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Editor's Note: Hamish Risk | July 29, 2020
In today’s Macro Briefing we focus on the potential regime shift in the global economy and markets triggered by the coronavirus pandemic. As Absolute Strategy Research highlights, given the COVID-induced full stop in activity, the initial stages of any recovery may look like a “V”, but the risk is the global economy faces a permanent loss of income. It may be difficult for some to accept, but the firm explains why this could herald a new investment regime, with a rotation away from the US, tech and growth towards the eurozone, banks and value. Meanwhile, Cornerstone Macro outlines why the dollar has further to fall, Capital Economics sets out why the global recovery is set to wane as economies diverge and The Cook Report reveals what is really concerning Democrats ahead of November’s US Presidential election. Elsewhere, as part of our high conviction ideas series, Pennock Idea Hub makes the case for Canada’s Major Drilling Group as gold prices flirt with record highs.
gold gold miners Pennock Idea Hub
1. High conviction idea: The Major matrix – remember the Yukon gold rushThe enduring lesson from the Yukon gold rush was that if you wanted to make real money, you weren’t the miner, but the miner’s supplier says Edward Pennock, CEO and Founder at Pennock Idea Hub. With that in mind, as gold prices approach all-time highs, he explains why the valuation of Canada’s Major Drilling Group, which provides specialised contract drilling services for mining and mineral exploration companies and has a fleet of over 600 rigs, looks so compelling. As Pennock notes, there has been an explosion in financings in reaction to the surge in the price of gold, with almost one junior gold mining financing per day, and all that money goes into drilling, in which Major Drilling is a global leader. The company’s business premise, he explains, is that the new deposits over the next 20 years will be in areas difficult to access and that specialised drilling will be a larger part of the market. Pennock says assuming capacity utilisation of 75%, revenues from the firm’s 600 rigs could reach $1 billion per annum, which could translate into a gross margin of $250 million for a company that currently has a market capitalisation of under C$450 million. That is why he recommends Major Drilling, which is the contractor of choice for many senior mining companies and has senior management with over 1,000 years of combined experience, as a high-conviction trade.
US presidential elections Cook Political Report
2. Democrats’ anxieties aren’t about the pollsGiven how far Joe Biden is ahead of Republican rival Donald Trump in national opinion polls and statewide surveys ahead of November’s Presidential vote, Charlie Cook explains just why Democrats are still so nervous. They are, he says, fretting over whether polling places will be open, whether a shortage of polling workers due to the pandemic—particularly in large urban areas—could depress their vote and they are also worrying about postal-sorting facilities being closed down due to the coronavirus, which would make it hard to get ballots out to people and back in time to be counted. Furthermore, says Cook, they worry about vote counters being overwhelmed in states where there is little history of mail-in voting, and then they worry about voter-suppression efforts by some Republican state and local election figures. Simply put, he says, whether legitimately or out of paranoia, Democrats are less worried about President Trump winning this election than about other factors allowing it to slip out of their hands. Whether any of these fears manifest themselves in any meaningful way or not, adds Cook, it is what keeps Democrats awake at night.
Asia Emerging markets Global economic activity Capital Economics
3. Global economy; Recovery to wane as economies divergeThe initial rapid pick-up in economic activity has offered encouragement after an almost unprecedented recession, but households and firms will remain in cautious mode, preventing a full V-shaped recovery according to Capital Economics’ third-quarter global economic outlook. While policy is set to remain supportive, says the firm, the recent huge impetus must ultimately be wound down with adverse effects. China, Korea and Taiwan are among the furthest along the road to recovery and Capital Economics expects them to stay in the lead, while economies in southern Europe, Latin America and Africa lag behind. The firm says while the US economy initially experienced a particularly sharp rebound, the recent resurgence in coronavirus cases has warranted caution about the economic outlook, and the recovery looks set to be slow regardless of who wins this year’s election. In the eurozone, the concerted fiscal and monetary policy response to the crisis and tenuous steps towards a fiscal union have come as a relief, according to Capital Economics, but the region will still take longer to recover than other advanced economies as the tourist-dependent south suffers long-term effects. In contrast, low reliance on tourism, strong banks, healthy corporate balance sheets and huge fiscal support should allow for a fairly rapid recovery in Japan by international standards, says the firm, while the UK may take some time to recover as Brexit adds additional uncertainty to an already cloudy outlook. In all, Capital Economics says it will probably be a few years before the global economy returns to its pre-virus path.
US dollar Cornerstone Macro
4. Models say the dollar still has further to fallRoberto Perli at Cornerstone Macro has looked at the recent depreciation of the dollar to evaluate whether it is the beginning of a long-lasting trend or if recent weakness is unwarranted. To answer the question, he has looked at whether major dollar pairs reflect current macro, policy, and trading fundamentals, without assuming how those fundamentals may change in the future. At the macro and policy levels, dollar depreciation seems justified by the weaker US outlook relative to other countries and by the Federal Reserve looking increasingly trapped at the zero bound, says Perli. Recent dollar depreciation also makes sense on a trading basis, mostly as the safe-haven flows that pushed the dollar up at the beginning of the crisis are fading, he adds. Furthermore, Perli says his methodology, which averages over millions of estimates, suggests dollar valuation is still a bit stretched and that it has further to fall even in the absence of further Fed dovishness or other fundamental changes. He says, the overvaluation of the dollar relative to the euro, the Japanese yen, the British pound, and the Canadian dollar now ranges from about 1% to 6%.
Asset allocation sector rotation US dollar Absolute Strategy Research
5. COVID as a catalyst for a new regime shiftThe complexity of interpreting the policy response to COVID, the uncertain profile of the recovery, and the possibility that a regime change may be underway make this a tricky period for investors to navigate, says David Bowers at Absolute Strategy Research. He believes, however, that the intensity of the events of the past three months has the potential to trigger a change of investment-strategy regime, with significant supply-side implications. Bowers believes rather than investing in areas attracting excess capital, it may be time for investors to explore sectors that were deprived of capital, maintaining the changing monetary and fiscal policy regime in response to COVID will likely trigger a shift in investment regime away from high valuations in the US, tech and growth towards the eurozone, banks and value. He concedes this may be a hard sell to some investors, but says US tech sector valuations are vulnerable to a correction, while there may be a secular opportunity for banks as the crisis could end the regulatory arbitrage that has hindered the sector for more than a decade. Bowers also sees further weakness in the dollar. Not only must the greenback now face the loss of a supportive real interest-rate differential at a time when investor expectations for the currency have turned more negative, he says, but the greatest uncertainty for the dollar is whether a less global, more autarkic world could become the catalyst for moving towards a multi-reserve-currency system.