ETF Edge - Commodities crosscurrents: geo-political, inflation & reflation 4/15/24

Episode Date: April 15, 2024

Contrasting macro-economic indicators plus geo-political concerns are tugging commodities generally higher… but new money is only following part of the trade. Find out why.      Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge podcast is sponsored by InvescoQQQ, Supporting the Innovators Changing the World, Investco Distributors, Inc. Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things, exchange, trade of funds, you are in the right place. Every week, we're bringing you interviews and market analysis and breaking down what it all means for investors. I'm your host, Bob Pisani, from geopolitics to inflation to reflation. There's several cross-currents driving commodity funds. Here's my conversation with Jan Von Eck, CEO Von Eck, and Mike Akins from ETF Action. Jan, you run a well-known commodity trading firm. This guy has a large suite of ETS for gold, silver, energy, steel, other commodities.

The reflation trade's done great this year. You've made the point that global manufacturing is ticking higher. That seems to be the key point. That's driving this reflation trade. Explain what's going on. Yeah, I think there's some powerful, investable trends. You know, kind of the stuff coming out of the Middle East is hard to predict on a day-to-day basis. But there was a big change that happened in the first quarter, which was that the world economy started growing again.

And the best measure I like for that is PMIs. They ticked above 50. And more importantly, the China, which had been such a huge driver of growth and so negative for growth over the last year or two, manufacturing PMI is now positive in China as of March and surprisingly positive. Right. This isn't like a little bit of a statistical move. You now have growth. The world economy is growing.

So that leads to your reflation trade. So that's what's driving commodities. Now, I think we have a chart here. An index of investable commodities is out there. That's the S&P GSCI. I don't know if we can put that up. That's advanced, what, 12, 13, 14% this year, outpacing the S&P 500 of, what, 9%. So copper and oil have had big gains as well,

respectively and that's reflected here it is the there there you go John look at the move up there this is a basket of global commodities that's being moving because manufacturing has been improving part yeah i mean the global PMI is is not just manufacturing it's both services and manufacturing china is just manufacturing because their services is always growing because they're moving from being a manufacturing to a services economy but no that's that's it it's copper dr copper they say that because it's a good measure of global economic growth and energy prices. Probably have gotten a little bit ahead of themselves, but they're reflecting the world is growing.

Now, how does higher interest rates play in here? What role does that play in the whole reflation trade? And can that trade still keep going? I mean, I bring this up all the time, and they say, well, that's nice, Bob, but oil's already had a big move this year, for example. Just explain interest rates and how it plays into the mix here. I think that's a great point because people in America look very short term, I think, and they're really focused on Fed policy.

The reason I think that we're seeing growth and inflation in the United States is because, and I missed this for quite a while, is fiscal spending is running so super high. It's crazy. We're running a six and a half percent budget deficit, and that's what's causing inflation. It's the government spending, and I think that's leading to this global growth trade, too. So that's why I like commodities, because I think it's more than just. a headline, I think these trends are medium term. Mike, we used to have Goldilocks a while ago.

We had a strong economy, we had earnings growth, and inflation was trending down. Now we still have a strong economy, and we still have earnings growth, at least projected for this year. But now we've got this sticky inflation problem. So how does this play into the world you're looking at the ETF world? How does sticky inflation and the reflation mix with these Middle East concerns, and what are you seeing in terms of flows for ETFs? ETFs. Yeah, on a flows basis, you know, we're seeing year to date it was primarily driven by technology,

growth equities, we're driving all the flows across the board. Over the past month, though, we've seen that a little bit reverse, especially across the commodity trades, whether you're looking at like commodity ETFs have turned positive over the past month. Year to date, they're still negative, but they've turned positive. And also, if you look across the equity sectors of the market, energy is the second the highest inflower from an ETF perspective energy ETFs over the past month. They're still negative barely year to date, but we've seen a big trend coming back into some of

