Chris Temple joins me today to look ahead to the key news events of the week. We start with the Fed meeting and our thoughts on what could be said about the repo market. Next up is the vote in the UK and how Brexit could move forward and impact markets. Finally the potential tariffs on December 15th are making this upcoming Sunday very important!
With Trump saying that the meeting with Xi went well, talks are back on the table and tariffs are delayed some of the geopolitical factors driving gold have dissipated for now. That is driving gold below $1,400. Doc joins me to discuss the action today and share why he is still bullish for the end of the year. When you have financial markets so headline driven all investors have to be ready for these events and take note of the bigger picture.
I hope everyone in Canada is having a very happy Canada Day!!
With the Mexico tariffs behind us the markets are continuing to move higher and the run that PMs were on is being faded. Chris Temple joins me to discuss how he is telling his members how to play this market. We also discuss the overall environment of how Trump can create news (arguably fake news) that moves markets.
Chris Temple joins me today to address the new tariffs announced last night on Mexico that is throwing the new trade deal between the US, Canada, and Mexico into turmoil. Plus some comment by the Chinese that they will be retaliating to the escalating trade tensions with the US. Market are down with the USD while treasuries and gold are bouncing.
“The next few weeks could be rocky.”
Bank of America’s fortune cookie writers may have undersold their case…
The trade war famously reopened Friday. The United States imposed 25% tariffs on $200 billion of Chinese products.
Come this morning, China announced retaliatory tariffs on $60 billion of United States products.
They enter effect June 1 — unless a negotiated truce first washes them out.
CNBC lists the butcher’s bill:
Beijing will increase tariffs on more than 5,000 products to as high as 25%. Duties on some other goods will increase to 20%. Those rates will rise from either 10% or 5% previously.
American agricultural products were not excepted. Soybean and cotton prices went plummeting today… in consequence.
Additional retaliation, suggest some Chinese sources, may await.
Trade war, like any other war, is harder to stop than to start.
China Maximizes the Market Impact
Was it coincidence that this morning’s blast arrived in time for opening whistle on Wall Street?
Samantha Azzarello, global market strategist at JPMorgan:
China retaliating as fast as they did was a clear signal they’re not going to be pushed around… It was interesting it wasn’t done on the weekend. It was done just in time Monday morning for markets to open.
On cue the floodgates swung open at 9:30… and a red deluge came washing down the canyons.
The Dow Jones was instantly 400 points under… then 500… 600… and 700 by early afternoon.
By midafternoon the worst of the hemorrhaging was plugged.
The Dow Jones ended the day down 617 points.
But for the first occasion since February, it has slipped beneath its 200-day moving average — which has the chart watchers shaken and rattled.
The S&P lost another 70 points today.
But percentage wise, the trade-sensitive Nasdaq withstood the worst slating of the three — down 270 points on the day — or 3.41%.
“Very bad for China, very good for USA!”
President Trump laughed off all concerns this morning… and insisted China is brunting the true impact.
Their [sic…] is no reason for the U.S. Consumer to pay the Tariffs, which take effect on China today… Also, the Tariffs can be completely avoided if you by from a non-Tariffed Country, or you buy the product inside the USA (the best idea). That’s Zero Tariffs.
Here he digs his thumbs into China’s eyes, and gives them a good hard twist:
Many Tariffed companies will be leaving China for Vietnam and other such countries in Asia. That’s why China wants to make a deal so badly! There will be nobody left in China to do business with. Very bad for China, very good for USA!
The American Consumer: Hidden Casualty
But the president’s top economics man — Larry Kudlow — conceded this weekend that American consumers will in fact pay much of the freight.
Companies that accept imports actually pay the tariffs at water’s edge.
These costs they pass along to the consumer further down the line.
Thus tariffs represent a tax increase upon Joseph and Jane Average American… who must stretch deeper into their pockets to purchase the same goods.
And now that China has responded in kind, Chinese demand for American products will slacken.
Oxford Economics has issued a new report. It reveals…
That a 25% tariff on $200 billion of Chinese goods imports would cost the United States economy $62 billion once all scales are balanced, once all accounting is settled.
That figure amounts to $490 per household… incidentally.
What if the president levies additional tariffs on all Chinese wares, as he has threatened?
Oxford estimates total economic losses would cost the United States some $100 billion by next year — or $800 per household.
The Seen vs. the Unseen
The president must have misplaced his copy of Economics in One Lesson by legendary economics journalist Henry Hazlitt.
