Paul V. Azzopardi's  Instablog

One problem with pumping oceans of money into world economies is that no-one can say where they will eventually erupt.  Is the magma we had to print turning into lava and nasty volcanoes?

I am still of the opinion that ominous creatures still lurk beneath the bubbly surface of many markets – what we see crawling are speckled vipers not green shoots.  In a way, it got worse these past weeks.  I thought there was slightly more than even chance of deflation, with inflation a distant threat.  Now I think I smell the sulfur of the first rude eruption of inflation.

 Quite an eruption, as we can see.  DBC (commodities) is up by 31% and SPY (S&P500) up by 39% since early March.  IOO, the international equity ETF, is also up a similar amount, closely shadowing SPY.

But notice that DBC hesitated between mid-March and early May, it temporarily stopped following SPY higher.  For more than a month, commodities were not confirming US stocks presumably because the market did not believe that the green shoots were real enough to justify second thoughts on previous thinking about deflation being (slightly) more probable than inflation.

I next plot TLT (20+ years US Treasury Bonds) against DBC and this is the interesting thing we get:

Both commodities (DBC) and long-term Treasury Bonds (TLT) were hesitating until late-April/early-May but they then threw in the towel and rushed to form a cross.  This means that both commodities and  interest rates (the yield on falling Treasury Bonds) practically took off together. 

This is quite a clear confirmation that, in late April and early May, the market’s thinking changed, dumping a fear of deflation and starting to fear inflation.

As to equities, the market seems to have an appetite for US equities (SPY), European equities (VGK), and emerging markets (EEM), although, as expected, the pace varied.  (For example, during the last three weeks of May, the US main markets seemed to be getting tired.)

The following graph shows gold (GLD) and silver (SLV), both acting in conformity with commodities. 

Energy and agriculture (not shown) are following commodities as well.

And, in the meantime, what is happening to the US dollar versus the other major currencies ?

 Notice the sharp fall starting in late April as the inflation scenario took hold, the dollar piercing the recent low set in mid-March, when the supposed green shoots started getting perkier.

Points to ponder:

•  It seems that equity valuations have been cushioned from sharper falls (and more appealing prices for buyers) by the “wall of money”.  It is difficult to argue that March prices, let alone today’s prices, offered cheap stocks.  At the same time, despite the Fed’s efforts, long term interest rates are rising.   These conditions usually make for weak holders and very choppy markets since they increase uncertainty.
•  If commodities, energy, and precious metals are not dead cats bouncing, we are already in the process of creating various future bubbles.  Worse, it seems this time there will be bubbles across the board.
•  If medicine is not to turn into poison, monetary authorities around the world must urgently review the “zero interest” and quantitative easing policies they adapted to fight the crisis. 
•  For bubbles not to form, money must have its own income stream and money must be perceived to be a scarce commodity, not easily printable.  Otherwise, nobody in his or her right senses will hold money but instead buy something else.
•  The big test is: can the authorities bite the bullet and raise interest rates with unemployment still on the increase?  If not, prepare yourself for some serious inflation and bubble-mania.
•  With widening fiscal deficits and mounting debt, maybe a falling US dollar and inflation will come to be seen as saviors, after all.  If the market seriously starts to believe this, one would prefer to open Pandora’s box.

The charts here are courtesy of StockCharts.com.  This article does not constitute advice, a recommendation or an offer or solicitation to buy or sell the securities mentioned.  This article is for information only and expression of an opinion and the ETFs mentioned are used only to illustrate the movements of the assets discussed.

 DISCLOSURE:  Long position in SLV.  No position in the other ETFs mentioned.