From the Desk of Ian Culley
I prefer to focus on price when analyzing markets.
It’s what pays us at the end of the day. And it bakes in all the news and lagging economic data I tend to ignore.
A few weeks ago, I urged investors to track trends, not inflation.
Honestly, I was only half serious. I pay attention to the Fed and CPI data – mainly to stay aware of the increased volatility accompanying important release dates.
But price is king. And when I look at my charts, the narrative of easing inflation appears suspect…
Check out the overlay chart of the Metals and Mining ETF $XME and the TIPs vs. US Treasuries ratio $TIP / $IEF:
These two charts move tick for tick at first glance. And a closer look at the lower pane reveals an overwhelmingly positive correlation over the trailing 126 trading days. This is why we focus on XME.
The tight correlation between these stocks and inflation expectations (TIP/IEF) lies in the direct relation the ETF has to commodity prices.
It’s simple. These companies can sell their goods at higher prices as inflation increases, resulting in better earnings and rising stock prices.
And from the looks of it, XME isn’t buying the gossip. Instead, it recently hit fresh highs as the TIP/IEF ratio broke down to multi-year lows.
Notice the typical positive correlation has turned negative. It happens. But over the past decade, those events have been few and short-lived.
So where does that leave us now?
If and when inflation expectations start to tick higher, we want to use XME and the strongest names in the metals and mining space as vehicles to take advantage of rising prices.
Based on the resiliency of commodities – especially commodity-related stocks— I continue to lean toward eventual upside resolutions for these risk assets.
I’m not an economist. Not even close! But if XME is printing fresh highs, I have to imagine CPI data is coming in hot, and inflation expectations are catching higher.
Countdown to FOMC
Following the recent 25 bps hike, the market is pricing in another single hike at the March meeting.
Here are the target rate probabilities based on fed funds futures:
Click the table to enlarge the view.
Thanks for reading. As always, be sure to download this week’s Bond Report!