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The Fed Hikes Rates – What Next?

Federal Reserve

As expected, the Federal Reserve hiked interest rates this week, and there’s obvious nervousness out there regarding the impact this will have, if any.

In his recent Big Picture podcast, Jim Puplava, Founder of Financial Sense and Chief Investment Strategist at PFS Group, said the Fed should hike once and stay quiet, in reference to the highly active “Open Mouth Committee,” as he calls it.

In terms of risks to the market, Puplava cites two: one is procedural and the other coming from China.

“Can they really get this right? We have a saying here that they keep raising until something breaks. Number two is China’s devaluation…because China pegs its currency to the dollar, and the dollar has risen 20 percent against other major currencies.”

As the Fed tightens, ostensibly making the dollar more attractive, the Chinese Yuan will come under increasing pressure, he noted. This means China is more likely to devalue, which could cause further disruption, as we saw earlier this year (see our recent interview with Felix Zulauf).

Another aspect of the global economy that’s playing into concerns are energy prices, with companies in the United States cutting back on drilling, and with rig counts also falling.

These companies are responding to market pressures by cutting production and reducing supply, Puplava noted, and interestingly OPEC is unlikely to cut back on production in this scenario. OPEC countries are more dependent on oil revenue to pay government expenses, he said, and if they were to cut back on production, the response in the West would be to increase production.

“I think … OPEC has figured that out, so right now OPEC producers from Saudi Arabia on down are scrambling to maintain market share,” Puplava said. “In a world of oversupply and reduced demand, the tendency is for prices to remain weak.”

However, we’re beginning to see signs typical of a bottoming process, he added, where companies pull back on investment. This is typical of what we see in the final phases of a bear market, and it’s a bottoming process of the cycle, he said.

In addition to layoffs in the energy sector amounting to hundreds of thousands of jobs and declining production, companies are struggling to remain solvent. And this is spilling into the mining industry as well, Puplava noted, highlighting Anglo America’s plan to cut 85,000 jobs from its work force, sell major assets and suspend its dividend to remain solvent.

Ultimately, the company that will emerge will be more cost efficient, leaner and focusing on profitability, he noted. Other miners are taking similar, though perhaps less drastic measures and many are focusing on high-grade ore deposits to maximize production value.

“The result is what we are seeing now, where the inefficient companies go under,” he said. “Expect to see more of that next year, or they’re taken over by the big guys, the big guys deleverage and divest in order to survive, and the result is you’ll see supply contract to the point that it becomes less than the demand, setting up the stage for the next bull market.”

There are a lot of aspects in play, Puplava stated, and many companies are still producing oil and miners are still mining to keep their operations going and service debt. Many producers hedged their production, but that is coming off in 2016, Puplava noted. What needs to happen is supply needs to contract dramatically, and not just gradually, for the bottoming process to play out, he said.

“At some point, we’re going to see a balance,” he said. “I like the blue chip energy stocks. Most of the companies are cutting back on (capital expenditures).”

Even though energy companies’ earnings are down about 70 percent over a year ago when the price of oil was over $100 a barrel, so far the expense cuts in CAPEX expenditures have allowed these companies to cover their dividends, Puplava said.

“If (oil) prices stay down at $30 for another year or two, the big guys would have to think seriously about maintaining their dividends,” he added. “This is what you see in a bear market. It’s that washout … (we’ve seen these) Maalox Moments, and you want to see that.

You want to see an acceleration of this and you want to see it pick up pace.”

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