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.

 

US 2yr & 10yr note yields and recessions. The spread between 2 year and 10 year yields as a proxy for the steepness of the yield curve. [PT]

 

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!

 

Investment Impact

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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Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.

   

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8 Responses to “Incrementum Inflation Signal Update – A Reversal To “Rising Inflation””

  • oroboros:

    Wishing you the best, Pater. I hope you’re doing well.

    “Hopefully our missives helped you navigate the treacherous waters of the financial markets this year. As our low posting frequency attests to, we unfortunately continued to be incapacitated by our poor health. Nevertheless, we did our best to chronicle the growing cracks in the bubble edifice.” – Pater Tenebrarum, December 24th.

  • Treepower:

    Missing your wit and wisdom, PT. Hope you’ll be back on form soon. The absurdities are piling up.

  • Hans:

    There is certainly no inflation of threads on
    Actingdead-man.com.

    I am afraid the end is hear.

    Now disconnecting bookmark.

    Sad, very sad to lose you. Thank you Pater and Mr Gordon.

  • Wombat:

    AUD is compared to what? USD
    Looks like AUD about to break to upside with strong reversal likely by this months end after being in strong downtrend since 2011.
    I am not a prophet

  • philc2:

    I fail to see how the authors see an opportunity in investing in the Australian dollar. As an Australian I am aware that our country’s wealth depends on our exports and the top five exports and their contribution to our total exports were as follows (2017 figures):

    Iron ore – 23%
    Coal – 19%
    Liquid fuels – 9.6%
    Gold – 6.2%
    Aluminium – 2.7%

    The main customers of these commodities (apart from the gold) are China, Japan and South Korea. All of these are in economic trouble and any drop-off in demand for these exports will have a significant effect on the Australian economy and hence the Australian dollar.

    A second factor is that the real estate market here is now weakening, prices are falling and the Government is getting worried that people are losing confidence. There is now a mood in the market that the Reserve Bank will drop interest rates to slow the fall in activity in the real estate market and keep prices stable. This must be a factor in deciding whether the Australian dollar is worthy investment material.

    I wonder if the authors have considered these points? Or perhaps I have misunderstood their strategy quoted as “we are building positions in commodity currencies (CAD, AUD, RUB)” and they really mean they are shorting them?

    • TheLege:

      Phil, I agree with you that the picture is not as straightforward as the authors paint.

      Their position is that the price of commodities is on its way up and therefore the currencies will do the same — they are going Long the commodity currencies, zero doubt. This trade would have been standard fare in the past but I don’t necessarily think it works this time round because commodity prices might well be rising into a global recession (IMO), with demand (paradoxically) dropping off as prices rise (stagflation as the authors suggested).

      The Long Commodity Currency trade also assumes upward pressure on interest rates, which in Australia’s case would be yet another nail in the coffin for the housing bubble (already under the pump, as you say). Once investors realise the RBA are trapped at close to the lower interest rate bound, you would assume any enthusiasm for the AUD would wane pretty quickly and it would tank. Both government and RBA policy from here on will concentrate almost entirely on trying to prop up the property bubble which is bad news (all day long) for the AUD.

      The only question in my mind is how much inflation the RBA is willing to ensure before they feel compelled to raise rates.

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