4th August 2023
July Performance Review
Dear Investor,
As usual we will start the month having a quick look at what the markets did in the previous month, our themes, and then the thematic portfolio performance.
Looking at the chart above, we can see that most markets were up with the exception of US bonds and the USD. Weak dollar beneficiaries performed extremely well with commodities at the top of the pile.
Our theme performance is shown below and it can be seen that “Other commodities”, Energy and the Precious Metals themes did extremely well, with the two first themes continuing on from gains last month.
Please see the Themes section of the website for a breakdown of our current investment themes.
The thematic portfolio performance is detailed below and was up 3.2% for the month, with the biggest contributors being Precious Metals and Energy. The biggest detractors were our short US market positions.
Japan took a breather this month after strong gains over the course of this year and our stock picks did better than the overall market with our bank position gaining after another tweak to the Bank of Japan’s bond policy.
So what happened this month to buoy the markets in this way? The key is in the article below:
Wall Street cheers cool CPI with stock rally; dollar, yields decline
July 12 (Reuters) – Wall Street stocks advanced on Wednesday and the dollar and Treasury yields fell after new U.S. inflation data showed a slowdown in the seemingly relentless rise of consumer prices.
The Consumer Price Index (CPI) gained just 0.2% last month, the Labor Department said on Wednesday, lifted by rises in gasoline prices as well as rents, which offset a decrease in prices of used motor vehicles. CPI advanced 3.0% in the 12 months through June, down from 4.0% in May and the smallest year-on-year increase since March 2021.
The latest CPI released on July 12th gave investors comfort that the rate hiking campaign of the Federal Reserve is over, and as the article notes, this gave a boost to stocks as well as a weaker dollar.
We do not share this view and, at the risk of being repetitive:
“We have stated multiple times that a lot of the drivers of inflation are structural in nature, and that the covid driven supply chain constraints had some impact in the short-term (which are now being worked through) but it was more the response to the self-imposed lockdowns that started the ball rolling.
In certain regions, we have seen this where reported inflation had come down from Covid/Ukraine induced spikes but then started moving up again.”
The problem is that the financial market’s response to these numbers all but ensures the Federal Reserve will continue hiking rates. As stock markets go up, financial conditions become loose and the drivers of inflation reignite. Let’s have a quick look at oil. The chart below shows the dollar price and percentage change for crude over the last month.
Crude oil, the core building block of most of the modern world is up 18% in the last month.
The CRB index, which measures a broader basket of commodities is shown below. Up 7% in the last month.
The price of commodities feed into producer prices (PPI) which eventually feeds into consumer prices (CPI), so while we may have some reprieve on the reported inflation numbers, it is a matter of time before they start ticking up again.
We have mentioned food and energy security as an additional driver of inflation going forward and we highlight a couple of articles below which show the trend continuing:
Russia halts landmark deal that allowed Ukraine to export grain at time of growing hunger
July 17th
LONDON (AP) — Russia on Monday halted a breakthrough wartime deal that allowed grain to flow from Ukraine to countries in Africa, the Middle East and Asia where hunger is a growing threat and high food prices have pushed more people into poverty.
Kremlin spokesman Dmitry Peskov said the Black Sea Grain Initiative would be suspended until demands to get Russian food and fertilizer to the world are met. An attack Monday on a bridge connecting the Crimean Peninsula to Russia was not a factor in the decision, he said.
“When the part of the Black Sea deal related to Russia is implemented, Russia will immediately return to the implementation of the deal,” Peskov said.
The suspension marks the end of an accord that the U.N. and Turkey brokered last summer to allow shipments of food from the Black Sea region after Russia’s invasion of its neighbor worsened a global food crisis. The initiative is credited with helping reduce soaring prices of wheat, vegetable oil and other global food commodities.
Guardian 21st July
India’s ban on rice exports raises fear of global food price rises
Attempt to curb domestic inflation behind country’s decision on non-basmati white rice
India has banned non-basmati white rice exports to curb domestic inflation, raising fears of further increases in global food prices just days after wheat and corn prices were sent climbing by Russia’s termination of a key grain deal.
