One ounce of gold currently buys 38 barrels of WTI oil. This ratio has only been seen in the great depression, before the dollar devalued, and during Covid.

There is a risk, we are really at the end of the age of oil. Then the only ratio we should be concerned with is gold/copper (copper being the vital commodity for electrification). But oil matters as it seems to be the commodity that drives inflation expectations, so it price movement remain important.

The big revolution has been in shale oil in North America. Production seems to be levelling out at 13.3 m barrels a day in the US, a number first seen in 2019. Slowing production growth should be bullish.

And a similar trend in Canadian oil production.

Shale oil production tends to produce natural gas, and well before US oil prices went negative during Covid, US natural gas prices would often be zero to negative (i.e producers would pay for someone to take away the gas - and would make enough just from the oil). Hence, I look at natural gas pricing to see if US shale producers are beginning to rationalise production. NGF28 below refers to January 2028 natural gas pricing, which changed dramatically in 2022. Forward pricing has held, up but not collapsed, which I see as bullish.

However, that being said, El Paso Natural Gas pricing (El Paso is near the Permian region - so area where production of oil and gas is still growing) has recently dropped back to negative spot pricing. So spot, and long dated forwards are telling a different story.

As it happens, the EIA no long produces a separate report on shale drilling, and includes the data in the DOE Short Term Energy Outlook. I am still trying to integrate the old data - but for our purposes, we can look at the Permian data. As suggested with other data, drilling in Permian has rationalised.

So why is crude oil so weak relative to gold? Inventory data is not useful - it shows US commercial crude oil inventory at lowest level in 5 year - which is bullish.

Even with the SPR beginning to increase inventory levels, we are still at very low levels.

It hard to find a good reason for the break between gold and oil, unless we start thinking in terms that energy consumption is ex-growth. Using the old BP Statistical Review numbers (now housed at the Energy Institute) Energy consumption per capita is falling in the developed world, and Asia and South America are already at 50% of European levels. Africa offers the potential for growth in consumption, but there is little sign of change at the moment.

When you add in collapsing solar power and other renewables fossil energy could be on the way out?

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I recently wrote about my existential angst. This angst came about because all I am looking for are “megatrades” that you can build an interesting portfolio around. On of these megatrades was food inflation. A few years ago, I noticed China had become the biggest importer of corn in the world, and was moving from self sufficiency to import reliant in food. While Chinese imports are not as large as they were, they are still large enough to be the biggest single importing nation.

I thought this would lead to a sustained change in agricultural good pricing. This has not happened. Corn prices have round tripped.

But a funny thing has happened. Traded agricultural good prices have come down, but food prices have not. The Commodity Research Bureau Foodstuff Index is still well above 2019 levels.

As anyone who does grocery shopping will tell you, food prices have not really fallen. This is clear in CPI data. Food prices have levelled off, but not fallen.

So what is going on?

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Food inflation is important. When food prices rise, expect politicians and central banks to act. Rising house prices benefits some people, and hurt others (renters), rising food prices hurts almost all voters. Looking at long dated US inflation indices, the inflationary 70s is very clear, as it the recent bout of food inflation.

However, grain prices, and agricultural related stocks have been weak. Is the food inflation trade done?

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Federal Reserve policy making makes far more sense when you think about PPI (cost to companies) than if you think about CPI (cost to consumers). CPI has continued to rise steadily, while PPI essentially flatlined from 2010 to 2020.

The Federal Reserve target rate and PPI yoy have a much better fit than CPI in my view.

Commodity inflation is always tricky to predict. Supply and demand can be extremely variable, so I am going to focus on wage inflation. Currently US wage inflation is running at 4.3%, down from a peak of 7%, but still at the one of the highest rates since 1980.

Since 1980s, the Federal Reserve has been able to induce a recession by raising interest rates. Typically a good sign that this was going to happen would be widening of credit spreads. I use the KDP daily high yield index, and 5 Year US treasury to generate this credit spread. No sign of any widening at the moment.

