Haven't we seen this movie before? The economy enters a recession; we have a bear market, the Fed cuts interest rates drastically flooding the global financial system with cash, and commodity prices begin to soar.
In the United States, the Fed has a handy way to ignore rising commodity prices, something they call core inflation. While most of us eat, drive, and heat our homes, the Fed excludes food and energy from its core inflation reading to remove "volatile" components of the inflation equation.
A March 3 Financial Times article touched on the Fed's current focus in terms of inflation and monetary policy "“ the key points related to the commodity markets are below:
Most members of the Fed's rate-setting Federal Open Market Committee have remained steadfast in their preference for looking at core inflation. Core consumer prices, excluding food and energy, were up by 1% vs. a year ago in January, while the headline index rose by 1.6%. "The Fed remains focused on core inflation at the consumer level, which it thinks will be restrained by high unemployment, and largely dismisses higher food, energy, and commodity prices," said John Ryding, chief economist at RDQ Economics.
The Fed carries our monetary policies, including quantitative easing, by giving freshly printed cash to the network of eighteen primary dealers in exchange for bonds in the dealer's inventory. Since the real world implementation of monetary policy, including QE2, floods the global financial system with cash, it is easy to understand how some of this money finds its way into the global commodity markets. Since we believe the Fed's role in today's asset markets is more significant than even what is perceived by experienced investors, we published a series of articles on Quantitative Easing and Asset Price Inflation in October 2010. Since then, commodity prices have surged. Understanding what QE is and how it works can help you make better investment decisions.
If excess liquidity is making its way through the global financial system, it is helpful to know where the majority of funds are flowing in the commodity complex. Ciovacco Capital's proprietary asset classing ranking models compare 220 different investment options around the globe, across market sectors, and numerous asset classes, including commodities. Using liquid ETFs as a proxy for the underlying commodities, how do commodity investments compare head-to-head in terms of their outlook for the next three-to-twelve months? The table below shows the results for our March 1 rankings.
While we are not out of the correction woods yet relative to the short-term, as we outlined on March 3, we believe the longer-term outlook for risk and inflation-friendly assets, including commodities is postive.
From a fundamental perspective, the primary drivers of these commodity markets are related to increased demand as the global economy expands and the attractiveness as a hedge against the loss of purchasing power caused by "at-the-checkout" inflation. Below are some specifics related to each commodity or investment:
One of the primary fundamental drivers of the commodity markets is the Fed's loose policies. Ten-month relative strength, where we chart a commodity's performance relative to the S&P 500, is one of the inputs in our asset class ranking system. The ten-month relative strength charts below give us a good visual indication of which markets are benefiting most from QE2 and near-zero interest rates.
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Copyright © 2010 Ciovacco Capital Management, LLC. All Rights Reserved. Chris Ciovacco is the Chief Investment Officer for Ciovacco Capital Management, LLC (CCM). .Terms of Use. This article contains the current opinions of the author but not necessarily those of CCM. The opinions are subject to change without notice. This article is distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. The charts and comments are not recommendations to buy or sell any security. Market sectors and related ETFs are selected based on his opinion as to their importance in providing the viewer a comprehensive summary of market conditions for the featured period. Chart annotations are not predictive of any future market action rather they only demonstrate the opinion of the author as to a range of possibilities going forward. All material presented herein is believed to be reliable but we cannot attest to its accuracy. The information contained herein (including historical prices or values) has been obtained from sources that Ciovacco Capital Management (CCM) considers to be reliable; however, CCM makes no representation as to, or accepts any responsibility or liability for, the accuracy or completeness of the information contained herein or any decision made or action taken by you or any third party in reliance upon the data. Some results are derived using historical estimations from available data. Investment recommendations may change and readers are urged to check with tax and investment advisors before making any investment decisions. Opinions expressed in these reports may change without prior notice. This memorandum is based on information available to the public. No representation is made that it is accurate or complete. This memorandum is not an offer to buy or sell or a solicitation of an offer to buy or sell the securities mentioned. The investments discussed in this report may be unsuitable for investors depending on their specific investment objectives and financial position. Past performance is not necessarily a guide to future performance. The price or value of the investments to which this report relates, either directly or indirectly, may fall or rise against the interest of investors. All prices and yields contained in this report are subject to change without notice. This information is based on hypothetical assumptions and is intended for illustrative purposes only. PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS. CCM would like to thank StockCharts.com for helping Short Takes create great looking charts Short Takes is proudly powered by WordPress . Entries (RSS)
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