Buy Rating Gold, Buy Rating Soybean, Inflation Cycle

| About: SPDR Gold (GLD)

Summary

As inflation picks up we expect gold and soybeans to move up.

Geopolitical risks through isolationism.

Fed behind the curve and global government liquidity spree could drive inflation.

We think that we are about to move into a cycle of inflation. We previously were not sold on buying Gold into Brexit for a trade. Thinking about it a little longer term though we see multiple positives. The main change for us to get bullish is based on the realization that the Fed is stuck (they cannot raise rates) and so will likely let inflation out of the cage.

For many reasons prices have begun to move higher and we think central banks are limited and can't raise rates. We think one of the best plays for this is to buy gold (NYSEARCA:GLD). Soybeans (NYSEARCA:SOYB) would also be a good call based on this scenario.

We were previously on the sidelines for gold because we thought there was the risk the Federal Reserve will tighten rates and cause a deflationary cycle. After a deeper dive we think the Fed is behind the inflation curve and they are stuck and cannot raise rates. If they raise rates they will destroy the stock market. We believe they know this fact (For proof see Fed Mulls letting Market Float).

We will list the reasons why we are warming up to gold (and by default soybeans) and then take each topic one by one.

1)The Federal Reserve Is Stuck And Behind The Inflation Curve

*The period of global government liquidity spending sprees will lead to higher prices not growth.

*The Fed knows that stock markets are at risk if they tighten and so are stuck.

2) 7 or 8 Year Commodity Cycle and weather

3) Elections And Isolationism

4) Countries buying Gold

5) Dollar down

Let's go one by one.

Fed Stuck And Behind The Curve

The Fed's monetary policy is now classified as pushing on a string. It means that whatever they do it will likely not lead to the desired outcome of driving economic growth. They are stuck. They can't ease any more. Rates are already low. If they ease further there is a more serious inflationary spiral of risk.

They can't tighten, as we reported in "Fed Mulls." They know that their monetary policy drives the overall stock market and any tightening will be detrimental to asset prices.

As inflation data is picking up, Fed's hands are tied. We therefore think that inflation will rise and that will give a bid to gold.

Here are some key US inflation measures.

CPI
Nov Dec Jan Feb Mar Apr May 12 Mos
Topline 0.1 -0.1 0 -0.2 0.1 0.4 0.2 1
Core 0.2 0.2 0.3 0.3 0.1 0.2 0.2 2.2
Click to enlarge
Click to enlarge

Topline CPI has picked up of late.

Import prices
May June July Aug Sept Oct Nov Dec Jan Feb Mar Apr May
1.1 0.1 -0.9 -1.8 -1.1 -0.3 -0.6 -1.2 -1.3 -0.5 0.4 0.7 1.4
Click to enlarge
Click to enlarge

Import prices jumped.

PCE
Dec Jan Feb Mar Apr
Current Dollars 0.1 0.1 0.2 0 1
Chained Dollars 0.2 0 0.3 0 0.6
Click to enlarge
Click to enlarge

PCE, the Fed's main measure jumped.

But the Fed is not raising rates. We think this will lead to inflation.

Elazar followers know the next chart well. We show the Fed's spending spree. They are stuck. They can't move down and they can't move up.

The yellow line is Federal Reserve balances (the higher balances the more liquidity in the economy) and the green line is the S&P 500 (NYSEARCA:SPY).

Click to enlargeThe above chart says many things.

1) The Fed is pushing on a string. Even with all of their liquidity they did not get the economy on its own footing.

2) The amount of liquidity, if it does not drive growth it will drive prices, and that is inflationary.

3) The Fed is stuck, they cannot tighten. They know that if they tighten (Sending that yellow line back down) they may cause a market crash (See proof that the Fed knows that here and here).

Here's the US GDP numbers slowing despite the spending.

Click to enlarge

Here is global numbers.

Click to enlarge

Here is a chart of the yellow line of Federal Reserve liquidity zoomed-in to recent trends further showing they are stagnant. The Fed saw the negative impact they had on markets in Q1 after raising rates 100% to 50bp in December. They do not want to do it again.

Click to enlarge

As long as Fed liquidity does not come down (tightening), inflation should continue to seep into the system.

Inflation could be in an up-cycle

Here are key measures of inflation.

