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Was the Quadrupling of Oil Prices Due to the Increased Price of Gold?

In his recent post, “The True Story of the Oil Crisis of 1973-1974,” October 19, 2023, John Phelan gets the facts right but the economic interpretation…

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In his recent post, “The True Story of the Oil Crisis of 1973-1974,” October 19, 2023, John Phelan gets the facts right but the economic interpretation wrong.

John argues, as the late Wall Street Journal editor Robert Bartley had argued, that OPEC quadrupled the price of oil in order to keep the price constant in terms of gold. John writes:

“In the first half of 1974,” Bartley wrote, “after “the shock,” a barrel of oil was worth almost 1/12 of an ounce of gold,” just as it was in 1969.

But he also quotes the September 1973 OPEC resolution’s statement that OPEC’s members would adopt “ways and means to offset any adverse effects on the per barrel real income of Member Countries resulting from the international monetary developments as of 15th August 1971.”

Why do I say “But?” Because real income is measured in terms of what it will buy. OPEC members didn’t sell their oil so they could buy only gold. They sold their oil so that they could buy goods and services. By how much did the overall prices for goods and services rise? Between 1969 and 1974, by which time almost all the price controls and been ended, the CPI rose by 35%. So OPEC’s attempt to keep their per barrel income constant in real terms would explain at most a 35% increase in the price of oil between 1969 and 1974, not a 300% increase.

Why would OPEC refer to “the international monetary developments as of 15th August 1971?” The most likely reason is that doing so was good PR for a move that OPEC knew would be unpopular, namely a quadrupling of the price of oil over a few months.

There could be another reason that somewhat fits OPEC’s idea of bringing gold into the discussion. When any cartel sets prices, it needs to set them with reference to something. But what? Possibly the OPEC members thought they could hold the cartel’s price together for a few years by setting it in terms of gold. But that’s different from OPEC’s claim that it was simply trying to maintain the Member Countries’ per barrel real income.

What about the effect of the oil price increase on inflation? It was not large. In 1973, we imported approximately 6.3 million barrels per day (mbd) of oil. So when the price of oil quadrupled, from $2.75 per barrel in early 1973 to $11 per barrel in early 1974, the annual income transfer to foreign producers due to that price increase was $8.25 per barrel times 6.3 mbd times 365 days, which is $19 billion. U.S. GDP in 1973 was $1.326 trillion. $19 billion is 1.4% of $1.326 trillion. Using the equation of exchange, MV = Py, where M is the money supply, V is the velocity of money, P is the price level, and y is real GDP, we can calculate the part of inflation due to the oil price increase. The effect of y falling by 1.4% is a 1.4% one-time increase in the price level. So the increased price of oil was a substantial contributor, but not the most important contributor, to the inflation from early 1973 to early 1974, and only a small contributor to the inflation from 1969 to 1974.

You might wonder why I consider only the price increase on imports. Didn’t the price of domestic oil increase also? Yes. But two things. First, Nixon’s price controls didn’t allow the domestic price of oil to rise to equal the world price. That didn’t happen until January 1981, when Ronald Reagan, in his first month in office used the discretion he had been given in 1980 legislation to end the price controls on oil and gasoline. But second, and more important, even if the price of domestic oil had been allowed to rise to the world price, that would have represented a transfer of income from domestic consumers to domestic producers but not a loss of real income to the U.S. as a whole.

 

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Banks Increase Car Loan Rejections Over $1,000 Monthly Payment Concerns

Banks Increase Car Loan Rejections Over $1,000 Monthly Payment Concerns

​​​​​​As borrowers struggle with making their $1,000…

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Banks Increase Car Loan Rejections Over $1,000 Monthly Payment Concerns

​​​​​​As borrowers struggle with making their $1,000 monthly car payments, banks with auto financing units are swiftly adjusting to stricter credit conditions by turning down many prospective buyers, further complicating the process for consumers to secure auto loans. 

According to Bloomberg, "That's freezing out buyers with lower credit scores who can't afford a large down payment, while Americans with healthy finances are having more trouble than usual securing loans." 

New data from Cox Automotive shows access to auto credit has tumbled to the lowest level since August 2020. The approval rate for loans is down 1.6% year-over-year. 

Source: Bloomberg 

Meanwhile, data from the New York Federal Reserve shows the percentage of auto loans 90 days or more delinquent rose above pre-pandemic levels to 2.66% in the fourth quarter of 2023. That compares to 2.37% at the beginning of 2020 and a 15-year average of 2.16%.

"What people are struggling with is the level of inflation causing them to have to juggle expenses and try to stay current on their loans," said Jonathan Smoke, chief economist for Cox Automotive. 

Smoke continued: "It's produced some very alarming statistics that indicate risk has grown in an environment in which lenders have become more risk-averse."

This is why banks have a very cautious view of the consumer as the era of Bidenomics fails.  

And this also comes as a recent Edmunds report showed the number of consumers with auto loans "underwater" or "negative equity" hit levels not seen since April 2020. 

