This week, Chris talks with Steen Jakobsen, Chief Investment Officer of Saxo Bank. We wanted to see through the eyes of a professional economist, which Steen kindly allowed us to do.
Steen agrees that central banks have largely failed in their misguided attempts to boost growth via trickle-down programs. Pretty much all the benefits of the recent years of money printing have gone to the upper echelons, with the true engines of growth and jobs — small to medium sized enterprises (SMEs) — getting very little.
As a result, financial asset prices have been driven up too high, which Steen anticipates will correct at some point in 2014; likely by 30% or so:
Here is my practical view. Since Q3 of last year I’ve been 70% in fixed income because I do believe, and I continue to believe, that we’ll see new low interest rates. In a world that cannot restart itself, it a world that believes in 'extend and pretend', you will not have any activity. You don’t have any move towards a mandate for change. So that means that history tells us the only way we get change is through the system failing. I’m not talking about a systemic failing; I'm talking about people owning up to the fact that we need to activate the SME. So I think we’ll see a progression towards helping the SMEs.
But in terms of the market, I have been very on fixed income, an increase in the exposure right now from 70 to 90% taking whatever equity I have down. Not because I’m afraid of 'doom and gloom' but simply because I think you can have a huge amount of leverage into the fixed income market here when everybody seems to believe that interest rates cannot go lower — now confirmed today by the Q1 data from the US. The world is simply starving because the world is rebalancing. The US current account deficit moved from -800 to -400. The world needs $400 billion worth of new export markets before it gets back to break even.
At the same time, Asia and China certainly are rebalancing their way from nominal growth towards quality growth. Again, the first derivative of that is lower growth, deflation, exported to the rest of the world.
So I think the low comes in economically in Q1 and Q2 in 2015. Every single macro indicator you can find will bottom at Q1/Q2. For the equity market, I think the top is 1900/1950. But you can't both predicted the level and the timing. And I’m more confident about the timing, not the level. So my timing I’m confident, and the timing I am confident on is the fact that the second half of this year is going to see a 30% correction from the top.
He also agrees that rising energy costs and overall resource scarcity are real threats to future economic growth; threats that he believes most economists and investors are blind to.
On all the above, we're in agreement with Steen.
In other areas, our predictions differ. But that's why we have guests like him on the program: to hear the rational behind contrasting views, and to learn what those moving large sums of capital in today's markets are thinking.
Despite the near term likelihood of a major correction, Steen remains quite optimistic. He believes that the correction will be a clearing event not just for overly-elevated prices, but also will serve as a wake-up call about the net energy situation that will lead to better policy decisions. We sure hope he's right, but we sadly think it will take a major price shock or supply shortage of key commodities to get the attention of our leaders.
Click the play button below to listen to Chris' interview with Steen (42m:43s):
Chris Martenson: Welcome to this Peak Prosperity podcast. I am your host Chris Martenson. I have to confess: Like many novices and professionals alike, I am finding it difficult to make any logical sense of today’s financial markets. When looking at Spanish ten year debt trading at record-low yields or German ten-year debt looking like it might test one percent—one percent—bonds are making a strong case for deflation. And so it gold, which continues to head downwards despite any and all geopolitical events. Yet when we wander to the land of equities we see nothing but blue skies, complete faith apparently in reflation and inflation and a future of even more spectacular corporate health as evidenced by the fact that the best performing equities of the past year, by far, were those with the trashiest balance sheets. So who’s right? Neither, both…? Is it possible there’s no good signal left to analyze after more than five years of extreme financial repression?
Well, to help us make sense of all this today is someone I recently met at the Wine Country Conference, and who’s views I immediately respected for a number of reasons. First, I found his views to be pragmatic, very reasonable and clearly formed with a wide view that comes from experience and a travel schedule that involves 30 or more countries a year. With us today is Steen Jakobsen, chief investment officer of Saxo Bank. He has more than 25 years of experience within fields of proprietary trading and alternative investment. His career has taken him from Citibank in Copenhagen to Hafnia Merchant Bank to Chase Manhattan in London and then to Swiss Bank, also in London. And after a few more transitions he joined Saxo Bank in 2000, and after a brief departure to Limus Capital Partners where he was chief investment officer for two years, he returned to the bank in 2011 as chief investment officer. Steen, it’s a real pleasure to have you with us today.
Steen Jakobsen: Thank you for having me Chris.
