1/
It’s no secret commodities have been on an absolute tear.
That'll happen when global supply chains shutter, consumption patterns swing wildly, war is launched, and inventory levels shift from “just in time” to “just in case".
But now we’re seeing a pullback.
🧵👇
It’s no secret commodities have been on an absolute tear.
That'll happen when global supply chains shutter, consumption patterns swing wildly, war is launched, and inventory levels shift from “just in time” to “just in case".
But now we’re seeing a pullback.
🧵👇
2/
The commodity market is now at the most critical crossroad it has been in the last several decades.
The issues are plentiful on both the supply and demand sides.
But the impact does not stop at the grocery store or the gas pump.
It ripples throughout the entire economy.
The commodity market is now at the most critical crossroad it has been in the last several decades.
The issues are plentiful on both the supply and demand sides.
But the impact does not stop at the grocery store or the gas pump.
It ripples throughout the entire economy.
3/
The commodity market is so important right now because of its effects on Fed policy and interest rates.
Higher commodity prices 👉 rising inflation.
Since the Fed aims to limit inflation as part of its mandate, they raise rates to contain it.
The commodity market is so important right now because of its effects on Fed policy and interest rates.
Higher commodity prices 👉 rising inflation.
Since the Fed aims to limit inflation as part of its mandate, they raise rates to contain it.
4/
Higher rates generally mean more contractionary policy, which increases borrowing costs across the board.
This causes a contraction in business activity and therefore revenues and profits.
Which ultimately affects equities in a negative manner.
Higher rates generally mean more contractionary policy, which increases borrowing costs across the board.
This causes a contraction in business activity and therefore revenues and profits.
Which ultimately affects equities in a negative manner.
5/
But there are 2 sides to the equation & the Fed only has influence over 1.
👉Demand: The propensity for the end consumer to spend money on goods
👉Supply: Actors that produce goods through processing and manufacturing raw materials
The Fed does not control the supply side.
But there are 2 sides to the equation & the Fed only has influence over 1.
👉Demand: The propensity for the end consumer to spend money on goods
👉Supply: Actors that produce goods through processing and manufacturing raw materials
The Fed does not control the supply side.
6/
So if it’s the Fed’s job to control inflation—but they can only really influence the demand side of the equation, and not the supply side—it makes sense to see just which force is dominant when it comes to inflation.
BUT...
So if it’s the Fed’s job to control inflation—but they can only really influence the demand side of the equation, and not the supply side—it makes sense to see just which force is dominant when it comes to inflation.
BUT...
7/
We’ll leave it up to economists to debate as to the exact percentage split and which is more important, but to me, it seems like supply-side improvements need to be made in order to see any peaking in the inflationary readings, no matter how hawkish the Fed signals.
We’ll leave it up to economists to debate as to the exact percentage split and which is more important, but to me, it seems like supply-side improvements need to be made in order to see any peaking in the inflationary readings, no matter how hawkish the Fed signals.
8/
While inflation has been running wild, we are finally starting to see some cracks in June.
Since a lot of growth was pulled forward on a YoY basis we are now “lapping comps”, meaning the explosive growth we saw in price levels gets re-rated from a higher base.
While inflation has been running wild, we are finally starting to see some cracks in June.
Since a lot of growth was pulled forward on a YoY basis we are now “lapping comps”, meaning the explosive growth we saw in price levels gets re-rated from a higher base.
9/
We see this, particularly in the industrial metals space.
I agree with much of this thread, but the 10yr avg growth trend is very difficult to pull as a baseline, considering the black swan events that have occurred.
Either way the trend is down.
We see this, particularly in the industrial metals space.
I agree with much of this thread, but the 10yr avg growth trend is very difficult to pull as a baseline, considering the black swan events that have occurred.
Either way the trend is down.
10/
Similarly, when you look at the outperformance of the Energy Sector from a GICS Index YTD versus the market, it is still up big, but gave about half of those returns back:
Similarly, when you look at the outperformance of the Energy Sector from a GICS Index YTD versus the market, it is still up big, but gave about half of those returns back:
11/
We’re also starting to see green shoots when it comes to the food crisis as well.
Supply may not be as impaired as we think because other areas are starting to compensate.
The Bloomberg Agriculture Spot Subindex is also on track for its biggest monthly drop since 2011:
We’re also starting to see green shoots when it comes to the food crisis as well.
Supply may not be as impaired as we think because other areas are starting to compensate.
The Bloomberg Agriculture Spot Subindex is also on track for its biggest monthly drop since 2011:
12/
So what does this all mean?
It appears on the inflationary front that bad news is good news, as anticipation of a recession rises, so do fears over shrinking demand across goods.
The cure for high prices is high prices.
So what does this all mean?
It appears on the inflationary front that bad news is good news, as anticipation of a recession rises, so do fears over shrinking demand across goods.
The cure for high prices is high prices.
13/
For now, the drop in key commodities may allow inflation expectations to ease off, and with that, the “higher for longer” rate pressure that we have been under.
In the coming months, it might be time to fade commodities and sharpen your pencil on beat-up darlings…risk-on.
For now, the drop in key commodities may allow inflation expectations to ease off, and with that, the “higher for longer” rate pressure that we have been under.
In the coming months, it might be time to fade commodities and sharpen your pencil on beat-up darlings…risk-on.
14/
Want more GRIT?
This thread summarized some of the key takeaways from our note to PAID subscribers in June.
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gritcapital.substack.com
Want more GRIT?
This thread summarized some of the key takeaways from our note to PAID subscribers in June.
Subscribe to get the next one and to unlock all of GRIT'S premium content! 👇
gritcapital.substack.com
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