Market Dispersion | Gold Pullback | USMCA Review

Markets, gold, and the USMCA: three stories making headline. 

In this episode of Off the Charts, Andrew Sarna and Vanessa Hui break down why the S&P 500’s June dips masks a broadening market, why gold’s recent pullback may not weaken its longer term case, and how the upcoming USMCA review creates serious uncertainty for Canada’s economy.

WHAT TO LISTEN FOR

0:30 Why Is the S&P 500 Hiding Strength in the Broader Market?

2:26 Are AI Hyperscalers Becoming the New Commodity Producers?

3:32 Could Amazon Become the Next ExxonMobil?

4:06 What Is Driving the Pullback in Gold Prices?

10:00 How Could a USMCA Breakdown Hurt Canada’s Economy?

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CONNECT WITH ANDREW SARNA

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CONNECT WITH VANESSA HUI

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This podcast is for informational purposes only and does not constitute investment advice. Views expressed are those of the speakers and should not be relied upon for investment decisions 

Transcript

Andrew Sarna (00:04):
Welcome back to Forthlane's Off the Charts podcast, where every two weeks we cover three market headlines that matter. I'm Andrew Sarna, portfolio manager.

Vanessa Hui (00:12):
And I'm Vanessa Hui, senior client advisor.

Andrew Sarna (00:15):
This week we're going to cover equity market dispersion, gold, and the USMCA.

Vanessa Hui (00:21):
Okay Andrew, let's start with equity markets. The S&P 500 is down about 3% in June month to date. What's the story behind it?

Andrew Sarna (00:30):
The S&P 500 being down 3% I think does actually a very bad job telling the full story. I want to segment the market into almost three different buckets. You have two sides of the AI trade and then you have the broader economy. The indices I want to look at for this are when we look at the broader market, we can look at the Russell 2000, which is small caps, or we look at the S&P 500 equally weighted index. Both of those indices are up more than 2% in June, while the S&P 500 is down 3%, so 5% outperformance. This is really driven because so much of the market cap weighted S&P 500 that is quoted every day is tied to the Magnificent Seven. And if we look at those seven stocks, all seven of them are down and the top performer is NVIDIA, down over 7%.

(01:25):
 Meanwhile, we look at the next nine largest stocks and they're all up with the leader being Micron. So we have the broader economy and then segmenting out the two sides of the AI trade. You have those spending money, which are essentially the hyperscalers. So the Googles, the Microsofts, the Amazons of the world. And then you have the recipients of those dollars, which is essentially the semiconductor supply chain and other parts of the AI supply chain. And that would be Micron, which is a memory maker. And then you have AMD and Intel. So given the Mag7 has such a large weight in the S&P 500 of almost 33%, you can have just these seven stocks struggling and it pulls down the entire market. Meanwhile, everything else could be up and that's exactly what is essentially happening this month. So let's turn our attention to the seven stocks that are struggling.

(02:26):
 They're just ploughing so much cash into this AI CapEx buildout and their businesses are transforming from these wonderful asset light businesses that have sort of dominated markets over the past 15 years. They're almost becoming commodity producers. Well, they're almost becoming commodity producers while they're actually becoming commodity producers. The CME and New York Stock Exchange have actually already announced that they're creating derivative contracts for token prices. So effectively they're becoming utilities or commodity producers. You know what? Just as an energy producer sells oil and the price rises and falls with the price of oil, this potentially could be happening to these hyperscalers. And if you look at what's happened to token prices, that seems to be exactly what is happening. Now it's early days of this story, but these businesses are transforming, so it's something to watch. And maybe longer term, Amazon becomes the next ExxonMobil.

(03:32):
 So I think it's really a story of the equally weighted index and Russell 2000 looking pretty healthy. Oil prices have fallen and, you know what, this could act like a tax cut to households and the spending could continue. This broadening of the market looks pretty healthy even as the biggest companies in the index struggle.

Vanessa Hui (03:58):
Now moving on to gold. After an incredible run, we're seeing some weakness in gold prices. Andrew, what's driving this?

Andrew Sarna (04:06):
Yeah. Gold is now down 26% from its peak earlier this year. Short term key technical levels are 4,000 and 3,600 to watch, but it's very hard to predict how something is going to trade when it doesn't have cash flows. Some analysts are beginning to chalk this up to liquidity conditions. I was reading some things over the weekend talking about how, as the war emerged, China decided to restrict liquidity conditions to try to cool their economy given that there was a chance that oil might be finite. And when I look at Bitcoin's price action in relation to this, maybe there's some credence to this narrative because they're selling off together. The other short term pressure was the high energy prices. Some countries were forced to sell gold to fund those energy purchases. And then on the other side, you can just think of a country like Saudi Arabia. They once had tons of profits to recycle into U.S. Treasuries and potentially some gold, and all of a sudden they're not selling oil, so that buyer has been removed from the market and you're likely seeing this from other countries around the world.