Why is there no sign of credit widening? Probably because the US government has gotten into the habit of spending it way out of problems. US government spending looks to have moved structurally higher.

One fly in the ointment in this pro-labour story is that, as I have pointed out many times, the Federal Minimum Wage has remained at USD 7.5 since 2010. The contrast to the rapid increases seen in the 1970s is stark. Why is the government not actively raising wages more?

Politically speaking, the Federal Minimum Wage is a bust. However at the state level there is a lot of movement. California has adopted a rapidly rising minimum wage, while its great rival Texas has kept its minimum wage flat. Broadly speaking, Democrat voting states have higher minimum wages. Which for me confirms the idea that in the US, what voters want, voters get. As an aside, the difference in minimum wages between California and Texas probably explains why “traditional Conservative” politicians in the US and the UK are political disasters. Pro-labour policies, while being culturally conservative is the only way forward.

What is interesting about this is I can now make a political guess, that will then drive a fairly clear economic outcome. I am going to guess that wages, including minimum wages, in Republican parts of the USA will rise to be much closer to those seen in the coast areas, and this will drive higher food and manufacturing CPI. This gives us some simple numbers to play with. If we assume Texas minimum wage doubles of 10 years, this implies 7% wage inflation for 10 years. Looking back at wage inflation in the 1970s, and post Covid boom, 7% wage inflation was where we got to. Add in a term premium and I suspect 30 year US treasuries need to get to 10% before they look attractive. Certainly that was the buy zone on 1980s.

For investors that believe the politics of the world is unchanged (why they would believe this is a mystery to me), for some reason they are locking in 30 year rates at below 5%. The surge in shares outstanding in TLT suggests old habits die hard.

7% compound wage inflation seems likely to me. Treasuries are a short.

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The food inflation story is (was?) attractive from many different angles. Wage inflation and food inflation seem to rise in lockstep, probably reflecting rising wages driving demand, and cost of production. We also saw China emerge as the world’s largest buyer of grain, and with contaminated land, reduced fertiliser use, and a shortage of labour, looked to be only becoming a bigger buyer of grain going forward. Russia’s invasion of Ukraine made most grain supply look problematic, it would have also suggested higher prices to support domestic production. Good story in 2021, but the reality has worked out differently.

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I was ordering my Pimms at Wimbledon, which I discovered would cost me £11 - and was extremely tempted to rant “You cannot be serious!”. But I sucked it up and paid. The next day I was drinking a £7 pint at my local, I looked at my phone and was assailed by financial commentators and substack writers with news that inflation was cured, and even deflation and rate cuts were looming on the horizon. Deflation you say? No one had told the drinking establishments I frequent. UK inflation index might be saying slowing inflation. But prices have not actually fallen.

I suspect the deflation camp is looking at the period in 2013 to 2020, when food CPI stagnated after the steep rise from 2006 to 2012, and thinking that we are headed for a similar period of falling prices. UK food inflation has an upward bias, but periods of accelerated inflation occur when underlying commodity prices rise, and deflation when commodity prices are falling. We can look at the CRB Food Index to get an idea of trends there. I am struggling to see deflation.

For me there are three drivers to food inflation. One is low unemployment in the west. Given the fiscal impulse we see from both the UK and US government, I don’t see any reason for unemployment to rise. The US is also seeing Federal Government expenditure turn higher.

The second is that the ongoing Russian - Ukrainian war threatens the supply of huge amounts of grain. For wheat, Russia and Ukraine at largest and seventh largest exporters respectively. While there has been an agreement in place to allow Ukrainian exports to reach the market, it is subject to Russian whims. Ukraine is also a large supplier of coarse grain (corn) and vegetable oil (sunflower).

The final and most important reason was that China is turning into a net importer of food. China turned into a corn importer after the problems with African Swine Flu - but despite that being largely under control, and huge efforts by the Chinese government to reduce reliance on the US, China remains one of the largest markets for US Corn exports.

