
- Murtagh, Gene M. (IRL), CEO, Kingspan Group plc
- Netherlands, H.M. the King of the (NLD)
- Noonan, Peggy (USA), Author and Columnist, The Wall Street Journal
- O’Leary, Michael (IRL), CEO, Ryanair D.A.C.
- Osborne, George (GBR), Editor, London Evening Standard
- Papahelas, Alexis (GRC), Executive Editor, Kathimerini Newspaper
- Papalexopoulos, Dimitri (GRC), CEO, Titan Cement Co.
- Petraeus, David H. (USA), Chairman, KKR Global Institute
- Pind, Søren (DNK), Minister for Higher Education and Science
- Puga, Benoît (FRA), Grand Chancellor of the Legion of Honor and Chancellor of the National Order of Merit
- Rachman, Gideon (GBR), Chief Foreign Affairs Commentator, The Financial Times
- Reisman, Heather M. (CAN), Chair and CEO, Indigo Books & Music Inc.
- Rivera Díaz, Albert (ESP), President, Ciudadanos Party
- Rosén, Johanna (SWE), Professor in Materials Physics, Linköping University
- Ross, Wilbur L. (USA), Secretary of Commerce
- Rubenstein, David M. (USA), Co-Founder and Co-CEO, The Carlyle Group
- Rubin, Robert E. (USA), Co-Chair, Council on Foreign Relations and Former Treasury Secretary
- Ruoff, Susanne (CHE), CEO, Swiss Post
- Rutten, Gwendolyn (BEL), Chair, Open VLD
- Sabia, Michael (CAN), CEO, Caisse de dépôt et placement du Québec
- Sawers, John (GBR), Chairman and Partner, Macro Advisory Partners
- Schadlow, Nadia (USA), Deputy Assistant to the President, National Security Council
- Schmidt, Eric E. (USA), Executive Chairman, Alphabet Inc.
- Schneider-Ammann, Johann N. (CHE), Federal Councillor, Swiss Confederation
- Scholten, Rudolf (AUT), President, Bruno Kreisky Forum for International Dialogue
- Severgnini, Beppe (ITA), Editor-in-Chief, 7-Corriere della Sera
- Sikorski, Radoslaw (POL), Senior Fellow, Harvard University
- Slat, Boyan (NLD), CEO and Founder, The Ocean Cleanup
- Spahn, Jens (DEU), Parliamentary State Secretary and Federal Ministry of Finance
- Stephenson, Randall L. (USA), Chairman and CEO, AT&T
- Stern, Andrew (USA), President Emeritus, SEIU and Senior Fellow, Economic Security Project
- Stoltenberg, Jens (INT), Secretary General, NATO
- Summers, Lawrence H. (USA), Charles W. Eliot University Professor, Harvard University
- Tertrais, Bruno (FRA), Deputy Director, Fondation pour la recherche stratégique
- Thiel, Peter (USA), President, Thiel Capital
- Topsøe, Jakob Haldor (DNK), Chairman, Haldor Topsøe Holding A/S
- Ülgen, Sinan (TUR), Founding and Partner, Istanbul Economics
- Vance, J.D. (USA), Author and Partner, Mithril
- Wahlroos, Björn (FIN), Chairman, Sampo Group, Nordea Bank, UPM-Kymmene Corporation
- Wallenberg, Marcus (SWE), Chairman, Skandinaviska Enskilda Banken AB
- Walter, Amy (USA), Editor, The Cook Political Report
- Weston, Galen G. (CAN), CEO and Executive Chairman, Loblaw Companies Ltd and George Weston Companies
- White, Sharon (GBR), Chief Executive, Ofcom
- Wieseltier, Leon (USA), Isaiah Berlin Senior Fellow in Culture and Policy, The Brookings Institution
- Wolf, Martin H. (INT), Chief Economics Commentator, Financial Times
- Wolfensohn, James D. (USA), Chairman and CEO, Wolfensohn & Company
- Wunsch, Pierre (BEL), Vice-Governor, National Bank of Belgium
- Zeiler, Gerhard (AUT), President, Turner International
- Zients, Jeffrey D. (USA), Former Director, National Economic Council
- Zoellick, Robert B. (USA), Non-Executive Chairman, AllianceBernstein L.P.
Natrually, the secretive nature of the group has given birth to conspiracy theories. Some have claimed that the Bilderberg is a group of rich and powerful kingmakers seeking to impose a one world government. Whether that is true remains in the eye of the beholder, however one thing is clear: as the graph below shows, the members are connected to virtually every important and relevant organization, media outlet, company and political entity in the world.
