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The New Concensus

In a recent webcast, I was told that my optimism about gold was unusual. Despite an inflation problem, most strategists expected rapidly rising interest rates to keep the yellow metal under pressure.

Now, in the face of a robust rebound in the gold price, the tune has changed. Forecasts of a new high and a quick rally to $2,500 or even $3,000 suddenly abound. The prevailing new narrative is that gold will continue to gain because a retreat in inflation is taking the pressure off the Federal Reserve and other central banks. We’re told that interest rate hikes will substantially moderate, perhaps even become unnecessary. Stocks, bonds, bullion (and perhaps even crypto currencies) are set to recover.

The dollar, under continuous upward pressure since 2021 and now clearly weakening, is also getting a lot of attention. Many commentators expect the trend to continue and perhaps to intensify. Yet another view that’s gaining traction is that foreign stock markets will outperform Wall Street.

Here are my reactions to the new consensus:

☐ I do not believe that price pressures are under control. To be sure, energy and food costs have fallen from their recent highs, but supplies are far from stable. Another reason for concern is that productivity enhancements and globalization were the two key factors for keeping inflation absent for so many years. The former has stalled and globalization is now in reverse gear.

Even if monetary authorities were to push short-term rates to even higher levels, I believe the Fed and its foreign counterparts remain too far behind the curve to stop inflation. To me, that is the principal reason for staying bullish on gold.

U.S. Government Debt: $30 trillion and counting

☐ After a dramatic two-year rally, the dollar is now correcting. The main reason: mainstream opinion now assumes that interest rate differentials vis-à-vis other currencies will no longer favor the U.S. currency. However, global capital flows are determined by many other factors, with economics and geopolitics looming particularly large. We believe there is a possibility that, during the coming few weeks, the United States may look better than other parts of the world.

Even so, from a longer-term perspective, the dollar does look vulnerable. Financial markets have been myopic, focusing almost exclusively on rates set by the key central banks. Far too little attention has been paid to fiscal developments. The U.S. deficit will continue to run at lofty levels, considerably higher than G-10 average. I am also concerned that America’s dominance of global trade and international payments systems, along with the dollar’s reserve currency status of nearly eighty years will over time recede.

☐ Considering these and a number of other factors (such as the growing possibility of a global debt crisis), I would expect global financial markets to stay on the defensive. That is why bonds make up a very small part of our portfolio and why we believe selection is the key to equity outperformance. When picking stocks, we continue to focus on sustainable cash-flow generation and balance sheet strength. We are currently finding those attributes in select natural resource, health, financial and non-discretionary consumer stocks. We’re also cautiously eyeing select emerging markets.

A Succession of Crises

North America, Japan and much of Europe have been pursuing unsustainable policies and tolerating systemic inadequacies for decades. That alone suggests that we’re in for a period of harsh adjustment. Add the visible decline of the unipolar post-war order and the severe military overextension by its lead nation (800 U.S. bases in more than 70 countries and bunch of proxy wars on the go), and it gets worse. And finally, bring into the mix a social order that was once dominated by a vibrant middle class but is now in utter disarray. Even worse, during the past few years virtually every Western government, through gross overreach and divisive policies, has managed to alienate its citizens.

What you get from all this is a guarantee of successive shocks. Some calamities, like the Ukraine war, will be more predictable. Others, like the advent of Covid or climate emergencies, will come out of nowhere. It also doesn’t help that governments keep reacting to the fallout from previous policy errors in a most imprudent way. Look at the measures implemented in response to the pandemic: a huge pay-off to the pharma industry at the expense of the economy and social cohesion. Or the sanctions regime against Russia and the massive military aid to Ukraine: yet another colossal gift to the “defense industry”, all while the people are being asked to accept austerity and, in the case of the Ukrainians, ongoing death and misery.

What always fascinates me is the confidence with which various “experts” forecast outcomes. To me, predicting how exactly the consequences of past and present sins will manifest or what effect a random event will have, is a mug’s game. My own preference is to be keenly aware of the challenges at hand, consider various possible outcomes and, as they become more defined, react and adjust.

Going into 2023, what are the most important developments to watch? Here is how I see it:

  • Geopolitically, apart from the Ukraine War, the Western attempt to contain China and the rapidly deteriorating situation in Iran will most likely take center stage.
  • Societally, I expect a noticeable decline in living standards and ongoing government overreach to keep up the pressure. I’m also expecting continued use of surveillance technology and Artificial Intelligence, which will add to people’s alienation.
  • Finally, in terms of macro-economics, chances of an inflationary recession and a global debt crisis are growing exponentially.

Neither the politicians nor the corporate complex, and least of all consumers, will know how to cope. After at more than half a century of living it up today at the expense of tomorrow, any adjustment will be hard to stomach.

Best regards,

Peter Cavelti