by Ivan Martchev

April 28, 2020

It is not often that gold bullion moves more or less in the opposite direction of other commodities, but this year gold bullion has doubled relative to other commodities, if one uses a balanced yardstick like the CRB Commodity Index. The gold/CRB ratio went from 8 to 16 in 2020 alone. Such an extreme relative swing is obviously due to the government-mandated COVID-19 recession, where the mandatory shutdowns of business activity caused serious imbalances in major commodity markets, the most important of which is the collapse of oil, where the May WTI contract settled Monday, expiring at negative -$37.67 per barrel.

Gold Price versus Commodities Research Bureau Commodities Index Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

This is the first time in history where a producer has had to pay a consumer of oil to take the commodity off their hands, since storage space is running out and oil demand is 30% below normal levels, so any production cuts have been insufficient to put the energy market in balance. Oil is the most heavily traded commodity in the world, and it tends to affect the price of other commodities, so the CRB Index is now trading below its 2008 lows and is approaching levels it last saw in the Asian Crisis in 1998. (The S&P GSCI Index, which is more heavily overweight in energy, is well below the Asian Crisis lows.)

This government-manded shutdown is the sharpest interruption in business activity on record. Typically, before any recession begins, there is a slowdown period which is relatively easy to see in advance, at least to those with some experience. In this case, we went from an accelerating economy in January and February directly into a recession in March, only to begin pricing in an economic recovery by late March!

The government-mandated nature of this recession is what makes the market reaction feel like whiplash.

United States Initial Jobless Claims versus United States Ten Year Government Bond Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

In the last five weeks, we lost more jobs than we created in the previous 11 years, including a record weekly jobless claims number of 6.867 million. For comparison, in the darkest days of 2009, the weekly jobless claims high was just 665,000 two weeks after the S&P 500 bottomed at a depressed level of 666.

That said, we are likely to see an economic bottom in 2Q and a very sharp rebound in 3Q. Based on where this pandemic is going, we could also see the sharpest economic recovery on record in the fourth quarter of 2020 and in 2021. Since the U.S. stock market is forward-looking in more normal economic situations, it appears to be trying to price a normalization of business activity in the latter part of 2020.

The support from the Federal Reserve and Congress in the face of the Cares Act is bigger and faster than what we saw in 2008-09, which is why I think that the ferociousness of the economic rebound will also be of a historic nature. My base-case scenario is that the stock market does not violate the March 23 low for the time being, which is clearly contingent on how the COVID-19 pandemic is being handled globally.

An Emerging Markets Debt Crisis is Now Very Likely

The legendary Mark Twain once said: “Substitute ‘damn’ every time you’re inclined to write ‘very’; your editor will delete it and the writing will be just as it should be.” With the risk of making the legendary American author turn over in his grave, I will use his hated adjective “very likely” in my headline, as I think there is a better-than-even chance of a major emerging markets debt default/crisis in the next year.

Previously, I thought that such a crisis could happen when the Federal Reserve was tightening in 2018. First, the currencies of Argentina and Turkey blew up. Then, China was under pressure but managed to avoid a blowup of the yuan. The major reason was that the bulk of dollar borrowing was concentrated in the emerging markets, which was a function of ultra-low interest rates after the 2008 Crisis.

While the Federal Reserve has unwound its monetary tightening – and then some, taking its balance sheet to over $6 trillion – the ability to service those dollar debts has greatly diminished, given the collapse in global trade and commodity prices due to COVID-19. There is a $12.1 trillion synthetic short position against the U.S. dollar as of the end of 2019, which is the total amount of dollar credit extended globally. Emerging markets were the fastest borrowers of U.S. dollars in the past 10 years.

Brazilian Real versus Russian Ruble Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The reason why dollar borrowing is a “synthetic dollar short” is that when emerging market entities take a loan in dollars they sell those dollars in order to use them as they please, but when they return those dollar loans, they have to buy those dollars back, creating a surge in the exchange rate of the dollar. The Broad Trade-Weighted Dollar Index is close to an all-time high and I think it’s going higher, if commodity prices stay depressed for a while, despite a rebound in the U.S. and European economies later in 2020.

With depressed commodity prices and less global trade, those record dollar debts will have trouble being serviced. Keep an eye on the Russian ruble and the Brazilian real, which is at an all-time low. Russia is fiscally well managed, but its economy is the most sensitive to the price of crude oil. Brazil has had a lot of dollar borrowing; it is also sensitive to commodity prices and may have entered a constitutional crisis with the resignation of Justice minister Sergio Moro last week and the prosecutor’s office petitioning the Supreme Court to investigate Brazil’s president. Brazilians are fast on the trigger when removing leaders from office. During this pandemic, if President Jair Bolsonaro goes, the real will see much lower levels.

All content above represents the opinion of Ivan Martchev of Navellier & Associates, Inc.

Please see important disclosures below.

Also In This Issue

Global Mail by Ivan Martchev
It’s Often Darkest Before the Dawn

Sector Spotlight by Jason Bodner
What’s Next: Bounce or Bust?

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Read Past Issues Here

About The Author

Ivan Martchev

Ivan Martchev is an investment strategist with Navellier.  Previously, Ivan served as editorial director at InvestorPlace Media. Ivan was editor of Louis Rukeyser’s Mutual Funds and associate editor of Personal Finance. Ivan is also co-author of The Silk Road to Riches (Financial Times Press). The book provided analysis of geopolitical issues and investment strategy in natural resources and emerging markets with an emphasis on Asia. The book also correctly predicted the collapse in the U.S. real estate market, the rise of precious metals, and the resulting increased investor interest in emerging markets. Ivan’s commentaries have been published by MSNBC, The Motley Fool, MarketWatch, and others. All content of “Global Mail” represents the opinion of Ivan Martchev

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