The immediate ban, introduced after heavy rains hit domestic crops, follows the failure of a 20% duty on international exports introduced in September to curb foreign demand, which has soared after extreme climate conditions hit production in countries.
India is the world’s largest rice exporter, accounting for more than 40% of global shipments. While the ban does not apply to higher-grade basmati rice – India’s best-known variety – non-basmati white rice accounts for about 25% of exports.
International sales of Indian rice soared by 35% in the year to June, contributing to a 3% rise in domestic prices over the past month alone. People in India are paying 11.5% more for rice than a year ago, according to its ministry of consumer affairs, food and public distribution.
These trends have benefited the thematic portfolio with large rises in our fertiliser plays as well as our energy picks including shipping and our recently added natural gas picks.
Gold and the related equities also had a good month as interest rates fears subside. We believe there is a high probability of gold making new highs in the next 3 or 4 months but again this is being postponed by the exuberance of markets which will prolong the rate hikes in our opinion.
In our opinion the US dollar is at a critical junction. After the lower-than-expected CPI number, the widely followed DXY index broke below support, and we had headlines like the below Bloomberg article:
Dollar’s Busted Bull Run Has Bears Calling End of an Era
July 16, 2023
It just may have been the week that broke the dollar.
The greenback’s worst slump since November has a bevy of strategists and investors saying a turning point is finally at hand for the world’s primary reserve currency. If they’re right, there will be far-reaching consequences for global economies and financial markets.
The US currency is teetering at the lowest level in more than a year after signs of cooling inflation bolstered bets that the Federal Reserve will soon stop hiking interest rates. Dollar bears are looking even further ahead, to what they say are inevitable rate cuts, something the market consensus sees happening at some point in 2024.
Of course, when these kind of headlines come out and everyone turns bearish, it usually marks a short-term bottom at least. As shown in the chart above, the dollar subsequently rebounded above previous support, now resistance. False breakdowns such as the above are usually a reliably bullish signal so we expect the dollar to rally against the Euro and likely the Pound as well. Our position in UUP protects us against that as a USD rally could hurt our commodity positions. At some point, our view is that gold will rally with the dollar as will certain commodities as the supply picture overwhelms everything else. Until that point, we will keep the dollar hedge on as it allows us to have a bigger position in gold, commodities etc
Continuing with currencies, we added a long yen hedge in the middle of the month based on the following (from Commentary #15)
“Now, there is currently a huge speculative short position in the Japanese Yen (looking at futures data in US markets) as everyone and their dog is short the yen.
This is a big potential risk to global markets, as the so-called yen carry trade is funding positions elsewhere. The simple way it works is that speculators borrow JPY, convert to another currency, and invest in assets denominated in those other currencies. So, for instance, you can borrow JPY at 0.5% convert to USD and buy US 2 year notes yielding close to 5%. As the yen weakens, you make even more money as you have to repay a lower amount in USD. The consensus view is that Japan is not raising rates anytime soon and so there is little risk here.
But, all it takes is a few % move in the JPY the wrong way to wipe out all that profit especially as the leverage used will be huge. We will add a 10% position in FXY, an ETF holding the Japanese Yen as a hedge against both our Japanese stock positions as well as a general move away from risk.”
In another surprise move, the BOJ again changed its band for the 10-year yield to move in. If you recall, we discussed this in Commentary #2 back in January:
“The current BoJ governor, Kuroda who is leaving in April 2023, raised the band of the JGB yield from a band of -25bps to +25bps to -50bps to +50bps in December. While this seems like a tiny change, it is an effective doubling of interest rates and the effect on the JPY was pronounced to say the least:
JPY strengthened over 4% vs the USD in one day.
So is this a “one and done” interest rate change? We tend to think not.
The market will test the boundaries of where the BoJ wants yields to end up and will continually pressure the new bound.
