by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EDT] | PDF

Good morning and happy Monday, the last day of November!  We’re back after a few days off.  U.S. equity futures are lower this morning in a quiet trade.  Gold continues to decline as well; we comment below.  We lead off with Iran and last Friday’s assassination and include other news from the Middle East.  China news follows; North Korea comes next.  We update the latest on Brexit as the deadline looms, and other European news is included.  We update the pandemic news and close with economics and policy.

Gold:  We have held gold in our asset allocation portfolios since early 2018, so we are watching with great interest the recent decline in gold prices.  Overall, the fundamentals for gold appear solid.  The central banks are still expanding their balance sheets, the dollar is weakening, and there is no sign of monetary policy tightening.  So, why the drop?  The most likely reason is hope for a vaccine.  Although the longer-term fundamental factors point to higher prices, the increasing likelihood of a vaccine next year is likely shifting funds away from gold to other assets, including industrial metals and equities.  In addition, cryptocurrencies are now sharing the spotlight with gold as a debasement hedge.  We have no reason to believe gold prices will not rise over time, but in the short run, the 1750/1700 area looks like a support zone.  We will have more to say on this asset in an upcoming Asset Allocation Weekly.

Iran:  Mohsen Fakhrizadeh, a leading Iranian nuclear scientist, was assassinated on Friday while traveling in a motorcade outside of Tehran.  Israel is thought to be behind the attack, although its policy is to never admit or deny an operation unless its personnel are caught.  It appears the assassination was partially done by remote control.  This isn’t the first time Iranian nuclear scientists have been targeted; at least four others were assassinated between 2010 to 2012.  Iran will likely avoid escalating the situation to avoid undermining the potential for improved relations with the incoming Biden administration.  In addition, Tehran will want to avoid an escalation in the waning days of the Trump administration, fearing a “parting shot” from Washington.  This gives Iran’s adversaries a window of opportunity to engage in attacks. At the same time, this attack, along with others, will make it difficult for Iran to change its relations with the U.S., even with a new administration in place.  Iran generally doesn’t directly attack Israel but instead focuses on Israel’s overseas interests.  However, it will be difficult for Iran not to respond in some fashion; the trouble is that responding after the inauguration would make it nearly impossible for the Biden administration to open negotiations.  The impact on markets, thus far, has been modest.  Iran isn’t trading much oil, and we would not anticipate any disruptions in oil supply, although there is a possibility that U.S. interests in Iraq could be targeted.

• An underlying problem in Iran is that in a country under tight controls, how is it possible that assassinations like this can occur? It appears that Iran’s security services are being penetrated.  Not only did we see Friday’s assassination, but the attack on Soleimani earlier this year shows a critical breakdown in operational security.  Our suspicion is that there is deep discontent with the regime, and even though the penalty for leaking sensitive information is almost certainly execution, it still seems to be happening.  The killing of Mohsen Fakhrizadeh was partially done remotely, meaning there was a high level of planning involved, which makes such operations vulnerable to discovery.  The fact that these high-profile targets continue to be struck suggests that Iran’s security services are failing to protect these individuals, and there are plenty of people with inside knowledge willing to share key information.
• In other Middle East news, the administration is working to end the standoff between Qatar and Saudi Arabia. Three years ago, Riyadh established a blockade on Qatar (there were pictures of dairy cows being flown into Qatar as part of the response).  According to reports, Jared Kushner is going to the region to hold talks on ending the blockade.

China:

• The EU is clearly hoping to improve relations with the U.S. in light of a new administration. The Europeans are offering a plan to create a common front against China in return for a less confrontational relationship with Washington.  We would expect the EU to back away from digital taxes as part of this offer.  There will be elements of this offer that will be attractive to the U.S., but part of the EU’s goal will be to continue Germany’s export economic model.  A unified front against Beijing makes sense, but our inclination is that Brussels is likely expecting more from the U.S. regarding trade than Washington will be willing to offer.
• More companies have been added to the blacklist of Chinese companies with ties to the military.
• The Chinese economy continues to show signs of recovery; its PMI reports remain at expansion levels.
• Tensions with Australia continue to escalate. Canberra is threatening to take Beijing to the WTO over barley tariffs.  Meanwhile, Beijing has sent doctored images of Australian soldiers committing atrocities in Afghanistan into social media, leading to protests from PM Morrison.
• The House is apparently taking up a previously passed Senate measure that would require Chinese firms that have listed on U.S. exchanges to be audited by American-approved accounting firms or face delisting. This issue has been contentious for years, but the Senate bill carries the potential for substantial power to force Chinese firms to accept U.S. regulatory oversight.

