The Ingham Analytics Weekly Letter on Sunday - 11 October 2020

Tuesday, 13 October 2020

Welcome to another Ingham Analytics Weekly Letter on Sunday in which we aim, inter alia, to take a step back to see wood for trees, in South Africa, and around the world. We try not to take ourselves too seriously, seeing the humorous side of life in trying times is a good sedative for melancholy.

This past week we issued "Fuhgeddaboudit!" and "Over a barrel?", the first dealing with the shape of a potential future economic recovery based on data out of the US and Europe and the second on latest developments in energy markets affecting companies such as BHP, ExxonMobil and Sasol.

BHP has made an opportunistically timed move in the Gulf of Mexico which seemingly signals a bottom in the oil market. Oil in inflation adjusted terms is at its cheapest in years. Demand for chemicals meantime has held steady this year and has benefited ExxonMobil, one of the largest chemical producers in the world. Chevron by contrast has minimal petrochemical exposure.

Sasol on the other hand is a forced seller of assets at the bottom that does nothing to remove an overhang concern around a rights issue and potentially huge dilution to shareholders.

In an earlier Sasol note called "Going, going for a song" we referenced flogging the shareholders' silver. Sadly true, with the sale of 50% of the Lake Charles Base Chemicals asset for what we estimate is a discount of at least 30% to what it has cost the latest. By their own admission, the purchaser LyondellBasell reckon they are buying in at the bottom of the cycle. For Sasol, the US dollar debt hangs around even as they have multi-billion write-offs and sales on the cheap.

ExxonMobil rarely comments on press speculation or reporting but it did this week, issuing a statement that a Bloomberg story was "false and misleading." Too right, it reads like a sensation-seeking foregone conclusion; after all, why let facts get in the way of a good story?

US markets were on firmer footing this past week although that's not saying much given the fragility in sentiment and the comedy show that is US politics. Several out-of-favour sectors and stocks have been getting a boost as tech mania shows signs of having cooled. Gold remains firm at above $1,900/oz. The US 10-year Treasury has also firmed to above 0.77% and compared to last year the yield curve has steepened. Oil was up this week, although easing Friday on news of a Norwegian labour strike being called off, and WTI seems to have found a floor at around $40/bbl.

Even unloved General Electric got a boost on Friday after news of a bullish call by a Goldman Sachs analyst saying he believes GE's at a bottom from both a fundamental and sentiment perspective, tacking on a $10 price target.

However, the SEC had previously rained on the parade as its considering civil action against GE for possible securities law violations relating to GE's revenue recognition practices and internal accounting controls on long-term service agreements. GE's reporting has been contentious for years, even dating back to Jack Welch. We can think of some names closer to home that took a creative approach to revenue recognition.

Who knows what the upcoming US presidential election in a little over three weeks will bring? Self-important psephologists chip in their two-cents worth in the media, its much like the self-taught epidemiologists with their Bachelors' degrees from Google University who natter on about COVID-19.

Politically, it all seems quite fluid. What passes for debate in America is so preposterous it's not worth tuning in.

The pandemic muddies the waters too and perhaps more so in the US, which is 50 countries in one, all seemingly doing their own thing, and that's before you get down to the municipal level. Politicians wearing a mask has become a token of pandemic one-upmanship, our side is more responsible so yah boo to the lot of you.

Polls have been discredited both in the US and UK and typically don't capture the silent vote, especially for a controversial candidate. The Conservative victory in Britain last December with a huge 80 seat majority that swept aside long-held Labour strongholds wasn't remotely projected.

Fiscal stimulus is the US market topic of the moment, a trillion here, a trillion there and soon you're talking real money.

The Congressional Budget Office says that for fiscal year ended 30 September, the US Federal deficit widened to $3.1 trillion, up over $2 trillion. That's 15.2% of GDP. However, two-thirds of the deficit is due entirely to policy responses to the black swan event that is COVID-19 and is partly mirrored elsewhere in the world.

For context, in 2009, the height of the global financial crisis, the US deficit was 9.8% and then 8.6% in 2010 and a still high 8.3% in 2011. During the eight years of the Obama presidency, cumulative Federal deficits were an astonishing 45.8%, which averages out at 5.7% a year. Prior to COVID-19, Mr Trump was tracking an average of 4% a year.

The GFC gave an acceptability to deficit spending in the US and was exacerbated by an increasingly fractious political setup, culminating in the divisiveness in this presidential election. This wasn't the case in the UK, which brought in austerity measures to balance the budget, whilst Germany had a small budget surplus going into COVID-19.

The British Chancellor of the Exchequer is already talking about support measures for the pandemic having to be paid back in one way or another, there is no such language out of Washington only yet more of the same.

That's the thing, the US runs deficits in good and not so good times. This is not what Keynesian economics propounded. You've got to go back to 2001 to get to a small surplus. In the past four years the cumulative deficit is $5.5 trillion. With COVID-19 policy responses, the number will grow regardless of who prevails on Capitol Hill.

On top of this is a persistent and growing trade deficit - the last time the US had trade surpluses was in the 1960s. Even excluding COVID-19 the normal twin deficit is around 8% of which the fiscal shortfall is typically 4% to 5%.

The only reason the US can get away with this profligacy, for now, is the exorbitant privilege of the US dollar as the most liquid and widely traded unit of account, which enables the US to live off IOUs and the kindness of strangers to fund those deficits. During the days of Britain as the worlds principle power there was a crucial difference - Britain was a creditor country.

Our note "All that glitters?" on 25 September took another look at the gold market. We said that gold interest from investors remains bullish with gold-backed exchange traded fund inflows this year the highest in several years. Gold bugs are increasingly concerned about fiat currency debasement.

Global central banks have accumulated between 200t to 300t of gold year-to-date. Diversification of reserves, particularly away from the US dollar, is a driving factor together with ultra-low interest rates. The announcement by the US Federal Reserve that employment will take precedence over price inflation in their monetary decision making is a further prop to strategic investment in precious metals.

Gold-backed ETFs recorded a tenth consecutive month of net inflows in September. Global net inflows of 1,003t worth $56bn in 2020 have taken gold investment demand and gold ETF holdings to new all-time highs.

Our note also observed that the low cost of money further supports gold's attractiveness (opportunity cost) relative to other assets. Gold does not pay a dividend or coupon like stocks and bonds because it carries no counterparty risk. If you've got borrowing costs at 3% gold isn't so attractive but cut that to half or less and the picture changes. Real interest rates in all developed countries are all effectively negative, which should keep the opportunity cost of gold lower for longer too, and be a prop to the intrinsic value of gold.

The price of gold has been sticky of late, it did take a healthy breather we believe from above $2,000/oz to about $1,850/oz but has since firmed and was $1,936/oz on Friday. At times likes this with the economic impacts of COVID-19 real, gold has credible characteristics in relation to most other conventional assets - it is liquid, it is no one's liability, it carries no credit risk, and it is scarce thus preserving its real value over time.

A final thought. In the Weimar Republic in 1923, the Rentenmark was introduced to replace the Papiermark at a rate of one trillion Papiermark for one Rentenmark. It was like a share consolidation as the Papiermark had sunk to 1 million per US dollar by then from 4 marks to the dollar in 1914 at the onset of World War One. However, that is wheelbarrows of cash, yellow metal manufacturer Caterpillar can supply the White House with supersize buckets.


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