One other implication of China turning to a net importer of food is that it has also become an importer of rice. The world rice market has become increasingly reliant on India and Thailand as suppliers. Note, even though China is listed as exporting 2m tonnes of rice, it now imports 5m tonnes, making it a net importer.

India is the low cost producer of rice.

With India placing restrictions on rice exports, Thai rice prices have been rising again, and are back to levels seen during in 2021. During the spike in corn prices caused by the Russian invasion of Ukraine, many farmers used rice as feed as it was cheaper. Higher rice prices are likely to feed back into higher grain prices.

This could cause a negative feedback loop. China has been very successful in getting domestic pork prices back to pre-African Swine Flu levels, even if that still means Chinese pork prices are twice US prices.

Typically we look at pork to corn price ratios to determine the profitability of pork farming. In China we have seen farmers are record low profitability as corn prices have stayed high and pork prices low. I suspect this was due to rice being used as a substitute feed. This would also explain why China has become a net importer of rice in recent years.

India ban on rice exports is likely to cause food inflation to return to Chinese pork prices - which will likely put upward pressure on other grains. To me, it looks more like we are coming to the end of a lull in food inflation. Deflation while food prices are going up? You cannot be serious!

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This is a follow up to “rethinking the short book”. Most of the comments were along the lines of a “too early to panic”, which is fair enough. My old investment model has been flashing bearishly (incorrectly) on the US for 6 years now, so this substack has been trying to find a new investment model. The model that I have been focusing on is a “food inflation” model. And the trade it has inspired is the GLD/TLT trade, which continues to do well.

As I talk about my own portfolio, this is a paid post.

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With the failure of Silicon Valley Bank (SVB), there is a widespread view that the Federal Reserve is done with its rate hiking cycle. Certainly, the bond yields of long dated Treasuries and JGBs have fallen in recent weeks.

This may be true, but I think this more muscle memory from the GFC, than a true reflection of the likely inflation and interest rate market outlook. For new subscribers, there are many detailed explanations in older posts, but in essence I am arguing that in 2016, we saw a political change, that began to favour workers over corporates. That is it became political unacceptable to put all the burden of economic adjustment on workers and wages. In fact policy is now geared to raising “real wages”, which means tighter monetary policy, and policy geared to ending speculation. The destruction of Chinese property developers was one feature of this, and I would say the demise of SVB is another. The end game for me is something like the 1970s, with strong commodity prices and higher interest rates as wage inflation gets out of control. We are still early in that trade, if correct.

The recommended trade for this view is long GLD/Short TLT. On Friday as TLT rallied 3 percent, GLD also rallied 2%. The GLD/TLT pair did no inflect deflationary in anyway.

If you are tin-hat, armchair twitter, look at me style substack writer, you may well wonder how GLD/TLT faired in 2007/8 period. Well I show it below. Actually, gold did well until late 2008, and then you wanted to be long bonds, and then back into gold.

So you might be looking at this and thinking this is random. But actually, the market is not random in this case. What I would argue is the market is sending a very clear signal, its just that you are not ready to receive it. What is the market saying? It is saying that China, not the Fed, is the market and government that sets global inflation trends. But not via construction, or auto and luxury sales, but via food (please see my food inflation posts for more detail). As mentioned in 2016, China move pro labour, and has been more successful at raising wages than other nations in recent years. China now has higher food prices in the US, and is large importer of food. So unless China devalues, food inflation will remain an issue globally.

Why is this an issue? Well politicians are very simple creatures. They just want to get re-elected. If people are worried about food inflation, then pressure will be on central banks to get food inflation down, with the easiest way to do this is via tight monetary policy and strong currencies. So over the last year, food inflation has been strong.

And to counter this, the Fed has pursued a strong dollar, tight monetary policy regime.

The problem is that it has not caused China to devalue. And with China exiting Covid restrictions, and the war in Ukraine continuing, the failure of SVB is going to have no effect on food inflation. In anything, US dollar weakness will make things worse.