Source: Bloomberg 

"It's a precarious spot for many Americans, coming after a twin surge in car buying and interest rates has strained finances and fueled an uptick in automobile repossessions," Bloomberg recently explained. The average rate for a new auto loan with a 60-month term via Bankrate data nears the 8% mark, or the highest level since the Dot Com bust.

Last year, when discussing the "perfect storm" hitting the US auto market, we showed that according to Fitch, "More Americans Can't Afford Their Car Payments Than During The Peak Of Financial Crisis"... The average new car loan has reached a record high of $40,000. 

And weeks ago, we penned a note showing how some dealers put consumers with likely poor credit into vehicles with payments comparable to mortgage payments of a small home

The auto financing market is preparing for a downturn as low-tier consumers increasingly struggle with $1,000 monthly payments. 

In the end-of-day market round-up on Wednesday, we shared with readers the Credit Managers' survey that shows the rate of rejections for credit applications and the number of accounts moved to 'collections' is surging back to near GFC levels...

... and about that 'strong consumer' narrative the Biden administration keeps pushing in corporate media. 

Tyler Durden Thu, 02/29/2024 - 14:20

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Investors Finding It Increasingly Pointless To Be Bearish

Investors Finding It Increasingly Pointless To Be Bearish

By Jan-Patrick Barnert and Michael Msika

Investors are finding it increasingly…

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Investors Finding It Increasingly Pointless To Be Bearish

By Jan-Patrick Barnert and Michael Msika

Investors are finding it increasingly pointless to be bearish as equity markets are about to lock in a fourth consecutive month of gains, the longest streak in Europe since the 2021 pandemic rally.

Even February’s performance looks quite impressive, contrary to the usual seasonal pattern of weakness in the second half of the month. Also, number crunching signals good news ahead: when the S&P 500 Index advances during the four winter months, the remaining calendar year’s performance has never been negative, and the year showed average annual gains of 21%.

And then there is the 1995 analogy that the Federal Reserve’s looming interest rate-cutting cycle may again allow the world’s largest economy to grow without stoking price pressures. If history serves as a guide, we could potentially be in for another massive bull ride.

So while keeping one eye on the exit door just in case the overwhelming belief in this rally starts to weaken, more and more bears seem to be giving in now. HSBC strategists this week ended their tactical underweight stance in equities. The bank’s chief multi-asset strategist Max Kettner said that sentiment and positioning have been stretched and remain elevated but that “this isn’t enough to prompt a significant correction in risk assets” without a “clear catalyst.”

And finding a shock event that would reverse the rally — and getting its timing right — is proving elusive. The macro backdrop and corporate earnings look fine, the US election is still a while away and it’s hard to see any candidate saying something so outrageous that it spooks investors. Geopolitics is one risk in investors’ minds, but unless there’s a serious escalation in the Middle-East, markets don’t seem to worry too much. China is busy tackling domestic issues, and while banks’ credit risk is in the spotlight, chances of contagion seem limited at this point.

Some market watchers are noting that the velocity of pushing to new highs is actually a sign of caution. Point taken, yet timing the peak seems almost impossible if looking at the history of the Nasdaq index. Also, the pace of gains is slower than during the Internet bubble.

Volatility is further adding fuel to the market — or at least not holding it back as the crowd of volatility sellers is stacking higher. Nomura strategists said that each month investors are selling $241 million of volatility, which helps compress market swings and keeps risk-on sentiment intact. That comes after $6 billion of inflows into ETFs using derivatives to create extra income over the first two months of the year, according to the bank.

Nomura’s Charlie McElligott said that the current market backdrop has created an environment for volatility sellers to “collect extra yield.” Namely, US stocks that “only go up and simply refuse to pull back due to AI mania and the perception of US economic Goldilocks allowing for a soft-landing” while at the same time investors get the benefits of expected easing by the Fed later in 2024.

The call wall — a significant resistance level for the market, sits just above the current spot price level. But there is very little to suggest this will cause big headaches anytime soon. The short gamma level, together with the CTA sell trigger, stand somewhere around 4,950/4,900 points for the S&P 500 Index. So we would need a sustained 4% move lower before even hitting this level, not to mention any pathway toward bigger declines.

“Investor optimism is high and positioning is elevated, as a Goldilocks outcome or better has become consensus,” according to JPMorgan strategists led by Marko Kolanovic. More than half of the investors in the bank’s latest client survey see their equity positioning in the 40th to 60th percentile based on historical terms and 39% said they are still planning to increase equity exposure.

Half of Goldman Sachs’ sentiment indicators are now over the 80th percentile versus their own history — lead by positioning. Flow indicators also improving and even the fact that investors are generally exposed to concentrated positions can be seen as a two-edged sword, according to Goldman strategists including Cecilia Mariotti.