Chris Martenson: Now you said in your presentation at the Wine Country Conference that you are the most optimistic you’ve ever been in the last 30 years. That was 27 long days ago, an eternity. Do you still hold that view?
Steen Jakobsen: Absolutely! I think that as your intro sort of indicated we have a very interesting setup where we—I call it the Bermuda Triangle of economics—we have high stock market valuations, we have very low employment growth, and we have almost zero productivity and innovation in the economy. And we ask ourselves, how is that sustainable? And the way I explain that, at least to myself, is what I call the 80/20 rule. So if you think about monetary policy, if you think about the political capital invested into fighting this crisis, 95 percent of that capital, 95 percent of the political credibility went into saving the 20 percent of the economy which is the listed companies. So essentially what has been going on is we’ve seen a transfer. We’ve seen the transfer from the 80 percent, the SMEs, the small to medium sized enterprises to the bigger companies. So the banks, the, indirectly of course, our own government entities and the listed companies. So what you see every day in the newspaper, Wall Street Journal, whatever newspaper you pick up, is the 20 percent. The trouble with that is that the 80 percent of the economy is the small and medium sized enterprises, as I stated. But they constitute a 100 percent of all private sector job growth. So if you cut up the 100 percent job growth sector and leave it to the 20 percent—the government and the listed companies—then, of course, you have an economy which is stale, but where the valuation makes sense because there’s so much cheap money flowing to the 20 percent. But it is directing money away from the productive side of the economy.
And why are SMEs so productive and so important for an economy? It is simply because they work harder, longer, higher risk tolerant, and they have a greater risk appetite in terms of doing new things, because the only way they do survive, of course, is to renew themselves and be an integral part of the economy. And that is where we are today. So we have this kept in place by this 80/20 rule and as long as we continue with asset purchases and policies where this is conducted, through the monetary policy, you’re really only having the 20 percent of the economy—listed companies—and in terms of inequality we only really have the 0.5 percent richest people that do own exactly the same amount of stocks.
Chris Martenson: So I certainly can understand what you’re talking about. I worked in large corporations and I have an SME myself now and my level of productivity is orders of magnitude higher working at an SME. And so this is interesting, this 80/20 transfer that you’re talking about. That happens—are you saying that’s—did that happen in the US, Europe, and Japan? Did it happen everywhere? Was this an intentional policy?
Steen Jakobsen: Yes, because if you ask the central bank, they do know that quantitative easing creates inequality. That is exactly what they call "the wealth effect." So if they can create the wealth effect they believe that that could trickle down into the middle class, the middle class then will spend some more money. The trouble, of course, being the middle class owns SME companies, they don’t own public listed companies. So you have a policy which, maybe not in its construction was meant to do this, but it's mostly indirect consequences of keeping this policy in place for too long. Its not that I’m against quantitative easing as the short term phenomena to stabilize the economy, but I don’t think anyone in academics, at least I haven’t seen it, maybe you have Chris—is there any evidence that you can create new jobs for low monetary and low interest rate? What you do know however is that if you allow the SME sector to have better framework, lower taxes, and less paperwork, access to credit, you immediately get not only growth but you get exponential growth at the peripheral. And that is exactly what the US needs, and that in essence goes to your question. What’s interesting is wherever I go in the world I can have this same speech whether it's in the US, South Africa, Sweden, Czech, anywhere. So pretty much anywhere in the world 80 percent of the economy will be SMEs and they will be that very, very important part in terms of kick starting the economy.
So for me the solution to this crises, or lack of jobs, lack of growth, is really simple. You need to conduct and have a proactive policy of helping the SMEs. And then you have to forget about the 20 percent. But you and I know both Chris that the financial lobby, the policy lobby, will always be in place for the 20 percent and not for the 80 percent. And that’s the other part of the equation, which really concerns me because, who are the SMEs? How do they feed themselves? Where is their lobby mechanism in terms of going to Washington to get concessions from the government? Its simply not there.
Chris Martenson: I totally agree. So Steen, let’s talk history for a minute. You said interest rates lead the economy by nine months. What did you mean by that, first?
