As energy inflation keeps on soaring, governments in all of Europe face the same economic challenge: How much to support struggling businesses and households facing up to ten times higher energy bills compared to the previous year. And secondly, how to finance these relief bills.
While the introduction of windfall taxes seems obvious and fair, it is a highly controversial and unusual measure when looking at it from an anti-fragility standpoint. After all, the elevated prices are the best incentive for economic actors to invest in new sources of energy. While high energy prices are also an incentive to lower demand, this rational does not hold when these prices are disrupting businesses and creating energy poverty that undermines overall welfare and thus productivity.
The increased adoption of renewables such as wind and solar energy has decreased the total part of the energy mix that is consistent and stable. This has created a relatively higher dependence on Russian energy imports for full-day energy demand. While higher adoption of renewable energy sources is not a bad development, this crisis highlights the need to boost energy storage possibilities for renewable energy sources to create reserves in times of scarcity.
In terms of future energy generation, it is highly advisable for governments to not only look at short-term economic relief but mainly focus on strategies to secure energy independence in the future. Therefore, it would make more sense from an economic perspective to use these windfall taxes for structural investments in new energy projects through which the harmed energy companies will be compensated for their current solidarity.
Just like The Golden Investor predicted in the 2020 case study The Golden Manifesto, the central bank expansion drift of the balance sheet does not come without consequences. It is easy to print money and spill liquidity in the system to suppress interest rates and prevent another crash, however reversing this policy is a more delicate process which asks for patience. As inflation surges in the low-interest rate Western economies, the ECB and FED find themselves in a though position in which raising interest rates would probably dampen inflation but put burden on some highly indebted companies and countries that depend on low interest rates. While the current energy crisis that is a result of in-stable energy supply and the Russian war in Ukraine is responsible for the current awkward financial position, the extreme risks these central banks took the last decade following the financial crisis of 2008 will come to light.
“This time we did the exact opposite, we spoiled excess money supply in the economy just to reach our inflation targets and to boost the economy. Nothing has happened, the ten times higher monetary base has led banks to sit on cash and has only boosted real estate and stock markets to all-time highs. The Golden Investor is afraid for a Paul Volcker scenario since this unconventional central bank policy will lead to inflation at the wrong time.”
The Golden Investor – Case Study II – 18 March 2020
As interest rates surge low-income groups with low-disposable income could be squeezed out financially, which could cause a wave of economic slowdown as consumer confidence and welfare is still a key stone for most economies functioning. Countries like Italy that are heavily con-stringed with Northern European financial institutions could default on government debt amid this fast-rising interest rate environment as the expansion of the balance sheet of the ECB has finally ended. Bond markets have lost more than five percent of their value year-to-date, this is unprecedented in a bad sense. This paves the way for the next financial crisis that will highlight the extreme vulnerability of the heavily globalized state of most developed economies.
Figure 1 – Corporate Bond Market Selloff
The Wage-Price Spiral Explained
If the inflation stays at this high level, this will need to be compensated in wages. However, The Golden Investor does not believe in the so-called wage-price spiral that suggests that this will cause even more imminent inflation. Yes, this would cause inflation however at the end of the day it is the same consumer that bears the costs of inflation, while companies rarely share excess profit in times of economic up-turns. That being said, wage increases will probably hurt SME’s more than globalized multinational companies which generally have the highest profit margins due to scale and tax advantages. Therefore, policy should be aimed at finding the right balance between accepting higher inflation and dividing the burden between consumer and the corporate sector.
In this environment not much can be gained in financial markets for retail investors. Commodities and energy assets could prove to be a safe-haven and amid falling markets Virtu Financial and Flow Traders tend to generate large profits, just like they did during the corona downturns. Other more passive options that can be considered is leveraging the appreciation of the Swiss franc (CHF) versus the euro and dollar as Switzerland is one of the least energy dependent developed countries.
Disclaimer: The Golden Investor is not a fortune-teller, be sure to make the right decisions in accordance to your own financial situation, this is not investment advise or anything like that.
Through the Zhejiang Geely Holding Group the company has a direct link to the innovative plans within Volvo. Technologies developed and researched in Sweden could spillover to the Geely group which could further benefit the already successful Chinese companies. Last year the Volvo Group announced it would create a joint-venture with Swedish battery company Northvolt to develop and produce more sustainable batteries. Innovations developed within this collaborations could benefit the Geely holding directly, while not having to directly invest in the joint-venture. Even though the Geely holding does not enjoy any boost from the announced stock market entry of Volvo subsidiary Polestar, success technologies developed using this new funding are potentially at grabs for the Geely Holding.
