Is Inflation Returning? Don’t Hold Your Breath
The movement of stocks, bonds and commodities since the election suggests inflation will remain muted.
By Michael Kahn
iShares 20+ Year Treasury Bond ETF
Although some now doubt the metal’s continued ability to act as an economic barometer, the sharp rise we’ve seen in the past three weeks was nothing short of spectacular (see Chart 2).
Using the iPath Bloomberg Copper Subindex total return exchange-traded note (JJC) it is easy to spot the bullish change.
iPath Bloomberg Copper ETN
And that, in turn, suggests some sort of temporary awakening, not a sea change from bear to bull.
SPDR Gold Shares Trust
But for now, I would expect more sideways action than a new bull market.
The second is a soaring U.S. dollar. Since most commodities are priced in dollars, they tend to move in opposite directions and that could be the reason for recent weakness. Gold priced in euros does not look as weak as gold priced in dollars.
The bottom line is that a flat to weak gold market suggests inflation expectations are still rather low. If the dollar rally stalls – and the dollar index itself is fast approaching major chart resistance – then gold might get a chance to recover more.
As with everything in the wake of this most historic election, conditions seem to be very fluid. If copper continues to rally and gold manages to turn itself around, then perhaps the markets will see inflation. For now, weak bond and interest rate sensitive markets do not seem to be enough of a reason to expect inflation for quite some time.
I will let the dismal scientists ponder what the Trump Administration will mean for inflation expectations but there are a few clues we can glean from the markets. while interest rate sensitive areas such as bonds, utilities and high dividend paying stocks are indeed weak the performance of selected commodities barely suggest that inflation is on the horizon.
Let’s start with the gorilla in the markets, the U.S. Treasury bond. Charting its proxy, the iSharesTLT in Your Value Your Change Short position exchange-traded fund (ticker: TLT), we can see that the bears went wild after the election results came in (see Chart 1). However, it is important to note that the ETF was already in decline since July. At that time, the polls, the pundits and a good deal of the population still doubted that Donald Trump would win.
Despite nearly everyone being wrong (Jeffrey Gundlach predicted a Trump win in January), the market already sniffed something that it did not like. Perhaps it was simply a technical condition of being overbought on long-term charts and at a resistance line trading back to the financial crisis. Fortunately, a chartist does not have to know the reason behind any move, only that the market reacted.
And that reaction of falling prices tells us that interest rates are rising as price and rates move inversely to one another. The question is how low will the ETF fall? The chart shows a supporting trendline in the $118 area (the ETF traded at $121.90 Monday afternoon). There is also horizontal or regular chart support in that area from the middle and late 2015 lows so the current decline is still well within the realm of a normal correction in a rising market.
For interest rates, that suggests the current spike up is also not the start of a runaway increase in interest rates. A long-term chart of 30-year Treasury yields shows the major trendline coming into view in the 3.5% area and I expect it to be near 3.4% by the time the market reaches it. The yield Monday was just a hair under 3%.
While rates back up, we should look at commodities and the most obvious change is in copper.
The question is whether it is a long-lasting change and this is where chartists will argue. A regular linearly scaled chart shows a long-term trendline breakout while a logarithmically scaled chart does not. Given the amount of time and tremendous percentage price change since the 2010 peak I will defer to the latter style.
Again, the rally began weeks before the election so something was already in the air. Or maybe it was a simple case of a bear market that ran its course, forewarned by a bullish divergence in momentum indicators. The simple explanation is usually the best both inside and outside the markets.
That brings us to gold, the traditional hedge against inflation. Judging by how the SPDR Gold Shares Trust GLD GLD in Your Value Your Change Short position (GLD) tanked after the election it would be easy to say that the market does not consider coming presidential policies to be inflationary (see Chart 3). The initial knee-jerk was higher but by the close of trading the day after the election the entire gain was gone.
As with Treasury bonds, gold peaked in the summer and was already in a long-decline before.
Curiously, bonds and the yellow metal were fairly well correlated over the past year so seeing both react this way now should not be a surprise.
But since I last covered gold here the technicals have changed for the worse. In August, I wrote that gold bulls should be patient as that market pulls back from long-term resistance. I also wrote that the 200-day moving average – and corresponding 40-week average – provided resistance in last bull market and support in the last bear market. At the time, the averages were not in jeopardy.
They were broken in earnest last week. I have no choice to put my optimism back on the shelf. While I still believe the bear market from 2011 is over we need a raft of new technical evidence to suggest the 2016 pullback is over.