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Input 15.09.2022

“The energy of the mind is the essence of life” Aristoleles

Good day,

Expect price inflation at the end of the year to be around 8.0%, down a bit from the peak of 9.1% in June, but still high. Inflation will likely fall to around 3%-4% by the end of next year since it remains a question to what extend energy prices are manipulated by political sources.

Oil prices did correct more than -30% from peak prices from USD 130/barrel, and consum-ers keep paying high gasoline prices at the pump – vide our reflections from 13.5.2022 on taxes imposed – is this part of the “green inflation”?

Why is gold peaking? Gold’s reputation as a reliable hedge against inflation seems at risk. Is there something we are not aware of? In mid-2022, measures of U.S. inflation were hitting multi-decade highs. The last time the U.S. experienced out-of-control inflation was in the 1970s and early 1980s. Looking back at this period provides insight into why investors think of gold as a hedge against inflation.

Oil price shocks and energy shortages drove average annual inflation in the U.S. to around 8.8% from 1973 to 1979. During those six years, gold won over many investors as a top inflation hedge since the yellow metal generated an impressive 35% annualized return.

Gold’s performance since that time has been disappointing. From 1980 to 1984, annual inflation averaged 6.5%, but gold prices fell 10% on average each year. Returns not only fell short of the inflation rate, but they also underperformed real estate, commodities and the S&P 500.

Annual inflation averaged about 4.6% from 1988 to 1991, but gold prices fell approximately 7.6% a year on average. Gold may not have offered the best protection against inflation over the past two years, but it has certainly outperformed another widely touted inflation hedge: crypto currencies – which have a dirty little secret that is very relevant to the real world: it uses a lot of energy. How much energy? It is estimated that Bitcoin consumes electricity at an annualized rate of 127 terawatt-hours (TWh). That usage exceeds the entire annual electricity consumption of Norway.

https://www.ecb.europa.eu/press/key/date/2022/html/ecb.sp220317_2~dbb3582f0a.en.html

At least politics, and not central banks can control it, such as the mania around Electric vehicles (EVs), where we question their true footprint on sustainability. EVs have no tailpipe emissions. Generating the electricity used to charge EVs, however, may create carbon pollution. The amount varies widely based on how local power is generated, e.g., using coal or natural gas, which emit carbon pollution, versus renewable resources like wind or solar, which do not. Lithium-ion batteries are expensive to manufacture, partly due to the high cost of cobalt, mainly mined in the Democratic Republic of Congo (DRC). Cobalt extraction is the largest source of DRC’s export income, and the country accounted for more than two-thirds of global cobalt production in 2021. While some carmakers have started building cobalt-free batteries—many Tesla batteries now rely instead on lithium phosphate—the demand for the hard, lustrous gray material is only likely to increase. The same is true for lithium, nickel, and other materials inside these batteries, which are mined in Russia, Indonesia, and other places where environmental oversight is often poor, labor standards are often lax, and where mining companies have been known to fuel conflicts with local communities. The European Union already regulates EV battery disposal under an “extended producer responsibility” scheme and is set to update its regulations to set specific targets for minerals recovery.

The Economist article of 8 September 2022 puts it in a nutshell: “For a year Europe has lived under the shadow of an energy blockade as Vladimir Putin threatened to turn off the gas taps to the continent. Now the threat has become reality and the prospect of a cold, dark winter is hitting home. On September 5th Russia said it will shut down its Nord Stream pipeline for as long as Western sanctions are in place, sending benchmark gas prices surging by another 30%; they currently stand at the equivalent of around $400 for a barrel of oil. At today’s futures prices, annual spending on electricity and gas by consumers and firms across the European Union could rise to a staggering €1.4trn, up from €200bn in recent years, reckons Morgan Stanley, a bank. The energy shock is now a full-blown political and economic crisis. Already 14% of families in Britain are behind on their utility bills. ArcelorMittal, a steelmaker, will shut down a plant in Bremen. As consumers and businesses reel and a recession looms, behind the scenes there is chaos in energy markets. Because Europe’s power prices are set by the costs of the marginal producer, which is often gas-fired, the gas surge has become an electricity shock, too. Everything that is happening around us triggers sustainable behaviour, which all of us born before the millennials still do/should remember. The question remains, however, how (green) politics, Germany being a bad example, deals with all this.

In the past, the top of an inflation cycle was a great time to reenter the stock market. After the December 1974 inflation peak of 12.2%, the S&P 500 gained about a 37% annual return, after posting around a 26% loss the prior year, according to data from the NYU Stern School of Business on “Historical Returns on Stocks, Bonds and Bills: 1928-2021.”

It is very likely that interest rates are peaking as well, especially considering the sharp upside correction, in comparison with the past – this again could stimulate stock markets.

Certainly, there is a lot of skepticism currently that the recent positive trends in equity markets can be regained. Positioning among investors is very defensive and concerns that earnings estimates might be too high given the more difficult macro environment are abundant.

So far, companies have proven resilient. In particular, high profit margins have been maintained despite continued price pressure.

The risk of a significant slowdown in growth or a recession remains above average due to the persistently restrictive monetary policy and the geopolitical situation. The inversion of the yield curve signals the danger of a hard landing for the economy.

The ongoing adjustment of monetary policy and uncertainties regarding the economic development will keep financial markets in a more volatile environment.

Successful investors follow a long-term strategic asset allocation plan. Adherence to that plan is a prerequisite for reaching the financial objectives set out.

On our portfolio assessment platform (https://jacotpartners.shinyapps.io/jp_portfolio_assessment/) various strategic asset allocations can be modeled and compared.

We remain at your disposal for additional information.

Best regards

Your JIMAG Team