2022 March CAD

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.93% MTD
3.13% YTD


Dear Partners,

For the month of March, the Caravel Capital Fund was up 0.93%, bringing the total net return for 2022 to 3.13%.

If these numbers leave you wondering what’s going on, we hope this letter will shed some light on what happened and why we don’t think this story is over. More like just getting started. In the coming months, you may hear news anchors say: “The CRB Index rose again to another record high.” For those of you who were not in the finance business in the ’70s, '80s, or early ’90s, the CRB Index (Commodity Research Bureau Index) is comprised of 19 different commodities which reflect the basic goods we use for existence. The Index’s price changes are very good indicators of inflation pressures. So good in fact that it’s what everyone uses whose job it is to forecast inflation and interest rates. We think it would be prudent to explain what has happened to its components, and how these developments could materially affect the prices of financial assets.

The Problem

1. Upward structural pressure on prices. 

The CRB index acts as a representative indicator of today's global commodity prices. It measures the aggregated price direction of various commodity sectors. 39% of the index is allocated to energy contracts, 41% to agriculture, 7% to precious metals, and 13% to industrial metals. You may or may not know that Ukraine and Russia together represent an astonishing:

  • 25% of global wheat exports.
  • 20% of global corn exports.
  • 57% of global sunflower exports.
  • 15-20% of global fertilizer exports.
  • 12% of global crude oil exports.
  • 45% of European natural gas imports.

The above list above represents 80% of the CRB Index’s 19 commodities. So what has happened to their prices this year?

Since January:

  • The price of wheat is up 70%.
  • The price of corn is up 30%.
  • The price of fertilizer is up 30%.
  • The price of oil is up 34%.
  • The price of natural gas is up 59%.

Let us now explain how these increases are structural and not transitory. The rise in grain prices is due to the loss of supply from Russia and Ukraine. Ukraine has largely missed the spring planting for corn and grains and Russian exports of wheat will be materially reduced due to sanctions. Grain and corn-based food prices are on the rise this year and are forecasted to rise materially next year as well. To be frank, the only foreseeable means to prevent substantial food price inflation (10%-15% per annum) is famine. The increased price of grains and corn in North America and Europe will influence beef, pork, and chicken prices. North America’s protein supply uses a feedlot system. Each pound of ready-for-market beef requires about six to seven pounds of grain, pork requires four pounds, and chicken requires about two and a half pounds. As input costs have popped, output prices follow suit, just like rising crude oil pushes up gasoline.

Speaking of crude oil, we all know the price of crude oil is around $100 per barrel up from $76 on Jan 1st (a 33% increase). The only reason it’s not $150-$200 is due to the US and International Energy Agency (The IEA) have agreed to release 120 million barrels from their strategic oil reserves over the next six months in an attempt to embargo Russia’s 5mm barrels a day of exports. The new supply is 1.5 million barrels a day for six months, while we need to offset 5 million barrels a day. The new production will take 9-18 months, maybe longer. As for the natural gas that heats everyone’s home in the winter and generates electricity to run air conditioners in the summer, its price has shot up 60% since December. For the most part, the North American price for natural gas trades between $2.50 and $3.50 per million British Thermal Units (BTU’s), and has since 2009.

In Europe, natural gas trades at more than triple that price because of limited domestic supply. Europe imports 45% of its natural gas from Russia (whoops, that’s not good). In an attempt to remedy this, the European market has begun importing Natural Gas from the US and other markets, reducing that 45% from Russia by two-thirds, as part of the unified effort to send Putin back to the economic dark ages. The global natural gas price will now drive the North American price until more supply can be produced in North America. Expanding Natural Gas export capacity takes years. These are material shifts in costs for the North American economy. Everything described above causes inflationary price pressure on operating businesses and consumers in North America. None are temporary. The impact will be felt for years.

2. "I should have taken my foot off the gas sooner."

Tiger Woods Jerome Powell

In March of 2020, every Central Bank in the developed world went full blast with monetary stimulus, dropping overnight interest rates to zero. Acting in concert, the central banks went over-the-top and pushed long-term lending rates (5- and 10-year government bond interest rates) to 0.0% in Europe and to 0.5% in North America, often referred to as Quantitative Easing. Bond yields became depressed when massive amounts of government bonds were purchased. The money that was borrowed by governments who were issuing the bonds, was paid out to private citizens and corporations, so people could stay at home during the pandemic. Before COVID, the U.S. Federal Reserve held $3.9 trillion in bonds. These were bonds leftover from the 2008 financial crisis (the first go of Quantitative Easing). The US Federal Reserve had been reducing its bond holdings since 2017, by 30 billion per month. In March of 2020, when the pandemic hit, the Federal Reserve stopped selling $30 billion of bonds each month and started BUYING $120 Billion of bonds each month. That’s like getting a brand-new customer who used to be a competitor, who then buys more than 50% of all your product each month. This is where it gets crazy. In August of 2021, 6 quarters later, the Federal Reserve was still purchasing $120 billion of treasury securities EACH MONTH. The Fed owned $8.3 TRILLION dollars of US Government debt. That is not a typo.  At that same time, the Chairman of the US Federal Reserve, Mr. Jerome Powell gave a speech. In this speech, he announced that “the US would begin to slow the purchase of government bonds starting in December” thus announcing the coming end of monetary stimulus in the U.S.  

Translation: I’m giving everyone lots of time to get their ducks in order. Go out and get your refinancing done. People, companies, anyone, please! - extend your loans to the maximum terms! I’m going to pull the plug on this party and it's gonna get ugly.

In his August speech at the Jackson Hole Economic Symposium, Powell used the word inflation 71 times. 71 TIMES! 

