Wednesday 2 March 2016

Metals - The path to inflation.


Many folk are debating whether the bounce in stocks is just a bounce or if a base is in. Many more are also in fevered debate over the intricacies of whether there are hints of slowdowns in deflation in country data. Meanwhile an elephant is lumbering around the room unnoticed, helping itself to their sandwiches. Metals. The rise in the price of metals has been continuing quietly for a while now, but for those of you who haven't been watching here's a charty catch up 




Iron



Nickel 



Zinc

And finally my friend Dr. Copper who has not disappointed in accelerating upwards through the resistance levels previously highlighted. 




Oh, and lets throw in Oil while we are at it for chart comparison purposes  


The moves in many started last year and a few of them only blinked in the great February sell off that was portending global doom. Country specific responses have been quietly on the move too. Whilst we were all focused on European banks, recessionary fears and the path of US interest rates the likes of Peru have shrugged off all of the things that would normally see it cratering and has been rallying strongly since January leaving it handsomely up on the year. Below is the Peruvian (coppertastic) market ETF - 'EPU'. there are a few Developed Markets that would give their eye teeth for a 15% up performance on the year. (In fact the whole of Latam is going great guns).



Metals are clearly telling us that this is more than a dead cat bounce in the growth story. Price rises in commodities have always been the root of all evil, when inflation was evil, but it is not now - inflation is the holy grail. So follow metals closely.

Commodity prices have always had a feedback loop that reinforces their direction. Prices start to rise on real demand and those rises push up inflation. What do you buy when you expect inflation? Commodities. And off we go in a 2005+ price push sucking in speculators and inflation hedgers.

In a negative interest rate world metals get another boost. the cost of holding them vs cash is dramatically reduced. Whilst many see gold as the escape route from negative yielding cash don't forget that any old metal will do. we are escaping negative rates not the end of the world in this scenario and so the requirement to carry your total wealth sewn into the lining of your coat or buried in your garden is bypassed. Whether you buy an ounce of gold or a ton of nickel is immaterial.

The transmission of Negative Interest Rate Policy is mostly discussed in the context of 'encouraging' banks to lend and companies to borrow and spend which will ultimately lead to inflation. But that isn't the only route. In a negative interest rate world metals get another boost as the cost of holding them vs cash is dramatically reduced. Whilst many see gold as the escape route from negative yielding cash, don't forget that any old metal will do. As we are escaping negative rates, rather than the end of the world, the requirement to carry your total wealth sewn into the lining of your coat or buried in your garden is also negated. Whether you buy an ounce of gold or a ton of nickel is immaterial.

So I would suggest that the direct path to inflation will be through the rising price of raw materials and as soon as that is sniffed speculative flows will bring it on all the faster.

It is also worth noting that the prices above are in USD terms. In the UK or Europe where the USD has been rallying, the inflationary impact is even sharper. With so much riding on the next ECB meeting with regards to policy easing, the risk for disappointment is only hightened.

6 comments:

nihoncassandra said...

Good points....love this:

Commodity prices have always had feedback loop that reinforces their direction. Prices start to rise on real demand, this pushes up inflation. What do you buy when you expect inflation? Commodities. And off we go in a 2005+ price push sucking in speculators and inflation hedgers.

However, you seem to dismiss "short-covering" with a pejorative tone which is deserving only by the most mindless feedback traders themselves (CTAs). While ultimately feedback loops do just that - divergently-loopy things to prices - there is all-too-often an abyss between the closing of one trade/meme, and the nascent beginning of it's next secular move. Even in a FFwd-world, this is likely measured in years - and could extend to a decade. So as H.Keitel's Pulp Fiction character "The Cleaner" said: "Let's not start...https://www.youtube.com/watch?v=fTN7Mhv59KA

Polemic said...

But there's the rub Cassy, short covering in most markets just drives psychology in that market. In this market it is driving actual inflation which in itself triggers the flip to actually going long .. "because inflation is going up innit' . .rather than just going long because of price trend.

Or do we strap the whole thing together and say inflation is going up on short inflation covering ? :-)

either way .. the feedback works hard.

Anonymous said...

Respectfully disagree.

Commodities ramp up 2009 to 2012. Trade sideways from 2012 to 2015. From 2009 to 2015 there is infrastructure build, massive debt issuance based on 2012-2013 price strips, and real money (PE funds, SWFs, EM development banks) coming in. So you have massive supply built up of which commodity owners are using their idle and mounting inventory as collateral for yield. As many have mentioned in MM blog - too much stuff, not enough takers.

For a ST trade, sure - a little bounce. But too much supply wanting to catch a bid I think.

TK Texas said...

"As we are escaping negative rates, rather than the end of the world, the requirement to carry your total wealth sewn into the lining of your coat or buried in your garden is also negated." I do love the writing and humor of Brits.

Corey said...

Happy belated Pol! Seeing a lot of comm/energy related basket cases really come to life. In other words just about every short sellers favorite stocks have all turned to red hot pokers all at once. How sustainable is something like that in our current environment or what I guess Im getting at is could it be the trigger for another leg higher?

I Will Never Accept The Terms of Service said...

Commodity prices tend to ramp up in the second half of a secular DM bull market, don't they?