The world was stirring today over the UK decision to leave the European Union. Here are a few things to keep in mind. As we discussed earlier in the week, the repercussions of the Brexit are very different than those that were feared over the potential “Grexit.” Greece was threatening to leave the euro. It would have had major and immediate financial complications, which could have quickly paralyzed the financial system.
The Brexit is more political than economic (not financial). And any retrenchment in the banking system because of uncertainty can be immediately quelled by central bank intervention. Not only were the central banks out in front of the potential exit outcome, promising to provide liquidity to the banking system, but they were also in last night stabilizing currencies, and likely bond yields as well.
As we said, there are also huge differences between now and 2008. When Lehman failed and global credit froze, we had no idea how policy makers might respond and how far they might go. Now we know, they will “do whatever it takes.”
The market volatility surrounding the Brexit may actually be a positive for the global economy. Seven years into the global economic recovery, global central banks have thrown the kitchen sink at the crisis, and they’ve proven to be able to stabilize the financial system and the global economy, and restore confidence. And that has all indirectly created an economic recovery, albeit a slow and sluggish one. But they haven’t been able to directly stimulate meaningful economic growth (the kind you typically see coming out of recession) because of the nature of the crisis.
Fiscal stimulus has been the missing piece of the puzzle.
Governments have been reluctant to spend, given the scars of the debt crisis. This may give policy makers an excuse to green light fiscal stimulus. After all, growth (or the lack thereof) is the primary driver of the public discontent – not just in the UK, but globally. Growth has a way of solving a lot of problems.
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As we said yesterday, we’ve seen a slew of threatening events come and go over the course of the past seven years, and with each passing of those events, the heightened scrutiny of the economy comes and recession predictions. Each has been wrong. The Brexit vote is just the latest.
With the UK referendum results looming (as of this writing), today we want to revisit some of our bigger picture perspective on the U.S. economy. The data just doesn’t support the gloom and doom scenarios.
The Fed has manufactured a recovery by promoting stability. And they’ve relied on two key asset prices to do it: stocks and housing. Today we want to look at a few charts that show how important the stock and housing market recoveries have been.
While QE and the Fed’s ultra easy policy stance couldn’t directly create demand in a world of deleveraging, it did (and has) indirectly created demand by promoting stability, which restored confidence. Without the confidence that the world will be stable, people don’t spend, borrow, lend or hire, and the economy goes into a deflationary vortex.
But by promising that they stand ready to act against any futures shocks to the economy (and financial markets), investors feel comfortable investing again (stocks go higher). When stocks go higher and the environment proves stable, employers feel more confident to hire. This all fuels demand and recovery. And, of course, the Fed has pinned down mortgage rates at record lows, which promotes a housing recovery, and gives underwater homeowners (at one point, more than 25 million of them) a since that paper losses will at some point be overcome, and that gives them the confidence to spend money again, rather sit on it.
Along the path of the economic recovery, the Fed (and other key central banks) has been very sensitive to declines in stocks. Why? Because declining stocks has the ability to undo what they’ve done. And it confidence breaks again, it will be far harder to restore it.
The first chart here is the S&P 500. Stocks bottomed in March of 2009, when the Fed announced a $1 trillion QE program.
Sources: Reuters, Billionaire’s Portfolio
Stocks surpassed the pre-crisis highs in 2013 after six years in the hole. But even after the dramatic rise you can see in the chart the damage from the crisis is far from restored. If we applied the long term annual rate of growth of the S&P 500 (8%) to the pre-crisis highs of 1,576, the S&P 500 should be closer to 3,150.
How does housing look? Of course, bursting of the housing bubble was the pin that pricked the global credit bubble. Housing prices in the U.S. have been in recovery mode since 2012. Still, housing has a ways to go. This is a very important component for the Fed, for sustainable recovery.
Sources: Reuters, Billionaire’s Portfolio
Housing prices have bounced 37% off of the lows (for 20 major cities in the index) – but remains about 10% off of the pre-crisis highs.
How has the recovery in stocks and housing reflected in the broader economy?
As stocks surpassed pre-crisis highs in 2013, so did U.S. per capita GDP.
Sources: Reuters, Billionaire’s Portfolio
While debt continues to be a big structural problem for the U.S and the rest of the world, growth goes a long way toward fixing that problem.
