The changing economics of China

 

China’s trade is evolving and has been described as China 2.0, a shift up the value-creation ladder from labor-cost advantages to more high-tech exports. To support growth, it has targeted high-tech exports to offset overall economic slowdown still driven by repricing of property risks.

Trade surpluses have continued to grow, with EVs, solar, and batteries being key drivers. China’s export growth has created significant economies of scale that will be hard for other countries to match. It is harder to raise trade barriers when the tariffs target goods needed to meet strategic environmental goals. The strategic move to high-tech manufacturing makes it harder to disengage with China. 

One of the only solutions is to innovate faster and leapfrog China’s high-tech manufacturing lead, but this is much easier said than done, and any innovation will take years to fully implement.

Dimension	China 1.0 (c. 1990s–2010s)	China 2.0 (c. 2020s–Present)
Primary Growth Engines	Property market, massive infrastructure investment, and domestic urbanization.	High-tech manufacturing, the “New Three” (EVs, lithium batteries, solar), and green technologies.
Export Profile	“China Shock 1.0”: Low-cost, labor-intensive, low-value-added consumer goods (clothing, toys, basic electronics).	“China Shock 2.0”: High-value-added industrial capital goods, advanced vehicles, industrial robotics, and clean-tech equipment.
Corporate Dominance	Real estate developers (e.g., Evergrande, Country Garden) and traditional heavy industries.	Advanced tech & industrial giants (e.g., BYD, CATL, Huawei, SMIC).
Policy Objective	Rapid, high-volume quantitative GDP growth (“Growth at all costs”).	High-quality qualitative development, technological self-reliance, and supply chain security.
Leverage & Debt Model	Rapid local government borrowing (LGFVs) and property sector leverage.	De-leveraging property, state-directed credit toward strategic high-tech manufacturing, and managed debt restructuring.
Global Trade Impact	Absorbed foreign investment; offered cheap labor to global brands.	Unprecedented trade surpluses, global manufacturing overcapacity, and direct competition with Western industry.

The big moves in fixed income - getting to equilibrium faster

 

Call it the "Great Bond Freak-out," as long-term yields have consistently moved higher, as measured by 3-day changes. The direction has been clearly upward, and the moves have been the largest since the Liberation Day debacle. The market has repriced bond risk quickly. Inflation expectations, while seemingly well managed, are above the 2% target. Real rates have risen on higher expected growth and stronger demand for AI financing. Monetary policy is moving to a hawkish stance, which places further pressure on the front end. 

The sudden repricing of bond risk should attract attention, but it does not imply bond market irrationality. Perhaps the irrationality was with the false valuations prior to this move higher.

The AI boom in historic perspective

Several investment booms have occurred throughout economic history. These booms have not always been part of a bubble or led to a bust, yet periods of investment exhaustion have occurred in which marginal firms have failed and early high returns have reversed or, at a minimum, significantly declined. Yet the current infrastructure boom is orders of magnitude higher than what we have seen in the past.

The AI investment boom exceeds the huge investment in railroads post-Civil War and is much larger than other economically changing technological investments. This is cause for concern because today's euphoria may not match reality tomorrow.

The short-term market is telling us rates will be higher

A good indicator of rate direction is the spread between 3-month Treasury bills and 1-year rates versus the EFFR. Market rates for slightly longer maturities show that the market is willing to clear at higher rates, and implied forward rates will, by definition, be higher. The switch from falling to rising rates occurred earlier this year, with the 1-year vs. EFFR spread rising sharply in the last month. Nothing suggests rates are headed lower.

AI impacting the arts employment

 

An interesting chart from Apricitas Economics on the employment changes in the arts since the introduction of ChatGPT. Live arts are showing job gains, but digital arts are showing significant employment declines. AI’s impact may come in unexpected places and shift job dynamics, with some winners and others losing out. 

Bonds at fair value - perhaps opportunity

We can look at real yields and say that real rates may be high, but there may be a view that real potential GDP is likely to fall and the natural rate of interest is lower.  If we assume growth will be higher, and the natural rate is closer to a longer-term average, we can say real rates have risen sharply, but their current level is not excessive. 

If we think nominal rates may be near fair value, we have to ask what the impact is of a 100 bps increase versus a 100 bps decrease. In that case, the risk-to-reward suggests that bonds may be attractive. If you assume the probabilities are equal, you may want to consider buying bonds. 

 

The bad road of speculation?

