Global Macro Notes: Winners and Losers in the Fed's Inflation Game

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 |  Includes: COPX, CU, DBC, DNN, GDX, GLD, KMB, OIL, PMY, SIL, SLW
by: Mercenary Trader

by Jack Sparrow

As of yesterday, “the day after,” commodities have gone insane.

Mid-morning on November 4th, crude oil was up 2%. Gold and copper were both up more than 3%.

The Federal Reserve has expressed a desire to create positive inflation. What they are creating, instead, is a sort of non-optional material inputs tax — a hard asset rocket ride — that divides the playing field into smiling winners and snarling losers.

Among the winners:

  • Commodity producers
  • Precious metals dealers
  • Hard asset related businesses
  • Companies with ‘pricing power’

And the losers:

  • End-users of commodities
  • U.S. savers and consumers
  • Companies with no ‘pricing power’
  • Anyone who eats food, heats their home, or drives a car

The risk at this juncture is immense, not just to the U.S. economy but to the Federal Reserve itself.

For most of its roughly 100-year existence, the Federal Reserve has seen its activity wreathed in shadows. Now, by enacting this “bold experimental plan” that the whole world can see will not work — in terms of the desired impact on unemployment — the Bernanke Fed is exposing itself to harsh public review.

And it is doing so by saying to the American public: “Here is the smiling bearded man who thinks he is helping you by causing your gas and grocery bills to double.”

Given Mr. Market’s reaction, the post-QE game plan is fairly simple:

  • “Ride the wave” with PM miners, commodity producers, and other advantaged names.
  • Maintain a short bias towards the “losers” in the Fed’s doomed equation.
  • Apply the caution and dexterity requisite to mania conditions.

Have a thought for poor Kimberly Clark (NYSE:KMB).

Via Peter Boockvar of Miller Tabak, KMB reported “the highest cost inflation increase in Q3 that they’ve ever seen” on its latest earnings call, “mostly from fiber but also from polymer resin and other oil based materials.” You can see what that did to the share price.

KMB is one of Ben Bernanke’s “losers.” There will be plenty of others, as the Federal Reserve’s Keynesian suicide mission breathes new life into a stagflation / inflationary recession scenario — one in which unemployment levels are not successfully lowered, even as raw materials and hard asset prices shoot the moon.

Click to enlarge

On the flip side, consider two clear and unabashed “winners” in the Fed’s insanity quest: Denison Mines (NYSEMKT:DNN) and Silver Wheaton (NYSE:SLW) (click on charts to enlarge).

(We featured DNN in our Strategic Intelligence Report #5. Silver Wheaton was featured in Report #6. Silver Wheaton is also currently the largest equity position in the Mercenary portfolios.)

The Federal Reserve, like the government itself, is simply no good at creating jobs. There is no empirical evidence — historical, theoretical or otherwise — that blatant asset-pumping creates jobs or spurs GDP growth.

If anything, there is substantial evidence suggesting the opposite — that Quantitative Easing, the encouragement of debt and leverage, and the deliberate lowering of interest rates have a net GDP impact somewhere between nil and negative. (See Jeremy Grantham’s most excellent GMO Quarterly Letter for a tour de force explanation of this.)

What the Federal Reserve is VERY good at, in contrast, is ginning up the gambling instinct among speculators and paper asset pushers.

But even in the paper asset realm, there is a reckoning and a cost. When the Fed makes “everything go up,” to use a David Tepper phrase, that “everything” ultimately includes input costs… and thus sharply negative impact on corporate profit margins (pain for the “losers”).

One must keep in mind, too, the impact of the regressive consumer tax being instituted by the Fed.

What tax is that, you say? Again, the one that is showing up in the grocery store… and at the gas pump… and in the heating bill… and, in doing so, disproportionately hitting the poor and the middle class (who spend a higher portion of income on basic staples and necessity items).

The bottom line:

Surf the wave, but be cognizant of the real value destruction that is taking place here… and don’t neglect the growing roster of bearish opportunities — the “losers” in the rising cost-input equation, as presented by the Federal Reserve’s destructive and irresponsible actions.

Disclosure: As active traders, authors may have positions long or short in any securities mentioned. Full disclaimer can be found here.