This is the persistent tendency of men to see only the immediate effects of a given policy, or its effects only on a special group, and to neglect to inquire what the long-run effects of that policy will be not only on that special group but on all groups…
The bad economist sees only what immediately strikes the eye; the good economist also looks beyond… The bad economist sees only what the effect of a given policy has been or will be on one particular group; the good economist inquires also what the effect of the policy will be on all groups.
Hazlitt’s is a faint and feeble voice coming from the tomb.
There is the seen, he reminds us… as he struggles to rise above the din of the living.
But there is also the unseen.
You must consider the unseen effects of any given policy.
But it requires a special effort of the imagination. And few can conjure the image…
They cannot observe the lost jobs, the money unspent on other goods, the cost of retaliatory tariffs.
Here is what the president does not appreciate…
The businesses that will not open or will not expand because the inputs of industry are costlier…
The money Americans will not spend on other goods and services because they are expending more for these goods…
The American products that will go unsold abroad because of the tariffs China throws up in retaliation.
Or as another president, Woodrow Wilson, once said in reference to the sugar tariff:
“Very few of us taste the tariff in our sugar.”
Few ask the right questions… connect the proper dots… draw the right conclusions.
Heave 100 bricks off a rooftop in any American city.
One — perhaps two — will find a man who tastes the tariff in his sugar.
That is precisely how the political men prefer it.
But the costs are nonetheless real.
In the Unseen… We Will See the Light
Yes, it is true… tariffs may open one door for one American.
But they slam one door shut on the nose of another.
For every extra dollar that jingles in the one fellow’s pocket… one less dollar jingles in the other fellow’s pocket.
This fellow will see his pay envelope shrink — in effect, his taxes raised.
In conclusion, tariffs benefit few. And damage many.
Let us instead direct our focus to the unseen, as a wise voice whispers from beyond the grave.
It is here — in the unseen — that we will see the light…
Managing editor, The Daily Reckoning
The trade war is back on. The trade deadline came and went at midnight last night without a deal. So 25% tariffs on $200 billion worth of Chinese goods took effect at 12:01. The tariffs had previously been set at 10%.
Based on Trump’s comments, 25% tariffs may possibly be applied to an additional $300 billion of Chinese goods.
China said it would respond with unspecified but “necessary countermeasures,” although negotiations continued today in Washington.
Some analysts say China can dump its large holdings of U.S. Treasuries on world markets. That would drive up U.S. interest rates as well as mortgage rates, damaging the U.S. housing market and possibly driving the U.S. economy into a recession. Analysts call this China’s “nuclear option.”
There’s only one problem.
The nuclear option is a dud. If China did sell some of their Treasuries, they would hurt themselves because any increase in interest rates would reduce the market value of what they have left.
Also, there are plenty of buyers around if China became a seller. Those Treasuries would be bought up by U.S. banks or even the Fed itself. If China pursued an extreme version of this Treasury dumping, the U.S. president could stop it with a single phone call to the Treasury.
That’s because the U.S. controls the digital ledger that records ownership of all Treasury securities. We could simply freeze the Chinese bond accounts in place and that would be the end of that.
So don’t worry when you hear about China dumping U.S. Treasuries. China is stuck with them. It has no nuclear option in the Treasury market.
How did we get here?
Trump’s trade representatives have complained that China had backtracked on previous agreements and that China was trying to renegotiate key points at the last minute. The Chinese are not accustomed to such resistance from U.S. officials. But Trump and his team are unlike previous administrations.
China assumed it was “business as usual” as it had been during the Clinton, Bush 43 and Obama administrations. China assumed it could pay lip service to trading relations and continue down its path of unfair trade practices and theft of intellectual property. Trump has proven them wrong.
Trump was never bluffing. He means business, which China is finally learning.
There’s still time to reach a deal, however, before the tariffs actually have any practical impact. The tariffs only apply to Chinese goods that leave port after last night’s deadline. That means goods already en route to the U.S. will not be affected.
So it will be at least two weeks until Chinese goods are actually subject to the extra tariffs. So that leaves the window open for a deal.
Trump announced on Twitter early this morning that “there is absolutely no need to rush” to get a deal done, which removed any urgency from negotiations for the moment. You can expect the cat and mouse to continue for the next couple of weeks, with volatile swings in the stock market depending on the news of the day.