Figure 1 – Overview of Geely Holding
Diversified Automotive Play
Despite announced profit cuts due to the chip shortage and announced lockdowns in Shanghai, the Geely Holding still benefits from revenue growth despite a profit shrinkage of 10% in 2021. The development of battery swapping company Livan is also an exciting development as the EV market enters a new stage of innovation. Battery swapping offers a key advantage over current recharging stations, namely quicker turnarounds, as well as allowing consumers to buy an EV without a battery at a lower cost and subsequently subscribe to a battery leasing programme. This creative business model could prove successful for Geely’s focus on middle income consumers. With developments in the field of autonomous driving, boosted income due to the profitable auto financing venture Genius AFC. Combined with growing market share in the high-end market with its European brand Lynk&Co and Chinese premium car brand Zeekr, the Geely Holding looks well-diversified within the automotive market.
High Exposure To Chinese Market Major Risk
Figure 2 – Sales and Market Share
However, the Chinese car manufacturer is mainly concentrated in China and as its market share within China does not grow tremendously, there is some market risk. While China sticks to its zero-covid policy, new supply chain issues could emerge due to the major challenge Omicron poses to this policy stance. As the chip shortage remains in-tact and other supply chains get affected by new stringent measure by the Chinese government it remains ambiguous whether Geely Automobile Holdings Limited (0175.HK) stock will find its reflection point after already dropping over 66% percent in the last few months. With a P/E ratio of 12.07 and expected sales growth of 24% the stock looks cheap, especially when compared to its sister company Volvo AB with a P/E of around 20. However, Volvo Group AB could enjoy large gains from the IPO of its daughter company Polestar that has its assembly line in Chengdu, China. Polestar will do this through a reverse merger with a special purpose acquisition company (SPAC) called Gores Guggenheim (NASDAQ: GGPI) and is valued at 20 billion dollars. Whether this step will be lucrative remains to be seen as rising interest rates pressure companies that focus mainly on future growth and need additional funding throughout the years.
The Chinese car manufacturer Geely seems to perform steadily despite supply chain issues and high competition within the Chinese market. However, large growth should not be expected on the short run but the Geely Holding proves that it performs consistently well with its profitable and growing business. It continuously develops and seems more dynamic towards changes which makes it more competitive than its European counterparts. Despite Chinese drawbacks due to (geo) political and pandemic related issues, the Geely Holding is certainly an interesting stock within well diversified portfolios.
Disclaimer: The writer of this article holds Geely Automobile Holdings Limited (0175.HK)stock, this article should not be interpreted as investment advice or anything like that.
Taking a quick look back at the situation in the 1980s learns us that the current situation may just well be quite similar. During the 1980s inflation reached double digit figures causing high inflation because of strong oil prices. These were partly caused by Soviet intervention in Afghanistan and the impact of the Iranian revolution, which frightened investors and disrupted energy supplies. In the same period gold hits record high at $850 per ounce, just nine years after the United States took the dollar off the gold standard.
In 1973 President Nixon had to devalue the dollar to gold, making an ounce of gold worth $42.22 dollar instead of the previous $35 dollar. This resulted in a selloff in dollars for gold by speculators fearing even more depreciation. Later in 1973 Nixon decoupled the dollar from gold completely, which made the price of bullion soar to $120 per ounce, ending the 100-year history of the gold standard. The following years inflation reached the double digits causing a huge crisis as wages were frozen. The overall value of the dollar has dropped 90 percent since the 1950s as more and more money was printed to overcome trade deficits and refinance long-term Treasuries used to finance wars and crises. This trend has continued following the financial crisis of 2008 when central banks used a new way of financing their debt by buying up Treasuries using digitally printed money. Following the 2020 pandemic purchasing programmes the Federal Reserve’s balance sheet is at an all-time high of over 8 trillion dollars.
Figure 1 – Balance sheet Federal Reserve
With Russia standing at the borders of Ukraine as geopolitical tensions rise, oil prices creep higher and are ready to break to new highs surpassing the psychological level of $100 dollars a barrel. And as investments in oil and gas exploration projects are declining, while demand keeps on rising on red-hot economic recovery, this squeeze could last for a while. If the economy will see a similar pattern as in the 1970s and 1980s remains to be seen, however it is almost certain that developments will occur at much faster pace as markets are way more interconnected than forty years ago.
