The World Order Becomes Disorder
Is the post-Cold War global boom over?
Since the fall of Bolshevism, the world has seen remarkably sustained growth in international cooperation, brought about by freer trade and new technologies. Financial assets have generally performed well, increasing prosperity across most of the world. There were just two major interruptions—the tech crash in 2000, and the financial crash in 2008.
The world warmed up fast after the Cold War. Prices of most commodities rose, despite major corrections:
- Oil climbed from $15 per barrel to as high as $140. It collapsed with the crash, but climbed back swiftly to near $100.
- Corn climbed from $2 to as high as $8 before sliding to $3.60.
- Copper climbed from 80 cents to $4.30 before sliding to $3.
- Gold shot up from $350 to $1,900 before pulling back toward $1,200.
So what’s happening with commodity prices now? Is this just another correction, or has the game really changed?
Commodity prices have risen against a backdrop of falling interest rates:
The US ten-year Treasury yielded 8% as recently as 1994, and as low as 2.1% during the crash. Recently the consensus target was 4%—before fears of outright deflation drove it to 2.4%. Bond yields have fallen below 1%. Even the bonds of the southern members of the Eurozone yield Treasury-esque returns.
Remarkably, those low yields persist even as major geopolitical outbursts have ended the mostly benign post-Cold War era. The foundations of global economic progress are being shaken by geopolitical earthquakes from Russia and Ukraine to Syria and Iraq, where a new caliphate has been proclaimed.
It seems bizarre, but the world is heading toward a revival of both the Cold War and the Ottoman Empire.
Unfortunately, these concurrent crises are occurring at a time when the great democracies’ leaders bear scant resemblance to those leaders responsible for the end of the Cold War and the launch of global cooperation and free trade: Reagan, Thatcher, and George HW Bush. Mr. Obama won his nomination by voting against the invasion of Iraq. He ran on the promise of ending wars, not starting them. Now, faced with sinking popularity in an election year that could give Republicans complete control of Congress, he naturally fears dragging America into the ISIS chaos—or Ukraine.
Obama is also haunted by the collapse of his most daring and creative foreign policy achievement—the reset with Russia. Last week, Mr. Putin doubled down on his Ukrainian attacks by warning that Russia should be taken seriously, because it is a major nuclear power and is strengthening its nuclear arsenal. Those with long memories recall Khrushchev banging his shoe at the United Nations and shouting, “We will bury you!”
Meanwhile, Western Europe’s leaders show few signs of being prepared for either crisis. Angela Merkel, raised in East Germany, is cautious to a fault. British Premier David Cameron is struggling to prevent Scottish secession and to deal with the likely return of hundreds of ISIS-trained British citizens. (Military analysts generally agree that well-funded returnees with ISIS training are much greater threats than Al Qaeda ever was… yet Cameron has failed to convince his coalition partner to support restraining their re-entry into British Muslim communities.)
The backdrop for long-term investing has, in less than a year, swung from promising to promises broken by wars and threats of more-terrifying wars.
Another unlikely threat is deflation.
When central bankers have been running the printing presses 24/7?
Most economists, strategists, and investors would have deemed deflation a near-impossibility with government debts at all-time highs, funded by money printed at banana-republic rates. Who thought that the Fed would quadruple its balance sheet? And who dreamt that such drastic policies would be sustained for six years and would be accompanied by outright deflation in much of Europe and minimal inflation in the USA?
So why have Brent oil prices fallen from $125 in two years despite production outages in Syria and Libya and repeated cutbacks in Nigeria? Are Teslas taking over the world?
The answer is that the US is once again #1 in oil production, thanks to fracking (in states that allow it). Mr. Obama likes to boast about the new US oil boom, but he has been a bystander to this petro-revolution. According to an oil company executive interviewed in the New York Times last week, without fracking, global oil prices might be at $200 a barrel, and the world would be in a deep recession. He’s a Texan and thus inclined toward hyperbole, but his point is directionally valid.
US frackers—deploying advances in science and technology with guts and skill—have averted fuel inflation. And farmers, using the tools of modern agriculture—GMO and hybridized seed, farm machinery equipped with GPS and logistics, and carefully monitored fertilizers—have combined with Mother Nature to unleash record crops of corn and soybeans. So much for food inflation.
Capitalism is doing its job: to expand output of goods and services, thereby preventing shortages from derailing recoveries through inflation. That success story means central bankers can keep printing away.
So what should investors do? The S&P’s rally has been sustained through near-zero-cost money used to: (1) buy back stock to enrich insiders and please activist hedge funds which have borrowed big to buy big; and (2) prop up the overall market because investors have learned that buying on margin when the costs are minimal—and below dividend yields—just keeps paying off. Stein’s law says, “If something cannot go on forever, it will stop.” Too bad it doesn’t say when.
Gold loses its luster when: (1) inflation seems to be as remote as a pot of gold at the end of the rainbow; and (2) even a concatenation of crises fails to send investors rushing into the time-tested crisis consoler.
We had predicted in February that 2014 would be the year of increasing geopolitical risks that would challenge conventional asset allocations. We see geopolitical risks expanding from here—not contracting—and stick to our investment advice that the broad stock market is precariously valued. A range of options is available for those who wish to hedge themselves against even worse news.
Gold is part of any such risk mitigation. So are long government bonds.
Most importantly, we have entered an era when wise investors will devote as much time to reading the foreign news as they allocate to reading the investment section.
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