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In previous posts, I have tried to talk about how I used to manage money using a 3M process - Macro, Micro and Market. In essence I was looking for a macro change, that was supported by underlying industry data (micro) and confirmed by market trends, particularly technicals. The biggest macro trend I paid attention to was currency, which I had seen be the least understood factor in investing in my career. This stopped working in 2016, with Brexit, China and Trump, making politics far more important than macro. It took me a long time to accept that politics is more important than macro, but now that it has, my investing process is improving. I have had to rename it 4M - with the additional M is motivation, which is another way of saying politics. Paid subscribers will be aware of the ideas I have already pitched.

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A large number of economic thinkers that I respect are calling for peak inflation, and that interest rates increases have topped out. With oil prices down from USD 120 a barrel to USD 77 today, this would be a strong indication of reduced inflation pressure. For “peak inflationistas” the cherry on the top would be this week’s cover of the Economist, warning that inflation will be harder to contain than people think. The Economist has a long and illustrious career as a “contra” (a contra is somewhere who gets market calls consistently wrong). Peak inflationistas even have the benefit of financial markets agreeing with them, with US 2/10 year yield curve as inverted as it gets. Inversion really is the markets way of saying that they don’t believe central banks will raise interest rates any further.

Is the Economist wrong again? Just looking at US CPI YoY, it already peaked out and started falling, and with the bond market in inversion, it does like the Economist leader writers have proven why they are writers and not hedge fund managers.

But, these days I place politics as more important than economics in doing financial analysis. From this perspective, I do not see central banks, and particularly the Fed going dovish until they get food inflation under control. Rising food prices are political dynamite. So lets us look at the most recent US CPI data from a food inflation perspective. On a year over year basis it is still rising at 10%, and even though it is slowing a little, it still doing 10% on high comps from a year ago.

What I really like about food inflation is that it is universal and easily understandable. A Birkin bag or a Panerai costing 30% more is not inflation that matters to most people. But the price of bread and meat? That matters to everyone. What is really great about the US CPI data is that it breaks down white bread and meat CPI back to pre World War II. White bread CPI is still rising at nearly 20% year on year, while meat CPI is back to 2% year on year.

For CPI calculations, food CPI is given a total weight of 13.5%, with bread having a weight of 0.2% and meat having 1% weight. This means that soaring bread prices should not really be that important to Federal Reserve and other western central banks. But soaring bread prices are very important to politicians - certainly more than the CPI weightings given above. For me the question comes down to whether the meat index is right, or the bread index is right. Or in other words, will bread prices fall back, or will meat prices spike? One of the best things about free market capitalism, is that incentives are transparent. For US pork farmers are currently disincentivised to farm pigs. The price of hogs relative to corn are at close to 40 year lows, meaning that hog prices are not covering the cost of feed (which is mainly corn).

With hog farmers disincentivized to farm hogs, then one of two things must happen - corn prices must fall, or hog prices will rise. When we look at the corn market, we see that China has become a major buyer of US corn.

This is despite the Chinese placing tariffs on corn imports that have meant that Chinese corn prices are much higher than US prices.

In other words, geo-politics has driven China to have high food prices, which it now exporting back to the rest of the world. Just as we have seen with Covid, it is possible for the Chinese to change policies, but self sufficiency in food production seems to be a key policy for China. With Chinese activity picking up, my guess is that corn prices globally will remain high, which means feed prices will stay high, and meat inflation will catch up to bread inflation. In my view food inflation is still ongoing, and hence central banks will keep raising rates.

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In food terms, Brazil is a superpower. If we look at food in terms of million hectares devoted to cultivation, we can see that Brazil is the largest for oilseeds (soybeans) and 5th largest for coarse grains (corn, sorghum, barley and oats). Coarse grains and oilseeds are vital crops for animal feeds, of which Brazil is a leading exporter. Rice is large grain, but relative to production is far less traded than the other grains.

In value terms, Brazil is 4th largest producer.