On November 3rd, following the Federal Open Market Committee meeting (really important to financial markets) Powell announced the Fed would dramatically accelerate the reduction of its bond-buying in December. He said they would cut their purchases of US Government bonds in half (by $60 billion) in December and then reduce it by $30 Billion each month thereafter. What happened? In this November speech, he also said he would start raising interest rates to combat elevated inflation. The Federal Reserve purchased their last US Debt on March 9th, 2022.

The above chart shows the historical relationship between the S&P 500 and the Fed’s balance sheet since quantitative easing was used to combat the global financial crisis of 2008/09. There is a strong relationship between the amount of liquidity in the system and the price of US stocks. We are now entering a period of quantitative tightening, and have added to the chart a range of possible future outcomes based on recently announced policy changes at the Fed. More on that below.

At their March 15th, 2022, meeting, the Fed Chairman announced it was raising the overnight cost of borrowing from 0.00% to 0.25%, and expects to raise this rate 7 times in 2022. 7 TIMES. Here is a snapshot of yields on US Government Debt. Clearly, markets believe he is credible.

MaturityMarch 31st, 2020November 30th, 2021April 7th, 2022
2-year treasury yield0.2455%0.5650%2.4595%
5-year treasury yield0.3799%1.1597%2.7076%
10-year treasury yield0.6695%1.4443%2.6578%

3. "You're going to need a bigger boat."

Chief Martin Brody

To put all this into perspective, the US bond market has lost its biggest buyer of bonds. We are not talking about the buyer who bought bonds because the old ones were maturing like the Chinese or the Japanese…. this buyer was INCREASING THEIR HOLDINGS EVERY MONTH. Losing this buyer is occurring at the same time inflation is running at 8%, a 41-year high, and forecast inflation (rise in CRB Index) is rising at that rate or more. Further, the US Central Bank has also announced it will not roll over its current $8.9 Trillion dollars in bond holdings. 

Translation: they will not repurchase new bonds when old ones mature. The Federal Reserve said it will let $95 Billion each month of maturing bonds stay in cash and not replace them.  

This is the scariest part of all.

The US Government has lost its largest buyer of debt. Imagine what we would think if Japan and China announced they would stop buying US Debt and start selling their holdings? Five-year borrowing costs have risen 120%, and ten-year borrowing costs have risen 70% since JANUARY!

Is anyone out there listening to this? Yes…the bond market is. The bond market is pushing yields higher to find new buyers to replace its biggest customer. How big a customer are we talking about? The market needs to find a new buyer for $120 billion of bonds (the amount the Fed uses to increase its holdings by), plus $95 Billion (what the Fed won't reinvest every month from maturing bonds), PLUS the US government’s new budget has a $1 trillion-dollar deficit, and so it needs another $83 Billion a month in NEW BORROWING.

Translation: the bond market needs to find an interest rate that will attract $298 billion of NEW money every month!

Ask yourself… what rate would you lend the US Government money with inflation running at 5-8% and the CRB Index indicating it’s not going to drop any time soon, we doubt the rate is 2.75%!  Rates are going higher. Rates are not stopping here. Repeat that to yourself, please.

Solution: Don't Fight the Fed

To summarize: The US loses its biggest buyer of debt coincidently when we have a structural spike in the CRB Index, combined with a current Consumer Price Index showing inflation at 8%. We should add one more thing – wage pressure. Last week employees of the world’s largest retailer Amazon voted to unionize the retailer's U.S. facility in New York. 

Amazon has 1.6 million employees worldwide and 1 million in the U.S. Expect more to come on this front. When meat, gas, bread, and electricity prices increase along with the rising cost of their home equity loans or floating rate mortgages, labour will start to demand a raise. When all these factors are combined, a first-year economics student can tell you this means less money available for goods and services. 

What will we cancel first? Maybe one or two of the 10 different subscriptions you have to online services you have been thinking, “I don’t use that, but it's only 10 bucks a month," and all of this at a time of elevated equity prices. How elevated? 

Bank of America released this chart on April 6th. It shows stock valuations at times of elevated inflation.

We said in our January letter 2022:

1) Tech hits the deck: we are biased short US growth stocks to reduce systemic risk.

2) Oil is black gold: we are long oil stocks and own puts on the underlying commodity for protection. 

3) Green is the color of money: we are long a variety of market-neutral strategies in lithium and uranium.

4) Love your Banks…

Well, you can’t always be right. We had a great return using options in Canadian Bank stocks in the first 2 months of 2022. With the compression of the spread between 2- and 10-year yields, and concerns about the impact of higher interest rates on loan quality, the banks have pulled back. We made out like bandits with a very low-risk trade, but unfortunately gave 30% of the profits back. We have an exceptionally high cash position of around 33%, and more like 40% if you add the short-term debt we hold. We own our risk tails and are well-positioned for volatility. We continue to be active in the market and firmly believe what the legendary Omega Hedge Fund manager, Leon Cooperman said this past week, “In Bear markets, the winner is the guy who loses the least.” 

Or, as my bond trading friends put it: “Never, ever, fight the fed.”

If you would like to discuss anything or just say hi, we love catching up with our partners at any time. In keeping with our disclosure policy, for the quarter, $500,000 of units were redeemed to make the penultimate instalment on Michelle and Jeff’s house, which they are slated to move into this month. The firm reinvested more than 50% of the performance fees paid in the quarter. Caravel employees continue to be the largest investor in the fund.

We thank you for your continued confidence and capital,

Jeff and Glen.

Monthly Performance (net of all fees)

JanFebMarAprMayJunJulAugSepOctNovDec YTD

Risk vs. Return Comparisons Across Indexes

Month Return YTD Return Volatility Sharpe Sortino Beta Best Month Worst Month Annualized
S&P 5003.71%-4.60%15.08%0.921.210.0912.82%-12.35%16.19%

Growth of $1000 since inception

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