Introductory Remarks by PT We have discussed the proprietary Incrementum Inflation Indicator in these pages on previous occasions, but want to quickly summarize its salient features again. It is a purely market-based indicator, this is to say, its calculation is based exclusively on market prices and price ratios derived from market prices. However, contrary to most measures of inflation expectations, the Incrementum Inflation Signal is not primarily focused on yield differentials, such as is e.g. the case with 5-year breakeven inflation rates. The 5-year breakeven inflation rate is derived from the differential between 5-year treasury note yields and 5-year TIPS yields. Interestingly, it has recently begun to tick up as well after
Mark Valek and Ronnie Stoeferle considers the following as important: Central Banks, Chart Update, Precious Metals, The Stock Market
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Introductory Remarks by PT
We have discussed the proprietary Incrementum Inflation Indicator in these pages on previous occasions, but want to quickly summarize its salient features again. It is a purely market-based indicator, this is to say, its calculation is based exclusively on market prices and price ratios derived from market prices.
However, contrary to most measures of inflation expectations, the Incrementum Inflation Signal is not primarily focused on yield differentials, such as is e.g. the case with 5-year breakeven inflation rates.
The 5-year breakeven inflation rate is derived from the differential between 5-year treasury note yields and 5-year TIPS yields. Interestingly, it has recently begun to tick up as well after declining sharply for several months.
The Incrementum Inflation Indicator instead focuses on the prices of traditional inflation beneficiaries (several of them are mentioned below), many of which tend to lead CPI by a considerable margin.
The indicator has recently switched from “falling” to “rising inflation”, which has important implications for investors. Below follows the official announcement of the shift by our friends Mark J. Valek and Ronald-Peter Stoeferle, the co-managers of the Incrementum fund family.
The Incrementum Inflation Signal Reverses – by Mark J. Valek and Ronald-Peter Stoeferle
Growing Concerns About Economic Growth
As of the beginning of January, our proprietary inflation indicator has switched from “FALLING INFLATION” to a full blown “RISING INFLATION” signal.
The reversal was triggered by the latest development in the gold/silver-ratio, which has weakened from 87 to currently 83. Moreover, gold mining stocks (HUI) broke out vs. the broad equity market (SPX) and gold itself also switched to a long signal. Only the broad commodity market (BCOM) still shows a somewhat lackluster performance, but seems to be in the process of building a base as well.
In our view, one can make a reasonable argument that gold is entering the next stage of its bull market. Miners seem to have put in quite a solid bottom, too. Our assumption was confirmed by the most recent surge in M&A activity (Randgold & Barrick, Newmont & Goldcorp).
We think the strong move in precious metals is the proverbial “canary in the coal mine” for a weaker USD environment, a rise in commodities and ultimately increasing price inflation.
As we have discussed in various publications, we still take the view that the Fed will eventually have to make a “monetary U-turn”. This will include falling interest rates, the end of QT and sooner or later another round of QE.
Quite recently growth concerns have increased globally. Central bankers are increasingly worried about faltering growth and it seems that a synchronized economic downturn might be on the horizon. In fact, the ECRI’s Weekly Leading Index is nearing decline rates that have foretold either recessions or, in the post 2008 world, incremental Fed/Central Bank liquidity injections.
ECRI Weekly Leading Index – Growth Rate (%). The WLI growth metric is quite useful as a leading economic indicator. For details on its construction see here. It currently sits at a 6-year low. [PT]
Running Out of Wiggle Room
Therefore, the global economic situation hardly provides much leeway for too many more rate increases, especially in combination with QT which has moved to its full extent of 50bn USD per month as of October 2018. Since then, financial markets have already felt the tremors of collapsing liquidity.
As has been pointed out quite frequently, the yield curve has steadily flattened, which indicates that the rate hike cycle may be coming to an end sooner rather than later.
Chances are, that we are now entering an environment of stagflation which we have been warning about for a long time. Once it is obvious that the normalization process of the Fed is faltering, we expect the long overdue depreciation of financial assets relative to real assets to begin.
S&P 500 (left hand scale) & Bloomberg Commodity Index (right hand scale). An enormous gap has opened up between the valuations of “paper assets” and “real assets”. This is reminiscent of the late 1990s. [PT]
Stimulus is Already Underway
On the back of this development the price action of gold is looking very healthy and rising financial market risk will present a significant driver for gold demand.
Moreover, recently commodity prices in general also seem to show some signs of life. As we have outlined in last years “In Gold we Trust Report” a suspension (or even a reversal) of the rate hike cycle would be huge news for the commodity and especially the precious metals sector.
Moreover, we have been pointing out the potential of a slowdown of the Chinese economy that has already caused the PBoC to intervene aggressively. Also, China now seems to be implementing fiscal stimulus as well.
As was just announced, tax rates on individuals and corporations— as well as VAT — will be cut. The Ministry is even considering ways to reduce social security fees to ease pressures on small companies. We believe that Western central banks and governments will (have to) follow the lead of China soon!
We are currently increasing our allocation toward the precious metal sector, which has undergone a pronounced phase of creative destruction. Considering the recent change of momentum, we are looking at gold miners, with a slight overweight in mid-tier companies as well as silver miners. Furthermore, we are building positions in commodity currencies (CAD, AUD, RUB), diversified commodity investments (BCOM) and some EM exposure.
Ladies and gentlemen, we believe that current valuations in inflation sensitive assets are a tremendous buying opportunity which we want to take advantage of.
Best regards from Liechtenstein,
Mark J. Valek & Ronald-Peter Stoeferle
Charts by: St. Louis Fed, Advisor Perspectives/Doug Short, Incrementum
Chart captions by PT
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