It is likely that the above data understates Brazil agricultural prowess. Recent data shows that area planted for grains has increased significantly in recent years.

And we have soybean production continue to grow.

And corn exports have risen dramatically too.

Given this highly developed agricultural industry is it striking that at his recent inauguration as President of Brazil, Lulu wept at how many of his fellow citizens were going hungry. When Lula was previously president food insecurity was greatly reduced through a variety of programs, and a booming economy. However, a combination of the end of the commodity cycle, as well as mismanagement has seen the number of Brazilians enjoying food security fall from 77% in 2013, to 41.3% today.

That is even though Brazilian farmers have consistently grown output, prices for agricultural good has risen. Brazil has tended to have constant food inflation, but recently the pace has been substantial. Typically it has takes 10 years for food inflation in Sao Paolo to double, but recently it has happened in only 5 years. The conclusion then is that food prices in Brazil have probably risen much faster than wages leading to food insecurity.

So Brazil is exporting more food than ever before, but Brazilians are the hungriest they have been in 20 years. How did this happen? The big shift is that China is now a large corn importer. Even with lower imports in 2022, China was still one of the largest importers in the world.

And here is the problem, food prices are generally higher in China. Why? Lots of reasons - a policy of trying to be self sufficient means that tariffs have risen on imports, lack of labour, lack of land, rising wages all contribute to China having an upward bias on food prices.

Corn prices also directly affect pork prices, and Chinese pork prices have been above US prices for many years now. Higher Chinese pork prices predate any cold war rhetoric or tariff increases, making me think that high food prices in China are structural, not cyclical.

Politically, it is very difficult for governments to sit idly by as farmers export records amounts of grain at record prices as hunger stalks its poor. Policy options for Brazil include export taxes, export bans or a range of other policies. Unless food prices collapse in China soon, I expect Brazilian food supply to be curtailed, and a food spike in the rest of the world to ensue. This should lead inflation to surprise to the upside again.

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As I and many of my subscribers have noticed, many of the key commodity drivers of inflation have seeming rolled over. European gas prices, Chinese pork prices, oil prices, US corn prices among others have weakened to levels seen before Russia’s invasion of Ukraine. Strangely, weak commodity prices should be disastrous for my key trade, long GLD short TLT, and yet strangely it has breached new cycle highs. Why is this?

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Let’s take a closer look at the logic I am using to get my bearish bond view. First of all, I think inflation is going to be consistently higher than expected. But not just any inflation - food inflation. This is already happening. This is on a log scale so that you can see the recent move in food inflation is substantial, and to my mind a trend breaking higher.

On a very simplistic basis, I look at us CPI and think both Fed Fund Rate and bond yields have to go higher. The chart below shows CPI compared to Fed Fund rate. This chart also shows you why Ben Bernanke get very little love, as he began a still ongoing cycle of keeping Fed Fund rates being set at below inflation in 2002.

So for me, if I see signs of food inflation going in reverse, then I will reverse my bearish view on bonds. At the moment, I see no sign of food inflation reversing. However, when I look at TLT US - an ETF that buys long dated bonds, I see record net inflows (shares outstanding - short interest).

For a lot investors, yield curve inversion is seen a sure sign of a coming recession, and time to buy bonds. Certainly since 1982 a yield curve inversion has marked out the top in a Federal Reserve hiking cycle.

By being bearish bonds am I saying that thing no fund manager should ever say - “this time is different”. Actually I don’t think I am. The first question is to ask where does yield curve inversion come from? There are lots of different ways to think about the bond market, that is economic cycle predictor, to a vigilante correcting wayward policies. There could be something to that, but at its most simple, bond yields also have to add up to what the market things interest rates are going to be over that life of the bond. If you think the Federal Reserve is going to keep the Fed Funds rate at 4% for the next 5 years, then you will be buying 5 year bonds at yields over 4%, and selling at yields under 4%. If you think about bonds in this way, you can value 5 year treasury yields versus the average of the fed funds rate for the last 5 years. It would look something like below.