 

There seems to always be a moral focus on the speculation. It is evil. It is a temptress. It should be avoided. Less time and effort should go into simple economics. Most people aren’t good at speculation because you need an edge. It could be information, better knowledge or decision assessment, or lower costs. The failure is not in our moral fabric or greed. It is in our limitations.

Regulators can do harm - a rare admit from the Fed

 

It is striking that the Fed admitted it made a mistake. Michelle Bowman gave a speech in London that should raise some eyebrows. Note that the speech was given outside the country. The key findings are listed below, but most surprising is that the review suggests a risk-averse culture among regulators. Better to do nothing than take some action. The bank regulation is done at the regional bank level. For all the speeches and economic research that is done at the regional Fed level, shouldn’t they get this right? It is not clear that centralization would be better, but this is interesting food for thought.

Now, the question is what will Governor Bowman do about this? 

For information edge you need expertise

 

An investor can generate returns based on their knowledge. The knowledge used creates an information edge that may allow you to earn a higher return than the market portfolio. To determine an information edge, ask what your level of knowledge is about a topic or firm. We focus on tacit knowledge, the expertise from practice and experience. There is ubiquitous tacit knowledge available to most, and specialist tacit knowledge focused on a much smaller set of individuals. 

Ubiquitous tacit knowledge exists in a number of degrees. We can start with beer-mat knowledge, which is a simple description. For example, the Fed controls monetary policy. There is popular knowledge, which you may read in a newspaper, and primary-source knowledge that may come from research analysts and academic articles. These are all fine, but they will not create an edge.

Specialist tacit knowledge can come in two forms: interactional expertise, which shows you can critically evaluate information and use it, and contributory knowledge, which shows mastery and the ability to use that knowledge to develop unique thinking.

If you want to know whether you have an edge, then ask what your level of knowledge is. If you don’t have a specialist’s level of knowledge, you are unlikely to have a chance of beating the market.

We force explanation through stories to calm our fears

[T]o trace something unknown back to something known is alleviating, soothing, gratifying and gives moreover a feeling of power. Danger, disquiet, anxiety attend the unknown – the first instinct is to eliminate these distressing states. First principle: any explanation is better than none … The cause-creating drive is thus conditioned and excited by the feeling of fear.

- Nietzsche hat tip top fs.blog.com

The unknown requires clear understanding, even of complex situations. We want to find causes for everything. If we have an explanation for the unknown, there is comfort and power. One creates sensemaking by substituting discontinuous concepts for continuous perceptions. Investors like a clear cause-and-effect flow.

What is the story here? And what will happen next? We use stories to make sense and to justify decisions or positions. Yet stories are often simplifications that make life easier and are not always the best tool for understanding a complex world.

Stories are important models, yet flawed.

Narratives help explain stock returns.

Narrative drives returns - even if stories do not generate measurable risk.

Investing reacts to narrative, not facts.

Is investment management a science? Use the “narrativeness” test

The change in reserve accumulation

 

We get used to an environment that may have existed for a decade and assume the recent past is the norm, yet we often find cases where recent history is the exception. Look ta the resereve accumulation around the world and we are seeing that high reserves as a means of protecting currencies after the Asian currency crisis in 1997-98 may be a thing of the past. This has implications for the dollar and for US Treasuries. There is less need for safe reserves, so this key source of demand is gone.

We are seeing significant purchases of dollar securities from foreigners, but the flows are in private equities and bonds as well as government bonds. These buyers are likely more price-sensitive and profit maximizers. This means their response to news should be stronger. Unfortunately, it is not clear who the end buyers are. This demand could come from hedge funds with offshore assets owned by US citizens. Nonetheless, dollar flows will be more news-sensitive and less stable.

Light bulbs and economists

There are many jokes about economists. I especially like President Truman’s comment about wanting a one-handed economist after hearing so many mixed opinions. While the light bulb joke is about philosophers, it could easily apply to economists or Fed officials. They will complain about what they don’t know and how hard their jobs are, yet will also redefine their goals. 

Why is it so hard to hit the 2% target? Is the new standard 3%? 

This issue seems to apply to many policy discussions. We redefine the goals we cannot reach. 

There is more than one type of surprise

 Surprise, there is more than one type:

• A bolt from the blue
• An issue is recognized, but the direction of the expectation is wrong 
• You know what will happen, approximately when it will happen, and in what order, but the timing is off
• The expected duration of the event proves wrong 

Need to think about the quality or characteristics of a surprise to better deal with it as an organization. Not all surprises are the same, so the response will be different.

