The Disinflation Meme

Food, water, shelter, and energy are some of humanity’s most basic needs, yet energy is one of the most misunderstood markets in the world today.

It’s understandable why since it takes hundreds of hours of study to truly understand the dynamics of the energy industry. Thus, most people just stick to the popular narratives and memes of the day that lack any real substance.

Amazingly, this is just as true in the financial markets even though energy has enormous and outsized effects on capital markets during certain energy cycles.

According to FMT’s research, we’re in a period where portfolio strategists better start paying more attention to energy, and its relationship to capital markets now.

For example, in the last two weeks, Jerome Powell has uttered the word “disinflation” at least 20 times in the context of the Fed being encouraged to see declining rates of inflation.

Algorithmic trading bots pick up on these cues from the Federal Reserve, trade the disinflation meme from the Fed, and force shorts out of their positions. General equities get a lift since they have been the most beaten up (not commodities), and the junkiest companies on the planet that have been flirting with bankruptcies see the largest moves of all during this sequence of events.

As FMT has articulated, the Federal Reserve and its actions will essentially lag whatever energy markets are doing, and this is exactly what we are seeing.

Oil prices are a big part of inflation rates, and oil prices were temporarily suppressed until very recently. The Strategic Petroleum Reserve (SPR) released 250 million barrels of oil on the market (40% of our reserves) over the trailing 12 months while 300 to 400 million Chinese consumers were still in lock-down over COVID. These measures just ended last month, and it’s no surprise to us that oil prices seem to be basing now after their recent retreat.

As the spot WTI Oil price decreased due to these temporary factors, the 10-year U.S. Treasury note also declined (which was no surprise: it has always had a very close correlation to WTI Oil prices as I showed in the last email).

This has given Jerome Powell and the market a sense of some relief because inflation and interest rates – which are a balloon or anchor for asset prices – have moderated with the temporary factors of oil price suppression.

As it relates to financial markets, a meme is best defined as “an idea that grips the consciousness of the public” no matter how ephemeral or how much it lacks substance or facts. The current disinflation theme may just be nothing but another weak meme where the unknowing are destined to lose big yet again.

For anyone following energy markets relatively closely, it’s no secret that the tightness between supply and demand is as narrow as it has ever been since the start of the Industrial Revolution.

Look no further than the need to drain our SPR by 40% just to get oil back down to the $75-$80 range as empirical evidence over the last year (in conjunction with over a quarter of the entire Chinese population being locked down at the same time).

Our overarching theme is that the only thing that will be able to tame oil prices is a long-lasting recession that will need to last for a period of years, and that is a highly unlikely probability given that government debts will not be able to sustain tight monetary policies for any significant length of time.

At FMT, we don’t invest in memes or vague ideas – we invest in the things we know.

Until key commodities such as oil and uranium begin a true capital spending upcycle and a sustained bull market, the margin of safety is in these areas because they are truly the cheapest and most valuable parts of the “markets” today. The following chart highlights the margin of safety in these assets:

Most other industries and sectors at today’s valuations require ultra-low interest rates to justify anything close to their current prices. Until we get back to energy surpluses that bring sustainably low interest rates, the secular trend with durable substance is in the materials needed to grease the wheels of our economic machine.