Global Deflation I - Commodities21 January 2015

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MARKET UPDATE

Market Update

Europe 2015 = Problematic

China GDP Miss + Market Crash

sources: HiddenLevers, NPR, Marketwatch 1 2, ZeroHedge, BBC, Economist, Forbes

- German rates at 0- Swiss rates negative- Swiss ditch Euro peg- Euro below 2012 low- Greece deteriorating fast- EU QE looming

USA Decoupling

Market Update: Goodbye Fed, Hello ECB

sources: HiddenLevers, Financial Times, Businessweek

- 85b usd monthly bond buying

- began at market bottom, led to rally

- treasury yields rose, driving money into market

- stimulus impact on inflation debatable.

- 60b usd monthly bond buying

- begins at market top, likely no equity pop

- hopes to drive up yields on German Bonds,

and people to take risks – hiring, spending

- BIG QUESTION: Enough to fight deflation?

Fed ECB

Market Update – Ebola Pandemic

sources: HiddenLevers, Barrons ,

USD chart tells many stories1m: Euro in serious trouble

1y: USD strong post QE

5y: Japan QE gave USD legs

10y: USD at top of range

Macro Snapshot – USDiesel

USD +16%

past surprise: US shale revolution- decreased trade deficit- increases oil supply

future surprises: - Fed hikes rates- ECB begins QE

USD even - China de-peg

Oil –52%

USD +16%

EUR –16%

JPY –16%

Macro Snapshot

Oil-gold ratio spiked to fifth highest level ever

Typically corrects quickly:- Does oil spike from here?- Or does gold crash from here?

5th highest level ever

Swiss Central Bank shocked the world (and bankrupted FX traders) by ending peg to Euro

Gold and silver seem to be acting as safe havens for now

GLOBAL DEFLATION SCENARIOSHiddenLevers

GOOD: ECB Successful QE

source: HiddenLevers, Financial Times,

ECB action avoids deflation in Europe

ECB program 30% smaller than Fed QE

Fed hands tied on rate hike

Crude Oil stabilizes at 50ish

EURO stabilizesat 1.20ish

noticeable unemployment

decreases in Europe

BAD: US Avoids EU/Japan Crisis

already baked inUS inflation below 1%

more upside surprises on US budget deficits

decoupling continues but EU/Japan hinder growth

markets flat to mildly down

source: HiddenLevers, Census.gov,

Japan + Germany #4 + #5

US trade partners

GDP washless trade but

stronger internals

EU more trade than

CAN/CHINA/MEX

UGLY: US Succumbs

retail sales already trending

down

Fed out of bullets – can’t return to QE

US unable to avoid first world problems

Oil punches through 30usd

source: HiddenLevers,

Not as severe a crash as 2009

expect all time lows on US Treasuries

USD + sentiment touching long

term resistance

HiddenLevers

GLOBAL DEFLATION I: COMMODITIES PERFECT STORM

$

Oil: Global Picture

sources: Economist 1 2

EU + Russia + Japan:Growth Near 0

China + India growth heading

sub-7%, can’t carry world

Africa rising, but from tiny base

USA! A rare rich country with growth

Oil: Addiction Getting Cold

source: Our Finite World , Oil & Gas Journal, EIA

Total US miles driven down 3% from 2007 peak while GDP up 9%

Less driving + better mpg oil demand down 11% from peak

US economy energy efficiency picking up

US fuel economy rising sharply since 2010

BTU/$GDP down 7% since 2010

Oil: Production Getting Hot

sources: EIA, DOT

Oil production approaching 1970 peak

OPEC determined to bankrupt US shale industry

Supply is up… But we are well below shale breakeven price:$50-80usd

Oil: Geo-Political Risk Premium = 0

sources: HiddenLevers

Russia/Ukraine didn’t bid up oilIraq/Syria – won’t matter unless oil-fields in flamesCurrently, ISIS and Russian sabre-rattling lack economic backing

WTI

$47.5BRENT

$49

Oil: Dance with Equities

sources: HiddenLevers

YearOil

Loss %

S+P Return

%

1985/86 -59 +22

1987/88 -35 -10

1990 -27 +5

1990/91 -45 +23

1997/98 -55 +54

2000/01 -53 -21

2003 -31 +11

2004 -34 +5

2006/07 -35 +12

2008 -76 -29

2010 -21 -9

2011 -32 -15

2012 -29 -2

2014/15 -57 +4

14 OIL corrections Six S&P 500 declines• Recessions knock down both oil + equities• Mid-cycle oil crashes have little impact

Scenario: Oil CrashGoodBounce

Back

BadIsolated

Crash

UglyPerfect Storm

$32 -33%

$48 PRICED IN

$74 +50%

key lever

OPEC relents or Shale producers fold.

Almost 60% decline in oil since summer 2014, S&P has been flat.

Oil prices pierce financial crisis lows. Unlike 2008-09, no V-Shaped recovery for Oil.

Deflation + Commodities

Oil crashes are not predictive of equity market crashes

Fed unlikely to raise rates, considering other

central bank moves

ECB QE unlikely to work at market topIsolated oil crash priced in. Further crash = deflation

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