And growth, low interest rates, higher stocks and higher housing prices goes a long way toward restoring household net worth. As you can see in the chart below, we have well recovered and surpassed pre-crisis levels in household net worth…
Sources: Reuters, Billionaire’s Portfolio
What is the key long-term driver of economic growth overtime? Credit creation. In the next chart, you can see the sharp recovery in consumer credit since the depths of the economic crisis (in orange). This excludes mortgages. And you can see how closely GDP (economic output) tracks credit growth (the purple line).
Sources: Reuters, Billionaire’s Portfolio
What about deleveraging? It took 10 years to build the global credit bubble that erupted in 2007. Based on historical credit bubbles, it typically takes about as long to de-lever. So 10-years of deleveraging would put us at year 2017.
You can see in the chart below, the average annual growth rate of consumer credit over the past 55 years is 7.9%. Over the past five years, consumer credit growth has been solid, just under the long term average. Meanwhile, FICO scores in the U.S. have reached an all-time high.
Sources: Reuters, Fed
With any volatility in stocks, there comes increased scrutiny on the economy and people like to wave the red flag anywhere they find soft economic data. But consumption makes up more than 2/3 of the U.S. economy. And you can see from the charts above, the consumer is in a solid position. Still, stocks and housing remain key drivers of the recovery. The Fed is well aware of that. With that, don’t expect the Fed, in the current economic environment, to do anything to alter the health of the housing and stock markets.
Have a great night.
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Tomorrow is the UK vote, where UK citizens will vote on whether to ‘stay’ or to ‘leave’ the European Union. In this post-Lehman (failure) era, we’ve had no shortage of fear and doubt. Remember the Fiscal Cliff, Sequestration, Cyprus, several chapters of the drama in Greece, Italy and Spain were threatening default, China’s slowdown – the list could go on.
Along the way, the message in the media has always had little substance, but one very common word to promote and validate fear: the word, “uncertainty.”
But throughout this entire post-Lehman era, the world has been a very uncertain place. Whether times have been relatively good or not so good, given the state of the world seven years ago, and given the unprecedented policies it has taken to get us here, uncertainty is the new normal. But what is certain, following the near apocalypse of the global economy, is how policy makers will respond. We know, without a question, they will do ‘whatever it takes’ — their own words. And they’ve proven that their actions can avert disasters and promote confidence and recovery.
With all of this in mind, let’s dig in a little bit and talk about the UK vote.
First, to be clear, there are a lot of comparisons made to the Greek vote last year (the “Grexit”). The UK vote (the “Brexit”) is very different.
The notion of Grexit threatened the existence of the second most widely held currency in the world, the euro. That was a much, much bigger deal. The UK, of course, is part of the European Union, but not part of the currency union. They did not adopt the euro. They have their own currency and their own monetary policy. The UK vote is about trade, immigration, ability to work and live in other EU countries — perhaps mostly about control and politics.
The polls have been broadly building the story for an exit, though they are also broadly deemed unreliable. Meanwhile the bookmakers have had the chances of an exit, along much of the way, as slim (at about 70/30 favoring the ‘stay’ camp). Still, at the peak of the frenzy last week, that number had narrowed to 56/44 favoring ‘stay.’ But when the pendulum of sentiment swung, so did the bookmakers odds of a ‘leave’ vote winning. They are putting the chances of an exit at just 25% as we head into tomorrow’s vote.
As we said, we’ve seen a number of events over the course of the past several years that have introduced fear and doubt into the minds of investors (and especially the media). Something to keep in mind: Any and all of the dips in markets associated with those flare-ups have proven to be extremely valuable buying opportunities. As we noted yesterday, some of the best spots to buy the dip this time around will likely be German and Japanese stocks.
Have a great night.
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On Friday we looked at four key market charts that suggested the worst of the Brexit storm may be behind us.
As of Friday afternoon, the bookmakers had the odds of the UK staying in the Eurozone at 64%, versus 36% leaving. And as we looked across the prices of gold, oil and stocks, all were suggesting, at least technically, that the peak of fear, regarding a Brexit, had passed.
Gold was rising sharply early last week. Oil began to slide. These are two very important barometers of global risk appetite, and those moves were clearly demonstrating fear and uncertainty in markets.