Steen Jakobsen: I think it’s interesting in a world where we have metadata, big data, we have quantitative analysis, we have PhDs coming out of our ears, but no one really just looks in simple terms and creates a simple sort of method to look at the economy. So what we’ve done some work on is to figure out, okay, we need to create some very simple rules to understand why the market is doing what it's doing today. And the nine month rule goes and leads every single rule of thumb I have. And it says: what happened nine months ago is what impacts what goes on in the marketplace today. So let’s go back to May of last year. The Federal Reserve chairman Bernanke went in front of congress and made his semiannual testimony. He uttered this very, very new word, (for me at least) "tapering." All of a sudden, ten year US yield is up 140 basis points. For some reason the economist thinks that that doesn’t have an impact on the economy. My rule says, well, nine months from starting this cycle there will be an impact on the economy. And true to form, of course, just this morning as we’re doing this interview, the GDP for US came in at -1%. And Chris, you and I know, less than four months ago everyone was talking about, like, this year is going to be the year of the recovery—IMF, World Bank, Federal Reserve, was all projecting higher growth rates for the economy, ignoring the 9 month rule. So for your listeners, it’s a very simple rule; if you want to understand what goes on today, find the front page of the newspaper nine and twelve months ago and you know exactly why we are where we are in terms of the economic cycle.
Chris Martenson: Well then, what sorts of messages are you reading into today’s interest rates where we have the ten year US yield at two and a half percent and its come down quite a bit. You’ve got, basically, sovereign debt yields all over the place heading down. What are you reading from that?
Steen Jakobsen: What the rule then tells you is that in nine to twelve months from now you need to look for a significant pickup in economic activity. But just as the 140 basis point hike out of tapering nine to twelve months ago had a negative impact, you also have to now price in 2015 second half to be positive. So what we are seeing in our model, the model we use today, is that we will see the low in economic activity, inflation expectations, innovation, productivity, between Q1 and Q2 in 2015 and then we’ll have a very sharp rise of activity, inflation expectation, as we go into second half of 2015. And to be totally honest, Chris, it's so primitive I’m almost embarrassed to talk about it, but that is exactly because there is a nine to twelve month lead from what goes on today. So in May or June next year we will have a flattening out of the negativity, the proactivity of central banks trying to do something in terms of the economy. And the economy in itself will be healing because the financing cost is coming down for everybody in the economy, and not just the 20 percent of the economy being listed.
Chris Martenson: Well, I’m very interested then in how this might translate into what the ECB might do. You know, we have a lot of talk coming out from the ECB. There’s a possibility of negative interest rates, maybe QE as well. What do think is actually going to be decided at the June meeting? And do they have access to this incredibly detailed model that says look forward nine months?
Steen Jakobsen: [Laughs] I wish they had. That would save a lot of money and a lot of worry for a lot of people, to be honest Chris. If we could just agree on this model I think the world would be a better place. But in terms of the ECB you have to remember the ECB, and certainly the president, Mr. Draghi, they love to talk and they hate to act. And what you will see probably with the June 5th meeting at the ECB is that the ECB will deliver but they will deliver far less than the market expects. So I do expect a repo cut, I do expect that they will take a chance with negative deposit rates, but I do not expect that they will activate the asset purchase program, in other words, a full Monte in terms of the quantitative easing, because they are afraid of how they can control this. And don’t forget, in the Federal Reserve system you have one country, one bond market; in the EU, in the European, the ECB banks' world, you have 28 different individual markets that you need to proactively go into. And underneath that there is a number of rules, among them being that the German government can only own a certain amount of its own bonds. So there’s a huge complexity which, in my opinion, will let the politicians do what they do best which is to wait and see and policy makers—just to wait and see and just see if there’s more data coming through. Ironically in my opinion that is exactly what’s needed.
I think the policy makers of the world should take a 24, 36 month sabbatical and just forget about the markets and let the market heal itself. Because what we don’t need right now is a lot of talk and no action, and we need no action at all in my opinion. And I think I mentioned that at the conference as well. Think about Belgium, they were without a government for 24 months very recently. What happened during those 24 months was that every single macro indicator improved during that period.
Chris Martenson: [Laughs] An N of one. A good experiment though. I think we should repeat it for a couple of other places.
Steen Jakobsen: You have it in the US to some extent. I mean some Americans like to disagree but I would argue that Bill Clinton, one of the most successful American Presidents in terms of creating growth and actually running a budget deficit—he had a lot of plans but his ability to implement anything during his eight years was very, very small. They had a policy of a strong dollar but the only thing they ever did was to sell the dollar in the Mexican crisis, right? So you had a President that talked again a lot but he did absolutely nothing in terms of implementation of policies. And that created this tremendous upswing in the US economy.