North Korea:  We are seeing scattered reports of erratic government behaviors emerging from the Hermit Kingdom.  According to reports, Pyongyang has been shut down, perhaps signaling a virus issue.  At the same time, uncertainty about the Biden administration has led the administration to warn diplomats to keep a low profile.  The exchange rate unexpectedly appreciated earlier this month; it has declined over the past week as authorities cracked down on the use of foreign currency.  A dealer was reportedly executed due to the depreciation.  Overall, it is difficult to know what exactly is going on in North Korea, but there does appear to be rising tension.

Brexit and the EU: 

• The deadline for a deal is looming—New Year’s Day will be it, and if a deal isn’t reached, a hard Brexit will occur. Even if a deal is made, it appears that neither side is prepared for border checks.
• The, Akademik Cherskiy, a Russian pipe laying ship, is apparently the only one in the Russian fleet that can complete the Nord Stream 2 pipeline project that would bring Russian natural gas directly to Germany, bypassing Ukraine. Both the U.S. and Ukraine oppose the pipeline.  The former wants Europe to buy U.S. liquified natural gas, LNG, and to reduce Russian influence in the EU, and the latter wants to keep control of the natural gas “chokepoint” that it has over Russian gas exports.  Apparently, the Akademik Cherskiy needs retrofitting to lay larger pipe and finish the project.  Congress has sanctions prepared, and there is a race to finish or kill the project before the new administration takes office.

COVID-19:  The number of reported cases is 62,838,150 with 1,461,249 fatalities.  In the U.S., there are 13,386,255 confirmed cases with 266,887 deaths.  For illustration purposes, the FT has created an interactive chart that allows one to compare cases across nations using similar scaling metrics.  The FT has also issued an economic tracker that looks across countries with high frequency data on various factors.  Case levels appear to be peaking, although holiday travel could trigger another surge.

Virology:

• Viruses tend to mutate, and COVID-19 is no exception. There was evidence that the virus had mutated from its initial form noted in Wuhan to one that was much more transmissible.  Although there was a great deal of skepticism about these reports initially, there is a rising consensus that, in fact, there was a mutation, and it did make things worse.
• Pharmacies are adding freezers in anticipation of holding the COVID-19 vaccines.
• The NFL is dealing with a myriad of pandemic issues. Games have been postponed.  A ban on gatherings in Santa Clara County could force the 49ers to move two home games.  Denver was without a quarterback for its game yesterday.
• Moderna (MRNA, USD 127.03) said it will request authorization for its vaccines from EU and U.S. regulators.
• One emerging problems with COVID-19 is lingering neurological issues.

Economics and policy:

• Congress returns today with 11 days to fund the government and perhaps fill two positions on the FOMC.
• State and local governments are struggling with higher demand for services amid falling revenues.  Without federal support, government could become a drag on GDP as it was in 2008-12.
• Evictions are starting to rise as bans against them are rolling off. This problem will increase into early next year due to the expiration of several benefits.
• The pandemic led to a very modest “Black Friday,” although online activity was elevated. Today is “Cyber Monday,” and it looks to be a strong one.
• The expansion of debt worldwide is breaking records. Given low interest rates, firms and governments, in particular, are expanding borrowing.  This overhang will tend to force policymakers to keep policy accommodative.
• The EU is looking to create policies designed to keep tech firms from getting too big in the first place. We doubt these measures will work.  Due to network effects, technology firms have the characteristics of natural monopolies.  In other words, they have increasing returns to scale that reward expansion.  Natural monopolies are better candidates for regulation, not competition.
• Working from home has been a big part of the business response to the pandemic.  However, there is a potentially dark element to this development.  Firms may realize that if work can be done remotely, let’s say, in Nevada instead of the Bay area, then it can be done even more cheaply in Panama.  Tech firms are already looking to reduce wages to workers who work remotely from lower-cost areas; the natural extension would be to move that work offshore.  Even if it doesn’t happen, the threat could act as a dampener for wages.

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