But on Thursday, gold put in a key reversal signal. So did oil, on Friday. Those reversals continued today. Additionally, a very key bond market in Germany (the German 10 year bund yield), which traded into negative yield territory at one point last week, has been clawing back into positive territory since Friday (trading above 5 basis points today – positive 5 basis points).
Why? Because of this chart…
Above is an update of the bookmaker odds on a Brexit. The chances of a leave have now dropped from 44% to 25%, since Thursday.
That’s why global markets are aggressively taking back the hedging and selling from last week.
The UK vote is this Thursday. We’ve said months ago, that despite the speculation of a UK exit, it was not going to happen, given where the oddsmakers were pricing the risk (at about 70/30 in favor of staying for much of the way), and given the scale of the “fear of the unknown” in the voter’s eyes. Adding to that, we expected that the warnings from big public figures would come in hot and heavy as the date approached. Type in the words “Brexit” and “warning” into Google and you get almost 7 million results.
Already, everyone has weighed in with draconian warnings in an attempt to influence the decision: from the UK Prime Minister, the head of the Bank of England, the head of the IMF, to the ECB, to the Fed and the U.S. President. Now UK employers have been latest, directly writing their employees to warn of the business damage from a ‘leave’ vote.
If the Brexit risk continues to abate, and the referendum comes and goes on Thursday, with a ‘stay’ vote, that should clear the way for broad global stock market rallies and a sharp bounce back in yields, as the focus will quickly turn to a July Fed rate hike.
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After a shaky few days for markets, we head into the weekend with some relative calm today. Next week the UK vote on leaving or staying in the European Union will dominate the market focus.
The pressure in markets had been building in recent days on the pick-up in momentum for the Brexit vote in the UK. A log on the fire for that pressure was the inaction from the four central banks that met this week (Fed, BOJ, SNB and BOE). Yields in German 10-years slid below zero. U.S. yields (10 years) hit four year lows. Stocks were sliding, globally. The upward momentum for gold started to kick in. And then we had the tragic murder of a member of British Parliament (widely considered to be politically driven, as she was a ‘stay’ advocate).
So leveraged positions across markets that were leaning in the direction of the momentum unwound, to an extent, on the news.
Today we want to step back and take a look at some key charts as we head into next week.
First, the odds of a Brexit from the bookmakers…
As we’ve said, along the way, despite the coin flip projections coming out of the many polls in the UK, this estimation has been clearly favoring the ‘stay’ camp by about 70/30. Though in recent days the probability of an exit had risen to 44%. Following the tragic news yesterday, that number is now back to 36%.
Next is a chart of gold. This is the safe haven trade, though it hasn’t much allure in quite some time. Still, gold found some legs in the past 10 days.
But as you can see in the chart above, after a $35 higher yesterday, it reversed sharply to close on the lows. In the process it put in a very nice technical reversal pattern (an outside day – where the day’s range engulfs the prior day’s range, caused by low conviction ‘longs’ reversing course near the highs and hitting the exit doors, exacerbating the slide into the close). That price action would argue for lower gold, and in general, the end of this recent flurry of doubt surrounding the UK vote (and uptick in broad market volatility).
As we know, the sustainability of the crude oil recovery is a huge factor in global financial market stability. After trading above $50, it had six consecutive days of lower lows, but it bounced back aggressively today, also posting a key reversal signal (bullish outside day – again, good for the global stability outlook).
Finally, a look at the chart of the S&P 500 …
Despite all of the negative messaging across the media and uncertainty from the investment community, as we head into the weekend stocks sit just 3% off of the all-time highs.
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The Fed held rates steady today. As we’ve talked about, this was a decision they laid the ground work for over the past two weeks. We want to talk about a few takeaways from the Fed event, and then continue our discussion from yesterday on the Bank of Japan decision tonight (where the big news may come).
First, the Fed did indeed consider the global stability risk that comes with the decision in the UK on whether or not to leave the European Union. The polls in recent weeks have continued to show that it could go either way. Meanwhile, the bookmakers have had this vote clearly in favor of “staying” in the European Union all along — as much as 70/30 ‘stay’ much of the way. But those odds have been narrowing in the past week.