(05:25):
 So it is likely being driven by more sellers coming to market, but nobody really knows. Taking a step back and when we think about things from a longer term time horizon, it's pretty hard to be negative. War is inflationary. Just think of not only the U.S. and the countries involved, but all countries around the world, including the Europeans, are increasing defence spending and that has to come from somewhere, and they're not cutting from anywhere. The U.S. effectively lost to Iran if they have to pay these $300 billion reparation payments. Have you ever heard the saying the U.S. military is backed by the dollar? Well, what happens when that military can't defeat a third world nation? So some are saying that this could lead to the long term downfall of the U.S. dollar. And then we look at things such as reshoring and the infrastructure investments the U.S. wants to make.

(06:27):
 Well, they're already in such a poor fiscal situation that I just don't know where this debt is going to come from. And I mean, well, I do know where it's come from. They're going to print the money. And then you just look at current deficits of around 7%. These are completely unsustainable and gold will eventually rise even if the economy is growing. It's just hard to see the dollar maintaining purchasing power over the next 10 years. So gold is one of the things that is going to benefit from that.

Vanessa Hui (07:02):
Finally, let's turn to Canada. So the United States Mexico Canada Agreement, or the USMCA, marks its sixth anniversary on July 1st and with the mandatory 2026 review approaching, uncertainty around the agreement has become a key discussion point. What are you watching this week, Andrew?

Andrew Sarna (07:23):
Yep. So the three governments must decide by July 1st, 2026, according to the agreement, whether to extend the agreement for another 16 years. If any party declines to confirm, the USMCA enters the cycle of annual reviews and, absent resolution, expires in 2036. Therefore, July 1st isn't necessarily the day the deal falls apart, but it introduces more uncertainty with the annual reviews. And without the certainty of an agreement, it's hard for businesses to make investment. The less volatility, the easier it is for these companies to make investments into these countries. Washington has had formal talks with Mexico without Canada. The Canadians are supposed to be joining the talks, but it's hard to say they've sort of been blackballed thus far. If I were to guess, nothing is really going to change once the agreement expires because with upcoming midterms, I think it just introduces too much volatility into companies being impacted even on the southern side of the border ahead of midterms.

(08:40):
 North Dakota exported 90% of their goods to Canada. Last year, Michigan, 65%; Iowa, 50%; Arizona, 40%. So these are four states Trump won in the 2024 election and if all of a sudden Trump rips up this agreement, I think you have unhappy people. So I think at least we have some breathing room until midterms have ended, but once midterms end, I don't think Canada's in a great situation. Unfortunately, the U.S. has all the power. 70% of Canadian exports go to the U.S. If these supply chains are unwound, it's going to create real economic damage and Canada doesn't really have a buyer to replace the U.S. I mean, we like to think we can ship the goods to the EU or China, but they're nowhere near as important a trading partner as the U.S. is. The problem is when I think of the Canadian economy, it's really four things: natural resources, housing, financial services, and manufacturing.

(09:48):
 So what happens when you break one of those legs of the stool? Ontario and Quebec would be disproportionately impacted because that's where the majority of Canadian manufacturing lives.

(10:00):
 I was reading a report this morning and it said, if the USMCA is terminated, GDP immediately drops by 2%, unemployment could rise to 8%. This would mean the Bank of Canada would have to cut. So we see further CAD weakness and maybe it explains some of the weakness we've seen year to date. The TSX would certainly be collateral damage, could be down even double digits. And I mean, on a go forward basis, Canada really will have to revisit why we are an attractive region to invest in because foreign countries invest in Canada to access the U.S. market. It would certainly push us to double down on natural resources because that is the one thing we would have left. And so the investment implications of this are really pretty simple. A lot of Canadians are overexposed to their home country and I think now more than ever, it's an important time to look and potentially diversify globally.

Vanessa Hui (11:09):
So to summarize, the headline S&P 500 index doesn't tell the full story about the U.S. economy and the broader market and market leadership has clearly broadened beyond the Mag Seven. Secondly, gold has pulled back, but the longer term debasement thesis remains intact. And finally, while July 1st is a key deadline for the USMCA review, it's not a hard deadline. However, until a deal is signed and uncertainty is removed, Canadians shouldn't rest easy.

Andrew Sarna (11:42):
Thanks for listening to this week's Off the Charts. Please like, subscribe and provide any feedback on your favourite podcast player.