We can do a similar chart, but extend this out to 10 years. This chart does scare me. Looking back to the 1960 and 1970s, even in a bond bear market, the 10 year did seem to mean revert back to the average. The current 10 year average of the Fed Fund Rates is only 0.8%, and rising slowly. The implication is that 10 year bond yield could fall all the way back to 1%, even if I am correct that inflation continues and the Fed Fund Rate does not fall.

But I think that is the wrong way to analyse it. A better way to look at it is to compare current Fed Fund Rate to average of the Fed Fund Rate over the last ten years. There is a clear benefit to that way of thinking. The 60s and 70s, were pro-labour eras for me, which shows that Fed Fund Rate can diverge widely from its previous 10 year average. It also shows the clear break in 1980s, where in a pro-capital environment tightening policy relative to the last 10 years would create a recession. As I believe we inflecting to pro-labour environment, I don’t fear the inversion.

Its back to wage led growth in the West, and monetary policy needs to be tight to protect real wages. Yield curve inversion is likely to be the norm for the foreseeable future - and bonds still look like a short to me.

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Shorting long dated bonds has been a great trade. But the view, and the positioning that I am seeing is suggesting that most investors think that trade is done. If anything, I would say long bonds has become a conviction trade for many investors. TLT US is a liquid ETF that buys long dated treasuries. Typically, the net shares outstanding (shares outstanding less short interest) in this fund follows share price performance. Not in 2022. In 2022 investors have been buying TLT all the way down.

I find this enthusiasm hard to understand. US CPI is back at levels last seen in the 1970s, when the US 30-year treasury yielded north of 8%.

The reason that people are getting bullish bonds I believe is that the yield curve has inverted. And every time that has happened, you have a recession, and you want to get out of equities and into bonds.

Very oddly, Japanese long dated bond yields continue to trade poorly. For as long as I have been in markets, the JGB market has acted as a very good lead on US bond markets. Not only has it been prescient in leading the US bond yields lower from 1999 onwards, in 2020 the JGB market was also prescient in signalling the future US treasury sell off.

What does the JGB market see that the US doesn’t? When I think about the Federal Reserve politically, the one type of inflation that they have to react to is food inflation. Food inflation is a very regressive tax, and is the one type of inflation that has proven track record of getting people on the streets.

Since 1980, food commodity prices have generally moved with raw industrial commodities. That is, if you could create and industrial recession (i.e. raise interest rates), that would be enough to get food prices to fall. And as most farmers will tell you, fuel costs are the biggest cost for most farm (fertiliser tends to follow natural gas prices).

And here is the problem. China is now the world’s biggest importer of food, and it has much higher prices than the US. Pork, which is the most consumed meat in China, is now 3 times more expensive than the US market, and has recently doubled in price. As Japan is also a large importer of pork, perhaps this was the reason the JGB market sold off before the US.

While pork and African Swine Fever (ASF) gets all the attention, China has also very quietly become a large importer of beef. Monthly data from the US shows how imports rose during ASF but have never really fallen off. These numbers understate Chinese demand for beef. On a global basis, China imports more beef than the rest of the world on a net basis (US and EU are both large importers and exporters).

Again, China beef prices are at a premium to US prices.

In essence, I am saying that China is exporting food inflation to the rest of the world, and I don’t see that ending at the moment. JGBs seem to agree - and when I look at the index value of US Food CPI on a log basis, I keep thinking that is says interest rates are going higher not lower. I have used log basis so you can see the inflection in food prices is close to what was seen in the early 1970s.

In essence, I am saying that food inflation has moved from being cyclical, driven by energy prices, to secular driven by an urbanising China. Secular food inflation implies POLITICAL pressure to have higher interest rates. US treasuries look a short to me, just as everyone has gotten long.

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Food inflation has continued to surprise to the upside in the US.

That food inflation has not calmed down in recent months is somewhat surprising as we have seen weakness in commodity food prices in recent months.