Chris Martenson: Well Steen, if you’re comfortable, I’m really very interested to get your take on the recent EU elections and how this might bare, if at all, on what that ECB is going to think to do. So what, if anything, shifts as a result of the elections, and what sort of messages were sent to the incumbent politicians do you think?
Steen Jakobsen: There’s a lot of analysis that needs to be done on this. But I think if you look in political terms, its important to notice that in the UK, in France, in Denmark, in a number of countries, the EU skeptics won outright. We’re talking about getting 25 – 30 percent of the vote in a multi party system. So this is significant change. There are a number of countries, mainly what we call the old countries, the northern countries, that turned aggressively against the EU. So around Northern Europe there’s a lot of parties right now who’s trying to redefine their policies on EU because, in Europe, most tend to the left than right parties will be pro Europe. They will have one or two issues with Europe but overall they’re always joining the eye line when there’s something going on in Europe. But their voters are clearly telling them they don’t agree with what goes on in Europe. So that’s lesson number one.
In terms of the new European parliament, it's very interesting that the European parliament started out with very little direct democratic election into it. Now they’ve been giving more powers and more electability in terms of democracy. But in a political system where you have, in the EU—I should probably note that the power of the EU sits with the EU council where you had a head of state. Now you have the head of state, EU Council minister meeting, as its called, and you have the European Parliament, almost sharing 50/50 the power of Europe. So inside the European Council Meetings you will have infight between France and Germany, between the Club Med [ph] and the Club North country. In the European Parliament you have all these anti EU and pro EU. So you are creating an additional layer of complexity where the conclusion will have to be that less will be done and that their time horizon in terms of fiscal deficit and reforms, of course, again, has been delayed into the very, very long future. So this is, unfortunately the move which makes Europe less able to act as a move. It's an election that sort of clearly showed you the European politician is totally out of trust with their voters, not dissimilar to what I feel is going on in the US, to be honest Chris.
But the final thing, and I need to say this: The thing about the EU is that if you’re very, very fortunate and very lucky, you can change the pace of Europe moving forward but you cannot change its direction. There is so much political capital invested in EU. There’s so much bureaucratic momentum built in that it is impossible to reverse a process. So this will never be about getting Europe to stop or reverse to another course. It will be about the speed limit on the EU turning south, going downwards, because you cannot change the direction of Europe, but you can change the pace. And that I think is the three conclusions. Number one: They will lead to no reforms. There will be a violation of all the austerity measures. France, Spain, will all get renewed end date goal lines in terms of fulfilling this goal and there’ll be no reforms. So we would do, just doing "wait and see" again. And in terms of political parties, a lot of political parties become more proactively negative the EU to get their voters back from the far left and the far right. And finally the EU process continues as is, but it will continue at a slower pace.
Chris Martenson: At a slower pace. So, that certainly fits well with your "do nothing" admonition there. So if that’s what’s happening on the political side, does this at all change what the ECB thinks it might do or what its mandate is, or does it insert additional caution into its actions for the June 5th meeting?
Steen Jakobsen: No, because they wouldn’t be doing the same conclusion. They will look at this and say "we are an independent central bank. We need to do what we think is right." Unfortunately, they don’t use the nine month model. They use just a classic forward guidance. And the thing with central banks is, I have a dog who’s better at predicting what goes on in the world economy than any central bank in the world, just by throwing a ball to the guy. And they’re useless, they’re hopeless. I mean don’t forget Greenspan. Before he became Fed chairman, he was a Fed watcher. Barrons ranked him in the bottom 10 percent as a Fed watcher before he became chairman. So I mean these guys are dogmatic. They don’t understand what goes on. So the ECB will be reactive not proactive. If they were proactive they would already be out fighting deflation through significantly lower repo rates and activation of this SME sector. Because don’t forget from an economist’s point of view there’s really only two ways of increasing the CPI if you use CPI as an inflation measure, and that is to have wage inflation, which is not happening in a world of excess capacity and too high unemployment. And the other one is to increase the velocity of money. And the way you increase velocity of money can only happen in two ways really. You can lose faith in the value of the money, which may ultimately happen, but I don’t think is happening in the next 50 years, 100 years, or you can have loan demand increase. So it's very, very simple. If you just break down the mechanics, the noticeable idea of how the economy works and how you have monetary transmission. The only thing you can do something about right now is to get the lending velocity up. The velocity lending up means that you need to short cut the 20% and activate the 80% of the economy and you will immediately get a huge boost in velocity of money, which will increase the inflation expectation at the ECB, Federal Reserve, Bank of Japan—all of a sudden will be at their expected inflation levels and growth will be coming back through activation of this inactive sector.