Cutting Inflation Or Financial Liquidity: Not An Easy Choice
As previously mentioned , prior the the pandemic the Federal Reserve already faced problems when they started with their quantitative tapering programmes slowly cutting the amount of assets on their balance sheet. This caused a financial crush in the interbank market that shocked the Federal Reserve. As fear started to mount, the Federal Reserve had to cut interest rates three times following their unsuccessful quantitative tapering programme. This time the Federal Reserve is not only expected to start quantitative tapering, but is facing inflationary pressure if they continue their current regime. Moreover, this time interest rates have to rise at a much faster pace to dampen inflation, but this could come at a cost, many SMEs are much more indebted due to the corona lockdowns. Facing higher interest rates to refinance their debt, this will hurt businesses hard. On top of that is the surge of non-viable zombie companies that have benefited and survived due to the ultra-low interest rate environment and now will face the harsh financial reality if interest rates indeed will be hiked as much as expected. As the Federal Reserve keeps postponing this decision inflation keeps to surge and consumers face the consequences, especially low income groups.
This year will be a pivotal year for markets as volatility on markets picks up. Central banks are under increased pressure by civilians facing lower levels of purchasing power due to years of easy monetary policy. Their next step is vital to prevent a major financial crisis, but the current situation is not an easy one as picking the right balance between inflation and interest rates, e.g. purchasing power or employment. Interestingly, the European Central Bank is much more dovish than the Federal Reserve as they increasingly keep an eye on a third goal as well: the green energy transition. High carbon emission prices, along with higher oil, gas and coal prices is not necessarily a bad thing in the light of this vision. However, letting inflation rise to uncontrollable levels will come at a much higher cost for society. An underestimation of the danger of money depreciation could undermine the whole economy and hit back hard.
Disclaimer: The Golden Investor is not a fortune-teller, be sure to make the right decisions in accordance to your own financial situation, this is not investment advise or anything like that.
Starting from September onwards energy analysts warned for potential energy shortages due to lower than expected generation of energy by windmill parks at sea. Especially the United Kingdom, Denmark and Spain were forced to ramp-up coal and gas-fired electricity plants were called in to make up the shortfall from wind. This has caused prices for coal and gas to rise to extreme highs in recent months as the shortage lasted and widened. However, due to the sudden need to generate energy using fossil fuels the prices for carbon allowances went through the roof as well causing even higher energy prices. Operating costs for power plants have gone up tremendously to unseen levels in decades. Even though this is exactly the function of the EU emission cap-and-trade system, this has further increased prices in the already hot energy markets.
Figure 1 – Energy Prices in the UK remain elevated
Governments Should Incorporate Energy Reliability In Their Green Strategy
Many governments in Europe have decided to limit the burden on households by covering part of the costs. This is the first time where the necessary push for green energy has caused side-effects burdening individuals and governments with rising bills. The end is not in sight, but governments should be aware of the necessity to provide stable and reliable energy systems in its green transition strategy. In this way, lowest income groups who spend most of their income will get squeezed out. Consumer authorities expects that energy prices for households will rise over 50 percent on average this year, an unmanageable rise in cost for lowest income groups.
Lowest Income Groups Are Hit The Hardest From Current Inflation
In the United States the price of food rose by 6.1 percent compared to a year ago, while the average energy price jumped by 33.3 percent in November. These price increases do not affect all households in the same way because the consumption baskets of high-income and low-income households differ. Because of variation in the composition of consumption bundles, a Wharton University study finds that higher-income households had smaller percentage increases in their total expenditure. This is because higher-income households spent relatively more on services, which experienced the smallest price increases. On the other hand, lower-income households spent relatively more on energy whose prices had large increases.
The same is the case in Europe where energy prices are elevated as well and will trickle down into food prices as manufacturers face rising costs and will try to use this correction to also improve their own profit margins. Therefore, even though energy prices have been dropping due to the increased energy supply from Russia and other parts of the world and the still relatively soft winter, the damage is already done and will most likely become visible in supermarkets as well in 2022. Analysts expect inflation to come down as government expenditures relating to corona have come down, while central banks have been hinting towards several interest rate hikes and tapering efforts to soften the current inflationary pressure.
Figure 2 – Inflation in the Eurozone on a record high
It is hard to assess and quantify which income group is hurt the most by rising inflation. However, a fact is that stock markets have seen double digit percentage increases, partly due to excessive quantitative easing programs by central banks. The highest income group benefits the most from rising stock markets as they simply have the most disposable income. That is the same reason why poorer people feel a much heftier burden of rising inflation even if their purchasing power would be affected by the same percentage. People with the lowest income are the socioeconomic group that find it hardest to purchase a home, and real estate seems to be one of the best inflation hedges. On top of that, low income groups often have much lower savings that means that inflation surges will directly impact their consumption abilities.
