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Mish’s market update: Commodity super-cycle has only just begun

Mish’s market update: A worker arranges bars of gold bullion on a surface.

This past week in the US stock market, the high percentage swings between gains and losses were particularly noteworthy. The last few days have also demonstrated that stagflation and the shift in Federal Reserve policy have – to paraphrase The Carpenters – only just begun.

The chart above elucidates these points. 

In 1984 government debt, P/E ratio in the S&P, and CPI all hit a nadir. From that point on, the economy and the market began a massive run until the bubble in 2000.

Fast forward to today, government debt, P/E ratio in the S&P, and CPI are close to all-time highs.

Will government debt decrease? Maybe. However, the real rate of government debt to GDP is north of 137.2% as of the end of 2021. Since the pandemic, government debt has continued to climb, driven by government spending. This is inflationary.

Will CPI decrease? Doubtful. We may see the rate of change slowing, but our sense is that there will be some new event to accelerate CPI further. This, of course, is also inflationary.

Will the P/E ratio in the S&P 500 fall? Possibly. Clearly, if we dissect the recent round of earnings, some of the mega-giants had huge issues keeping up with the pace of growth they have enjoyed for at least a decade. Alphabet [GOOGL], Netflix [NFLX] and Amazon [AMZN] are just three examples of behemoth companies that saw a post-earnings sell-off.

Furthermore, Apple’s (AAPL) conference call, which took place after it reported positive results, illustrated the concerns of all tech companies that rely on the semiconductor supply chain, or, in the case of Amazon, that depend on consumers continuing to buy non-essentials.

This is a reaction to inflation along with the end of the Federal Reserve’s accommodative policy. The bigger point though, is that the Fed does not want to drive the US economy into a recession, hence they are beginning quantitative tightening, but to date ever so gently.

That brings us to our next point – stagflation, with lots of room for gold to soar.

The above chart illustrates how gold has been the lead commodity during inflationary periods in post-war history. We are particularly interested in the bottom line, showing the ratio between gold and the S&P 500 (SPX). 

Note that during the late 1970s gold outperformed all commodities. Gold also outperformed the SPX until its peak in 1980.

In the 1970s, oil ran first, followed by silver, while later on in the decade, copper, coffee and lumber flattened out. Gold was the strongest runner.

If history is any guide, we may see oil prices rise, with copper, lumber and coffee potentially peaking, while gold and silver have yet to get started. Furthermore, the gold-to-SPX ratio is still bottoming out with lots of room to the upside.

If we put that together with the first chart and the declining P/E ratios created by the end of near-zero interest rates, rising debt to GDP and historically strong CPI numbers, we can surmise that gold could just be getting started.  

In 1961, the London Gold Pool was formed by eight countries. Their goal was to keep the price of gold from rising too much from its $35 per ounce peg.

The group began by buying gold against the British pound in an arbitrage between the London exchange and other countries. The idea was to control the inflating currencies relative to the price of gold.

But over time, as parallel markets for gold emerged, the price of gold soared relative to the inflating currencies, and the collaboration or Gold Pool began to collapse by 1968. In 1971 President Nixon ended the guaranteed convertibility of US dollars into gold at a fixed ratio.

Comparisons for today have surfaced as, in simple terms, central banks have been selling gold and buying the US dollar as an arbitrage.

Will they get caught holding too many dollars and selling too much gold? We believe that this prospect is just one more reason why gold has a long way to go to the upside. 

As the above chart shows, the ETF GLD is in an uptrend. For over a year, buying weakness and selling strength has prevailed. But for how much longer? Although momentum has declined along with price this past week, gold is outperforming the SPY index. Additionally, we see a cup-and-handle formation in the works. 

If gold has only just begun to rise, we should see gold futures hold above $1,875, clear $1,940, and the next time the price pierces $2,000, the breakout could be palpable. 

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