Fimrs need to be HRO - highly resilient organizations

Better risk management requires mindful organizing that creates high-reliability organizations. Mindful organizing develops decision-making processes to protect against high volatility, chaotic markets, and surprises. 

This post synthesizes the key points of Managing the Unexpected: Sustained Performance in a Complex World by Karl Weick and Kathleen Sutcliffe. 

The mindful organization focuses on the firm’s coordination problem. The core problem of any firm, and its reason for existence, is to coordinate activities to increase efficiency and lower costs. Yet coordination is not easy. There is good and bad coordination. According to Barry Turner, “organizations achieve a minimal level of coordination by persuading their decision-makers to agree that they will all neglect the same kinds of consideration when they make decisions.” 

A good organization can adapt to surprises and be resilient. A highly resilient organization (HRO) should act through what the authors classify by the simple acronym FSORE: failure, simplification, operations, resilience, and expertise.

Mindful organizations look for continuity with a specific focus on some key principles:

• A preoccupation with failure - Work hard to detect failures and pay attention to anomalies, information that does not fit the normal; do not normalize; anticipate mistakes or show institutional wariness of mistakes and anomalies; realize that knowledge is incomplete and organize doubt of what may be occurring. There is a tendency to exaggerate the best case and most optimistic view, so be a skeptic. 
• A reluctance to simplify - Clarification does not mean simplifying in a complex world. Accept that complexity is a process and part of the environment. Simplifying tasks or explanations will cause you to miss important details. 
• A sensitivity to operations - Focus on the work itself, what is actually being done, to protect the system and keep the work flowing. Operational breakdowns will be costly. There should be an integration map, so everyone knows how processes are conducted in a failure or crisis. This requires strong situation awareness. 
• A commitment to resilience - Maintain key functions during a crisis or failure. Manage and anticipate the unexpected, so you create resilience, not just expect it. A response to surprises doesn’t happen without training to account for them.
• A deference to expertise - CHAOS - “the chief has arrived on scene”. To avoid chaos, organizations need to defer to experts or those dealing with an issue in real time. 

Adaptive managing from Gary Klein should follow the simple format - STICC:

• The situation - What problem or situation are we facing? 
• The task - What task has to be undertaken?
• The intent - What is the intent of our actions for this task?
• The concerns - What concerns are associated with this problem and solution?
• The calibration - What are we missing or need to adjust given this situation, task, and intent? 

Organizations need to think beyond measuring risk and valuation models and focus on building better organizations.

The demand for credit - both public and private

 

Most investors are concerned about the size of government debt. They should be. Deficits are out of control, with interest pushing debt-to-GDP higher as the cost of past excesses. Primary debt remains high with no controls in sight, yet the problem is broader. 

There is a strong demand for private capital given the strong increases in global capex. The private sector is competing with public markets for savings, and the cost of capital is increasing. Technology is showing strong capex, but the commodity sector is also demanding capital. Beyond energy, there is a strong need for many metals, which is finally leading to more capex after the decline in the aftermath of the commodity supercycle in 2008.

The competition for capital is real, but it is not clear that public markets are a better credit. 

What is the fixed income market telling us?

 

Fed Chairman Warsh stated that he will not provide forward guidance. The fixed income markets should do their own signalling. The combined weights of bond market participants should tell others what they are thinking. The market is speaking, and it is telling us that rates are going higher. The spread between the 2-year Treasury market and the EFFR is widening, suggesting rates will rise for a longer period. The market is expecting the Fed to raise rates to fight inflation. There are no Fed rate cuts expected as desired by the President. 

Nevertheless, we have to place the current rate increases in context. It is a return to normal after the QE and ZIRP era. That does not mean the economy will not feel the pain. The cost of capital is ,rising, which means projects will be rejected because they will not be financially attractive. 

When the extraordinary continues for too long, it becomes normal, and a return to the true normal becomes abnormal.

The garbage can model and investment decisions

Investors within organizations often face the garbage can model of decision-making. Decisions are made in a chaotic environment where goals are unclear, and participation in the process is fluid. There is often organized anarchy. Problems arise and need attention. They could be random. Solutions may or may not exist when the problem appears. The participants that may help with the decision may shift, and the choices that need to be made, when and how much, are often unclear.

Within this model, resolution is needed quickly but is not always clear. Oversight is difficult because it is not always clear who is in charge of the decision. There is often an issue with flight. Decisions are delayed or abandoned as priorities shift. The garbage can model differs from rational decision-making, yet it more closely reflects reality. 

