UNCHARTED

Yesterday's CPI buys more time for the "free money" cycle. Buying time can be expensive.

Keith and I talk about history frequently. I know a bit about a fairly broad range of economic and political history, in part because of my education and in part because of my interests. Like many students of history, I have a tendency to massively discount its importance in the decision making process. To my mind, the more you know about past events, the more you understand the unique factors involved with each and, as such, the less confidence you will have in drawing conclusion solely based on corollary. When discussing yesterday's consumer inflation data I told Keith that the current environment seems anomalous to me, and those looking for clues in the reflation puzzle will be frustrated by historical comparisons.

At -1.28%, yesterday's CPI reading arrived at the lowest level since 1950 when the massive deflation/reflation cycle that followed the end of WW2 were wreaking havoc on global commodity markets (see chart below). 

UNCHARTED - cha

This reading leaves the fed with ample room to keep easy money train rolling at next week's board meeting and also provides the market with clear signals that the return of year-over-year inflation growth will not arrive until mid to late Q4. This breathing room gives the economy more time to recover but that time may come at a steep cost:  with the scales tipped so far in one direction, even modest catalyst could trigger inflationary pockets rapidly, providing a nasty "snap-back".

One of our core ideas coming into 2009 was the demise of correlation of returns for different asset types, and this will be critical in our approach as we position ourselves to profit when inflation does finally raise its head.  We anticipate significant divergence inside the commodity matrix as overlapping demand factors and currency valuation throw the momentum mentality that worked perfectly in the 07-08 boom out the window in favor of market specific fundamentals. In other words, in the cycle that we see on the horizon, soybeans won't necessarily go up because Chinese demand for coal increases, and gold won't necessarily go down because the Brazilian cotton crop is larger than expected. 

As such homework will be required and, if history is any guide, many investors will not do the assigned work and fail the exam.

Andrew Barber
Director


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