The Worst Has Yet To Come
Within this topic the potential harsh side effects of rising interest rates and quantitative tapering remain out of the discussion, while these factors could mean that economic growth could drop significantly as well. While the aging of the baby-boom generation will put increased pressure on government finances that have to rely on a lower amount of workers for their tax income, a major problem that slowly will dampen the economic prosperity seen in the last decade.
Meanwhile also other commodities have seen major price spikes last year, like aluminium, copper and oil. All these assets face investment shortages, while gas and oil explorations have been going down due to lower investment in fossil fuels. The push for alternative energy sources has come at a cost of energy security which next to the surge of demand has pushed prices higher in almost all physical assets. It has to be seen whether more hawkish central bank attitudes will dampen these price surges or whether 2022 will see lasting inflation.
Two years after The Golden Investor’s first article on rare-earth opportunities, Lynas Rare Earths has risen over 500% as only big viable rare-earth miner outside of China. As prices for rare-earths like Neodymium have gone through the roof, profits have multiplied in this very concentrated market. Under great geopolitical and environmental pressure the EU is looking for alternative ways to secure the necessary amounts of critical raw materials needed for its ambitious green transition. However, as rare-earth mining is relatively unenvironmentally friendly rare-earth miners have been pushed out of the West towards China which now holds key market shares in the raw material market.
Figure 1 – Leading Edge Materials expects major growth in the CRM market
For small-cap miner Leading Edge Materials does have a differentiated asset portfolio of mines. With their full ownership over the Woxna Graphite mine and the Norra Karr rare earth deposit in Sweden, the company has a great foothold in Europe. While the tender for the exclusive exploration license in the Bihor Sud area in Romania that would add nickel and cobalt to the strategic raw material portfolio, could complete the extensive grip the company has in Europe.
China’s Power Is Major Supply Chain Risk
These critical raw materials the mainly Swedish board of Leading Edge Materials tries to attain are essential elements for batteries and magnets used in growing industries that the EU has appointed as important. The green and digital agenda of the EU cannot be completed without high dependency on China that still holds a firm grip over the critical raw materials market. The latest merger of the three big rare earth miners Minmetals Rare Earth, Chinalco Rare Earth & Metals Co and China Southern Rare Earth Group Co in China could drive prices in the already hot raw material market up even more.
Figure 2 – Geopolitical Risk in the CRM market is high
Licensing Risks Are Not Over Yet
On the long run a demand versus supply squeeze can uphold current elevated prices. However, as Norra Karr is located in a Natura 2000 region, Leading Edge is facing some counter-pressure as its initial mining license was not granted as it did not comply with the Natura 2000 regulations. However, since then Leading Edge Materials has been supported by the European Union as legislators realize extracting materials at Norra Karr could make the European rare-earth supply not only more stable but also more sustainable on the long run. Therefore, Leading Edge Materials could soon be finally set free to start their environmentally friendly operations at site. Important is to note that Leading Edge Materials uses cutting-edge technologies that cut emissions down 90% in the mining and processing of materials, in itself this company could give a helping hand to the EU to reach its green goals and supply chain targets.
Speculating on approvals could prove to be a lucrative gamble for investors looking to diversify their portfolio with high-risk green investments. However, this comes at a risk that these approvals will not occur and Leading Edge Materials (LEMSE:STO) will only be able to operate at their Woxna Graphite flake graphite mine that has the lowest operating margin in normal circumstances as competition is higher in that market. For now, Leading Edge Materials looks like a sustainable option in the mining sector.
Disclaimer: The writer of this article holds IQE (STO:LEMSE) stock, this article should not be interpreted as investment advice or anything like that.
In finance, in the broadest sense of the term leverage can refer to several situations : If we talk about corporate finance, it refers to the asset to equity ratio and thus presence of debts on the liabilities side. It also appears in the decomposition of the Return on Equity (ROE) with Return on Assets (ROA):
Where I is the interest rate due on debts. ROA – I is the leverage, it will be positive if the ROA is greater than the cost of debts. Debts create value for the company from an investor’s perspective. The same rationale can be used for funds using leverage. In this case a portfolio manager is borrowing money (has a short cash position / is short buying) to increase his buying power. The portfolio manager in turn pays interests over his short cash position. This means that with the additional amount of money invested it must generates a return greater than the interest paid over this borrowed money.
In these situations the two edged-sword and the danger of leverage are materialized by the increase in overall exposure to the acquired asset. The absolute impact of any movement of the value of the investment is greater in such situations. A more interesting point is reached when we shift our focus over derivatives, products whose values depend on the value of an underlying which can be an asset but also a variable. Examples are: Options, Futures, Swaps, Convertible bonds or CFDs. For these instruments, the leverage materializes less explicitly. The power of these instruments is that they permit investors to expose themselves to greater positions than initial costs.