Taking a long-term view, you could also convince yourself that food prices have topped out, and food deflation is more likely.

However, well before Ukraine became an issue, Chinese food prices were driving global food prices higher. In 2019, China suffered from Asian Swine Flu which destroyed much of China’s pig herd. China has more pigs than the rest of the world combined

As China rebuilt its herd, but this required large imports of pork and corn. Pork is essentially processed corn, with 4kg of corn needed to produce 1kg of pork. China in 2021 became the biggest importer of US corn, but now these imports are falling.

Currently there is no sign of African Swine Flu returning to China, but in recent months we have seen Chinese pork prices surge again.

So why are pork prices rising? The simple reason is that Chinese pork prices fell too low versus domestic corn prices, and without corn prices falling, eventually pork prices had to rise.

So Chinese pork prices have normalised relative to Chinese corn prices. The problem for the US and the rest of the world is that China now draws on global pork markets. Despite its best efforts to boost domestic supplies, China is still a large importer of pork from the US.

Why does this matter? Because currently US producers of pork are disincentivised to produce pork with the US pork to corn ratio at levels where either pork prices rise, or corn prices have to fall.

With pork price in China now three times US prices, my guess is that pork prices rise, and push food prices higher again.

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The basic idea behind recommending a long GLD (gold) short TLT (treasuries) trade was the idea that as governments moved pro labour, this would force up wage inflation, and force central banks to raise interest rates. GLD/TLT has traded well and touched a new cycle high during the month.

However, the TLT side of the trade has been the much better trade. TLT has erased all gains since 2010, while GLD has fallen 20% putting in a bear market. The smart trade has been to be short GLD and TLT.

Should I get rid of the GLD part of the trade? I have mixed feelings about this. First of all, my working assumption is that pro-labour policies would occur with food inflation. Causation is difficult to tease out here (that is - do high wages cause food inflation or does food inflation cause high wages??). Food prices have been much strong than gold this year. Gold has much more closely tracked raw industrial commodity prices, than food prices.

While food is a global consumed and produced, raw industrial consumption is much more heavily concentrated in China. And China has seen a big slowdown this year, driven by a slowdown in the property sector as well as its zero covid policies. The CRB Raw Industrial index tends to follow Shanghai Interbank Rate fairly closely, as both are driven by levels of Chinese activity. There was a breakdown in this relationship in 2021 and early 2022, probably driven by the rest of the world exiting Covid and then the Russian invasion of Ukraine, but the relationship between commodities and Chinese activity seems to have reasserted itself.

Since 2008, it has generally made sense to buy commodities when Chinese interbank rates are starting to turn, and particularly around the 2% level they are today. As mentioned in a previous post, when we look at new deaths to new case ratios in China, they are converging with Korean, Japanese and Singapore levels, which suggest that Covid in China is not as deadly as it was, leaving the possibility that restrictions could be relaxed.

Commodities (and particularly gold) do not like a strong dollar and particularly a weak Chinese yuan which has breached the 7 level lately. I perceive a weak yuan as deflationary, and Yuan weakness in 2015 to 2016 was accompanied by a collapse in Japanese bond yields. This time the fall in Yuan has not been accompanied by a fall in Japanese bond yields, but rather the steepest sell off in decades.

What does this all mean? I think pro-labour policies are extremely inflationary, and that this inflation has been held in check by rapidly rising interest rates AND zero covid policy in China. If zero Covid should end, then the brake on industrial commodities should come off, and all commodities should rise again, which will require further interest rate increases. The risk is that China economically implodes, but oddly the bond market does not seem to be signalling that at the moment. I think keeping the GLD side of the trade makes sense to me.

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Recently there has been some sizable falls in commodity prices. Combined with the flattening yield curve, the drumbeats of recession and deflation have been rising across the financial commentator jungle. Key long term measures of long term inflation have seemingly inflected lower. Spikes in food prices such at in 1996, 2007 and 2011 have led to very deflationary market outcomes; the Asian Financial Crisis, the GFC and the Euro-Crisis respectively.