Over the past three years, gold has found itself in an odd place: while it still remains the ultimate “safety” trade and store of value should everything go to hell following social and monetary collapse, when it comes to “coolness” it has been displaced by various cryptocurrencies, all of which have vastly outperformed the yellow metal in recent months. Meanwhile, central banks continue to pressure the price of gold to avoid a repeat of 2011 when gold nearly broke out above $2,000, putting the fate world’s “reserve currency” increasingly under question. As a result, gold has traded in a rather somnolent fashion, range bound between $1,100 and $1,300 over the last few years, failing to break out on either side.
But is that a fair price for gold?
That is the question Deutsche Bank’s Grant Sporre set out to answer in a special report released overnight, which among other things finds that gold is a “metal” full of paradoxes.
Here is what Deutsche Bank found: as Sporre contends, in order to determine whether gold is cheap or expensive, one must first define what gold actually is.
At its simplest form and yes we are stating the obvious, gold is a shiny yellow metal, relatively scarce and mined from the earth’s crust. Valuing the metal should then be just as easy? Gold is a simple commodity, governed by supply and demand, and valuing it should bear some relationship to the cost of digging it out of the earth? But it turns out; gold’s nature is far more mercurial. Gold can be many things to many different people – a store of value, a financial asset, a medium of exchange, a currency, an insurance policy against disruptive events or global uncertainty and even a “barbarous relic*” according to John Maynard Keynes. (*As with any famous quote, there are suggestions that the term was not originally coined by Keynes himself, nor that he was actually referring to gold, but rather to the constraints of the gold standard at the time).
All of this means that finding an absolute valuation method which will be accepted by all is rather optimistic; and that the value of gold is more likely to be determined on a relative basis depending on the individual’s perception of gold.
Whilst we contend that there is something of an art to valuing gold, we have used a more scientific framework to come up with that true fair value. There are flaws in any one of the individual approaches, and even averaging out the different approaches still seems like a bit of a cop out. However, in our table below the average of all the selected metrics would suggest that gold should trade around USD1,015/oz, with relative G7 per capita income valuing gold at USD735/oz, whilst the bloated size of the big four central bank balance sheets suggesting that gold should travel at USD1,648/oz.
Here is a summary of DB’s findings:
And DB’s take: the reason why gold is trading with a roughly 20% premium to “fair value” is because “there is a heightened perception of risk or uncertainty in the broader markets.“
Although gold screens as expensive, there is a short term scenario (3 month) which would justify gold trading higher, in our view. In the near term, our US rates economist Dominic Konstam sees scope for the US 10-year bond yield to fall to 2% (before rising to 2.75% by year-end), as falling excess liquidity points to softer US growth momentum ahead. If we apply a US 10 year bond yield of 2%, a USD 2% weaker from current levels (not our FX strategist view) and the S&P500 down 5% from current levels, our fair value model points to a gold price of USD1,320/oz.
Our own simple four factor model points to a value of USD1,185/oz. Our conclusion is that gold is still trading at a premium versus a wide variety of metrics; 20% versus the average or 6% versus our fair value model. This suggests to us that the certainly through the lens of gold, there is a heightened perception of risk or uncertainty in the broader markets.
And some additional thoughts from DB on how it scores gold’s value across its various roles in society:
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Gold as a commodity – scarce but always in surplus?
Many investors are uncomfortable with treating gold as a commodity in that gold is not “consumed” like other commodities – it is not eaten, or burned or forged as food, energy or industrial metals would be. At first glance the price of gold relative to the marginal producer on the cost curve would provide a perfect yardstick to determining the fair value of gold. There are however two fundamental problems with this method. The first is that the conventional supply demand analysis does not work very well for gold. Partly due to its value and enduring nature (and high incentive to recycle), very little gold is actually consumed or lost every year. Thus every year, we add to the stocks of gold, with the industrial surplus being “consumed” by financial investors. We would argue that even the jewellery market is not “pure” consumption and the motivation is linked to a store of wealth.
Gold’s price trajectory relative to the marginal producer on the cost curve should be reasonable determinant of value. However, the mined supply of gold is relatively stable and only responds to pricing signals with a four to five year lag. Gold has been falling since 2012, the bump in 2016 notwithstanding and we only forecast mined supply to finally decline in 2017. It turns out, the gold miners are very good at adjusting their cost bases to the prevailing gold price, not least by targeting the richer parts of their ore bodies. The practice of “high grading” is much frowned upon in the industry, as certain less economic parts of the ore body may be sterilized thereby reducing the NPV of the mine. However, when faced with significant cash burn, many miners have little choice.
If indeed gold is a commodity, gold’s perceived value relative to copper and oil should revert to a long run equilibrium level, based on the relative abundance of various commodities in the earth’s crust. There is no doubt that gold is scarce relative to copper for instance (10,000x less abundant). However the perception of utility will vary according to global growth. In a high global growth environment, copper should be seen as more valuable relative to gold.