those more sensitive commodity-driven sectors of the market. And if you look through it to kind of an industry level, you're seeing that play out in natural resources and some of the exploration and commodity-driven hard asset producers within the sector ETS. So I think from that perspective, perspective. Oh, go ahead. Go ahead, Mike. I'm sorry. Finish your point. I was going to say, well, I think one of the big things that's different now than, say, three years ago when we had this kind of inflation crisis is that at that time, the fundamentals for the hard producing commodity sectors were really broken down. You've looked at like if we rate, you know, ETFs on a quality basis and energy, you know, three years ago had the worst quality rating out of the 11 gig sectors. Today,

it's the second highest quality rating. So I think you've seen over the last three years a situation where these energy equity ETFs have really cleaned up their balance sheets. And now if we can see some sort of that growth demand and you can see an increase in their margins, it's likely to go through to that bottom line because if you look at the quality metrics and they're still trading at a much lower discount relative to the overall market, it sets up nice for this area of the market. Mike brings up a very interesting point because his point here is just recently have we seen little upticks in energy. When I look at flows on the yearly basis where the money is going, it's still into technology. Your Vanx-Sevi still gets inflows.

Energy ETFs have not seen big inflows at all, even with energy up 18% this year. That's amazing to me. Why investors not showing any love for energy or commodities when that's what's moving? Usually they follow the trend that they don't seem to be doing that. Because it's a recent phenomenon. I mean, flows, you know, buyers like higher, right? So only when prices started ticking up. And this news is fresh.

That's why I'd like to focus on it. Like this China PMI data, this is only March data came out, you know, a couple of days ago. And so I think investors are now starting to focus on it. And I think also, yes, the companies are higher quality, meaning they fix their financial situation, but there's still some headwinds. There's a lot of regulation in Africa and Latin America that have been trying to take some, renegotiate the profit share with some of these producers. So that's favor of the United States and Canada.

So there's still some internal headwinds with that sector. And it's hard to compete with technology. So investors, I don't think, are really looking at these allocations yet. But what is a, energy is what? 7% of the S&P 500? What is a sensible weighting to energy stocks in a diversified? global portfolio. The investors seem to have no interest. It went down as low as 3% a few years ago. It's higher now. Maybe it's six or seven percent. But is there a sensible allocation for people

in your opinion right now? Yeah, I mean, we like the 5% range for commodities. I also think you need to have some gold or Bitcoin in your portfolio for what I call the 2025 fiscal reckoning. So just I think in 25 we have a lot of fiscal decisions to make the United States. We can't spend the money that we're spending. We've got Social Security coming up. The Trump tax cuts need to be renegotiated. They come up in 2025. And you've got the two candidates are the two biggest spenders ever in U.S. history, peacetime spenders. So I think the market is starting to worry about that. That's why gold's rallying so hard. Mike, do you agree with Yon's point here that the reason we haven't seen much inflows into gold and commodities this year is because the data is still

fresh and investors haven't caught up yet. Or it. investors just not interested. Your thoughts on this? Yeah, no, I think the gold trade's a little bit different in the sense that, sorry, I'm getting, can you hear me okay? Yeah, we're good. All right, sorry. The gold trade is much more about a flight to safety, in my opinion. and when you look at the commodity trade, it's broader base. Like the S&P, GCI, it's much more about the inflation trade and the growth of the economy. So I keep those kind of, in my view, a little bit separated. So I do too.

I do too. And so I'm medium bullish on commodities. I'm very bullish on. You need some gold or Bitcoin in your portfolio. I've been saving. Well, you're saying that. a different dynamic. Yeah, we're both, I'm agreeing with Mike.

I'm just following up and I just say that our conviction on gold and Bitcoin is very high because you need to have a play on what? A hedge for that 2025 fiscal problems in the United States. People around the world are buying gold because they think the U.S. government is spending way too much money, right? It's not even close. We have the huge largest fiscal deficit in U.S. history in peace time. It's a little more than 100%.