Options, The Ultimate Leveraged Product For Risk-On Investors
You expect AlphaBeta, a biotech company, to successfully launch its future vaccine in 3 months. Currently, the stock is trading at $25 and the call price is $2 for a strike of $28, e.g. the option is currently out of the money. With $800 you can buy 4 contracts (standardized 100 options/contract). Suppose that at maturity the stock is worth $33 you are in the money. By exercising the profit of this trade is 400 (33 – 28) – 800 = $ 1,200. Representing a 150% return against only a 32% return of the underlying stock. Options allow for leverage without borrowing. Similar operations can be executed with futures and other derivatives. As holder of the options we transfer the risk to the writer of the options by paying a premium. The initial costs are simply the premium paid over the call options of $1, after acquisition the value of the options is increasingly dependent on its intrinsic value, e.g. the difference between strike price and the value of the underlying asset. As the maturity of the options is less than 9 months there is no buying on margin in this scenario.
Figure 1 – Value of call options
The writer of the options at other side of the contracts takes on the risk and receives the premium as compensation for it. However, the writer of the option must meet margin requirements. If the writer of this option, wrote it “naked” (he did not owe AlphaBeta) the margin he should have paid to the broker would have been:
Indeed, the writer receives in any case the premium by writing the options but note that this is not a free lunch, he must afford his protection against the leverage of the product. This protection exceeds the premium received, in addition of the initial margin. Moreover, if things go wrong for the writer he will have to pay the broker if the maintenance margin is broken.
The leverage for this type of product is linked to the convexity of the instruments. For options we pay attention to Gamma, the second derivative of the option price regarding stock price. As stock prices increase, the option comes more in the money and exercising it more profitable. That is the same reason why as stock prices increase, the option price tends to follow the underlying price more closely. The non-linear shape of this dynamic is what creates the leverage effect of this product. This leverage effect makes the short position on options risky, especially when the underlying asset is not very liquid. This has huge consequences for the costs of hedging such short positions and meeting margin requirements. Realize that the option premium is a compensation for being on the sharpest edge of the sword.
Disclaimer: This article has been written for information purposes only from a personal viewpoint. It does not constitute a solicitation, offer, advice, consultancy or investment recommendation and as such is not intended to encourage the purchase of assets. The Golden Investor would like to remind you that any of assets is highly risky and therefore, any investment decision and risk remains with the individual investor.
As central banks start unwinding their immense quantitative easing programmes and inflation keeps on soaring, the tech bubble seem to be over and losses are likely. However, IQE could be an exception and a good potential holding for investors looking to keep some part of their portfolio exposed to this booming sector. Global trends and adoption of technology pushes demand for semiconductors, the corona crisis has been a catalyst for this process. After initial lockdowns demand for semiconductors and complementary products has increased and outpaced supply. Where large companies like ASML (ASML:AEX) and Taiwan Semiconductor Manufacturing (TSM) hold key positions in the semiconductor supply chain, IQE could find its own niche as R&D-heavy player in the wireless and photonics field.
IQE, which makes semiconductor wafers for chips used in Apple (AAPL) products, recently announced profits could be lower than in 2020 as demand for smartphones went down, while the 5G rollout is still in its beginning phase. Two weeks ago IQE projected a potential 40% plunge in its annual core profit, as the British firm’s smartphone-making clients place fewer orders due to supply chain issues, driving its shares 20% lower. However, this also means the company now is trading at a discount. And as governments worldwide, including the Biden Administration, have made this one of their top priorities better times could be ahead. Despite the announced increase in production in H2 2021, semiconductor companies continue to suggest that these tight circumstances could extend well into 2022. So investors could best gradually increase their position over the course of the next months, as the disruptions can last over time.
Figure 1 – Semiconductor Disruptions
Transitory Supply Chain Disruption Could Be Buying Opportunity
IQE’s strong cash position makes it likely that this stock will rebound once the disruptions are over. Note that many markets that IQE is targeting with its products have yet to reach their full potential, and thus so is IQE’s stock price. However, some analysts point to the oil crisis of the 1970’s that turned the world on its neck as global changes caused major inflationary pressure. Currently, inflation can be partly explained by supply chain disruptions and supply and demand dynamics, and partly due tremendous amounts of liquidity pumped in markets by central banks. Interestingly, the latter is now reversed as even FED-chairman Jerome Powell now has admitted he made a policy mistake by calling inflation “only transitory”. However, this tightening next to the lasting supply chain disruptions could pose a huge setback to the now booming tech sector. As IQE has already adjusted their profit expectations, the current share price perfectly reflects the tight situation and could therefore be a buying-opportunity for those who think current disruptions will not last long anymore.
