Gold Prices Stable After Fall, Google Cloud AI Deal | The Pulse 10/22

Key Concepts

• Banking Sector: Barclays, Tricolor Holdings, First Brands, Investment Banking, Due Diligence, Impairment, Share Buyback.
• Luxury Goods: Hermes, LVMH, Kering, Gucci, Iconic Bags, Resilience, Demand.
• European Markets: Mixed Picture, Goods and Retail, Luxury Earnings.
• U.S. Markets: Wall Street, Equities, Performance, Competition.
• Artificial Intelligence (AI): Anthropic, Alphabet (Google), Cloud Deal, Multibillion Dollar Deal, AI Infrastructure, LLMs (Large Language Models), OpenAI, Gemini, AI Safety, National Security, Data Centers, AGI (Artificial General Intelligence).
• Currency Markets: FX, Dollar, DXY, Sterling, Yen, Dollar-Yen.
• Inflation and Monetary Policy: Inflation, CPI, Bank of England, Fed, Rate Cut, Interest Rates, Monetary Stimulus, Fiscal Stimulus.
• Labor Market: Labor Market Data, Jobs Growth, Recession Risk.
• Gold Market: Gold, Geopolitics, Debasement Trade, Sovereign Risk, Credit Trade, Central Bank Buying, China.
• Geopolitics and Trade: Trump Administration, Putin, Xi Jinping, Trade Deal, Tariffs, Reciprocal Tariffs, WTO Rules, Rare Earths, Export Controls, Sanctions, Export Controls, Blacklist, Taiwan, Gaza, Ukraine War, EU, NATO.
• European Union (EU): Sovereign AI, Regulation, Trade Policy, Security, Defense, EU Presidency, Housing, State Aid Rules, Carbon Market, Deforestation Laws.
• Life Sciences: Cambridge Biomedical Campus, AstraZeneca, Merck, Wastewater Treatment, Infrastructure, Investment.

Banking Sector and Credit Concerns

Barclays Earnings and Exposure: Barclays reported "fascinating earnings" with shares up and a share buyback announced. However, individual incidents caused pause. The investment bank's performance was described as "just not delivering" and "underestimating" market expectations, particularly in equities where it was "basically flat" compared to a 22% increase in the U.S.

A significant point of discussion was Barclays' exposure to Tricolor Holdings, a subprime auto lender. The bank explicitly named the entity and took a £110 million impairment against a single-name client. The CEO expressed dissatisfaction with this situation, stating a need to learn from it, amp up due diligence, and take extra care, noting it was a fraud situation. Barclays confirmed no exposure to First Brands, despite being approached multiple times. The transcript raises the question of whether fraud is due to one bad actor or circumstances stretching a company's finances, leading to risky behavior. Investors are advised to look for these indicators in the coming months and quarters.

Comparison to U.S. and European Banks: The comparison of Barclays' investment banking performance to Wall Street was described as "painful." While U.S. equities saw a 22% increase, Barclays' performance was flat. Barclays is reportedly looking at ways to boost performance, with suggestions of potential exits and a focus on long-term client franchise and relationships. Despite the tough competition and perceived loss to U.S. firms, Barclays aims to find an edge.

Other European Banks:

• Unicredit: Reported "pretty good" earnings, meeting most expectations, with shares up around 60% historically. However, shares slipped slightly, possibly due to some questioning the quality of earnings and a "somewhat disappointing" Net Interest Income (NII).

Luxury Goods Market Performance

Hermes: Hermes, previously seen as an "electric company that could do no wrong," experienced a crucial division that "slightly missed earnings." Despite this, the brand is noted for its resilience during tough times due to high demand for its iconic bags. The limitation, however, is its inability to produce enough bags to meet demand when conditions improve. Investors are looking to the luxury sector for a rebound, favoring brands that have been hit harder and are expected to outperform in better times.

