From the desk of Steven Strazza @Sstrazza and Ian Culley @Ianculley
Nobody likes inflation.
The costs of day-to-day necessities rise. Long-forgotten and disliked sectors of the market start to outperform. And many of the cool tech names that were a must-own for every portfolio turn into a pile of hot garbage.
Now that everyone – even the Fed – agrees the current inflationary environment isn’t transitory, cries of a near-term top in inflation have emerged.
Yes, breakevens and inflation expectations have peaked and are beginning to roll over. Whether this will turn into a substantial downturn in the coming weeks and months is anyone’s guess.
Instead of playing the guessing game, we’re focused on commodities – the assets that benefit most from inflationary pressures.
Here’s what we’re seeing.
This is a chart of our equal weight commodity index overlaid with the 10-year breakeven inflation rate:
These charts look incredibly similar for one simple reason. Commodities are inflationary assets.
When inflation is on the rise, commodities tend to catch higher. On the flip side, when inflation is falling commodities struggle.
Both charts peaked earlier this spring and have started to turn lower with the 10yr. breakeven pulling back to retest its former 2012 highs. If the benchmark inflation rate can dig in at those former highs we can expect similar action from our equal-weight commodity index.
On the other hand, if breakevens undercut those former highs, further downside action is likely for commodities.
As we pointed out last week, commodities are poised for a corrective period. The main question is simply what that will look like. In other words, do they correct through price or time?
The direction the 10yr. breakeven inflation rate takes from here will likely dictate the nature of the correction within commodities.
We’ll continue to watch breakevens for further insight into commodities.
COT Heatmap Highlights
- Lean Hogs: Commercials carry their smallest net short position in three years.
- Feeder Cattle: Commercial hedgers hold their largest net long position in history.
- Palladium: Commercials added to their net long position, inching within 3% of a three-year record.
- US Dollar Index: Commercial hedgers remain within 7% of their 3-year record short position.
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