But Trump holds the superior hand as far as trade goes. China exports far more to the U.S. than the U.S. exports to China, so China has far more to lose in the trade war. Since the trade war began, the U.S. has suffered only minor impacts, while the impact on China has been overwhelming. The new tariffs will have even more serious effects on the Chinese economy.
A 25% tariff on $200 billion of goods could take 0.3–0.4% off Chinese growth. And if Trump carries through with 25% tariffs on an additional $300 billion of Chinese goods, it could subtract an additional 0.5% from Chinese growth.
That would cost China 0.8–1% of lost GDP at a time when the Chinese economy is struggling and can least afford it.
To go along with slowing growth, the Chinese financial sector is totally insolvent. Consumers’ savings have been used to finance ghost cities, white elephants, capital flight, Ponzi schemes, bribes and kickbacks.
There are some real assets to show (their trains are the best in the world) and some growth, but not nearly enough to cover liabilities.
With a debt-to-GDP ratio of about 250%, China is already well into the danger zone. How much more debt-financed stimulus can it take?
Research by economists Kenneth Rogoff and Carmen Reinhart indicates that debt-to-GDP becomes a drag on the economy at 90%.
China’s leadership can only hope the damage can be limited before the people begin to question its legitimacy.
Could China’s leadership lose “The Mandate of Heaven?”
for The Daily Reckoning
Tariffs are front and center right now in the markets, and during the 2002 steel tariffs, the steel tariffs were not good for the U.S. markets. The Dow Jones Industrial Average, S&P 500, and the NASDAQ were all down between 20-30% during the 2002 steel tariffs, before recovering, when tariffs ended in December 2003. With the US now imposing steel tariffs on Canada, Mexico, and the European Union. While exempting Australia, South Korea, Brazil, and Argentina. What does this mean for the Canadian stock markets, and what will happen to the Australian markets, if Australia gets hit with the steel tariffs? Both the TSX & ASX are heavily weighted to financials and materials, and both experienced huge housing booms over the past decade. Will gold be a safe haven for Canadian and Australian investors?
“I do think that this trade stuff is a negative. It is going to hurt sentiment. Its badly thought through. Its not strategic. There are legitimate complaints about trade. But this is not the way to go about it. And you see it in the volatility in the market” Jamie Dimon (Chairman & CEO of JPMogran Chase) (Source CNBC)
2002 TARIFFS IMPACT ON CANADA TO THE S&P/TSX Composite & S&P/TSX Venture
Even though Canada was exempt during the 2002 steel tariffs, S&P/TSX Composite fell by almost 30% during the US imposing the steel tariffs in 2002. The S&P/TSX Composite finished slightly positive by the time the tariffs were over. The S&P/TSX Venture Composite (Venture), Canada’s junior market, not only FELL less during the bear market but significantly outperformed by the end of the tariffs. The Venture was up by almost 50%. The sector rotation out of technology and into commodities had begun, and the Venture saw HUGE fund flows because of its heavily weighted in junior mining (gold stock, silver stocks, copper stocks, etc.) and junior oil & gas stocks. You had capital pull out of speculative tech stocks (Nortel Networks) and venture capital and put into high-risk commodity focused junior explorers, developers, and junior miners. The Venture is the largest venture capital space in the world to invest in small cap natural resource stocks, providing exposure to exploration, development, production, and mining services. If history repeats, then the TSX Venture is set to outperform the broader markets once again.
2002 TARIFFS IMPACT ON THE ASX 200?
The broader ASX 200 fell less than the Canadian and US markets during the 2002 US steel tariffs while the North American equities were selling off in the second half of 2002. The broader ASX Materials Index finished positive, just over 10% by the end of 2003. We can see that even in Australia the sector rotation into materials had started to take place following tech burst. What was surprising, in 2002, was that both the ASX 200 bottomed in February 2003, posting modest negative returning during the trade situation. The ASX Materials in contrasts bottomed in September 2002. While only a few months into the US steel tariffs, the overall ASX Market continues to be up, with the ASX materials up but lagging the broader index ASX 200. Gold significantly outperformed the ASX, even when adjusting for currency appreciation.
WHAT IS DIFFERENT THIS TIME FOR CANADA?
Unlike the U.S Federal Reserve, that was decreasing rates, after September 11, only a few months prior to the steel tariffs, and the bursting of the tech bubble. In Canada, the Bank of Canada (BoC) raised its target four times over the same time period, by 125 BPS, from 2.25% to 3.5%. But it didn’t stop there. In July 2003, the tightening was over, and the target was reduced to 3.25%, then again to 3.00% Where the is Bank of Canada today? No change in its target yet since the US steel tariffs started and no reaction yet to them being implemented on Canada. But will they be forced to raise their targets?