In a chaotic environment, decision-making is not optimal; anarchy is present. Hence, investors have to break the cycle of decision-making and focus on process. One simple approach is to use models that rationalize decisions, but sometimes choices are unique and require decisions outside a model. Organizations must become process-oriented to avoid these issues. 

So what is your process? Does the organization follow it? Is there clear responsibility for who has to decide? Are preferences clear? There should be a linear sequence of actions that lead to a decision, not all information and choices coming at the same time.  

Stories are important models yet flawed

“Partial knowledge is more often victorious than full knowledge: it conceives things that are simpler than they are and therefore makes its opinion easier to grasp and more persuasive."    - Nietzche 

"History will justify anything. It teaches precisely nothing, for it contains everything and furnishes examples of everything."

- Paul Valery 

Storytellers are model builders. There is a need to describe the causal basis of experiences. A stream of events needs some causal explanation or sense-making that is realistic and comprehensible. A story will use stylized facts to support an argument, but stories are not the same as models. It is a process of causal inference that is not always based on empirical testing from large samples of data. 

Stories are especially important when data are limited or uncertainty is high. In environments of radical uncertainty or complexity, a story or narrative is a useful tool for describing the environment and making sense of causal relationships. 

Organizations use stories to help explain their actions. The story will serve as a model for how an organization behaves. Nevertheless, these stories focus on certain mythical themes: rationality, hierarchy, individual leader significance, and historical efficiency.

The story can be flawed, so investors must question the underlying assumptions behind any story, no different from how model assumptions are reviewed and tested. Stories should be reviewed through a rigorous process to avoid flawed logic based on partial knowledge.  

The two components of investor intelligence

We can think of intelligence in two components. Both are needed to be an effective trader or investor. First, an intelligent person needs to effectively adapt to an environment. Managing the environment requires resources, so an individual must know how to use them. It requires knowledge about the world and the ability to make decisions. Second, people need to interpret experiences within an environment. The skill to provide meaning and learn. Experiential learning links these two forms of intelligence. 

Intelligence is about adaptation, which may involve low intellect, where success is obtained through limited effort and causal understanding, or high intellect, which is associated with a need to understand the causal structure.

This leads to three forms of intellectual adaptation: rules and heuristics. The second is harder because rules may not work, especially in dynamic environments. The second is imitation, where one actor follows another’s success. The third mechanism is selection, which reproduces attributes associated with prior success and eliminates those associated with failure. Yet, controlling or managing the investment environment is difficult.

Success in controlling an environment is limited because history is complex and stochastically uncertain, and outcomes depend on the sequence of choices that lead to a specific action. Success depends on the sample of experiences and the sample of outcomes. 

Intelligent investing is more than applying models; it is an attempt to control a complex environment that requires understanding, action, and learning.

The ambiguities of experience - impacts decision-making

 

James March is one of the great professors of organizational management, yet finance and investment professionals rarely discuss or even consider much of his work. This is odd because organizations, not individuals, make so many investment decisions. Organizations, through investment committees, are a key driver of all institutional action. Organizations manage risk and oversee individual managers.

In his older book, The Ambiguities of Experience, March focuses on the paradox that experience "may be the best teacher" but "is not a particularly good teacher". Organizations are driven by experience, yet the links between action, decision, outcome, and learning are often unclear. The problem is that there are many ways to interpret the link between action and outcome. We have discussed this before in our work on “wicked” environments. 

Experience can be noisy because many links can attach to any action. We cannot always say that our action caused an outcome. Our experiences are also selective. We will often focus on the decisions we made that turned out to be correct and dismiss our incorrect actions. Similarly, success and failure can be misleading. If something worked well, we will likely repeat it. If some action fails, we are likely to stop, yet this stopping rule may not be correct when there are probabilistic outcomes. Additionally, the world changes, so the lessons in the past may not apply, and our aspirations of what is successful also change. There is ambiguity because the environment is complex, noisy, endogenous, constructed, and miserly from small samples.

Experience may not contain the correct lessons for investors or traders. Ambiguity remains about what happened, why it happened, whether it was good or bad, and whether our actions affected the results. Superstitious learning assumes that because some action of ours is followed by a result, the takeaway is that we did that. Is experience unreliable? No, but it should be tempered. 

The key issue for investors and any asset management organization is that causal inference is difficult. The problem permeates all organizations, and inference is not an issue that is left to science. Organizations, like individuals, have behavioral biases tied to group action and decisions. Organizations must explore to learn, then convert that learning into exploitation or action. 

