Reflation Trade?
A: Seems to be on, but for how much longer remains the question! Equities up nearly 40% in 10 weeks, gold creeking higher ever so slowly to its highs, treasuries selling off.....hmmmmmmm, sounds like a reflation move to me! The 'reflation trade' was inevitable as a result of the fed's zero interest rate policy, trillions in money printing via QE, and fiscal actions taken to stem this crisis and prevent another depression. Ben wants to inflate. Banks are rushing to take advantage of this opportunity to fortify balance sheets by raising capital through stock offerings that are dilutive for shareholders. Keep in mind that those betting on the reflation trade via equities, should think about current deflationary pressures and how cheap the company's stock is after the huge move. Also, what commodity inflation can do to profit margins down the road. An era of shrinking profit margins could be ahead of us as endgame ensues - remember, there are no free lunches.
Make no mistake about it: THE FED IS TRYING TO INFLATE US OUT OF THIS MESS!
Here is what a reflation trade looks like:
Equities UP 40% in 10 weeks
Gold UP 8% in 7 weeks
10YR Treasury Yield UP 70 basis points in 9 weeks
I gave my thoughts about using Manhattan real estate as a hedge against inflation in March:
"The combination of where we came from and what has changed that allowed the boom to take place, must be taken into account when looking into the future. In short, prices are still high and the system of credit that was in place during the boom, has deconstructed itself.The re-flation trade will move markets, and as that occurs borrowing costs are likely to rise. The fed will try to contain it when they announce an increase in planned purchases of treasury securities - who knows when they announce this. We may very well be at the beginning of an era marked by declining profit margins if this inflation trade continues; especially in the treasury and commodity markets. I'll discuss thoughts on that in detail in another post.Given the artificial lowering of rates by our fed through rate cuts, lending facilities, and quantitative easing, the snap-up of rates may be quite fierce - unless of course you think that the fed can keep low rates forever and ever, without any consequences at all. I wonder about things like, how will housing perform if mortgage rates are 200-300 basis points higher? I think early signs of inflation will move the markets that make money more expensive, and that means inflation as an unintended consequence of policy, will act to depress real estate a bit further as the latter stage of the housing cycle plays out. I want to buy towards the end of that phase, not in anticipation of it for a hedge."
Comments (12)
Noah - I agree that now we appear to be looking at a Fed and Treasury that are both supportive of aggressively inflationary moves. You may have seen on Bloomberg yesterday how Mankiw is all for inflating our way out of indebtedness. I have to say, as someone who's highly liquid, I'm terrified.
Now how to play this. TBT is an obvious play, but I think the Fed continues its QE to keep yields down. Is this your read? And if so, what's the play? Gold is EXTREMELY crowded. Ag commodities? Land?
Posted by faustus | May 20, 2009 12:17 PM
faustus - you know its so hard to tell, whats a head fake and when the actual move will come. I actually sold TBT 7-8 days ago, hoping to re-enter lower, and missed it at 48...
I have gold etfs, and calls and I am not trading out of that unless gold flies in one surge to 1500 or so, like oil did on its run
If we have a equity selloff, I think we will have another flight to safety, and I think the fed will want this with how much issuance is coming. Its setting up nicely for that 1-2 punch
recapitalize banks via stock offerings
issuance into treasuries after falloff, limit what fed must purchase
fed doesnt wat rates to rise, and will buy if they have to. I would think that has some effect short term, but ultimately the treasury market is bigger than the fed, especially in long end
tbt/pst will have its day and is a hold in long term accounts, as a hedge against inflation and possible endgame
Posted by Noah | May 20, 2009 12:23 PM
I don't think there is much chance for inflation/reflation, at least in the next 3 years, because this is a full-on credit bust. MISH's webpage has some great articles on this topic (http://globaleconomicanalysis.blogspot.com).
Even in deflation, gold and other physical commodities can go up via relative asset repricing (i.e. commodities go up, but something else has to go down).
I suspect equities are up as a result of undisclosed quantitative easing (see articles on www.zerohedge.com re: GS/JPM Special Liqudity Providers ("SLP") and Open Market Operations ("OMOs") for details).