Still, as we discussed yesterday, holding pat on rates today was a “no risk” decision, especially because they had an event (the weak jobs data) and the platform (through a prepared speech by Yellen just days after the weak jobs data) to manage away expectations for a hike.
With that, stocks remained steady on the decision. And markets in general remained tame.
So now the Fed is in position to see the outcome in the UK. There was some two way talk about the jobs and inflation data, but it looks like the Fed is most concerned with what’s going on in the global economy. That’s clear in their reaction to the oil price bust, when they responded back in March by taking two rate hike projections off the table. And it’s clear in their reaction now to the Brexit risk.
But their new projections on the future path of interest rates have been ratcheted down in the coming years, and in the long run. For perspective, a year ago the Fed thought the benchmark rate would be 2.75%. Now they think it will be 1.5. Why? What’s been acknowledged more and more in recent meetings is the impact of the weakness and threats in global economies on the U.S. economic outlook. The U.S. economy has been relied upon to drive global economic recovery, but it’s being dragged down now by the weight of global economic weakness.
This all puts pressure on Europe and Japan to follow through on their promise to do “whatever it takes” to restore their economies.
As we’ve said, the most important spots in the world, right now, are Japan and Europe. The Fed only began its campaign of removing its emergency level policies because Europe and Japan took the QE baton handoff from the Fed – picking up where the Fed left off. And unlike the U.S., which is constrained by “flight to safety” global capital flows and a world reserve currency, they have the ingredients (primarily Japan) to make QE work, to promote demand, to promote growth. Japan has the largest government debt problem in the world. They have an undervalued currency. They have a stagnating economy with big demographic challenges. They have are in a deflationary vortex.
They have the perfect attributes for a mass scale currency printing campaign. Not only can it work for their domestic economies, but it serves as the liquidity engine and stability preserver for the global economy.
In normal times, the rest of the world wouldn’t stand for a country outright devaluing their way to prosperity. But in a world where every country is in economic malaise, everyone can benefit – everyone needs it to work. It can be the solution for returning the global economy to sustainable growth.
With that, and given the position of the yen and Japanese stocks (see our chart yesterday), along with the underperforming economy in Japan, even after three years of QE, now is the time to throw the kitchen sink at it (i.e. they should act tonight, and in a ‘shock and awe’ fashion).
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German yields (10 year futures) went negative today, but importantly didn’t close negative. We’ve talked about the important symbolism of this market. This is a big deal, especially the recovery into the close, finishing spot on the zero line heading into tomorrow’s Fed and tomorrow nights BOJ meeting.
The Fed decision is tomorrow afternoon. Remember Fed members went on a public campaign to build expectations for a June hike — a second hike in their nascent rate hiking cycle. Of course, it’s not a normal hiking cycle, but just the slow removal of emergency level policies that were in place to avert a global economic disaster and fuel a recover, albeit a very slow and weak one.
But now, as the vote in the UK on whether or not to leave the European Union has become increasingly questionable over recent weeks, the expectations of a Fed hike tomorrow have evaporated. With that, the weak job creation number at start the month came as a gift to the Fed. It gave them a credible reason to back off of their stance, even though the threat to global economic stability (the chance of a UK/Brexit shakeup) is front of the mind for them.
Remember, last September, the Fed had set the table for a first hike. They told us they would, and they balked. The culprit then was the currency devaluation from China which shook up global markets and sent stocks falling. The Fed didn’t hike. And that added even more fuel to the market shakeup. It warranted the question: Does the Fed have that little confidence in the robustness of the economic recovery?
So this time around, changing course again on the Brexit risk would have made them look weak and uncertain (as they did back in September). But influenced by the changing data (the weak jobs number) — the market this time has given them a pass.
If they were to surprise and hike at this point, it would likely be equally as harmful as it was back in September when they chose not to hike.
What’s the point? The Fed has made it clear all along that they need stocks higher. It’s a huge component in restoring wealth, jobs and broader confidence and stability. Anything that can derail that is very dangerous to the recovery, and the Fed knows it very well. So do central bankers in Europe and Japan.
With that said, as has been the case the past three Fed events this year, the main event for monetary policy isn’t in Washington, the main event this week is in Japan.