3D Sensing Equipment And Further 5G Rollout Future Cash-Cows For IQE
IQE’s VCSEL technology could play a major role in future technologies that more and more rely on real-life scanning of objects to operate. IQE’s technology is at the heart of multiple target detection, identification, tracking, and border protection systems. The company is focusing on the expansion of the Internet of Things where interconnection of devices will play an essential role in society. It’s innovative products are of top-notch quality, their tight relationship with Apple signals quality-excellence within this competitive market.
Figure 2 – Key markets in need for IQE’s semiconductor products
On the short run a re-surge of 200MM wafer production could push IQE’s profits up, depending on market conditions. However, the immense potential of photonic technology can go beyond all imaginations. However, IQE is not the only semiconductor company out there and picking a winner is hard, but considering their quality standards and large R&D investments, new innovations can be expected boosting profits on the long term for shareholders.
Disclaimer: The writer of this article holds IQE (IQE:LSE) stock, this article should not be interpreted as investment advice or anything like that.
A majority of 51 percent of registered voters say they’d support the Republican candidate in their congressional district, versus 41 percent the Democrat. That represents the biggest lead for the Republicans since 1981. There are several key points where Biden severely under-performs. Surging inflation and rising gas and food prices are the main reason for his low economic approval rating of 39 percent. This is even lower than Donald Trump’s low amid his trade war with China. Just 41 percent of Americans approve of the President’s performance, which is down 11 percentage points since spring 2021. Interestingly, is the drop in confidence amid Democrats, as just 80 percent of the Democrats are still satisfied with Biden’s performance so far, down from 94 percent this summer.
Figure 1 – Biden’s approval rating
Polarization Is One Of The Key Issues For U.S. Voters
A Quinnipiac poll has showed that the top problem the United States faces is polarization, as 11 percent of the respondents pointed it out as the most important problem in today’s society. Biden’s push for a vaccine mandate for large companies has cost him some support, as President Biden’s net approval rating among unvaccinated black voters has dropped a stunning 17 points after the announcement. Black voters have a vaccination rate of 53 percent and are a key demographic group in swing states, therefore this drawback is potentially very harmful to his overall approval dynamic. Support for Biden in swing state Iowa dropped to a new low of 33 percent, where he just one year ago got 44.9 percent of the electoral vote during the Presidential Elections. However, it should be noted that there seems to be slight majority that support vaccine mandates.
More shocking is the widening gap between the support for the Republican Party versus the Democratic Party as can be seen in the following graph of the New York Post.
Figure 2- Republicans could regain control
Supply Chain Disruptions Soon To Be Resolved
However, as new trillion dollar spending bills are passed by the Senate the continuous and non-transitory inflation could last even longer affecting Americans to the point where his approval could drop to historic lows. However, there are signs that supply chain problems will be over soon as manufacturers are increasingly investing in the scale up of supply chains, as the spike in consumer demand seems to be lasting. But the new spending bills will place continuous pressure on supply chains and the overall economy.
The FED Is Finally Changing Its Attitude Towards Current Inflation
The announcement of the scale down of quantitative easing by the FED was expected. Interesting is how their choice of words and phrasing changed compared to previous months. As the sentence: “inflation is elevated, largely reflecting transitory factors” was altered in the newest FED announcement.
“Inflation is elevated, largely reflecting factors that are expected to be transitory”
Chairman Powell on U.S. inflation levels
Even though it is not a big change, “expected to be” is much weaker than simply “are”. This means that the Fed’s confidence in its own transitory narrative has diminished, which implies that inflation might be more persistent than initially thought, further hurting Biden’s approval.
For now, Republicans are expected to win by a sweep in the 2022 midterm elections, but much can change in the meantime. However, if Democrats continue to hurt American consumers with elevated inflation due to their excessive spending, no real change can be expected. The FED’s policy change is a good start, however, The Golden Investor remains skeptical of the success of the quantitative tapering which is supposed to start in May 2022. Back in 2019 the FED was forced to stop tapering, this time the economy is even more delicate. Time will tell whether the United States will come out of this split.
Disclaimer: The Golden Investor is not a fortune-teller, be sure to make the right decisions in accordance to your own financial situation, this is not investment advise or anything like that.
A column in the New York Times, authored by Spencer Bokat-Lindell, suggests that the United States needs to increase government spending on child care to “shrink the gap” with other nations. The main evidence for this proposition is a chart showing the United States at the bottom, see Figure 1 below.
