2016 is going to be a year of transition and extremes. There are so many political, geopolitical and economic events colliding.
-Will Trump stay strong in the pools?
-Will the far right in Europe continue to gain strength?
-Will Iranian and Saudi relations continue to deteriorate?
-Will Saudi Arabia alienate the rest of OPEC?
-Will Russia retaliate on Turkey and will Article 5 in NATO be invoked?
These are just some of the possibilities.
Markets will be volatile.
America is the likely to remain the destination for capital. This should push markets higher, well past fair valuations as this is capital fleeing the battlefield.
Europe is recovering, but will flare up. I believe by the second half of the year the periphery will begin to outperform the core nations.
Asian markets are maturing. China’s inclusion to the SDR and the MSCI, in combination with the devaluation of the Renminbi will drive money into Chinese equities. The rest of the region will likely remain lackluster, other than some smaller markets.
Inflation may be the surprise of 2015. I think we are at an inflection point. Wages are rising in the US, while Europe is stabilizing. Core inflation is at the FEDs 2%, and any increase in the price of oil will pull headline inflation higher. War is heating up and war and inflation are connected.
Oil has been testing 2008 and 2004 lows. I believe oil drifts higher, but the largest price effect will be the renewal of the terror premium.
Gold should bottom below $1000 sometime in mid-2016 and finish somewhere north of $1200. A new gold bull is on the horizon.
Copper will make a new low in early 2016 .This cycle is bottoming. The green revolution will need a lot of copper to wire all those solar installations.
Surprises and Contrary Bets
A new year is upon us. Even the least jovial of us can enjoy the rebalancing of their portfolio. For myself I like to think of what could surprise me in the New Year and three topics come to mind.
Geopolitical risk and a new risk premium in the price of oil
Creeping headline inflation
A rally in the Euro
1) The price of oil appears to trade in utopia. Supply will never disappear and the glut is permanent. This glut is measured as high as 2-3 million barrels per day. Global demand is just north of 93 million barrels per day, making this an oversupply of 3-5%. Global stockpiles are 10-15% higher than they historically are in this calendar month. Below is a chart of OECD Total Oil Stockpiles. The 2015 number is certainly higher than the 2010-2014 range, but when you review the numbers (3000-2750/2750 = ~10%), the current level is only 10% higher than the top of the range over the past 5 years. 10% does not seem like as large of glut as the headline “Unprecedented Oil Stockpile”.
There are a number of geopolitical risks that could quickly destroy this margin.
-Venezuela Supreme Court rejecting opposition party Super Majority...is there a coup in the works?
-Iran testing missiles near US carriers.
-New Iranian sanctions on ballistic missile program, Iran not deterred...does the nuclear deal fall through?
-Iraq threatening war against Turkey, if Turkey does not remove their troops.
-Russia accusing Turkey of aiding ISIS.
-Kuwait sending troops to Saudi to protect border.
-Rebels in Yemen firing missiles at refineries in Saudi...what if the next Patriot missile is not as successful?
The roll of a risk premium is to make marginal production ready to come online due to a shutdown of cheaper but geopolitically riskier supplies. With the negative sentiment and lower for longer thesis, there appears to be either no, or even a negative risk premium in oil. If any of the potential geopolitical risks accelerate, there could be a huge short covering in oil.
2) Core inflation has been trending around the FED’s 2% target, yet headline inflation has been subdued due to declining energy prices. However, as year over year energy price comparisons become less of a boat anchor, any surprise to the upside will pull the headline number higher.
In the past El Nino events have affected odd parts of the supply chain causing input inflation that passes through the production process. Will any of the potential geopolitical risks amplify this possibility?
3) What if everybody who wants to own the dollar does and everyone who plans to short the EURO already short? Earlier in this document the crowded trade analogy of a capsizing boat was used and the Charles Schwab “sell the news” dollar and rate hike chart shown. On the CS chart, the dollar tends to sell off for 3-6 months following the first rate hike. But what if there is only one rate hike and traders got a little too excited? Any positive news in the EU area and negative news in America could cause a strong short covering rally, as long USD is a crowded trade.
None of these Contrary Bets are certain, but they are something that is worth watching…as you never know.