2020 Forecast:  Will The Emperor Finally Be Revealed To Be Wearing No Clothes?

Interest Rates

The main event in financial markets this year, which will drive markets more than any news about Iran, nothing burger trade deals with China, or impeachment, will be interest rates.  The Fed will resume cutting interest rates and ramp up its current program of $60B/mo of treasury purchases to a higher dollar amount, which I think will eventually surpass $250B-$300B per month by the end of 1Q21. And when the Fed begins lowering rates, make no mistake that we’ll see nominal rates below zero.  You can see in this paper that the Fed is gearing up to lower rates to -6.0% to -8.0% (click “download the paper”, it’s on page two).

At first market participants will mistakenly think this will bring relief to the market and the economy.  After all, lower rates means better cash flow to consumers and businesses.  However, once the Fed lowers the overnight rate below 1%, market participants will finally wake up and recognize that the economy is far weaker than everyone thought.  The Fed will do this because the evidence will look more and more like we are heading into a recession. 

The Fed will try desperately to move rates lower in a futile attempt to keep the economy going, and the Fed will do this in dramatic fashion along side increased treasury purchases.  If the economy crashes before election day, we’ll probably find ourselves with a new president whose name is preceded by a (D). 

What this also means is that the dollar will finally fall.  It has remained strong, and will continue to do so as long as other currencies and bonds denominated in those currencies are yielding lower than both the dollar and dollar denominated bonds (meaning Eurozone and Japan).  However, as the Fed increases treasury purchases and lowers rates, inflation will also increase and cause the real yield on the dollar and dollar denominated bonds to fall below the yield of other currencies and bonds.

Regarding the strength in the dollar and support for treasuries, this will only remain true as long as pension funds, sovereign wealth funds, and financial institutions remain in the trade. They naturally want to get the higher yield with less risk.  And right now that is the dollar.  Even if you think you can trade negative yielding bonds for a profit, Treasuries might still look better.

But what happens when the Fed lowers rates too low for even the pension funds and financial institutions to be interested to buy, especially in the face of much higher inflation? Up to a certain point, financial institutions of all types will be willing to buy zero or negative yielding bonds, but once that certain point is crossed they begin to lose interest in the guaranteed loss.  That point is when they perceive that they can’t trade the bonds at a profit faster than they will realize the loss on the yield, and that’s when the bottom drops out of the bond market.  The result will be what I’ve been warning about all along, which is a massive spike in interest rates that the Fed won’t be able to control, ending the party for the almighty dollar.

One final comment about interest rates is that most people will see what’s happening with ZIRP & NIRP policies as well as QE, and regardless of political affiliation they’ll all paraphrase the president on this one and say in unison “we want some of that too.”  Trump said it about negative rates in Europe, the people here will say it about their own government. 

The problem will be that the people will have absolutely no access to mortgages at or below zero, not to mention car loans, personal and student loans, credit cards, or any other loan. Only the government will merit such low rates, and perhaps a handful of lucky blue chip businesses like the biggest banks or companies included in the Dow Jones Industrial Average.

Interest rates will be the main event in 2020, and the direction of those rates will determine the perception and direction of everything else that happens in markets next year.

Tariffs & Trade Wars With China

Let’s first review what has actually happened over the last three years of the Trump Administration’s economic relationship with China and trade talks: talking and tweeting, talking and tweeting, and you guessed it, talking and tweeting. Including Phase 1, it’s all still just talking and tweeting.

I wouldn’t be surprised if something constructive actually happens, but I put the likelihood of anything positive happening at about the same chances as a snowstorm staying frozen over the crater of Mount Kilauea.  What I do expect is more of the same of what we’ve had over the last 3 years. There will be lots of press conferences boasting about the progress that never quite materializes.  The outcome of this will be that all the talk will move markets in a positive direction for stock market bulls.  On the opposite end, tariffs will continue to weigh on the economy because our tariffs make it more expensive for Americans to live, and their tariffs make it more expensive for the Chinese people to live, which is the complete opposite of what is intended.  

I also expect that as the stock market begins to show a shakier and shakier foundation because the economy is becoming shakier, the tweets and pronouncements will begin to come at an accelerating pace. And the more talk you hear, the more you can believe just how shaky that foundation really is. In the end, as they say, buy the rumor, and sell the facts.

Gold

If you haven’t read my article about gold, you should set aside 30 minutes and read it.  I published it almost two years ago, yet I find that the fundamentals all still line up for gold and are strengthening, because the fundamentals underlying the economy are worse now, and weakening, than when I originally published the piece.

I remain very bullish on gold, and silver for that matter.  What will most effect the precious metals is interest rates.  That is because interest rates will reach an inflection point this year, and investors around the world will finally recognize that interest rates in America are a reflection of dollar weakness.  When the Fed begins to cut rates in earnest, that is when we will see gold really rise to new heights.

Gold was up over 20% in 2019.  If it does 20% again this year, that will put the price over $1800/oz, and regardless of what the percent rise is this year, I suspect that gold will continue to outperform.  While it didn’t outperform the S&P 500 which returned 28.9% in 2019, it far exceeded expectations. Yet we find the gold mining companies trounced the S&P: GDX returned 38.7% and the HUI Index returned 50.7% on the year.

Herein lies the real opportunity.  The mining companies that pull the metals out of the ground.  Expectations are still too low for the miners, so it won’t take much for them to surprise to the upside.  As the price of the metal rises, their profits will also rise, and if you own the companies it’s said to be like leveraging the price of the metal.  If the metal is up 20% this year, putting it over $1800/oz, the miners will probably be up, as a group, by double that or more.  When gold nears its all time high of $1950/oz, shares in the mining companies will probably go a little cuckoo to the upside. 

Just a word of caution about the gold mining shares, and that is only 1 in 3000 projects will ever see the light of day, which means most junior miners will bounce around a little before going to zero. And you can’t use traditional security analysis when looking at the majors.  Resource extraction is a whole different ball game, and unless you can do proper analysis, you’re better off with a mutual fund like EPGFX or SGDM. If you buy bullion bars and coins, stay off the numismatic coins and stick to bullion.  If you want to earn interest on your ounces paid in additional ounces, hit me with a DM and I’ll introduce you to the person and company who can help you with that.

Other Moves To Grow And Protect

I’ve made the case for uranium in the past, and to rehash, both China and India have over 400 nuclear reactors each, either in the planning stages or are being built. The cost of uranium is insignificant compared to the other costs of building the plants and generating electricity.  Combined with the trend of electric cars and other electronics and machinery needing more electricity, the need for more power plants will continue to grow world-wide. 

Uranium is the single most economical and efficient way we have currently to achieve that goal.  In addition, several of the world’s largest mines, accounting for over 20% of annual new supply, have shut down.  And the third biggest reason, though there are others as well, is that the cost of extracting uranium from the ground is still higher than the spot price.

The spot price is moving in the right direction, and as it continues to move higher and above the cost of extraction, the mining companies will begin to outperform on the fact that they’ll go from losing to making a bottom line. And because the expectations for these companies are lower than gold and silver miners, it won’t be difficult for them to surprise Wall Street to the upside. Do your homework here and choose wisely, because the most popular mutual fund or ETF, or the biggest, most entrenched companies will not always be the best choice for your portfolio.

Also, traditional defensive moves will be very prudent this year.  That means discount retailers.  Healthcare and pharmaceutical companies. Consumer staples like toiletries, food, and fertilizer to grow all that stuff will also pay off.  And utilities like gas and electric companies who pay very steady and growing dividends.  Whenever the economy falters, all these types of companies do very well because people can’t live without covering the very basic needs of life.