LVMH and Kering: LVMH performed "a little better than expected" and is considered among the top contenders. Kering, however, has been an underperformer. Investors are watching for signs of improvement at Gucci, and the new CEO's plans are of keen interest.

AI and Tech Investments

Anthropic and Alphabet (Google) Cloud Deal: Bloomberg understands that AI company Anthropic and Alphabet's Google are in talks for a multi-billion dollar cloud deal, potentially worth tens of billions of dollars. This agreement signifies a wave of investment in AI firms and cloud providers, totaling hundreds of billions of dollars.

Impact on Competitors and Market Consolidation: This deal is seen as keeping Anthropic "in the game" rather than being a game-changer for competitors. The question remains about the number of AI platforms the world will need and whether this deal will help Anthropic close the gap with leaders like OpenAI and Google Gemini. The market is expected to consolidate, with a "small handful" of dominant players. Companies that have lost pace may struggle or pivot to niches.

AI Infrastructure Investment: The CEO of Coreweave emphasized the long-term nature of investing in AI infrastructure, stating it's reasonable to invest now to build intellectual property, products, and mindshare, with returns potentially taking 5, 7, 10, or even 20 years.

Data Centers and Overcapacity Concerns: There's a debate about potential overcapacity in data centers, with billions being invested. The technology sector worries about the arrival of AGI, while others question if demand will justify the build-out. Data centers have a long shelf life, but the chips within them may become obsolete in four years, creating a tricky balance.

Value in AI: Value is seen across different levels of the AI market:

• Infrastructure Providers: Currently showing the firmest strength.
• Cloud Providers: The "trunk" of the market.
• Model Makers: The "nebula rangers."
• Applications: Where the ultimate value will lie, though likely with only one or two LLMs supporting them. Venture capitalists are finding the applications space, particularly agents, to be an interesting area for the next two to three years.

Europe's Position in AI: Europe faces challenges in the AI race, with a tendency to regulate while the U.S. innovates. Concerns about "sovereign AI" and national security are rising. While some European LLM makers have ceased operations, Mistral remains a key player. The capacity to power these models is also a critical factor.

Currency and Inflation Outlook

Currency Volatility: After a significant dollar drop in May-June, the DXY has been trading within a narrow range of +/- 2%. This subdued volatility is attributed to equity markets and inflation moving in the right direction towards targets.

Sterling and UK Inflation: UK inflation data reinforced the market's expectation of a December rate cut by the Bank of England. Despite sticky domestic wage growth, the overall direction of inflation is clear. Two labor market reports between November and December meetings are expected to provide sufficient justification for a December cut.

Yen and Bank of Japan (BOJ): The new Japanese Finance Minister suggested that the "duck each e*trade" (likely referring to the weak yen policy) is probably done. Policy continuity is expected, with increased fiscal spending focused on cost of living and strategic investments. The BOJ is seen as being "behind the curve" with the steepest yield curves across G4 economies. A rate hike is anticipated by December, or as late as January, to prevent further yen weakening and support household budgets.

Gold Market Dynamics

Gold's Rally and Fundamentals: Gold's rally is described as "incredible," with narratives shifting from geopolitics and debasement to a "credit trade." While a correction has occurred, the rebound from credit space uncertainties suggests potential for a bigger correction.

Central Bank Buying: A consistent fundamental driver for gold has been central bank buying, with China increasing its gold volume by 20% since the beginning of 2024. A cessation of this buying would remove a key component of the fundamental story.

Reasons for Central Bank Buying: This buying is linked to a fear of the Trump administration using financial markets as a weapon and the need for diversification following Russia's actions in Ukraine. Central banks have shown a clear trend of increased demand since the Russia-Ukraine war.

Trade Policy and Geopolitics

U.S. Trade Policy under Trump: The next two weeks are considered "consequential" for trade policy in a potential second Trump term. Key events include the Treasury Secretary's meeting with his Chinese counterpart, the on-again/off-again summit with Xi Jinping, and a Supreme Court hearing on reciprocal tariffs. The focus is on reducing the trade deficit, though this comes at a cost to U.S. consumers, with small businesses being particularly affected by tariffs.

