Australia stands to bank higher copper, iron ore and base metals prices as the world becomes unmoored from its fiscal settings, one of the most high-profile Aussies on Wall Street predicts.
Matthew McLennan, the co-head of the global value team and portfolio manager at the $US161bn ($243bn) First Eagle Investments, stormed the market with a bullish bet on gold and has about 15 per cent of his portfolio invested in the precious metal today.
“The thing that’s interesting, that’s arguably a positive for Australia, is if you look at the price of copper or the price of oil, they’re quite depressed relative to gold,” McLennan said.
“The base commodities have suffered by virtue of the slowdown in China, and that’s had a negative impact on Australian terms of trade and the Aussie dollar.
“But if we had a scenario of some economic growth playing out because we’ve got easy fiscal conditions around the world, and you see oil, copper, iron ore, the basic commodities complex recover to more normal levels of valuation relative to gold, that could be inflationary for the rest of the world, and it could be rocket fuel for the Aussie dollar,” he said.
Gold hit a fresh record this week rising above $US3875 an ounce, up 47 per cent this year and placing the metal on track for its biggest annual gain since 1979. Broker forecasts for gold are racing higher too, with the key risk being the Federal Reserve raises rates due to inflationary surprises.
“Gold has basically recovered to a level that’s pretty close to its 30 year average versus equities, but below its 50 year average. So it’s not stretched versus the S&P 500,” he said.
Mr McLennan, who will feature at the Sohn Hearts & Minds conference in Sydney next month supported by The Australian, said loose fiscal policy could reinflate base commodities and boost the Australian dollar.
Mr McLennan’s early bets on gold were premised on the view that interest rates had decoupled meaningfully from wage growth, and that geopolitical dynamics were becoming more complex.
“The bifurcation of the world’s geopolitical order at a time of structural fiscal issues told us that there were two tail risks that were emerging. One was monetary in nature, and the other was geopolitical in nature,” he said.
Fiscal discipline was being abandoned.
“We started to see that what was getting unmoored was the structural fiscal situation, and this mattered a lot, because interest rates had to play catch up to a higher level of inflation than expected, and then as interest rates move away from their zero bound, the government has to start to roll its debt at those higher interest rates.”
It was a process that McLennan said was clearly “negative for money.”
“Our feeling was that you had this kind of dynamic that was a runaway freight train, but happening in slow motion,” he recalled with the Biden administration in mind.
“The Biden fiscal policy didn’t make sense because corporate confidence had already recovered.”
McLennan’s thinking around the value of money was influenced by reading 18th century French philosopher Montesquieu’s “Spirit of the Laws” where he talks about the “distinction between real money and ideal money.”
“What makes gold go up the most is if the quality of our money goes down, real interest rates go down and fiscal settings become increasingly unmoored,” McLennan said.
Indeed, it could go several ways: the expansion continues and there is more inflation, or there is an attempt to tighten things up that leads to a recession.
“The problem with fiscal settings being unmoored is that you have to choose almost between recessionary fiscal adjustment or inflationary fiscal status quo. It’s a fork in the road. One is an inflationary fork, and one is the recessionary fork. If fiscal policy remains very accommodative, if we keep issuing fixed nominal claims on a limited real taxing ability, then the value of everything will go up pretty much in nominal terms.”
And chances of a fiscal tightening?
“If the US tariffs get upheld as being legal and we get other forms of fiscal tightening, I would just make the simple point that markets aren’t priced for that recessionary risk. If you get a recession, you’d expect to be in an environment with much wider credit spreads, higher levels of unemployment, much lower interest rates, all of which could be beneficial for gold.”
But the reality looks more tilted toward the former.
“We don’t see legitimate fiscal tightening on the radar anywhere. The reality is that we don’t see it in the US. We don’t see it in France. We don’t see it in the UK. We don’t see it in Japan. We don’t see it in China.”
Both the International Monetary Fund and the Organisation for Economic Co-operation and Development warned governments that greater fiscal discipline was needed and that difficult budgetary decisions needed to be made.
Despite plunging into its first deficit under the Albanese government, Australia’s prized triple-A credit rating is reaffirmed.
He is equally alert to a scenario where the gold price could fall.
“Let’s say corporate earnings stay okay and job openings pick up, and all of a sudden the Fed easing is off the table. And let’s say AI is producing great productivity growth and the fiscal deficit is improving, at the margin, by virtue of better growth.
Those are the scenarios where gold would have more moderate value,” he said.
On the other extreme, “stagflation is probably the most powerful scenario.”
McLennan is saving his best ideas on gold and base metals for the Sohn event.
“In an era of abundance of sovereign debt printing, scarcity value matters more, whether that’s gold or whether it’s the nature of the businesses that you invest in. And I am going to explore that theme.”
This article was originally posted by The Australian here.
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