Wednesday, February 12, 2014

Still Waters Run Deep

Back in October and November of last year, we speculated that the conventional wisdom going into a prospective taper was widely being viewed by participants through a broken prism. When Goldman declared gold a "slam dunk" if and when the Fed pivoted from their policy stance, we greatly disagreed and considered the taper broadly "bullish" towards inflation expectations and those assets closely associated with what we perceived to be a gathering reflationary tide.

"In the end, further stimulus was just more causative smokescreen for those wed to a poor investment idea. Today, as the precious metals and commodity sector continues to languish in the smoldering ruins of those hitched to this false narrative, we ask ourselves what likely will be the next upside catalyst for these assets. Does further easing provide such causative propellent and make much sense in the shadow of what transpired with QE2 and QE3? From our perspective the opposite appears more likely." A Closer Look at Gold & Silver 11/27/13

While the initial December taper was the bell that returned Bernanke ringside from another round of sparing with disinflation and the greater specter of deflation, it also signaled to the market that the Fed expected firmer and more sustainable growth; henceforth, the significant still water reservoir of monetary accommodations accumulated since the financial crisis, may finally have the potential to exert inflationary pressures that so many were concerned with years before. 

Having said that, we find it ironic - but fitting (considering the remedial wisdom of the inflation/deflation debate), that the inflationistas who foolishly rode their investment theses to an ephemeral crest in 2011- have been completely silenced by dogmatic attrition just as the tide starts to roll in. 

If nothing else, the market never fails to project a wicked sense of humor. 

A few things to consider
  • The commodity markets are breaking out and pivoting higher relative to the SPX. We think the crux of the story from an investment and market perspective is while it's a relative unknown how the SPX will handle both a pivot from historic monetary policy and a shift in inflation, for the commodity markets themselves its a win-win after navigating a disinflationary tide over the past three years. 
  • The historic ratio chart (yearly) between the CRB and the SPX presents both a positive test of the secular cycle lows found around the new millennium and a clean and supported positive divergence in relative strength.  
  • Despite treading water together in a relative narrow range over the past two years, the US dollar index and commodities should break the range and take more divergent paths. Naturally, we see the CRB and CCI indexes breaking higher while the USDX turns back down towards its 08' lows.  
  • The precious metals sector continues to be led by their respective miners. This is a notable divergence and one that our value-trap comparative has pointed towards for some time. 
  • We see real rates continuing to fall under the rare conditions where interest rates became historically stretched going into the year while inflation expectations largely improve. 
  • Commodity currencies - such as the Australian dollar, should greatly benefit from the newfound bid beneath the commodity sector. Helping things along as well is an important policy shift by the RBA.
  • Should the trend higher in commodities continue, we would strongly prefer emerging market and Chinese equity indexes versus developed markets.   
Click to enlarge images