Inflation Ahead

We've recently noticed a number of commentators referring to the inflation trade as "crowded". Meaning, we guess, that there is perception that traders are starting to load up their books with long positions based around an inflationary scenario.

Truth be told, we have some long positions in expectation of rising inflation.

Perhaps it is not being US based, but we are always mindful that inflation is currency related and will look at how currencies other than USD are performing with respect to commodity prices. We treat commodity prices as leading indicators of the price of goods.

What is inflationary for USD may not be so for GBP, EUR, AUD, JPY, BRL, etc.. and their related economies. , let us quickly look across the relationships between various currencies and commodity prices.

Commodity prices rising against: USD, EUR, JPY, CHF, GBP, CAD

Commodity prices not rising against: AUD, NZD, BRL, ZAR

So inflation is localised at the moment. Is this likely to continue? Let us examine one currency, the AUD's, relationship with commodities and see what we can discern.

Compare FXA (Aussie Dollar) against GSG (Goldman Sachs Commodity index). Initially, we can hardly determine inflationary pressure from the below graph, but looking at the Rate of Change (ROC) indicator our position changes to seeing the next likely move as being on the upside.

If we want to remove the GSG energy bias (approx: 70%) we can use the Rogers International Commodity index.

A similar pattern can be discerned and the ROC again leads us to the view of increasing inflationary pressures (commodity prices) for FAX and the Australian economy. Try the same exercise against BRL, ZAR, and NZD and you will most likely reach the same conclusion.

There is, of course, much more detailed fundamental and technical analysis that can be performed which we don't have the space & time to reproduce here. You should delve a bit deeper yourself before placing your own trades.

So, our position, at the moment, is that we do expect all the major currencies, and economies, of the developed world to experience inflationary pressure. This should mean that commodities, or physical assets used to make stuff, become the world's strongest currency.

Unusually for us, as contrarian traders, we are trading with crowd in the "crowded" inflation trade.

Disclosure: Long DBC, FXA.

Comments

[chap08:]

If the inflation trade really was "crowded", what would the yields be like on treasuries?

Aug 26 07:19 AM

[prairiedog555:]

When the market crashed, commodity stocks sunk and the dollar soared, So... if you believe that this rally is precursor to Japan style malaise for at least a few years, and the market will trend downward, what will happen to commodity plays?

And as a contrarian can you remember when the herd was correct?

Aug 26 08:23 AM

[Andy1234:]

If the market goes to crash again.....I think more and more stimulous will result......

Aug 26 08:42 AM

[conceptwizard:]

The FED is still tremedously worried about spiralling deflation at this point. If Bernanke really thought we were recovering he would have raised the interest rates.

Watch what they do , not what they say.

You have to guess which shell the peanut is under.

Aug 26 09:43 AM

[DaveW:]

Agree, significant inflation is coming....eventually. It may take some time for a true up-trending in PPI and CPI and for real monetary velocity to increase. IMHO, right here, right now, the inflation trade is built more on speculation and less on real facts.

Aug 26 10:53 AM

[clipper:]

In your charts and ROC Oscillator how do you discern between inflation and reflation?

Aug 26 12:34 PM

[Russ Wetherill:]

Not in the US. And since US consumption has driven global growth I don't see other markets seeing appreciable inflation either.

Reasons to expect deflation and not inflation in the US: 1) continuing double digit unemployment; 2) increase in savings rate above 1982 12% rate; 3) reduction in available consumer credit; 4) historically unprecedented deficits will result in tax increases, reducing discretionary spending; 5) salary freezes and furloughs further decrease discretionary spending, thereby mitigating or reversing rising CPI; 6) Cap and trade legislation forces manufacturing jobs overseas reducing skilled labor force positions in US, further exacerbating unemployment; 7) health care reform drives up federal budget requiring some form of Europe style VAT to be enacted, reducing discretionary spending; 8) stupid inflation articles are believed by the masses causing assets to be parked in unproductive commodities like gold - precipitating further economic decline due to loss of capital for business expansion or production optimization.

Aug 26 12:57 PM

[Tony Daltorio:]

The deflation trade and the related bubble in Treasuries are probably the most crowded trade in history.

Deflation is nothing more than a fairy tale dreamed up by Wall Street and Washington to sell Treasuries at near zero percent.

I am still waiting for a deflationist to show me where the deflation is, except in assets which were inflated to bubble-like levels and are merely falling back to earth.

Aug 26 02:43 PM

[Jason Rines...:]

Then why the oil spike and now sideways trading with falling demand? You make great arguments. Reality is we are seeing almost an exact repeat of the GD where all assets fell hard with the exceptions of commodities which rose between 1935-1937. The only difference this time is the rate of business which is compressing this depression event into a five year event instead of ten.


On Aug 26 12:57 PM Russ Wetherill wrote:

> Not in the US. And since US consumption has driven global growth
> I don't see other markets seeing appreciable inflation either. <br/>
>
> Reasons to expect deflation and not inflation in the US: 1) continuing
> double digit unemployment; 2) increase in savings rate above 1982
> 12% rate; 3) reduction in available consumer credit; 4) historically
> unprecedented deficits will result in tax increases, reducing discretionary
> spending; 5) salary freezes and furloughs further decrease discretionary
> spending, thereby mitigating or reversing rising CPI; 6) Cap and
> trade legislation forces manufacturing jobs overseas reducing skilled
> labor force positions in US, further exacerbating unemployment; 7)
> health care reform drives up federal budget requiring some form of
> Europe style VAT to be enacted, reducing discretionary spending;
> 8) stupid inflation articles are believed by the masses causing assets
> to be parked in unproductive commodities like gold - precipitating
> further economic decline due to loss of capital for business expansion
> or production optimization.

Aug 26 05:36 PM

[Bruce Vande...:]

Inflation? deflation? How about: "Out of Control". The FED would like a steady 1-2% inflation rate, but those days are gone. Now the window is very hard to hit. It could go to either extreme and then swing back the other way viciously, so fasten your seat belts.

Aug 26 08:08 PM

[mlonz:]

Inflation will happen, but the inflation trade is in the process of having the final wash out right now and over the fall. Lot of commodity stocks have already doubled and tripled. Should sell to buy back much lower. Just look @ TBT chart, it doesnt say inflation.

Aug 27 12:46 AM

[TheFounder:]

Inflation will happen, but will be delayed somewhat due to the stimulus funds "parking" for a while on banks balance sheets for the purpose of bringing their regulatory required capital and net worth ratios back to normal levels before continuing their journey as loans to businesses and cunsumers.

Aug 27 01:40 AM