I think we are looking at a Japanese-style, lost decade, zombie bank scenario.
Posted by Thisson | May 20, 2009 12:48 PM
im on record for stating that initial inflation, if any, will show up in commodities (energy, food, metals) and things like health care...not real estate. Eventually in real estate, yes, but not initially. Real estate has its own issues and a much less sexy system of credit in the years ahead that will cap out any V recovery
Posted by Noah | May 20, 2009 1:11 PM
Markets seem down right crazy at present. Seems to smack of indirect "manipulation" by central bank policies.
Desperate attempts to reflate the bubble (current FED/Treasury policy) will only lead to greater pain later. Only question is when. Until the underlying problem of bad debts has been dealt with there cannot sustainable growth without it.
My biggest fear is that we are headed into crazy-town again.
Posted by lars | May 20, 2009 8:15 PM
TBT, GLD, UGA, DBA
Posted by Dave | May 20, 2009 8:19 PM
i like it
Posted by Noah | May 20, 2009 8:26 PM
GLD, Oil Royalty Trusts, you pick the other commodities you want. All fiat currencies printing and you can't trust any central banks now. Even US TIPS will be manipulated with low inflation data.
Want real estate? Go buy a farm. Food is a great hedge vs. inflation.
Posted by Out there looking | May 20, 2009 10:46 PM
DBA seems to me a logical place to go. Biggest wildcard: ethanol subsidies.
Posted by faustus | May 21, 2009 7:32 AM
Noah:
I am with you 100%. I sold TBT a while ago because I did not want to be on the other side of Bernanke. However, as I wrote in an earlier post, the only places where I have been adding to positions are GDX, GLD, SLV, MOO and DBA. I own some OIH, UNG, and FCX, but have not and will not add to them right now. For the reasons that you have articulated for the past several months, the Gold and Commodity trade is now in effect. My sense is that after Gold crests above 1200 you will start hearing lots of chatter about the inflation adjusted high of 2400...That will start the bubble inflating fast. After becoming persuaded by your arguments, I have been doing a decent amount of research on all of this, and I have concluded that the fundamentals are in place for a weakening of the dollar, and an increase in Gld and AG. I am less confident about base metals in the short run, but they, as well as UNG and OIH and DBC could do very well beginning in 2011.
I am still long many of the equities I listed way back in 08, and some have made a substantial comeback (DOW, DD, NWL, AA, KFT) while others are still languishing well below my entry price (GE). I think as inflation, or a devaluation of the dollar kicks in, these positions will do just fine. I regrettably do have some small positions in what I would consider low quality stocks (IAK, XLF, XLY), but these are small and I don't mind having them around in case of a sharp rally this or next fall.
Right now, the only companies that I like as long term investments are WMT, TUP and MCD because they and others will reflect what I believe will be a decasde or more alteration in consumer behavior.
Kudos for being so prescient on the Gold thesis!
Posted by mh23 | May 21, 2009 8:04 AM
I wouldn't touch DBA. It's starting to hit the regulatory limit on corn and wheat futures because of its size. While you could be willing to pay the price of this for greater liquidity I'd still go with JJA. Then again, that's an ETN which happens to be backed by the Barclays. Pick your poison.
Posted by MeekSheep | May 21, 2009 8:09 AM
all good stuff. Personally, i have shorts on now and have taken some hits in past 10 days or so as this rally sustained itself. I still think we need a surge above 950 before a fall, but hey, thats just a gut feeling.
As for gold, its a hold in my book and I dont think you can time it. When fed announces increase in treasury purchases from 300Bln to say over 1Trln, who knows when, watch how gold and the dollar react.
Im sure many will get short gold as it nears its hihgs because every time it got there, it shot right back down. When it doesn't shoot down, you could have a short squeeze that powers it higher and fundamentals go out the window, like they did the past few weeks that saw some banks stocks up 250% in 9 weeks - wells fargo
Posted by Noah | May 21, 2009 8:53 AM