“The economic progress we have seen makes us more confident that higher interest rates will be warranted over time, although some monetary policy accommodation will still be needed,” Governor Poloz said. “We will continue to watch how households and the entire economy are reacting to higher interest rates. And we will be cautious in making future adjustments to monetary policy, guided by incoming data.”
Canadian households have built up about $2 trillion of debt, including $1.5 trillion of mortgage debt….a prolonged period of low interest rates that allowed borrowers to take out larger mortgages for the same payment size. This debt is now a vulnerability, both for the whole economy and for highly indebted households who will face increased debt-service costs when interest rates rise. “We are closely watching the vulnerability represented by this group and the debt they carry, and how it poses a risk to both the financial system and the economy,” Governor Poloz said. – Bank of Canada
Canadian households continue to be significantly more leveraged than they were before the 2008 recession. But will the Bank of Canada raise rates? They may have no choice. Are household and businesses going to be able to handle inflation pressures they are already experiencing from rising gas prices? Brent crude hits its highest level since 2014. There is also the July 1st deadline of tariffs being added to US imports.
“The problem for the Bank of Canada is this. What do they really control? So, when we get the Bank of Canada press statement, what is it they do? They actually just have an influence on the overnight rate and the overnight rate you can say as sort of an impact to the very front end of the curve. But the reality is that the Canadian bond curve is 90% correlated to the US Treasury market. What are US Treasury yields doing? They’re back up. There’s nothing the Bank of Canada can do about that. US Treasury yields are backing up. We are importing a good part of that into Canada. Mortgages are ultimately priced off the bond curve. And so, look at what happened last week. Even just weeks after the Bank of Canada said we’re are on, maybe on hold indefinitely. Mortgage rates went up last week because of the importation of higher bond yields south of the border.
…. This is the shocking statistic. Normally conservative Canadians that historically really went and took out five-year mortgages. They didn’t want to take on refinancing risk. Half of the Canadian residential mortgages rollover in the next year. Almost half, the number if 47%. That shocking” – David Rosenberg (Source BNN Bloomberg)
WHAT IS DIFFERENT THIS TIME FOR AUSTRALIA?
The Reserve Bank of Australia (RBA) during the 2002 episode of tariffs, followed the similar path to the Bank of Canada by raising its cash target rate four times, by 100 BPS from 4.25% to 5.25%. But there were no reductions, only hikes, and holds. Where is the RBA now? The RBA has stayed the course by holding rates, but will it follow history and begin raising rates? What about the impending interest-only loans that need to be refinanced over the next three years? Will the RBA hold back from raising rates? Time will tell.
In Australia interest-only mortgages, which during “their recent peak, they accounted for almost 40 per cent of all mortgages. While interest-only loans have a role to play in Australian mortgage finance, their value has limits.” Will overseas funding costs that are impacted by the US increasing rate, rise well? “Over the last 20 years to 30 June 2014 the correlation between Australian and US 10-year yields has been 0.84 measured over quarterly periods with a correlation of 0.71”Source: Franklin Templeton. While not the short-end of the curve, as we have seen recently with many emerging markets rising interest rates is becoming the new normal and Australia will have to raise the cash rate soon if the Fed keeps going.
IMPACT ON CAPITAL MARKETS IN CANADA & AUSTRALIA
Due to the tight correlation that Australian and Canadian rates have to US rates, we could see banks hike their mortgage rates higher if the US Fed continues to raise its target rate. We would also expect this would further put pressure on both of their housing markets and the capital markets if a broader sell-off takes hold because of the tariffs as had previously occurred in the 2002 tariffs. This may present opportunities for royalty stocks like to provide funding to the sector because capital markets funding through equity issuance and commercial lending from banks would dry up.
WINNERS FROM THE US 2002 STEEL TARIFFS
- Gold was the clear winner in the US Steel Tariffs.
- Canada’s TSX Venture Index was the clear index winner in terms of performance because it is heavily weighted in small-cap natural resource stocks in mining and oil & gas.
- If history repeats, the tariffs may be the signal over a 1-2 year time period, the start of the rotation out of technology and into commodity assets, just like the 2002 US tariffs signaled the rotation into the 2000’s commodities boom.
The outlier remains how long will the US Federal Reserve continue to keep raising and removing liquidity until something breaks?
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