Chris Martenson: Now it's very interesting. I think that of the things you just mentioned there, Japan is certainly trying to ruin the faith of the people in its currency. And if I lived in Japan I would take them at face value and not wait anymore. But they’ve had tremendous difficulty getting the velocity of money to go up through what I consider to be fairly extreme efforts to both talk down the value of the Yen and to convince people that they should spend them now with tax policies with a variety of monetary policies. They’ve done what they can. It hasn’t really worked so obviously structural issues really rule the day. And so then we wander over into the wage side of your story and there’s some really interesting structural issues there on the wage side so that we do see that—I think US CEOs just broke the ten million average compensation mark. And there’s really some sort of a big paradox, as you mentioned at the Wine Country Conference, between the two ends of the labor markets. These feel structural to me. Are they immune to policy? Is there anything policy can do and what did you mean first by that labor paradox?
Steen Jakobsen: Yeah, so my fear is that in certain parts of the labor market there is certainly wage demand increase. If you want an IT guy in California, you are paying up every single time you try to sign someone. The same in Austin, which of course, is due to tax benefits and a huge influx of companies moving to Austin. So you can have local markets, local job description having a very high demand and high wage demand pressure, but at the other end the people who have been left behind in the globalization and the transformation of the society to be one of being online instead of being in tangible assets, then you have the opposite. So you have wage power at the top and you have no at the other end.
So I think there are two unemployment queues in the world today. One queue where people can be retrained, they can get back into the market so they kind of recover. But also an unemployment cue where people will never work again. And I think we have a social responsibility to address that issue. And it is part of that rising inequality equation we have. But if we go back to Japan, and I think it's an excellent example because in worst case, the US, the world, ends in what I call a Japanization—low growth, no hope in terms of creating inflation and everyone owning bonds. And you know, to some extent if you’re really afraid of the future you can argue the bond rally going on right now could be an early part of another Japanization leg.
But in Japan you have to look at the context. Why are there structural issues in Japan? They have one of the lowest women participation rates in the world. They have the worse demographics of the G10 countries. They have a corporate structure which is still cross ownership. And they have lack of accountability in terms of the accounting rules. And then on top of that they have very few foreigners in terms of running the business to renew the management skills and everything else. So Japan is a society that benefits from being in deflation because they are huge net savers, they lose what equates to about 20 billion dollars of GDP every year due to the birth and death rates. So in Japan more people die than get born every year. And that costs society 20 billion dollars right now, increasing to over a 100 billion dollars over the next ten years. So think about this, Chris, Japan as an economy needs to find roughly 50 – 100 billion dollars just to break even, so to speak, in growth terms. That means huge pressure on innovation, productivity—that is not happening in Japan because the market, the local market, where you have to test this, the SME companies, the breakthrough companies, everyone wants to work for a big company playing it safe and no one wants to go into SME because there’s no incentive at that end of the spectrum both in the labor market but also in terms of your prospect to maintain this job. So a lot of what goes on in the world is structural. But to say that we can’t address it is absolutely wrong. In Japan you can increase immigration. You can increase labor participation by women. You can make school reform so the women can get—can pick up their children like they can in Scandinavia at 5:00 in the afternoon, not at 2:00 as it is right now. So there’s lots of simple things that can be done that will not cost society anything net in terms of utility.
But this society maintains this status quo because—and that is another big, big rule of mine that what we’ve seen since ’89 where we celebrated the free markets when the Berlin Wall came down is that every single economy, including the US, has moved to the demand economy. There is no ability for the individual to react. There’s no ability from the supply side of the economy to be what drives it. I mean when Microsoft started in a garage in California do you think they were sitting around trying to figure out where they fit into the demand curve? No. What they thought was "we have a great product. We will take a chance. We will take—we’ll probably go bankrupt but we’ll take a chance to do what we do." So they created their own supply, so they are what as an economist I like to refer to as Say’s Law, which says that supply creates its own demand. And that is the way, Chris, we get through this crisis. It needs to be more innovative.