The BOJ has given us plenty of clues that more action is coming:
1) Even after three years of Japan’s unprecedented policy attack on deflation and a stagnating economy, the head of the BOJ has said numerous times that they remain “only half way there” on meeting their objectives.
2) As we’ve said, two key components of Japan’s stimulus program are a weaker yen and higher stocks — both assist in demand creation, growth and debt reduction. On that note, there has been talk out of Japan that they may increase the size of their direct ETF purchases (more outright buying of stocks).
3) There has also been talk out of Japan that the BOJ may start paying banks to borrow money from the BOJ (negative interest rates on loans) and may start buying high risk corporate debt.
To simplify it, below is the most important data for the BOJ. The yen and the Nikkei. Both are going the wrong direction for the BOJ. All of their work since initiating the second round of QE in Japan has been undone.
Source: Billionaire’s Portfolio
The Nikkei opened at 15,817 the day the BOJ surprised the world with more QE in October of 2014. After trading as high as almost 21,000 last year, the Nikkei closed today at 15,859. And the yen is already at a higher point against the dollar than it was when the BOJ boosted stimulus last – bad news for the BOJ.
We said this last month going into BOJ: “An aggressive response would surprise markets. That’s what the BOJ likes and wants, because it gives their policy actions more potency.” It didn’t come then, but we think we will see it tomorrow night, even though the market is betting on no change.
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Last week we talked a lot about the German bund yield, the most important market in the world right now. Today we want to talk about how to trade it.
The best investors in the world love asymmetric bets (limited downside and virtually, if not literally, unlimited upside). That’s the true recipe to building huge wealth. And there is no better asymmetric bet in the world right now than the German 10-year bund.
With that in mind, in recent weeks, we’ve revisited Bill Gross’ statement last year, when the 10-year government bond yields in Germany were flirting with zero the first time. He called it the “short of a lifetime” to be short the price of German bunds – looking for yields to bounce back. It happened. And it happened aggressively. Within two months the German 10 year yield rocketed from 6 basis points to over 100 basis points (over 1%). But even Gross himself wasn’t on board to the extent he wanted to be. The bounce was so fast, it left a lot of the visionaries of this trade behind.
But over the past year, it’s all come back.
Is it a second chance? German yields are hovering just a touch above zero — threatening to break into negative yield territory for one of the world’s most important government bond markets.
As we said on Friday, the zero line on the German 10-year government bond yield is huge psychological marker for perceived value and credibility of the ECB’s QE efforts. And that has huge consequences, not just for Europe, but for the global economy.
Given the importance of this level (regarding ECB credibility), it’s no surprise that the zero line isn’t giving way easily. This is precisely why Bill Gross called it the “short of a lifetime.” With that, let’s take a look at the incredible risk/reward this represents, and a simple way that one might trade it.
There is a euro bund future (symbol GBL) that tracks the price of the German 10-year bund. Right now, you can trade 1 contract of the German bund future at a value of 164,770 euros by putting up margin of 3,800 euros (the overnight margin at a leading retail broker). If you went short the bund future, here are some potential scenarios:
If you break the zero line in yield, the euro bund future would trade up to about 165.50 (it currently trade 164.77). If you stopped out on a break of zero in yield, you lose 730 euros (about $820 per contract). If the zero line doesn’t breach, and yields do indeed bounce from here, you make about 1,500 euros for every 10 basis point move higher in the German 10-year bund yield.
For example, on a bounce back to 32 basis points, where we stood on March 15th, the profit on your short position would be about 4,600 euros (or about $5,200). If German bund yields don’t breach zero and bounce back to 1%, where it traded just a year ago, you would make about 15,000 euros ($16,900) per contract on your initial risk of $820 – a 20 to 1 winner. Of course, there are margin costs to consider, given the holding period of the trade, but in a zero rate world, it’s relatively small.
If you’re wrong, and the German 10-year yield breaches zero, you’ll know it soon.
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On Wednesday we talked about the most important market in the world, right now. It’s German bunds.
The yield on the 10-year German bund had traded to new record lows, getting just basis points away from the zero line, and thus from crossing into negative yield territory for the 10-year German government bond. That has inched even closer over the past two days, touching as low as 1 basis point today.
