Real But Unacknowledged, Inflation Is the Elephant in the Room

A failed rally in the 10-year Treasury took yields back to the highs for the week, passing 1.62%. Though the FED speaks as if inflation is a non-issue and merely “transitory,” the Treasury market five-year breakeven rate at 2.578% suggests that we have many years of inflation ahead, and that the FED has likely already fallen behind. The market’s control of Treasury prices is an inconvenient pressure both in the tightening of financial conditions that it portends and on the central bank’s credibility. Should rates continue higher, there is little doubt that further monetization of bonds by the FED (yield curve control) will be necessary.

The 1.9 trillion-dollar Covid relief package is official. You can count on more and varied initiatives to follow even before the Covid money filters into the US economy. We have not seen the end of monetary and fiscal activism as a global phenomenon. Across the pond this week, the ECB put a little PEPP (Pandemic Emergency Purchase Program) in the step of equity markets to close out the week, promising an increase of bond purchases estimated at between 20-25 billion more, each week. Rates receded and prices rose in European government bonds, (opposite the US market trend). An ECB official had already announced that any market tightening would be countermanded by ECB bond purchases. The loosest financial conditions imaginable are now the only acceptable conditions for asset pricing.

At this point, we see the back-and-forth conversation on inflation as somewhat inane. Inflation is more obvious to the general public with each day that passes. Statisticians are reluctant to count increases the way the general public does. For instance, the BLS shows an increase in gasoline prices year over year at 1.5% when the actual price increase is 40%. In the most recent PPI report they come a little closer to reality. As a result, the non-seasonally adjusted PPI figure is at +2.8% and the seasonally adjusted monthly figure at +.5%, both slightly above expectations. PPI is not as thoroughly scrubbed and sanitized as CPI. In PPI, you have a hint that even the official (and vastly understated) statistics are unable to quell inflation concerns.

For now, fiscal liquidity is driving sentiment wild within equities (DOW, small caps, Value Line), with warning signs from the leading Nasdaq stocks still offering a counter-narrative. Volumes have now contracted in equity trading six days in a row, which is very unusual. Even though the Dow and S&P 500 performed well all week, the declines in volume tell you this rally is not supported by institutional buying, and can turn sharply lower without warning.

One of the conclusions coming from this week’s PDAC conference (Prospectors and Developers Association of Canada), is that in spite of expansive exploration for copper, nickel, zinc, (and gold for that matter), a dearth of big discoveries remains an issue. Demand will run into supply constraints, and the world will be shocked by commodity pricing that results. Ten-year highs for the copper price are a good example, and don’t yet account for a global economy back on its feet. Higher prices will certainly drive exploration budgets higher too, but in the past decade increased spending for exploration has yet to yield the desired resource replacement and production results.

Precious metals staged a highly probable bounce off technical support levels last week, and battled to maintain gains throughout this week. Once again, the HUI outperformed bullion. Gold finished the week higher by 2.2%, silver higher by 2.7% and the miners higher by 4.2%.

Infrastructure represented by the I Shares US infrastructure ETF was higher for the week by 6.7%. S&P Global Natural Resources Index gained 2.89%. The Alerian MLP index outperformed other oil and oil service companies, posting a 1.59% gain. Utilities and real estate rebounded this week in spite of the rise in the 10-year, Dow Jones Utilities rose 3.68%, and the Dow Jones US Real Estate Index a positive 4.6%

Until next week…

Best Regards,

David McAlvany
Chief Executive Officer
MWM LLC