I mean one of your expertise is, of course, is energy. And that’s another thing we haven’t even discussed yet. But I mean energy is becoming so expensive again. At the same time inflation is dropping in the rest of the economy. How can we have high energy prices and falling inflation? Because essentially some part of the economy is inflationary due to QE, and some part of the economy is deflationary due to the fact that labor has no wage power and the economy has excess capacity. So we have a society and an economy where you can—whatever you believe in you can find it in pockets of the economy.
Chris Martenson: Well, let’s switch gears to that for a bit. I’m really interested to continue this idea around resources and how access to resources is shaping the current landscape, maybe how you expect them to shape the future. So one of the ways that they’re shaping our current situation, which is what you mentioned where we have low wage growth; in some cases actually negative wage growth. And we have rising costs for people. I do take exception with the idea that inflation is very low because that’s maybe true across everything in terms of how its measured but when you look at things particularly here in the US, when it come to tuition, healthcare, food, and energy, those things are absolutely not in anything remotely close to a disinflationary environment. All of those are heading up reasonably smartly at this point in time. So when we look at this view of resources, how do you, if at all, do you see resource issues playing out in political and economic markets today?
Steen Jakobsen: I think politics dictates every single macro impulse. So in other words, I think that policy mistakes conducted by politicians and policymakers is what makes markets—that’s what changes markets, that is what changes directions. I’ve thought that all through my life and I’ve been more and more convinced every single day. So a great example of a misplayed energy policy is Germany. So after the Fujiyama incident, they decided to move away from nuclear power. So what the decision Germany then took at a ten thousand feet level is that they said, "hang on a minute, because of the risk to nuclear power as a production, in terms of the risk to this melting or whatever could happen, we will instead take a higher dependency on natural gas from Russia." I think someone in Germany right now is regretting that on a political scale, but more importantly energy in Germany today, due to this energy shift, is the most expensive in the world except for my country, Denmark. So the fact that Germany wants to be most green actually has a side effect which is that they have the most expensive electricity. BMW just recently moved an engine factory from Southern Germany to Seattle. They pay one-sixth the price of electricity. They physically practically saved six times the price of electricity by moving to Washington State. So energy is—and people don’t recognize it. You do Chris. I know this is one of your main fortes. But energy cost is a huge chunk of the inpute cost of anything that goes on. Every single app you load into your phone or whatever has a high energy intensity. Recharging your iPhone costs more than having a heater standing by for a year. I mean people don’t realize that what they see as progress in terms of apps and online and everything actually has a service somewhere. They use massive amounts of quantities of energy. So the energy consumption of the world is going up in a finite world. Because people can believe or not in "cheap has peaked," but as far as I know the world is finite. There’s only a finite place in terms of geographic area and resources. It’s not like its being renewed by someone coming from Mars and putting more energy into it.
So I agree with you. I know your point is that if you can understand energy you can understand what goes on in the world. And for me there is politically one thing that’s more important than fossil energy, and that is the fact—and this is a key fact to me, that in ten years time from now, less than 50 percent of the world’s population can have access to clean water. I mean clean water, energy, in my opinion, is going to be the tulips, it's going to be the thing everybody wants in the future. And I don’t think anyone is prepared. Countries like China, Singapore are deficient on water. Countries like Germany, all of Europe except for Denmark and Norway are deficient on energy. So structurally we put ourselves up being very, very unable to deal with what comes in the future in terms of our deficiencies. If anything, we are pushing further away from that equilibrium level, the development, the investment into these things that should happen because we pursue idiotic, in my opinion, things like windmills and stuff that—you know, windmills have been around for 400 years. There must be a reason why they haven’t become the number one energy source in the world, right?
Chris Martenson: Well absolutely! You know, I’ve been following very carefully what’s been happening in Ukraine particularly because of the large geopolitical wedge that seems to have been driven between Russia and the West, and seeing China right there with open arms. To me the landmark deal was that gas deal where essentially 20 percent of all Russian exports of gas are now going to redirect to China starting in 2018. And its not clear to me that Russia has the capability to dial up its current production by 20 percent. It’s a magnificent amount. And so is there any concern at all anywhere on the European continent, particularly on the monetary side, people are looking at this saying where’s our—is there any concern over supplies, not just costs, but supplies of the needed gas to run the economy?