We believe yields will slowly be allowed to move up in Japan and this will impact the yen, the bond and equity markets.”
Fast forward 7 months and…
Nikkei Asia July 28th
BOJ tweaks policy to allow 10-year yields to rise up to 1%
Gov. Ueda says bank has no plan now to drop yield curve control policy
TOKYO — The Bank of Japan unexpectedly tweaked policy on Friday, providing more flexible bandwidth for government bond yields to fluctuate — a potential step toward the end of the bank’s yield curve control (YCC) framework.
The nine-member board’s decision – an 8-1 majority vote — will allow 10-year JGB yields to rise above the current cap of 0.5% up to 1%.
While it maintained its policy of guiding yields 50 basis points above or below 0%, it added new wording in a statement, saying “it will conduct yield curve control with greater flexibility, regarding the upper and lower bounds of the range as references, not as rigid limits, in its market operations.”
“The Bank will offer to purchase 10-year JGBs at 1.0 percent every business day through fixed rate operations, unless it is highly likely that no bids will be submitted,” the statement said.
Gov. Kazuo Ueda made it clear that the BOJ has no plan at the moment to drop the YCC policy.
The Japanese equity market reaction on the day was quite muted (apart from a big move up in the banking sector – a sector we highlighted as a beneficiary of the end of YCC in Japan) and in fact the currency first strengthened and then weakened. The issue is that now that the band has been raised, it will be tested again and the intervention to buy bonds to keep rates below 1% will mean more yen printing and a weaker yen. At some point this will stop and will cause mayhem in markets as Japanese capital is repatriated sucking money out of global markets. Our long position in the JPY will be our hedge against our Japanese stock positions and a general risk-off move.
Staying in Asia, one would think, by looking at the market performance that HK/China had turned the corner with the market up nearly 7% for the month. This all happened in the last few days of the month, as Beijing seemingly became more desperate and had announcement after announcement to instil confidence in investors.
Throughout the month, the economic data continued to deteriorate and announcements by Beijing did little to change the sentiment but at the end of the month, more concrete measures on the property sector (that huge and key sector of the Chinese economy) helped kick start a rally in the HK/China markets. Investors are now betting that things are so dire that big stimulus a la 2008 will happen. We are not so sure about that given the Chinese debt levels and the way this has played out so far but there are actions that will be announced and taken.
China to step up policy adjustments amid tortuous recovery
BEIJING, July 24 (Reuters) – China’s top leaders pledged on Monday to step up policy support for the economy amid a tortuous post-COVID recovery, focusing on boosting domestic demand, signalling more stimulus steps.
The world’s second-largest economy grew at a frail pace in the second quarter as demand weakened at home and abroad, raising pressure on policymakers to deliver more stimulus to shore up post-COVID recovery.
China will step up economic policy adjustments, focusing on expanding domestic demand, boosting confidence and preventing risks, state news agency Xinhua cited the Politburo, a top decision-making body of the ruling Communist Party, as saying.
China dribbles out new hints on stimulus as weak data stokes expectations
August 1, 20239:24 AM GMT+1Updated an hour ago
- China officials promise to formulate policies, but no specifics
- July official mfg PMI shows contraction for fourth month at 49.3
- Construction index, key jobs sector, at 51.2 vs 65.6 in March
- Property sector faces ‘potential death spiral’ – economist
Now, the Hong Kong market is extremely cheap and has such negative sentiment, that it makes sense to continue to have a small position here as the upside potential is large.
We are not going to make any changes to the thematic portfolio this month (the changes highlighted in red below are the addition of FXY mid July and the subsequent reduction in cash) Equity market risk is high which is why we continue to hold a US equity short position. While this has detracted from returns, it has allowed us to sleep at night holding all the other positions we have.
From a positioning standpoint, we would increase our allocation to energy, gold and other commodities on any equity market sell-off.
August Thematic Portfolio
We will be taking some time off and so the next commentary will be the August performance review.
Until next time,