At all employment. This is like the Fed buying mortgage bonds in the middle of the hottest housing market a year or two ago. This is insane. The young people today are going to look back at this 23-24 era and say, what were you guys doing borrowing trillions of dollars with full employment? Yeah. It's a tough situation. And that's what people are worried about.

That we print money to get out of this debt problem, boom, great for gold. Yeah. Let me move on. Your Vanek Semiconductor, it's the big Kahuna in the space, SMH. We talk about it all the time. That's what's getting the inflows, not commodities. It's had big inflows since November, in fact. You must be very happy. You collect a nice little fee for that. He's doing well. But it's been moving sideways for the last couple of months, and even Nvidia is too. I know you don't comment on, you know, stock trading and advise people. But any thoughts on what's happening? Well, semiconductors had become the heart of the AI trade. They're really the cleanest AI ETF out there. I don't know if Mike agrees with that. And a lot of these companies are, SMH just has the top 25 semiconductor companies

and they're super high quality companies. They've got competitive modes, they've got, and the real question for semis is, and they have become revalued from being a highly cyclical business with short product lives to these sort of, you know, so it's part of the growth trade and they have,

more recurring revenues and they can, you know, they can just stay at high profitability even, you know, despite some of the short-term stuff. Mike, doesn't it amaze you that even with technology underperforming this year, that's where the money still goes. It's like they, it's like they have a sort of a recency bias investors. I mean, we know this, the behavioral economics, but they think that, oh, this used to work in the past. I'll just keep buying that. And yet we know that that's obviously a problem. But any, any thoughts on the flows? far it's technology still. Yeah.

I think you allude to it earlier, but when we track flows, we see it very much it's chasing returns. So we often caution our clients to almost think about flows as a contrarian indicator. As flows get really depressed, that's potentially an opportunity to buy and vice versa, as flows get really extended, it might be time to pair a little bit. But I do agree broadly on the kind of fundamentals of the semiconductor space. I mean, it is a high tech commodity in some sense. And right now, the competition is not to such a level where they, you know, where they can push prices down.

It's dominated by the top end of the market and they control that pricing. And there's no indication that the demand for growth is going to change in that sector. So you have very clean balance sheets. You have a high moat is a good way to put it. And they control that kind of pricing point. So until there's a situation where competition increases meaningfully in this space where you can have some pricing pressure, it's hard to see that trade going away. Yeah. And I got to ask you about bonds. You run a suite of bond ETFs as well. Fallen Angels, high yield fund ETF, floating rates. You have a high yield muni. I had you on at some point last year. I forget when you were very big on bonds and you hated commodities.

And you seem to have flipped around here. You're big on commodities now and you don't like bonds? What's the issue here? Totally flipped. Yeah, that was exactly that conversation. And I think because of fiscal spending, I know everyone knows this fact, but the risk is to investors that it's not priced into the market yet. And that's why I think you need a gold hedge to that.

But it's also a reason I think interest rates could go higher. So in your fixed income portfolio, go where the yield is short term. and don't do the duration risk. I don't think that's worth it. And remember, like, U.S. sorry. So everybody's advising, don't go out on the middle part of the duration, you know, five years, for example,

middle part of the curve rather than the short end of the curve. I would not. I would not right now. If I'm right about this fiscal, because fiscal budget deficits, because if the market gets worried, it's not. Gold is signaling it, And I would argue other things are signaling.

So for rates to go up, you don't necessarily, you seem implying, you don't necessarily have to have the Federal Reserve suddenly raises rates and makes a policy mistake. Fed doesn't control the 10-year. Yeah. Right? They only control the short end. And if investors around the world are saying, U.S., you're spending too much money, and the only way you get out of that debt problem, like every other country is inflation.

You could have a series of what? Failed treasury auctions that would drive me? higher, you could have a bond of debt downgrade. So credit default swaps. How do you get to this concern? So credit default swaps, right, is the risk of U.S. defaulting on its debt. It went up during the financial crisis. It spiked last year.