Not surprisingly, stocks sold off today. Volatility rose. Commodities backed off. And the broader mood about global economic stability heads into the weekend on the back foot. For perspective, though, U.S. stocks ran to new 2016 highs this week, and are sniffing very close to record highs again. Oil and commodities have been strong, and the broad outlook for the economy and markets look good (absent an economic shock).
What’s happening? Of course, the vote that is coming later this month in the UK, on whether or not UK citizens will vote to ‘Stay’ in the European Union or ‘Leave’ continues to bubble up speculation on the outcome. That creates uncertainty. But the real reason rates are sliding is that the European Central Bank is in buying, not just government bonds, but now corporate bonds too. The QE tool box has been expanded. That naturally drives bond prices higher and yields lower. But the question is, will it translate into a bullish economic impact (i.e. the money the ECB is pumping into the economy resulting in investing, spending, hiring, borrowing). As we discussed on Wednesday, it’s the anticipation of that result that sent rates higher in the U.S. when the Fed was in, outright buying assets, in its three rounds of QE.
With that, the most important marker in the world for financial markets (and economies) in the coming days, remains, the zero line on the German 10-year government bond yield. Draghi has already told us, outright, that they will not take benchmark rates negative (as Japan did). That makes this zero line a huge psychological marker for perceived value of the ECB’s QE efforts.
With this in mind, we head into a Fed meeting next week. The Fed has done its job in managing down expectations of a hike next week. With that, they have no risk in holding off until next month so that they can see the outcome of the stay/leave vote in the UK. And, as we’ve discussed, the Bank of Japan follows the Fed on Wednesday night with a decision on monetary policy. They are in the sweet spot to act, not only to reinvigorate the weak yen trend and strong stock trend in Japan, but to add further stimulus and perception of stability to the global economy. We think we will see that happen.
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On Tuesday we talked about the quiet bull market in commodities. Today we want to talk about one specific commodity that has been lagging the sharp rebound in oil, but is starting to make a big-time move. It’s natural gas. And this is an area with some beaten up stocks that have the potential for huge bounce backs.
Natural gas today was up almost 6% to a six month high. The U.S. Energy Information Administration said in its weekly report that natural gas storage rose less than what analysts had forecast. But that was just an extra kick for a market that has been moving aggressively higher in the past NINE days (up 37% in nine days).
Now, we should note, nat gas is a market that has some incredible swings. Over the past three years it has traded as high as $6.50 and as low as $1.64.
For perspective on the wild swings, take a look at this long term chart.
You can see we’re coming off of a very low base. And the moves in this commodity can be dramatic.
Three months ago natural gas was continuing to slide, even as oil was staging a big bounce. But natural gas has now bounced 58% after sniffing around near the all-time lows. Meanwhile, oil has doubled.
Based on the backdrop for oil, broader commodities, the economy we’ve been discussing, and the acknowledging the history of natural gas prices, we could be looking at early stages of a big run in nat gas prices.
Summer is one of the most volatile periods for natural gas with the combination of heat waves, hurricanes and potential weather pattern shifts such as La Nina. During the summer months, a 50% move in the price of natural gas is not uncommon. Another 50% rise by the end of the summer would put it around $4. And four bucks is near the midpoint of the $6.50 – $1.65 range of the past three years.
Billionaires investor David Einhorn has also perked up to the bull scenario in nat gas. In his most recent investor letter his big macro trade this year is long natural gas. Here’s what he had to say: “Natural gas prices are not high enough to justify drilling in all but the very best locations. The industry has responded by dramatically reducing drilling activity. As existing wells deplete, supplies should fall. The high cost of liquefying and transporting natural gas limits competition to North American sources. Current inventories are high following a period of over-drilling and a record warm winter. However, the excess inventory is only a couple percent of annual production, which has already begun to decline. Normal weather combined with lower production could lead to a shortage within a year.”
This all contributes to the bullish action we’re seeing across commodities, led by the bounceback in oil. The surviving companies of the energy price bust have been staging big comebacks, but could have a lot further to go on a run up in nat gas prices.
In our Billionaires Portfolio, we have an ETF that has 100% exposure to oil and natural gas – one we think will double by next year. Join us today and get our full recommendation on this ETF, and get your portfolio in line with our Billionaire’s Portfolio.
