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Don’t be Fooled, Here's What You Need to Know about QE3, Gold, and Inflation

Aug 02, 2012
Chad Karnes, CMT

Price continues to tell us all we need to know about today's markets. Forget the central banker rhetoric and watch the data points that matter instead.

Yesterday, Bernanke spoke and the market yawned.  Today, it is Draghi's turn, and the markets are selling off.  The markets are showing us that deflation, not inflation, is still the prevailing trend.

The mainstream continues to anticipate inflation justified by a loose monetary policy around the world, but we are not in the inflation camp, not yet anyways (we also are not mainstream, but that is another story).  We prefer to use data and facts instead of speculation before forming an opinion and taking a position.

Just Tuesday (7/31), the infamous Bill Gross released his “Cult Figures” with the conclusion that inflation is inevitable.  That may or may not come to fruition, but he has said this for well over a year as he continues to short treasuries, much to his misfortune (and underperformance to his benchmarks).

Yesterday (8/1) the market found out that Bernanke is not going to perform his next magic trick and QE3 is again put on hold, at least for another day.  Why not just wait until we get real signs of inflation actually occurring before trying to pick a bottom?  It would have saved a lot of money and heartache over the last few years.

Below are some of the assets we are following to tell us if inflation is indeed right around the corner.  Right now, that answer is no, but if it does occur, we will let price tell us instead of trying to guess.

If Gold is an Inflation Hedge what Happened this Year?

Below is a chart included in the August issue (7/20) of our ETF Profit Strategy Newsletter of the performance of the SPDR S&P 500 (NYSEArca: SPY) compared to SPDR Gold (NYSEArca: GLD) year to date.  Gold has underperformed stocks by 10% YTD.  These are not price movements that would be occurring if another round of QE was about to be released and inflation just around the corner. 

We have been bearish on gold all year and it continues to be in a downtrend until it proves otherwise.  When/if it does we may switch our view on inflation expectations.  Other Exchange Traded Products (ETPs) to follow gold are the Sprott Physical Gold Trust ETV (NYSEArca: PHYS) and the iShares Gold Trust (NYSEArca: IAU).


Bond Yields Reflect Inflation Expectations

Bond yields continue to make all time lows.  This has been occurring for years now.  In an inflationary environment, bond yields rise, as in the 1970s, in an attempt to counter the future erosion in purchasing power. 

The iShares Barclays 20+ Year Treas Bond (NYSEArca: TLT) is an ETF that we follow to track bond prices and interest rates.  The TLT has been in a profound uptrend since the ETF was introduced in 2002 and recently its price rise has steepened as interest rates have fallen faster than in previous years.

On 7/1 with the TLT at $125.20 we stated in our ETF Profit Strategy Update, “Continue to disregard the media and talking heads that say bonds are overvalued and inflation is around the corner.  Until we see it in price, it is not happening.  Price is the only true leading indicator, and we will rely on it to tell us when inflation is here.  Until then, we continue to stay long the longer duration treasury bonds.”

TLT has retreated from its July high of $132 and is priced around $130 today, but we continue to feel the same way about bonds and will wait for a true trend change before giving in to a potential change in inflation expectations .  If a trend change does occur, the ProShares Short 20+ Year Treasury (NYSEArca: TBF) is an ETF that can be used to take advantage.

Housing is in a “Recovery” for the Umpteenth Time?

Housing, the largest contributor to net worth at over $16 trillion in value based on Federal Reserve estimates,  is a real and value-adding asset.  It is no doubt important in the inflation versus deflation debate, as prices of homes should go up in an anticipated inflationary environment.  A home's price also is a huge factor in the consumer's "wealth effect".

We have been told numerous times by “credible” sources that "housing is in a recovery.  Yet, the average home price is down 32% since April 2006’s high price and the recent four months of very small monthly growth in prices does not make a new uptrend.  That has happened many times since 2006’s high and in fact happened 9 consecutive months starting Sept 2009.  Looking at the next chart we can see where that has gotten us (hint: nowhere). 

Digging one level deeper into the data released on 7/31 by Case Shiller, May 2012's average home price is still below even last May’s average home price which was also below May 2010’s average price; the longer term trend remains down and shows no real signs of a change in deflationary trends.

The latest ETF Profit Strategy Newsletter provides comprehensive technical and thought-provoking analysis that helps investors filter through the noise from traditional media sources and focus on the important market facts.  The August issue of the Newsletter evaluates the bullish and bearish potentials of the commodities, bond, forex, and stock markets along with actionable price targets and profit strategies for each.

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