Remember when we had that budget standoff? It's still at high levels. Now, not as high as a financial crisis, but maybe let's call it half as high. So that is another indicator. It's like, well, that risk is not out of the market. The last thing I look at, Bob, is EM local currency bonds. against U.S. treasuries, U.S. local currency bonds have been outperforming treasuries consistently over the last three years, which is like, you got, what that makes no sense, because the dollar has been strong,

but government bonds have not been great. I mean, there's the duration issue, you know, that hurt them. But they're getting re-rated. We've got to go, but I'd be remiss if I didn't ask you about Bitcoin. You're one of the nine new Bitcoin ETFs out there. Hodel folks, huh, get it? H-O-D-L. That's very Jan Vonnegki, by the way. Did you come up with that? It's a long story, but we got it. So go ahead. Give us some thoughts. Flows have been good. So a year ago, I was pounding the table on gold and Bitcoin. Now I'm like, no, pound the table, but we're in a bull market, which means expect corrections of 20, 25 percent. I would buy the dips. I think we are in a bull market for gold and Bitcoin. If you don't own it, buy on dips,

you know, keep that part of your portfolio. Mike, what are you telling people about Bitcoin and Bitcoin ETFs? Yes, I mean, the flows have been impressive. And I think part of the outflows in gold this year, so just broadly in gold ETFs can be due to the launch of the spot Bitcoin ETFs. I do think there's some people pairing a little bit of their gold exposure with the new crypto spot price products out there in the marketplace. And I think that's pretty evident in that first month of flows that we saw.

Crypto broadly speaking, I'm not ready to call it a safe payment asset yet. So I believe it's, you know, if you just look at it, it's still more of a speculative asset class. It doesn't say I don't think it can get there. I'm not an expert in this space. So I really kind of just keep my opinions to myself. But I do think that it's hard to think of it as a safe pavement asset when, you know, it's generally speaking, trading at a significantly high beta to broad equity markets, especially risky equity markets. It's hard to think of it that way, at least in the short

intermediate term. Yeah, I've quite it hard to believe. It's a speculative. It moves along with like Kathy Woods' arc fund. It's a sort of a speculative investment. What you say? I don't think so. I mean, Bitcoin and gold both hit all-time highs this year. So they don't, they don't correlate super highly, but they follow the same macro forces. I mean, Bitcoin's got other things going on. It's got a tech element. it's also evolving as an asset. So anyway. We're not going to get into Bitcoin right now.

I've said my piece on Bitcoin. I said my piece on blockchain. Big blockchain bull. Bitcoin, not so much. But that's all right. That time for that. As always, wide-ranging discussion. I've known this guy a long time.

That's why I keep having him on. It knows a lot about a lot of things. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs. This is the Markets 102 portion of the podcast. Mike Akins from EETF Action continues with us now. And Mike, thanks for sticking around.

One of the things that's amazing to me this year is the inflows that we're seeing and the moves inactive. Never a big area before, but it's starting to pick up rather noticeably. What are your thoughts on it and what's driving it? Yeah, so I think it's going to be a continuing theme for the remainder this year and probably for the next several. years. Hold on. I apologize. I'm getting, can we kick that back over, Bob? Go ahead. Start again. I don't know what's doing it. Just start again. Can you hear me okay? I'm getting my voice and my headphones. You're getting an echo in your head. All right. Sorry, Bob. One, two, three. Good to go. Yep, perfect. No worries.

So Mike, I just wanted to chat about active inflows this year. I've been surprised how strong they are. Can you explain a little bit about what's going on there and why that's happening? Yeah, so the trend into active is real, and I think it's got legs behind it. I think it'll last for a while. And there's really a couple of different things leading to that trend. Number one, there's been a broad-based acceptance by active managers to go transparent. And I think a big part of that is the Kathy, Kathy Woods phenomenon.