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Gold as Money – a medium of exchange with little intrinsic value?
Gold is often seen as a medium of exchange and one that is officially recognized (if not publically used as such) in our view. Simply, gold is widely held by most of the world’s larger central banks as a component of reserves. The ideal medium of exchange must balance the paradox of representing value while having little intrinsic value itself. Fiat currencies physically have no use other than that which is ascribed to them by government and accepted by the public. Arguably, gold is a purer form of money because it actually costs something to produce, compared to fiat currencies which cost very little. However, the concept of relative scarcity or abundance comes into play. If the rate at which fiat currencies have been printed exceeds that rate at which gold has been mined, then ceteris paribus, gold should become scarcer and rerate versus fiat currencies. Since 2005, central bank balance sheets have expanded nearly fourfold. In contrast the global above ground stocks of gold have expanded a mere 20%. The gold price has rerated accordingly, but not enough to keep the value of gold at parity with the global (big four central banks to be precise) money stock. The average ratio since 2005 between global money stocks and the value of global gold stocks is c.1.8x. In order for gold to get back to this level, the price should appreciate to USD1,648/oz, nearly USD300/oz above the current spot price.
If we assume that gold reverts to the long run ratio of these two commodities, then at an oil price of USD50/bbl, gold should be trading at USD840/oz, and at a copper price of USD5,600/t, gold should be trading at USD960/oz. Gold remains expensive versus other commodities
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Gold as a store of value – capital appreciation but no yield
We all need ways to store the fruits of our physical or intellectual labour for use at a later stage. We all have our preferences, be it bricks and mortar, the equity markets or gold. It depends on your confidence in how well you believe your asset of choice will preserve and in many instances grow your wealth or capital. We have examined the level of the gold price in real terms i.e. versus US CPI, relative to the per capita income and versus an alternative financial asset, the US equity market.
In terms of the relationship between gold and the S&P500, we have adjusted both for inflation and applied a further equity time value adjustment. Both should rise with inflation, but the S&P 500 should rise more and its retained and reinvested earnings should generate real EPS growth. We find that the adjusted gold to S&P500 ratio at 0.65x is still above its historical average of 0.54x. To bring this ratio back to its long run average would require the gold price to fall to USD990/oz. The average G7 per capita income since 1971 could buy just over 62 ounces of gold. Currently the average per capita income can purchase 47 ounces which implies that gold should trade at USD740/oz.
The real gold price average since 1971 when the gold standard was relinquished in the US is USD735/oz in PPI adjusted terms and USD810/oz in CPI adjusted terms.
Gold as a measure of market uncertainty
In order to adjust for the current gap between the actual gold price and our model forecast, we have adjusted our model (yes all models have dummy variables to account for the periods when they don’t quite work) for global risk perceptions. The adjustment we apply is simply a risk perceptions adjustment factor derived by plotting the model residual against the VIX index. We note that any significant period above 20 on the VIX index causes gold to trade above its “fair value”. The scale we apply ranges from -20 to 20, with each point accounting for USD10/oz. This is the minimum and maximum range of the deviation. The current gap of USD80/oz or 8 on our scale would suggest an above average sense of risk or uncertainty in the market. If we apply the DB house view forecasts at year end for the US 10 year bond yield of 2.75%, a US 10 year break even of 2.15%, an S&P year-end target of 2600, IMF gold purchases of 5 tonnes and a USD up 7.6% versus the broad trade weighted basket, then gold should trade all the way down to USD1,031/oz. Even if we increase our risk perception index from 8 to 12, this brings us back to USD1,150/oz by year end. In the near term however, our US rates economist Dominic Konstam sees scope for the US 10-year bond yield to fall to 2% (before rising to 2.75% by year-end), as falling excess liquidity points to softer US growth momentum ahead. If we apply a US 10 year bond yield of 2%, a USD down 2% from current levels and the S&P500 down 5% from current levels, our fair value model points to a gold price of USD1,320/oz.
Attorney Elizabeth Lee Beck’s office received a call just before 5PM on Thursday from an individual who was apparently using a ‘robotic and genderless’ voice changing device, sniffing around with questions about the DNC lawsuit filed over cheating in the 2016 election. The suit – based on documents released by hacker Guccifer 2.0, claims that the DNC colluded with Sec. Hillary Clinton’s campaign ‘to perpetrate a fraud on the public.’ (see more here)
After a brief chat with the law firm’s secretary, the ‘mysterious’ voice-masking caller concluded the call with an ‘Okey dokey.’
And whose number showed up when the law firm turned around and googled the number from the caller ID? Why, who else but Debbie Wasserman Schultz’ Aventura office!
— ZeroPointNow (@ZeroPointNow) June 2, 2017