From a purely technical analysis perspective I can understand the urge to be bearish commodities from here. The problem is that underlying data on key commodities have actually begun to inflect bullishly. Within the food space, corn is probably the most important crop, from both a volume perspective, as well as a feed for livestock. The initial stage of the spike in food prices was driven by China becoming a large importer of corn and pork.

When we look at corn prices, we see that US prices have been much weaker than Chinese prices over the last month. If you were bearishly minded, you would note that US prices led Chinese prices in the last down cycle in 2011 to 2017

The problem with the bearish narrative is that Chinese pork prices have suddenly begun to spike again. This was the catalyst for the first rally in food prices. With the big increase in Chinese imports of both pork and corn, its seems to me that its hard to push the food deflation button when Chinese pork prices have doubled in last 3 months, and are at the highest level outside of the African Swine Flu crisis.

Energy markets are correctly seen as having an outsized effect on inflation and inflation expectations.

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The original cause of food inflation was African Swine Flu (ASF) that sent Chinese pig prices soaring, and incentivised Chinese farmers to import grain. However, with the rebuilding of the pig herd …

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From a purely economic perspective, food inflation should be cyclical. The most obvious reason for this is that demand for food should be relatively stable. Humans tend to eat better food as they get richer, but they do not need more calories. In some richer economies, per capita consumption of meat is falling, which actually implies falling demand on a total grain usage basis. The other factor pointing towards food inflation being cyclical rather than secular is the ongoing increases we see in yield on food production.

When we look at US Food CPI (we use a log scale, so we can see the scale of change at the beginning of the index) we can see that from 1913 through to 1947 or so food inflation was definitely cyclical. But post-World War II food inflation stabilised before taking off in the 1970s, before stabilising again in from 1990s onwards. My working assumption has been that food inflation and wage inflation are highly correlated, but I am unsure which way causation flows. Looking at the US Federal Minimum wage on a log scale matches US food inflation fairly closely.

Or to put it another way, when average incomes are growing fast, then price for food can also grow quickly. The corollary of this argument is that suppressing income growth will control inflation. Looking at US average per capita income growth, it matches closely with what you would expect. It is also noticeable that the 10 year average income growth has picked up considerably recently.

Here is where the argument of whether inflation is cyclical or secular moves away from dry economic analysis to one of political analysis. The question is what do governments need to do to win and maintain power? Both Trump and Biden have focused on government spending policies.

China has already moved to a policy of focusing on rising labour share of GDP, which has involved increasing regulation of big tech, and a focus on high cost of living. It has also led to a big change in currency markets. I had expected China to be similar to Japan and Korea, where the government would seek to devalue the currency to create inflation to reduce levels of debt, and restore export competitiveness. Instead on a BIS Real Effective Exchange Rate Basis it has remained at an “expensive” level far longer than either Japan or Korea ever managed.

UK and US politics are tricky beasts to analyse. But China is perhaps a little easier. Why? Well as long as China chooses to pursue a strong currency policy, its sending a clear signal that it is choosing pro-labour policies. Given it position as the biggest food producer and food consumer this should continue to lead to rising food prices, and I suspect put Western governments under severe pressure to pursue pro-labour policies. The “good news” about this analysis is that if the Chinese Yuan begins to weaken, then we know this theory is busted, but I would suggest as long as the Yuan stays strong, we will see inflation, and upward pressure on bond yields.

The Chinese Communist Party took power in 1949. In 1955, the collectivisation of farming land, and forced industrialisation of China caused a huge famine that is estimated to have led to 20 to 50 million deaths. In 1970s a virtual civil war was also marked by severe famine in death. That the Great Leap Forward and the Cultural Revolution caused huge amounts of death and famine is widely known. I had assumed that when I began to look at Chinese food supply, I would see a marked convergence in Chinese farming yields to Western farming yields beginning in the 1980s.

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