Soybeans, as one of the largest grains is a key driver.

Soybean spikes have led gold prices to start moving up.

The recent price spike in 2008 for soybeans preceded a huge run in gold.

Confirmation we entered into an inflation cycle year

If we look at a longer term chart it looks like we could be entering into an inflationary year.

See this longer term chart (click here). Every 7 or 8 years there is a run up in soybeans. We found soybeans to be the best fit to this cycle over other grains.

Years of run-ups in soybeans (about every 7 or 8 years)

2008-2009

2002

1995

1987-1988

1980

1972-1973

...2016 could be the beginning of the next inflation run up.

While everybody is focused on deflation, we think inflation is the more likely outcome. That is, unless central banks tighten, which, so far we do not see.

Here are some reasons why we think grain production could be down globally.

Weather has likely hurt crops.

Click to enlarge

We think these higher temperatures can disrupt crop output.

Hotter weather along with storms around the globe over the last year likely will hurt crop output this year which can push up prices.

Weak economies in emerging markets may not get the needed funding as well.

The US Department of Agriculture expects (June 2016), "This month's U.S. soybean supply and use projections for 2016/17 include lower beginning stocks, higher exports, and lower ending stocks."

Supply should be down which can give a bid to prices.

Elections And Isolationism

We've been reporting that we have been bearish on the US Dollar (see here and here). We think the main reason is because foreigners are selling US assets.

Click to enlarge

You can see the chart above that foreigners have been pulling out of the U.S. This chart has been making lower highs and lower lows.

This is sending the dollar down.

Click to enlarge

Japan has been one of the largest investors in the US which is why we show the above USD.JPY chart (NYSEARCA:YCS). We think disinvestment is driving this currency trend.

Here is the Euro (NYSEARCA:FXE)

Click to enlarge

It's possible that Brexit could be a prelude to isolationism. We think a Trump presidency, based on his stated immigration policies could lead to a domino of isolationism.

We think this could all lead investors to move to safe-haven investments such as gold. Less global trade can also reduce supply which is inflationary.

Countries buying gold

We recently reported that we see China stepping up activity in purchasing gold.

Click to enlarge

The above shows monthly net purchases by governments around the world going back through 2008. The spike recently is from China buying.

Countries were net sellers in 2008 and flipped to net buyers in 2009. The flip to buying helped launch the price of gold.

We expect countries to pick up gold purchases as they, one-by-one realize that the central bank led global liquidity splurge is leading to inflation which will reduce global currency values.

We had worried that this chart made lower lows but after further thought, the only way out for a country to protect their currency's value, we feel, is to support it with hard assets. We are not seeing this yet in a big way except in China. We expect other countries to follow which can also give a bid to higher gold prices.

Dollar Down, Gold Up

Since the dollar has been going down, gold purchased in dollars are cheaper. Foreigners can afford to buy more gold, pushing up demand, which can lead to higher prices.

Click to enlarge

Above you see the Gold ETF in blue and the Yen (NYSEARCA:FXY) in red and green. They tend to move together.

We expect, as countries defend their own currencies or move to a higher state of isolationism, dollars will continue to be sold.

As inflation picks up in the US, we think dollars will also be sold.
That will allow gold to move higher.

Risks

If the Fed decides to tighten, which could come at any time but most likely after the elections, then there is a risk to gold and the inflation story.

We'd guess that if inflation continues to pick up into the elections, gold can rise. We will know if the Fed is raising rates or plans to tighten because most likely they will inform markets. Gold will likely take a hit that day. If we see that the Fed is finally serious then we may change our tune on gold.

Until then there could be a run higher.

Another risk for gold is if stock market selling takes other assets with them. If there is a global rout we'd guess investors that speculate on gold could sell it.

Conclusion

After coming to the conclusion that the Fed is stuck (they can't raise and they can't lower rates) they have likely let inflation out of the cage. While we are early on we also see that other drivers such as country buying, weather, and cycles can drive inflation and gold.

We think it is a fair longer term strategy to buy gold in any event. This call is more for 6 months to a year. Even if the Fed were to tighten and we remove our buy rating on gold and inflation measures, we think gold is a good long term purchase to store away regardless of if it outperforms in the near term.

Good luck and please be in touch. All of your comments teach US a ton.

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in GLD SOYB over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.