Steen Jakobsen: One of the bigger infrastructure projects in EU right now is a rechanneling of the natural gas pipelines in Europe due to the fact that we’ve became over dependent on Russia. So you know, we have a lot of natural gas in the North Sea as well from Statoil and Norway. So they’re rerouting and spent a huge amount, I think if I’m not wrong, like 500 billion dollars or something in total developing infrastructure on this, which is behind the scene and not really done so. But the short answer is no, Chris. I don’t think anyone knows where to turn because, as much as you and I and everybody else want alternative energy to become more of a force, we still have this storage issue in terms of energy, which I think we will deal with right now or in the next ten years, certainly as we need to do it. But the Russian deal is very, very significant. The way Iran today also sort of bypassed the international markets for its products, I mean a lot of the crude in the world today is actually bypassing the international markets, which means that more and more money, more and more energy resources is given up and not coming to the world market and asking. First of all, that is a concern for the market to sell, but it is also a concern for you and me in terms of what will happen to energy prices.
And you know, I have friends that argue that the European monetary crisis, the debt crisis, actually started from the fact that we have deficiency in energy. So the energy cost actually killed Italy, Spain, Greece, and all these countries which at the start of this crisis, took most of their natural gas from Libya. So I think it will be a huge input to a potential downside in—and that could actually be what gets us into Japanization in Europe and, of course, in the US you’re less dependent on foreign imports these day. But on the other hand you have, as far as I remember, huge environmental issues in terms of doing open sea drilling and the like from tar sand, you know, which is probably not the most efficient way to go about getting your energy out.
This morning I read shale gas companies have the biggest debt per balance sheet of any companies in the Russell-3000. So there’s a number of issues, and I think the exploration cost of keeping this flow going is becoming immensely expensive. I think you showed—you can follow-up Chris, but I think you showed me a chart that between BP, Texaco, or whatever, all these guys, the exploration cost of actually maintaining the resources is up—is four or five times?
Chris Martenson: Yeah five times since 2000.
Steen Jakobsen: Yeah. I mean think about it. Its five times more expensive. And at the same time BP is being sued left, right, and center in the US, right?
Chris Martenson: Yeah, yeah, and their production is actually about flat from where it was in 2000. It hit a peak in 2005 - 06. And the truth is that when we look at all the North American shale operators as a bucket they’re spending a dollar-fifty in CAPEX to get a dollar in revenue and that’s been true for five years. And these wells deplete in only three years. So the truth is that—in my world if you take a set of companies and they’re all spitting out negative free cash flow when they should be in the peak of the stride of their current model—they’ve tapped the sweet spots, they’re in the best plays, they’ve been drilling for long enough, and they’re still spending more than they’re earning, somebody really on the investment side needs to think about that carefully. Of course, we don’t have a lot of careful investing happening right now.
So as we wrap this up, I’m really interested: We look forward, you look at equities, you look at bonds, you have to put your money somewhere; where do you put it today?
Steen Jakobsen: Okay. So let me sort of—so this has been very top level macro. Here is my practical view. Since Q3 of last year I’ve been 70 percent in fixed income because I do believe, and I continue to believe, that we’ll see new low interest rates. In a world that cannot restart itself, it a world that believes in "extend and pretend," you will not have any activity. You don’t have any move towards a mandate for change. So that means that—history tells us then the only way we get change is through the system failing. And I’m not talking about a systemic failing. But I’m talking about people owing up to the fact that we need to activate the SME. So I think we’ll see a progression towards SME.
But in terms of the market, I have been very long fixed income. I'm increasing exposure right now from 1790, taking whatever equity I have down. Not because I’m afraid of doom and gloom, but simply because I think you can have a huge amount of leverage into the fixed income market here where everybody seems to believe that interest rates cannot go lower—and now it's confirmed today by the Q1 data from the US. The world is simply stopping because the world is rebalancing. The US current account deficits moved from minus 800 to minus 400. The world needs 400 billion dollars-worth of new export markets before it gets back to break even. At the same time, Asia and China certainly are rebalancing their way from nominal growth towards quality growth. Again, the first derivative of that is lower growth, deflation, export to the rest of the world.
So I think the low comes in economically in Q1 and Q2 in 2015. Every single macro indicator you can find will bottom at Q1, Q2. I think the equity market for me—I’ve said all along, I think the top is 1900, 1950. But I’m more—as you know, when you make predictions, you can't both predict the level and the timing. And I’m more confident about the timing, not the level. So my timing I’m confident. And the timing I am confident on is the fact that the second half of this year is going to see a 30 percent correction from the top.
