Could It Be Time For The Inflation Trade?

For many months, the economists have been telling us there that deflation is going to be our main concern, not inflation.  What’s deflation look like?  In 2008, stocks went down, commodities went down, real estate was down, bonds were down (with the exception of U.S. treasuries), emerging markets were down.  That was truly deflation.  Fast forward a few months, and we see that stocks have rallied tremendously, along with REITs, emerging markets, commodities, bonds, and every other risk asset.  But, they are still calling it deflation.  So, how can we have deflation when all theses different asset classes are going straight up?  We’ll let the economists continue to debate over what you call it.  Meanwhile, you & I can continue to make money from owning these assets.

Many people confuse rising commodity prices with inflation.  The Fed did this very thing when they started raising interest rates a few years ago hurting not only the United States economy, but the global economy.  Rising commodity prices isn’t always inflationary.  The reason we are seeing rising commodity prices is simply supply and demand.  There aren’t enough resources around the world to produce the goods and feed the rest of the world.  When something is scarce, the price of it rises.  When it’s plentiful, the price of it falls.  Right now, resources people need are scarce and things like American labor and the U.S. dollar are plentiful.  That’s why resources are rising and the dollar is falling.

But, it’s not just about the definition of inflation.  It’s also the perception.  Many people around the world are worried about inflation, whether it’s next week or next year.  And that fear of inflation is ramping up in a hurry.  Let’s look at some the “inflationary” trades that are working.  The dollar is falling to new lows daily, commodities are going up, gold & silver are going up, and today the interest rates started to rise.  So, whether or not we really have actual inflation, the fact that the public believes there is inflation around the corner, those “inflationary” investments are going up.  I own some of these not because they have to do with inflation, but because they are going up, including gold.  Sometimes stocks go up because they are in high demand, not because the fundamentals are improving.  It’s the same thing with “inflationary” trades.

This brings me to interest rates.  Over the past few years, we’ve been long treasuries and short treasuries using various mutual funds and ETFs.  One of the best trades in the early part of 2009 was shorting U.S. treasuries and going long almost every other type of bond betting on credit spreads tightening.  But, since June, interest rates have been moving down.  Thus, we’ve been avoiding shorting treasuries as tempting as it’s been.  In fact, several weeks ago I mentioned going LONG treasuries for a trade.  But, now may be the time to short them once again.

Treasury rates on 10-year treasuries fell to 2% in late 2008.  By June as the risk appetite returned to the market, rates went to 4%.  We have now fallen halfway down to approximately 3%.  Interest rates are the last part of the inflationary trade.  If anyone is scared of inflation, this will start to move.  I talk to many people everyday.  Their main concern is inflation and the value of the U.S. dollar.  Those are the people buying these types of securities.  Everyone knows about ETFs like the Proshares Ultrashort Lehman 20+ Year Treasury ETF (TBT).  When rates start to rise, they jump on this.  We’re just at the point where investors may start dipping their toe.  In fact, today we saw TBT trade with the most volume we’ve seen in months and go up over 2%.  This came after some hawkish comments from Ben Bernanke.  If TBT goes above $45, it’ll break the downtrend since June and I think more money will start to pile in, especially if investors decide to take some profits in gold and want to re-allocate to other inflationary trades.  Keep an eye on it.

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4 Responses to “Could It Be Time For The Inflation Trade?”

  1. 1 James October 9, 2009 at 1:44 pm

    Party like its 2009! Stocks will go up forever, 1500 SPX by year end!

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