Choosing Between Wall Street and Main

If inflation drives people to park money in gold – including securitized pools such as streetTracks Gold ETF (GLD) – then judging a purchase today comes down to choosing between Wall Street and Main.

"Investment funds and pension funds are still in the early stages of taking in interest in commodities," believes Jill Leyland, economist at the World Gold Council [WGC].

"We think there is more to come there. While some investors are judging the worst of the financial crisis to be over, inflation remains a major concern."

"With gold viewed as a hedge against inflation, it could take good support."

Yet inflation-linked US Treasury bonds [TIPS] point to a drop in inflation rates by next January. Consumers and business owners, on the other hand, expect the cost of living to shoot higher.

The University of Michigan's latest survey of consumer price expectations puts average forecasts at the worst level since 1982, way up there at 5.2% per year – far ahead of the already woeful 3.9% reported for April '08.

The percentage of small US business owners citing inflation as their No.1 concern also reached a 26-year record last month – up at 14% of respondents – on the monthly survey from the National Federation of Independent Business [NFIB].

Almost one third of independent business owners said in April that they plan to raise their sales prices – "reminiscent of the 1970s as companies raise prices even under conditions of weak domestic demand," says Tim Bond, head of asset strategy at Barclays Capital, in today's Financial Times.

Treasury Inflation Protected Securities [TIPS], in contrast, are pricing inflation at 2.95% for Jan. 2009 – "in line with its average of 3.1% over the last 20 years," as Bloomberg notes, and almost 100 basis points below the current rate of increase.

"The disparity [between consumer and bond-market inflation forecasts] has never been wider."

What to make of it? Since launching in 1997, TIPS have been shown as imperfect inflation forecasters thanks to the "liquidity premium" that bond buyers pay for conventional fixed-income from the Treasury. TIPS make up less than 10% of the entire US government bond issue, after all.

But unless the big bond funds are genuinely happy to sacrifice their clients' purchasing power in return for further Fed rate cuts, the broader T-bond market also points to a sharp fall in Wall Street's inflation expectations.

The yield on plain vanilla US Treasuries currently stands just shy of April's headline CPI reading at 3.83% annually. The long-term real yield paid above inflation, however, stands at 2.59% – the long term being 55 years of St.Louis Fed data.

Whether you're sitting in Gold, bonds or TIPS right now, where you stand on inflation depends on a choice between Wall Street and Main. And with producer prices rising sharply in April – even ex-food and fuel – just maybe the bond market is badly mis-pricing inflation.

Comments

[Cobradon:]

The US's CPI should include food and energy, it would make the inflation story easier to forecast...

2008 May 21 07:54 AM

[dieuwer:]

The yield on Treasury debt instruments has ZERO correlation with the actual rate of inflation.

Example: FED prints money and hyperinflates the money supply. Next, FED buys treasuries by the boatload. As a result, yields come down.
Conclusion: money printing leads to hyperinflation, but is not reflected in the yields of treasuries.

To prove this, plot the ratio of gold divided by the price of 30 - Year treasuries, i.e. $GOLD/$USB. It is going UP, i.e. INFLATION.

2008 May 21 08:19 AM

[ussmls7:]

I have voiced my views on inflation readings by the Fed to my Senator, that sits on the commitity, Banking & Finance! His replyed, by a phone call, Stateing that He had the same concerns, but with out help from other ranking members, his proposed changes in the Fed's way of doing things, was a slow process! I ask how far would the Fed go? Choice being ruining, Savers, Retired & Disabled or support the Wall Street Elites? No anwser!
Inflation numbers, kept low by the Fed, save them Billions in funds, to bring the Retired & Disabled up to the true inflation COLA! The Fed cares not of their fight to get by, thus they tap all there savings, build up big Credit Card Debt, thus adding to the next bubble! Untill sane minds, take back the control, that the Banking Cartels have on all, Danger looms & people do not see it. Gold & Silver, are the choice for many, but main street is jumping on Silver fast, & not just in the U.S.A., there is great reading on siverseek.com. A fight to truth!!

2008 May 21 10:28 AM

[Jimbo:]

Knowledgeable people have lost faith in the willingness and/or capability of the government to manage the currency ethically and intelligently.

2008 May 21 01:38 PM

[User 175117:]

It's a known fact that the Fed has morphed the tools used to report inflation some time ago, presenting a watered-down version of where inflation truly sits. Also, I wouldn't put it past the Bush Administration to have put pressure on the various Federal agencies reporting CPI and labor statistics, among others, to present the economy in the most favorable light. The fundamentals tell a different story that Wall Street, and Joe-6pack investor, don't seem to want to believe. It's difficult to trust the news/hype that comes from our Government any more.

2008 May 21 08:25 PM