Back to the Future 2
Investing for a transformation in Energy and the Monetary System
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Newsletter rundown:
Back to the Future 2: Investing for a transformation in Energy and the Monetary System
Reverse Repo drawdown is today’s money printer
Final Word
Back to the Future 2
When I first wrote “Back to the Future” in September 2021, we outlined how changes in energy and the banking system are uncomfortable but I believe necessary to build the U.S. on a growth path for the next decade.
The core idea here is that investing for a transformation in energy and the monetary system is beneficial for long term investors on a risk/return basis.
This transformation has been on pause because policymakers have chosen to drawdown reserves instead of making difficult decisions today.
Stockpiles in money and oil, stored during years of plenty, have suppressed inflation.
Drawing down reserves can be likened to dipping into your savings account during a financial emergency.
Just as an individual might have a savings account to provide a safety net for unexpected expenses, a country, or a company, holds reserves (e.g., foreign exchange reserves, reverse repo, and oil reserves) for unexpected situations or emergencies.
Current drawdowns of reserves in the Strategic Petroleum Reserve (SPR) and Reverse Repo facility (RRP) will continue to boost the stock market short term and keep oil prices under control until they run out.
Let’s take a look at inventory levels today:
The administration’s 2022 drawdown of 180 million barrels constituted the largest annual decline on record.
As of August 4th, there are approximately 347.8 million barrels in the reserve – remaining at historically low levels going back to 1982.
At the current pace, total reserves would go to zero by 2025.
Based on our research, we found no rules that dictate how much oil must be held in reserve, nor how fast inventory levels need to be replenished.
This leaves the decision to replenish reserves up to unelected politicians who have the authority to dictate energy prices.
We believe energy policymakers will make short term decisions which benefits their own self interest. (Refusing to restore reserve levels back to prior levels)
We believe this could have longer term inflationary pressures on the energy market.
We believe this SPR imbalance will support oil prices higher in the medium to long term.
Reverse Repo drawdown is today’s money printer
Since the regional banking crisis in March, $734B has been drawdown from the Overnight Reverse Repo (RRP).
The flow of funds away from an overnight sweep into longer dated treasuries is beneficial for risk assets, like the stock market, for two reasons:
1. Longer time to maturity
2. Greater capacity for margin (borrowing)
The Fed is now using the stockpile of overnight funding, which was printed and held back during Covid, to continue to juice the market.
Fundamentally, having securities with longer maturities equates to having more flexibility in managing risks. Rather than being required to settle and sweep transactions on the same day, traders are now afforded the luxury of several days or even weeks to complete a trade. This extension in the timeframe for using new capital permits institutional trading desks to implement market strategies over a period extending beyond just one day. This is advantageous for the stock market as single-day trades do not always pan out as anticipated.
As you can see in the chart above, as the drawdown in RRP occurs, the total level in SPY 0.00%↑ has closely followed.
Powell has not been asked any poignant questions regarding the phenomenon in reverse repo.
As greater attention is given accumulates, we expect questions to come up during the Fed’s next meeting.
Until further guidance from the Fed is provided, we anticipate the reduction in the RRP is a natural occurring trend that will continue to persist, which is likely to provide a short-term lift to the stock market.
Final Word
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This is not investment advice. Do your own due diligence. I make no representation, warranty or undertaking, express or implied, as to the accuracy, reliability, completeness, or reasonableness of the information contained in this report. Any assumptions, opinions and estimates expressed in this report constitute my judgment as of the date thereof and is subject to change without notice. Any projections contained in the report are based on a number of assumptions as to market conditions. There is no guarantee that projected outcomes will be achieved.
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