Commodities & Energy Sector

The EU’s transition to a carbon tax launched this week via its Carbon Border Adjustment Mechanics (CBAM) will lead to higher inflation in the medium term (3 – 5 years out), and will stoke consumer (i.e., voter) antipathy if it becomes effective in 2026. As a result, the tax will be watered down. Food and energy prices are particularly at risk, as imported fertilizers, and electricity-generation and -transmission components made from steel and aluminum are affected by the CBAM. We remain long oil, gas and metals equity exposure via the XOP, XME and COMT ETFs. We also remain long gold to hedge inflation.

We unveil the ‘Joshi rule’ real-time recession indicator as a much better version of the Federal Reserve’s own ‘Sahm rule’. And we identify what would trigger these recession indicators in this week’s and future US jobs reports. Plus: airlines, soybeans, and tin are all good rebound candidates based on their collapsed short-term complexities.

Aggressive monetary tightening has always led to recession, although the timing is uncertain. The effects of high interest rates are starting to be felt. Investors should stay risk off and buy government bonds as a safe haven investment with carry.

Downside risks to equities are building. Rates, the dollar, and energy prices will remain elevated into yearend. This trifecta makes a soft landing less likely than before and hurts corporate profits and multiples. However, high cash balances may offer downside protection against a sharp correction.

The global energy transition will become more disorderly, if oil-and-gas capex growth continues to outpace that of critical minerals. We remain long exposure to the equities of oil and gas producers via the XOP ETF; the COMT ETF to retain direct commodity exposure, and $100/bbl December 2024 Brent calls. Slower supply growth of metals facing off against steadily increasing demand also favors exposure to metals miners and refiners via the XME ETF.