Shifting Geopolitical Order: The global order is shifting from efficiency to security, leading to economic friction. Sanctions and export controls have shaped global trade. Diplomacy is attempting to compensate for the disruption of the old order, with new trade negotiations occurring between countries with common strategic interests.

Europe's Position: Europe is in a difficult position, reliant on the U.S. for security and AI, and on China for rare earths and exports. They are navigating relationships and playing powers off each other. Europe has managed to align with European interests, as seen in the Ukraine situation. Diversification efforts are underway.

Rare Earths and Dependence: China's expansion of rare earth export controls has prompted European trade policy thinkers to consider the issue more seriously. However, both the U.S. and Europe have been slow to diversify away from rare earths, and this is not a quick fix.

Gaza and Ukraine Conflicts:

• Gaza: The initial phase of a peace deal, including hostage release and halting major fighting, is seen as a success, though disarming Hamas remains difficult.
• Ukraine: Trump desires a solution but faces conflicting goals. He is torn between his personal relationship with Putin and American interests. The continuation of the status quo is likely until significant economic pressure on Russia forces a solution. Europe's biggest security concern is Ukraine remaining heavily militarized, necessitating continued support.

China's Demands in Negotiations: China likely wants the removal of fentanyl tariffs, a relaxation of export controls, and an end to fees on Chinese-made ships. China holds significant leverage in current negotiations, with Taiwan also being a potential topic.

Life Sciences and Infrastructure Challenges in the UK

Cambridge Biomedical Campus Issues: The UK's ambition to be a life sciences leader is being tested by infrastructure challenges in Cambridge. Despite major investments, basic utilities like wastewater treatment are struggling to keep pace. The company responsible for wastewater in Cambridge has stated it lacks extra capacity, hindering developers and investment.

Wider UK Problems: This is part of a broader issue in the UK's life sciences sector. Companies like AstraZeneca are halting plant expansions, and Merck has pulled out of plans. There are concerns that the UK is becoming less attractive for life sciences investment, with the sewage problem exacerbating the difficulties.

EU Climate Ambitions and Competitiveness

EU Climate Commitment: The EU remains committed to its climate ambitions, recognizing their necessity for planetary survival. However, the transition presents challenges, including significant energy costs for consumers and businesses in Ireland.

EU Competitiveness: To enhance competitiveness, the EU needs to simplify its agenda, with the European Parliament needing to engage more actively. The development of a Savings and Investment Union is crucial to attract investment within the EU. Housing is identified as a key priority for competitiveness, impacting employees and investors. Simplification of state aid rules and addressing judicial reviews on planning are also necessary.

Pan-European Stock Exchange: Ireland is interested in proposals that enhance EU competitiveness, including the idea of a pan-European stock exchange, to encourage more investment within the EU.

Conclusion

The transcript covers a wide range of critical economic and geopolitical issues. In the banking sector, Barclays faces scrutiny over its exposure to a fraudulent entity, while European banks generally lag behind their U.S. counterparts. The luxury goods market shows resilience, with Hermes performing well despite minor misses, and LVMH outperforming Kering. The AI race is intensifying, with a significant cloud deal between Anthropic and Google highlighting massive investments in the sector, though consolidation is expected. Currency markets are subdued, with expectations of rate cuts in the UK and potential policy shifts in Japan. Gold's rally is driven by central bank buying, particularly from China, amid geopolitical uncertainties. Trade policy is a major focus, with potential U.S.-China negotiations and the impact of tariffs on businesses. Europe is navigating a complex geopolitical landscape, balancing reliance on the U.S. and China, and facing infrastructure challenges in its life sciences sector. The EU remains committed to its climate ambitions despite transition costs and is working to enhance its competitiveness through policy simplification and investment initiatives.