Cue the Inflation Trade

What's wrong with a little inflation? With almost all asset values in freefall, a little inflation would be a good thing right? It could mean salvation for the housing market and make it easier to repay the $10 trillion federal debt. Don't think the federal government isn't aware of that fact.

Of course, you can't have inflation during a recession, or can you? Over the past 50 years, annual CPI inflation hit double digits just three times. Two of those years, 1974 and 1980, saw negative GDP growth but annual CPI jumped 12.2% and 12.4% respectively. The other year was 1979 with 13.3% CPI growth on the eve of the first quarter 1980 downturn.

The U.S. is once again in a recession and therefore the Fed's printing press is pumping out money at a shocking rate. In the week ended Sep 22, the narrow M1 money supply swelled by 4.3% to $1.47 billion. For some perspective, it took 4 years to grow M1 by 4.3% prior to last week's jump. The current annualized seasonally adjusted 13-week growth in M1 is 8.8%. This dwarfs the year over year M1 growth rate of 2.6%.

The broader M2 money supply is currently painting a contradictory picture. M2 is up only 2.4% on a 13-week annualized basis. Due to the money multiplier effect, M2 is typically much higher than M1. Year over year M2 is up 5.8%, more than twice the expansion of M2. The weak M2 growth and declining velocity of money reveal the dire economic straits we are in.

How quickly things change. On July 2nd, I wrote "The inflation trade is Out, the Recession Trade is In". Now the inflation trade is already beginning to reward investors in the precious metals sector. In less than a month spot gold advance as much as 24% to hit $920 on Sep 8 (kitco.com).

After an initial flight to quality, the 10-year Treasury note is backing up in a big way. Over the past three sessions its yield has advanced to 3.77% from just 3.43%. Bloomberg reports the 10-yr TIPS note spread fell to 0.93% on Wednesday its lowest level since Jan 1999. This is a clear signal of inflation expectations.

Other commodity related industries including chemicals, coal, energy, metals & mining are mixed. Most are weighed down by their close ties to the business cycle.

On Thursday afternoon, expect another significant jump in M1. The M2 growth could accelerate from its subdued pace. The inflation pipeline ran dry during the third quarter commodity crash, but now with the Fed priming the biggest pumps ever assembled, inflation is just a question of when.

What's wrong with inflation? Just about everything, unless you are up to your ears in debt - like Uncle Sam.

Stock position: None.

Comments

[Smarty_Pants:]

Inflation hedges:

Booze, cigarettes, soap, silver, gold, long lasting food supplies, guns, ammo, gasoline. Stock up now before it's all gone or too expensive to buy. Avoid the last minute rush.

2008 Oct 09 02:58 PM