Figure 1 -Child care spending across the world
The obvious goal is to convince readers that the United States is doing something wrong. And that comes across in the text of the article. If you’re active on social media there’s a decent chance you came across this chart, about how much less the U.S. government spends on young children’s care than other rich countries. The infrastructure and family plan that President Biden proposed and that’s now being negotiated in Congress is an attempt to shrink the gap through four key policies: a federal paid family and medical leave program, an extension of the child tax credit (in the form of a monthly payment) that debuted this year, subsidized day care, and universal pre-K.
But why is it bad to be at the bottom of this list when all the nations above the U.S. have lower living standards?
I’ve repeatedly made the point that we don’t want to “catch up” to nations that have lower levels of prosperity.
Household consumption is 50 percent higher in the United States than the average of other developed nations.
The bottom 10 percent of Americans enjoy better lives than the average citizens of OECD nations.
But maybe this isn’t just about living standards.
The article also suggests that childcare subsidies are needed to avert demographic decline.
…Why does the United States have such an exceptional approach to family and child care benefits…? European and Latin American countries began enacting these policies…the end of World War II accelerated the process, particularly in Europe… “Part of it had to do with fears of demographic decline…the need to recover from those years and to ensure that there was a strong work force going forward,” Siegel told the BBC.
For what it’s worth, I agree that demographic decline is a major issue. Falling birth rates and increased life expectancy are a very worrisome combination for government budgets. Which leads to the hypothesis that childcare subsidies can help deal with this problem by enabling higher levels of fertility. That’s theoretically possible, I’ll admit, but we certainly don’t see it in the data. Here’s the chart from the New York Times, which I’ve augmented by showing fertility rates.
Figure 2 – Child care and toddler spending, including fertility rates
As you can see, the United States has a higher fertility rate than almost every other nation on the list, which certainly suggests that childcare subsidies are not an effective way of encouraging more babies. Moreover, U.S. fertility of 1.71 is higher than the OECD average of 1.61. And when you compare the United States to peer nations (“OECD rich nations” and “EU-15 nations”), the fertility gap is even larger, 1.71 to 1.52.One moral of the story is that government handouts are not an effective way of increasing fertility. And the other moral of the story is that it’s not a good idea to copy nations that are economically weaker.
Disclaimer: This is a republishing of Dan Mitchell’s personal work.
Last quarter, for the first time since the establishment of the enterprise, Pretium Resources’ cash position exceeded its debt after payment of its loans. However, this gold miner is also facing the rising costs of increased gasoline prices and the ongoing COVID-related costs. All-in sustaining costs (AISC) in the second quarter of $1,099 per ounce sold were higher than the comparative period in 2020. However, the still relatively high gold prices boost profitability. For the first six months of the year, their AISC is $1,053 per ounce, but this could creep upwards as diesel prices have surged even more in Q3. After a corona outbreak among employees it had to shut down operations temporarily last quarter which slightly harmed results. Interestingly, despite this unexpected break, their output only dropped four percent signalling the quality of the high grade soil on the Brucejack mining site.
Green Sustainability Path Of Pretium Could Drive Down AISC
The company has committed to purchase seven battery electric haul trucks to replace their fleet of 12 diesel-powered underground haul trucks, with the first one already in operation. Mobile combustion of gasoline and diesel contributed to roughly 68% of the greenhouse gas emitted from operating the Brucejack mine in 2020. After the rollout of this multi-year plan, we forecast a reduction of approximately 24% or 6,900 tons of carbon dioxide equivalent annually from the implementation of this initiative. As diesel costs remain high and are most likely to be taxed more in the progressive Canada of Trudeau, this shift can be considered a smart one. However, in terms of ESG standards this will boost the already high ranked ESG rating of the company, which is already among the top performers within the industry. This decision will most likely attract even more investors, providing equity cushioning insolvency issues in less prosperous times.
The Board Is Not Taking Risks, Which Is A Good Thing
During last quarters meeting directors were very reluctant to say anything about potential dividends or share buyback programmes as they explained to rather stay focused on decreasing their debt level and maintaining a healthy revenue stream. However, part of that could be a potential asset purchase at the end of next year. For now, the company remains focused on improving its own site and drilling for new high grade ores, as the current site is only sufficient for another one year of mining. After that, new sites have to be explored, so positive drill results are essential. The board of Pretium Resources wants to assure the long term viability of the company before rewarding shareholders. Paradoxically, this could benefit long term investors more than if the company would spend millions on investor compensations.