Are global reserves moving away from the dollar?

The share of dollars has been declining, but not consistently across countries. Some have increased their dollar share while others have reduced their dollar exposure. In a NY Fed blog posting, “Are Central Banks Moving Out of Dollar Assets?” the authors try to disentangle the problem through two channels. One is the preference channel, which represents a change in the desire to hold a specific currency. For example, it can be a desire to hold fewer dollars. The second channel is the reserve change channel, which represents a change in the overall amount of reserves held. If a central bank has less dollar exposure but increases its overall reserves, overall dollars held will decline when central bank data is aggregated. 

What is clear is that the change in preferences has centered on a limited number of large central banks and does not represent a shift in behavior across all reserve holders. Second, some of the decline in the dollar share of foreign reserves is caused by large reserve holders that have had a lower allocation of dollars but have seen an increase in overall reserves. 

In conclusion, dollars as a percent of all reserves have declined over the recent reporting period, but the reasons for the decline suggest it is not a wholesale rebalancing of dollar exposure.  

 

Bond markets - is this just a return to normal

 

There is consternation in the bond markets that may be unwarranted. Rates are higher, and the sell-off has been strong, but we are returning to the normality seen before the GFC. Was the post-GFC period normal, or is the current environment, with a positive real rate, an inflation premium, and a term premium, the norm? 

I would argue that the current environment is a return to normality, and the low interest rates during the QE period were abnormal. The Fed and the Us Treasury cannot be in a continual mode of amping up the economy. There has to be a focus on inflation and controlling credit excesses. Of course, there is a threat of recession, and people will be in need, but the labor market is close to full employment, and inflation is well above target. 

Should we expect lower bond yields, or is the market just reflecting reality? 

Exchanges mergers and EU Capital Market Union (CMU)

An important news article states that Euronext is open to a merger with Deutsche Börse, which would be an important step in the one-European-exchange move to unify rules and regulations for stock trading; that is the hope. One of the most urgent and important discussions about competition in EU integration is reducing bottlenecks in capital markets. The EU has been a laggard in venture capital and private equity funding. New companies look to the US for capital. The disperse set f stock marklets redcues liqudity and makes any listing more expesneive in Europe. A consolidated exchange environment should allow for better listings, more liquidity, and lower operating costs across European markets. 

It is early to say whether there will be any merger announcement, yet a discussion is a good first step. 

Inflation expectations are still high

 

Inflation won't be tamed in the near term. First, CPI is staying above 3%, not 2%. Second, PPI isn't supporting lower inflation. The PPI is usually volatile, but commodity prices are rising with greater volatility.

While longer-term inflation expectations suggest inflation could get closer to the 2% target, one-year expectations aren't falling toward 2% and are centering around current levels above 3%.

The danger in in the covariance matrix

 

While most investors focus on volatility, the covariance matrix can significantly affect performance and is hard to measure. A large covariance matrix with N assets will have N(N+1)/2 free parameters and T degrees of freedom based on the number of observations. A large portfolio will be hard to calculate and difficult to use out of sample. 

Work has also been done on shrinkage estimates, which suggests that the raw sample covariance should contribute only about 20% to the new covariance matrix. Linear shrinkage does better than nonlinear out-of-sample estimates. Overall, shrinking toward zero correlation will help long-short portfolios because they rely less on extreme values. 

The problem is that, in optimization, weights depend on risk aversion, the inverse of the covariance matrix (the precision matrix), and expected returns. Estimation errors are amplified during inversion. A 10% mistake in the covariance matrix will cause the precision matrix to take much larger values, which can be catastrophic. 

Additionally, illiquidity can distort covariance in hidden ways. Illiquidity creates positive autocorrelation in the return series, so measured volatility is lower than true volatility and measured covariance is lower than true covariance. 

These issues are one reason funds should focus on covariance across the environment and try to adjust for relative volatility and risk contribution. It is not just the overall volatility that is an issue but the link across markets which defines diversification and the risk hidden within portfolios. 

The Almighty Dollar - a deep dive into monetary history

 

The Almighty Dollar: 500 Years of the World’s Most Powerful Money by Brendan Greeley explores how money functions not as a sovereign creation, but as an evolving financial product. Don't think of money as coins or greenbacks, but as a product that facilitates trade and investment. Greeley’s primary argument dismantles the nationalist myth of our almighty currency: the United States did not create the dollar, nor does it fully control it. In Greeley’s framework, money is a private liability or financial instrument that responds to global commercial demand rather than state decree. Sovereigns and central banks frequently adapt to monetary ecosystems created by merchants, private bankers, and international traders rather than originating them. The dollar derives from the German word taler, used to describe silver-coin mints in Bohemia.

