Mike Campbell asked me, as an Inside Edge guest columnist, to write a short piece about the “most interesting places to invest for the remainder of 2019”. As you may know, HRA confines itself to a specific, and often benighted, market sector – the junior resource space – so I’ll answer the question as it applies to that sector.
Of course, we can’t ignore the impact of the broader economy and market on the resource space. How the world’s major markets trade, and what happens in the US, Chinese and world economy has a huge impact on investor sentiment and more directly on metal prices. Gradual reductions in economic growth rates in most of the main trading blocks since the middle of 2018 has been weighing on base metals. Base metals are “pro cyclical’ meaning both metal prices and demand will wax and wane with perceptions about future growth rates.
Currently, the US is putting up the best growth numbers, but the Eurozone and China, particularly, are more important by far when it comes to base metal demand. The US-China trade negotiations hang over all of this. There has already been some impact on Chinese exports, but traders are more worried about future effects if the talks fall apart. Trump has just increased the amount of Chinese imports to the US under 25% tariff to $200 billion, and is threatening to move that figure to $525 billion
Incredibly, this situation is not impacting Wall St, thanks to “it’s all good” tweets by Trump, who clearly doesn’t understand how tariffs work. It may be a tempest in a tea pot, but I assume the fight will drag on and that the US may impose the 25% on everything, coming from China. China’s main stock market, and base metals, aren’t taking the situation so lightly.
There will be a trade deal at some point, but I don’t know how long tariffs will last so I’ll assume that will be part of the backdrop. Tariffs are borne by consumers, and if the US does move to 25% on all Chinese imports, we’ll see margins and profits squeezed hard in the US, and more price increases from importers that can’t “eat” a tariff that large. Worse, if Trump decides tariffs are “working” (his MAGA base is cheering them) there’s a real risk he’ll lengthen the list of countries he’s fighting with. This late into an economic cycle, that won’t end well unless this mess is solved fast. Remember, 40% of Fortune 500 profits come from exports. It’s not small.
The chart above is a recent version of the NY Fed Recession Probability Index. Currently, it estimates about a 25% chance of a US recession in the next 12 months (I’m not showing one for Canada but, if they go, we go). Few indexes successfully predict recessions, and none of them do very far in the future. 25% is a pretty high reading, a level that has rarely been a “false positive” in the past. You’d better believe the Fed knows this. There’s a reason they keep mulling over rate cuts when rates are already so low, and the US economy seems to be doing so great. And this reading hasn’t accounted for a trade war yet. If Trump follows through, this reading is going higher.
With that backdrop, a trade war and high odds of recession in the US in the next 12 months, its tough for me to get excited about base metals, which are pro-cyclical. Traders sell base metals if they smell a recession. That doesn’t mean you should ignore them though. Most base metal resource pipelines are weak. Miners need new deposits. High quality base-metals developers will get bought, but timelines might be longer. They are a good place to be but should be stink bid, not bid, unless this trade war gets fixed fast.
Markets tend to look best and traders, especially retail, are at their bravest just before things turn ugly. Right now, bullish sentiment is very high. That’s a negative for gold unless and until the big markets roll over. Since I think that will happen, I expect the gold price and gold sector will improve later in the year. It’s ugly right now, which means there are some great gold developers on sale. Those with high margin resources will also get bought and gold stocks are one of the few counter-cycle sectors so there’s an insurance argument to me made for them. Finally, high quality explorers with new discoveries are rare. That means they are also always in demand. Keep a lookout for new discovery stories. The good ones can weather even terrible markets. HRA focuses all above in the resource sector. Good luck and good trading.