Figure 1- Pretium’s balance sheet has improved tremendously due to higher output and rising gold prices
The results of the following quarters Q3 and Q4 of 2021 will not show any shocking results in terms of output. However, in terms of exploration and drilling positive results are the key point to look at. Investors will want to look at the drilling results and assess whether the mine has a longer lifetime than currently can be disclosed. On the other side, gold prices remain strong and have been creeping up the last few weeks which obviously positively impacts the overall business. As stagflation fears are surging, gold prices could benefit from increased risk-off tendency after months of bullishness. However, within the industry Pretium Resources (PVG) is an example of excellence.
Disclaimer: The writer of this article holds Pretium Resources (NYSE:PVG) stock, this article should not be interpreted as investment advice or anything like that.
Since big players like Vanguard and BlackRock introduced exchange traded funds (ETF’s), investors have been able to effectively reduce risk in their portfolios. However, this has created a market externality that comes at the cost of the overall economy and might dis-incentivize firms to compete with each other. ETF’s contribute to common ownership of companies, and their boards are effectively only serving the interest of their shareholders by trying to gain as much capital as possible for them, creating a distorted business model on the long run. As many ETF’s are industry and sector specific some competing firms will come under the watch of the same shareholders whose interest is not always in-line with what is best of the company. These companies will be less inclined to compete with each other if the opposing competitor has the same owner.
Silent Cartel-Forming Can Harm Consumers
If all companies across the industry will have the goal to serve the common owner, this can lead to silent cartel forming, where there is no need for specific agreements to offset anti-competitive behavioral practices. This can vary from limiting production and the raise of prices, but also more in-evident measures like reduced investment which leads to lower innovation. Where in mergers there are clear regulations in place to prevent the creation of monopolies, common ownership is harder to map, analyze and therefore harder to regulate. In many different countries new policies are set in place to improve transparency related to ownership. In the European Union the Ultimate Beneficial Owner (UBO) register has been adopted and impelemented to map all shareholders with over 25% ownership within a certain firm. Under the 5th Anti-Money Laundering Directive the register has been mandated to be open to the public.
Empirical Evidence Is Ambiguous
Koch et al. (2021) do not find a robust relation between common ownership and industry-wide price-levels, nor do they find evidence for industry profitability. However, their results could differ if tested for higher percentage levels of common ownership. Moreover, we know that there are anti-competitive effects from common ownership in the airline and banking industries (Azar et al., 2016; Azar et al., 2018). However, it is clear that common ownership has its effects on the market and therefore could be prone to regulation if competition authorities find more robust relationships. Three index fund manager effectively control the whole index market, Vanguard has 51%, BlackRock 21% and State Street Global 9%. The large jump below in 2010 is due to the acquisition of Barclays Global Investment by BlackRock in 2010. This shows that the rise of common ownership of large blocks of stock is to a large extent a consequence of the rise of index funds and of what Azar (2020) calls “the Big Three”.
Figure 1 – Common Shareholder Pairs S&P 500 (Azar, 2020)
The Common Ownership Trilemma
But it all comes down to the classic common ownership trilemma in which portfolio diversification, shareholder representation and competition are balanced. The most extreme scenario being a situation where all companies within a certain sector have to same common owner, that is when both shareholder representation (of the common owner) and portfolio diversification are maximized, but effectively create a monopoly in which there is no place for competition. There is a wide gap between some common ownership and monopoly-like destruction of competition, but the drawbacks of common ownership should be faced as it the whole of society benefits from healthy competition driving market dynamics leading to technological innovations and ultimately economic growth. Moreover, it could be argued that shareholders on the long run benefit more from competition and the resulting innovation as competition does not have to be a zero-sum game. When discounting for future profits, shareholders could actually be better off in a situation with high levels of competition, therefore competition authorities have every incentive to keep protecting healthy dynamics within the market.
In conclusion, it is good that regulators start implementing policies that map the common ownership. Tackling the potential negative sides of the drive for diversification in the financial sector will be much harder, as investors and thus large stakeholders in this debate have deep pockets which will potentially undermine the effectiveness of every policy set in place to reduce negative externalities involved with high levels of common ownership. For now it remains to be seen if governments are strong enough to withstand lobbyists.
Bibliography
Koch, A., Panayides, M., & Thomas, S. (2021). Common ownership and competition in product markets. Journal of Financial Economics, 139(1), 109–137. https://doi.org/10.1016/j.jfineco.2020.07.007
Azar, J., 2016. Portfolio diversification, market power, and the theory of the firm. Unpublished working paper. University of Navarra.
Azar, J., Schmalz, M.C. and Tecu, I. (2018), Anticompetitive Effects of Common Ownership. The Journal of Finance, 73: 1513-1565
Azar, J. (2020). The common ownership trilemma. University of Chicago Law Review, 87(2), 263-296.