The Almighty Dollar offers an interesting narrative history for those who love origin stories, reframing how we understand global currency. By highlighting the historical tension between state control and private market demand, Greeley presents a valuable reassessment of monetary power. It is a little long and feels rushed when it comes to modern monetary history, but money grew not from some grand plan but from many small acts and attempts to ease trade. 

Net interest and entitlement 98.4% of tax receipts

 

This is a crazy number - over 98% of all Federal Government Receipts go to net interest and entitlements. Only 2% of tax receipts cover the other expenses, the real activity of government. Put differently, we pay for all our non-entitlement programs, like the military, by borrowing money. I don’t think the American public knows this. I don’t think they may care. We aren’t even accounting for future commitments we have made that we will not have the money for. 

The only good news is that entitlements and net interest, if held by domestic investors, can be viewed as a large transfer payment with deadweight costs. We borrow from citizens who then pay taxes to meet the interest payment. We tax citizens and then give the money back to other citizens. Significant money moves between taxpayers and entitlement recipients, from one set of consumers who may save more to another set of citizens who spend more. It could be worse, but that doesn’t mean this money is being used productively. It is a great transfer of wealth

The shifting Overton window

 

The Overton window is an effective tool for describing changing opinions in politics and science. The window is a simple construct. Joseph Overton,  a public policy specialist, wanted to show how think tanks and political strategists can change public policy by shifting the boundaries of what people are willing to discuss, rather than just arguing within existing limits. There are degrees of acceptance, yet those ideas that can be acceptable are subject to change. Policy experts can shift those boundaries by changing public opinion.

The issue today is that the boundaries are shifting fast, and the process of shift means that extreme voices become more vocal in an effort to move the window. 

We are seeing the economic policy Overton windows shifting on monetary and fiscal policy, and that creates uncertainty. A shift in policy thinking also shifts the potential effects from these new policies, and markets may not be prepared for these chnages. 

1873 - the first depression and monetary mistakes

 

1873: The Rothschilds, the First Great Depression, and the Making of the Modern World by Pulitzer Prize-winning historian Liaquat Ahamed expands on the themes of global financial fragility introduced in his acclaimed Lords of Finance. It is a compelling story that most economists who focus on economic history since the Great Depression have largely forgotten. 

The key takeaway is how a normal recession became a major upheaval based on changes in the financial system. The shift from many countries using a bimetallic (gold-and-silver) monetary system to a gold standard significantly reduced the money supply in the global economy. The shortage of money and credit exacerbated the financial crisis. The implications were significant: a decline in the Ottoman Empire, an intervention in Egypt, a period of deflation, a rise in anti-Semitism, and an extended recession that some may call the first global depression.

Unfortunately, the author wanted to focus on personalities like the Rothschild banking families. Still, the real story was policy mismanagement driven by a lack of understanding of credit markets and money.  

How bad are the bond market returns?

 

Bonds are a bad bet, or have been a bad bet. In fact, the current period has been the worst in the longest history available. It is worse than the period of high inflation in the 1970's, worse than the Civil War. 

However, there is hope. As rates move higher, current yields rise, which offsets some of the capital loss. Coupons provide a cushion for further yield increases. Total returns can improve quickly if overall yields are higher.

Where are we going to get the needed copper?

Copper has hit new highs as investors focus on rising demand from the tech sector, yet a fundamental supply problem remains. Not enough new fields are being discovered and developed to meet demand. 

There is talk about commodity cycles, yet understanding long-term demand requires looking at how supply is created. Mining is expensive. It requires capital investment, but that only happens after a discovery, and discoveries have different ore qualities. If prices are low for an extended time, then there is no development, which creates a shortage. The shortage then raises prices, which, if sustained, creates the incentive to develop new mines. This is the basis for a commodity cycle. 

 

The gold real rate change in sensitivity

There are supposed to be certain “rules” between market drivers and gold. Gold is supposed to hedge inflation. This relationship has proven mixed. A second relationship is linked to real rates. Since gold does not earn a return, investors should prefer an asset with a positive real return over gold. The longer-term relationship is negative, yet the last four years show a relationship in transition. Right now, there is a a much stronger link with real rates. 

Gold can be viewed as a meme asset that reflects investors’ fears. There may be an economic relationship, but the link is often unstable.