“On one side, this inevitably increases concerns around potential near-term setbacks in case of related shocks,” she wrote. “But on the other side it suggests there is space for bullish sentiment and positioning to be further supported, especially if we start seeing a more meaningful rotation out of cash and into risky assets and laggards within equities.”

Tyler Durden Thu, 02/29/2024 - 12:40

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No Asset Class Is Remotely Ready For More Inflation

No Asset Class Is Remotely Ready For More Inflation

Authored by Simon White, Bloomberg macro strategist,

Stocks, bonds, commodities and other…

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No Asset Class Is Remotely Ready For More Inflation

Authored by Simon White, Bloomberg macro strategist,

Stocks, bonds, commodities and other real assets are dramatically unpriced for a resurgence in inflation.

If fortune favors the prepared, then no market is going to have much luck. A re-acceleration in inflation is increasingly on the cards (see here), an eventuality that is materially underpriced across asset classes. That means portfolios are cheap to hedge, as well as leaving markets subject to outsized moves when they do price in inflation’s return.

Inflation complacency can be seen clearly in one chart. CPI fixing swaps foresee a continued steady decline in headline inflation in the US back toward 2% through this year. Not only that, most of the swaps have been falling in recent months as spot inflation has eased. The implied probability of a return of inflation is dwindling to zero.

But it’s not just fixing swaps predicting a return to inflation utopia. Across markets, there are indications that are not only underpricing a revival in price growth, they appear to be ignoring the possibility altogether:

  • nominal yields with negative inflation risk premium

  • real yields with low downside skew

  • low expectation of much higher short-term rates

  • high exposure to equity sectors with steep duration

  • low exposure to the sectors best placed to weather inflation

  • commodity volatility that’s very subdued

  • ownership in commodities that is at histrocial lows

The charts will do most of the talking. Start with nominal yields. We can decompose them (via the DKW model) into a real expected short-rate, real term-premium, expected inflation and inflation term-premium (aka risk premium).

The drop in the 10-year yield from its October high has been driven by a fall in the real expected short-rate, as well as a decline in expected inflation. But there is nothing built into the price for inflation’s volatility rising again, as it typically does when price pressures increase. In fact, the inflation risk-premium is more negative than it was in the years leading up to the pandemic.

Real yields too are bereft of any risk premium for inflation. If the Federal Reserve does not immediately react to rising inflation (as happened in 2021, and I suspect will happen this year if and when inflation starts to pick back up), real yields are likely to experience downside volatility, i.e. call skew for TIPS should rise. Again there is no sign of market nerves here.

As the chart above shows, TIPS call skew has tended to lead inflation over the last few years, and thus there is little in the way of rising price growth expected soon. The inflation-bond market may have this one wrong.

Short-term rates don’t look any better. The market is still expecting lower rates over the next year, which might make sense from a weighted-average perspective given that when things go wrong (e.g. a recession) they go violently wrong. But there is little likelihood priced in for much higher rates – the distribution for SOFR rates has a clear downwards skew.

Overall, bond investors just aren’t anticipating more inflation, with the number of investors who say they are short USTs in JPMorgan’s Treasury survey plumbing its series lows.

Stocks are also very much on Team Transitory (and we can make similar arguments for credit). There continues to be a bias toward high-duration sectors (which are more likely to fare worse when inflation is high), such as tech and telcos, with these strongly outperforming the index.

On the flipside, the sectors with historically the best record when inflation is elevated are those with low duration such as energy and staples, which continue to lag heavily behind.

Bonds, and stocks in the main, are assets to avoid (or short) when inflation is troublesome, but commodities and other real assets are havens. But here as well, there is no sign investors are making hay while the disinflation sun is shining. Commodity ownership relative to stocks and bonds continues to fall, and now represents only a measly 1.7% of the total.

That’s not just down to valuation effects, given commodities are now 30% lower than their 2022 peak, but due to real outflows from the asset class (using commodity ETFs as a proxy).

It could be the calm before the storm. Implied volatility in several commodities, mainly in metals, has been falling and is near 10-year lows. Lead, copper, nickel and most notably gold and silver are within ten percentage points of their vol troughs over the last decade.

Again, why own real assets over financial assets when you think inflation is yesterday’s story? That’s reflected in BofA’s Global Fund Manager Survey from December, showing the biggest underweight in commodities versus bonds since the post-GFC equity-market bottom in March 2009.

Source: Bank of America

Just maybe though there is one market sensing price growth is returning and is moving to hedge it. I mentioned above TIPS skew did not appear to be anticipating an inflation-driven lurch lower in real yields. But inflows into TIPS ETFs as a whole are slowly picking up. This had a good call in the pandemic, starting to rise about three months before CPI started its ascent in 2020 (when inflation leading indicators were already rising, as they are today).

Either way, there are precious few signs a re-acceleration in inflation is being priced in even as much of a tail-risk across markets. Fortune favors the hedged — and at the moment, that’s exceedingly cheap to do.

Tyler Durden Thu, 02/29/2024 - 08:05

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