The “trade of 2021” has been long copper (+27.9%) and short the 30-year Treasury (-13.8%), BofA’s Michael Hartnett wrote, in the latest edition of the bank’s popular weekly “Flow Show” series.
Copper touched $10,000 this week and was poised for a new record. Q1 witnessed the first bond bear market in 40 years, depending on your benchmark. I suppose this was predictable. Everything is in hindsight.
The inflation theme (and surging commodity prices, including metals, are one manifestation) is pervasive. Hartnett noted that “asset price inflation [is] now mutating into real estate [and] commodities.” The “next leg of the trade,” he said, is wage acceleration, new highs in oil and (gasp!) a “further breakdown in long duration stocks,” which, for the uninitiated, translates roughly to: Additional weakness in the stuff that’s generated outsized returns for as long as you can remember and/or the stuff that’s gone through the roof over the past year or two. Hartnett mentioned XBI under $130, TAN below $80 and the flagship ARK ETF below $110 as levels to watch for possible signs of further de-frothing.
Notably, last week witnessed a large inflow to cash. ICI’s data shows money market funds took in $59.35 billion during the period (figure below).
Taken with robust inflows to bank loans, Hartnett suggested “investors [are] positioning for inflation and tapering.”
He advocated a “long inflation, long quality” barbell. That could mean long commodities, short bonds, long commodity FX, long small-caps and long utilities and stapes in equities.
It also entails being short (or, at the least, underweight) long duration stocks. As ever, that’s a tough proposition considering how difficult it is to abandon names like America’s tech titans. Indeed, they’ve become akin to utilities and they delivered incredible quarters this week (here and here).
Hartnett does allude to the cognitive dissonance that many market participants experience in that regard. “We say own defensive quality [as a] good market hedge in H1 and [a] good macro hedge [in] H2 [as] tapering equals rising credit spreads and pressure on tech even if FAANG are the ‘new consumer staples,'” he wrote.
Globally, equities took in another $10.5 billion last week, bringing the 2021 total to $438 billion (figure below).
Inflows to US stocks were $5.6 billion.
For what it’s worth, BofA private clients pulled the most from stocks since June of 2019, something Hartnett attributes to Joe Biden’s capital gains tax announcement.
Copper, iron ore and such. Unlike the cryptos as well as gold & silver, to some extent, those commodities are actually tethered to real supply and demand dynamics. Specs may buy them as an inflation play, but reality tends to set in pretty quickly as stockpiles are released and producers step up their forward hedge selling.
I was surprised some years back to read that some academic studies found that over time, commodities were NOT a good inflation hedge. Some of that may have been due to the heavy weighting of oil in the popular indices. Gold was found to show a higher correlation but even that was pretty low. Perhaps it’ll be different this time.
Over time industrial and ag commodities do not really inflate because when prices rise there tends to be a following supply rise, killing the price. In ag cattle has the longest lag because it takes two years or so to raise a 1000# steer from birth. Chickens can be done a just a few months. Mines take a while to open but even metals can respond to price rises fairly fast, there is storage, etc. The truth is the fact that commodity prices can fluctuate enough to dampen inflation should keep the prices of many commodity based products fairly stable. Malthus would have disagreed about the long run, but reason his predictions didn’t come true is that commodity price rises are a very powerful driver of supplies and innovation.
Commodities as an inflation dampener. Never thought of it that way, but you are spot on!
Both supply and demand vary. As you noted, some markets faster than others. Some of the “tropicals” like coffee, cocoa, palm oil and smoked rubber usually have a longer lag. Grains and oilseeds once had longer lead times as well, depending on the crop cycle in the northern hemisphere. But thanks in part to the US embargo on exports to Russia, production in the southern hemisphere was expanded so we now have a shorter reaction cycle.
Please forgive, in advance, an old man’s thread veer:
I love this stuff. My first job was as an assistant to the assistant to a grains & oilseeds futures broker on a major commodities futures desk. Our clients were the major global trading houses and a few users so I learned a lot. Plus, I loved talking to some of the old-timers who were delighted to school me on their respective specialties. Or regale me with tales about the great apple futures squeeze of 1953 or the semi-famous death spiral in onion futures around that time when futures prices were driven down below the cost of the bags they were packaged in for delivery.
Back then commissions we fixed at $50 per contract. These guys came from a world apart from the well-dressed and coiffed bond traders in the “white shoe” houses, but they probably were wealthier. Until the evil regulators steeped in and banned those fixed commissions.
I keep wondering if commodities, short bonds, and reflation assets generally won’t take a hit as one reaches peak PMI which as traditionally mean reverting series seems a fairly simple call to make when these series are in their 95th percentile or more. If ISM cracks 5 points over the next 3 months or so, would reflation trades be the place to be—colour me sceptical…