They're highly concentrated portfolios, and she went out and kind of started this trend. And the bigger firms realize that, you know, maybe active transparent isn't the end of the world. Maybe our having our trades out there in the public is not that big of a deal. So I think that led to the bigger firms that have the majority of money in the mutual funds saying, okay, we're going to launch some of our same strategies into the ETF market. Then you get the benefit of the transparency, added to the benefit of tax efficiency, added to the benefit of tradeability, and suddenly that active story becomes much more relevant. The other side of, I think, the active piece is, you know, smart beta strategies have been around for years. And they've got significant amount of assets, whether it's value, growth, quality, low volatility.

And I think most investors recognize that an active overlay to that to that component, it is a big deal. And it doesn't mean that they're going to go away from what their stated objective is, whether it's value or growth or quality, but the ability to change your sector dynamic and have an active overlay to that makes a lot of sense. So I'm not surprised by that trend in the space. I think now that the big boys are involved, the fidelity is the Black Rocks. It's a distribution machine is alive and well, and I think you'll see a continued growth in that area. Another area that I think is quite surprising is the flows into Bitcoin ETFs. We had nine new ones and an existing one that's out there, a gray scale that converted. And there were

a speculation we could do $5 billion in a month or so. And we actually had bigger inflows in that, even accounting for outflows from the gray scale. How do you feel about what the flows have been in the Bitcoin ETFs. I've been surprised. The sheer amount, I think we're at total flows into cryptocurrency ETFs, including all of your futures-based strategies is over $13 billion here today. That's almost all driven by the spot. Bitcoin launches.

And to your point, that makes up for the $17 billion that's come out of GBTC. So really impressive amount of flows into the space. And I guess two things that jump to my mind. when I see that. One is you just can't argue with the ETF wrapper, right? Everybody was saying it for a long time that it's a better wrapper for this type of trade because you're not going to have that huge discount to premium to be underlying by trading directly in it. And I think everybody that's involved in that should be applauded with how smoothly it's gone. The second thing, though, is a little bit more concerning to me. And it's just how big is

this space and where is how much is the true underlying liquidity of this? Are we just literally in a position now where as long as the users of these, the distributors of these ETS can drive flows to it, are we going to keep pushing the price up? I think it's really interesting to see how this plays out because I don't think there's anybody truly understands the underlying liquidity of the Bitcoin market. And where does that start to come into play when in times of stress? Just over the weekend, it was crazy to see, you know, with the Middle East tensions, you saw Bitcoin sell off massively while the ETFs weren't trading. You know, does that start to cause issues with these products and whatnot?

So there's a, the story is still really early, I guess, is what I'm trying to say. And I don't think we truly understand the breakdown of the ETF market. Finally, the commodities. We were talking in the main program with Jan Vannick about the fact that inflows are still strong in technology, which has been lagging. And yet energy and commodities, which have been big performers this year, the flows are kind of, they're actually negative overall on the year. Now, you're saying just recently there's been some modest inflows. Are investors playing catch up now?

Do you think that's going to continue here? Yeah, I mean, so over the last month, we've seen all of the kind of the underlying inflation sensitive areas to market, whether it be precious metals, whether it be commodity producers. on the gold miners on the equity side or on the commodity side broad base. I think this is one of the first months, first couple of months since basically the pandemic where we're seeing positive flows into the commodity ETF sector. And I think it's part of it's playing catch up. They are some of the best performing sectors here today. And a lot of investors trade on momentum.

They allocate on momentum. So a lot of models out there shift in to those momentals. But the other side of it is, and I think Jan did a really good job. kind of explaining it, there are really good reasons to think about that side of the market from a fundamental perspective. So something to keep an eye on, but the flows have definitely turned recently. All right, Mike, I've enjoyed it very much. Thank you for partaking in ETF Edge. And I appreciate it. We'll talk to you soon, Mike. That does it for this week's ETF Edge, the podcast. Thanks for listening. Join us again next week. And remember, etfedge.cbc.com for all of our

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