The Rise of Inflation Premiums

Includes: DBC, GSG, MUB, SLV, TIP, UST
by: Thomas MacLeod

We are not alone in believing that the seeds of long-term inflation were sown, nicely watered and nurtured by the recent massive cash injection to the US economy.

Others have been quite vocal in declaring that the we are quite wrong; they are certain that deflationary conditions will abound.

We are happy to be proved wrong, but simply cannot see any fundamental or technical deflationary indicators. This article will provide a quick overview of one of our favourite tools used to determine inflation/deflation.

In this exercise we compare the performance of inflation-protected bond mutual funds relative to the US 10 year. The TIPS relative to the US 10 year could also be used. For the purpose of this exercise we have chosed mutal fund performance as this does tend to iron out some volatility. We then compare the results of this test against commodity trends.

What we have below is two of the bigger inflation-protected mutal bond funds relative to the US 10 year, ACITX and VAIPX. If we can see outperformance on the part of the inflation-protected side of things, then we have a reasonably clear indication that there is a rising expectation of inflation, measured by the increasing premium.

Unsuprisingly, the top two charts are almost identical, with both reaching multi-week highs recently. They are also showind a very consistent rising trend as of December last year.

Keep in mind how the bottom chart (NYSEARCA:GSG) has an almost mirror-like appearance, albeit with an offset of around 3 months. The bond market does tend to be more efficient, so you can use the behaviour of inflation-protected bonds as clues to the likely future commodities performance.

Mr Deflation did pop around for sherry and cake, but it seems the market told him..

"Could you close the door, please? No, from the other side." (Gil Grissom - CSI)

We are listening to the market and have positioned our trades accordingly.

Disclosure: Long TIP, DBC, SLV