And Chris, that sounds like a lot but don’t forget every five years we have a 25 – 30 percent correction. So its way inside the norm of what the stock market has done since World War II. But I think the corporate balance sheets are in a better position, but I think the volume they can sort of send to the marketplace will be significantly lower as you go into the second half.
So the two big trades I have on right now is that yield, core yield [ph] especially Germany, US, Canada, Norway, Denmark will go to new lows. They’ll retest the lows we saw during the financial crisis. And the second thing is that Germany will be very, very close to recession because they are the one that is being hurt the most by falling export volumes, certainly to the Asia but also to the US now. And there Germany stands and stood very strong, nine – twelve months from this being implemented is about July – August we will see this impact in Germany. If Germany gets to zero percent growth, you and I know, Chris, that then Spain, France, Portugal will be—with a wide margin—be negative in growth. I think that is the mandate for change. I think the mandate for change is that when Germany gets into trouble, Europe is in trouble. That will create some sort of activity where you have to mandate to do something you cannot do right now because right now people are just buying paper money and not investing, real people. So long fixed income. 30 percent correction in equity. That needs to be used to buying long term.
And then I think you need to start looking at two specific sectors in my opinion, mining overall, and secondly emerging market as a play. Brazil is a horrible macro story but a great micro story. There are great businesses like Vale, the iron and coal producer in Brazil now trading at an almost all time low. But I’ll tell you what Chris, the world is not going under. Demand will be back ultimately. But there is this cleansing process over the next six to twelve months that you need to be using proactively. But I do believe this is the low. So its not a doom and gloom speech here. This is, I think, useful to clean up, to reconfigure and certainly as per your advice, look at how you become more energy efficient and you know, don’t count on any support from central banks, don’t count on any support from the politicians. This is about you running your business in a better way, more efficient way, and hire smarter people because at the end of the day what needs to be done all over the world is to invest in people.
Chris Martenson: I agree. Well, since you briefly almost touched on it, I have to ask what’s your view on gold during this next cycle through Q1-Q2 2015?
Steen Jakobsen: So the significantly low interest rate will ultimately start to support gold but the problem, as you say in your lead into this talk, the problem is that the inflation expectation continues to fall back. And I expect the inflation expectation to bottom between now and Q4. So I see gold bottoming out timing-wise. Again, I’m more confident about the timing than the price. But timing-wise I see Q3 as a low in gold. Mining prices—you know, to mine gold is about 1100 on average as far as I know. Supply will be closed down, as we’ve seen, certainly in diamonds and in iron ore productivity. We have new CEOs of all the mining companies in the world. I think the mining companies are actually one of the few businesses in this cycle that have felt the crisis truly, and their response has been to cut investments and to cut mining capacity. I think the demand is pretty much stable in terms of gold and other assets in metals. So for me I am buying Alcoa [ph], I’m buying Vale [ph] in Brazil in terms of stocks. So I’m buying the individual companies because any day, Chris, I’d rather buy a company than buy a story. I believe in people. I don’t believe in Power Points.
Chris Martenson: Wonderful. Absolutely Wonderful. You’ve been extremely generous with your time. I love your views Steen, just very practical and very grounded. It’s a pleasure to talk to you. And if people want to follow you more closely going forward, how would they do that?
Steen Jakobsen: Saxo Bank, the organization I work for, has a very neat website that does research, and not just me, but a whole bunch of people including external people. And it's called tradingfloor.com. So "tradingfloor" in one word, .com where everything’s available. I don’t even think you have to sign up or if you sign up you have some added benefit of getting whatever research you want. And maybe Chris, the thing we need for you to do is to get you to do one or two blocks in there because I think your inpute—yours and Adam’s impute is so important and what you’ve got going on at Prosperity to me is very, very interesting and something I would love more people, at least in my part of the world, to both see and listen to.
Chris Martenson: Oh thank you so much for that. I would love to get the views out. It truly seems to me that there’s an additional element to this story that needs to be dragged into it and we have to be looking at it just fundamentally differently. So you’ve heard my talk and people listening to this probably have as well. But I would love the opportunity to test these ideas out and expose people to them and refine them and get better at figuring out where this is all headed. So Steen, thank you so much for your time today. Its been a real pleasure and I hope we can do it again.
Steen Jakobsen: Absolutely Chris! It was a great honor being on your program and I hope to see you soon in beautiful California.
Chris Martenson: Very good! Alright, thank you and have a great day.
Steen Jakobsen: Thank you.