Short-Term Inflation Expectations
What if we repeat the exercise for short-term inflation expectations, here measured by the two-year TIPS breakeven rate of inflation? We can convert expected inflation into a note and plot the correlations inversely as we did for repo rates. Here, Period 3 correlations jumped for coffee, sugar, natural gas and crude oil.
No more. For all those who believe commodity prices and inflation are one and the same, this must be a great disappointment. Please see an October 2005 column on the weak relationship between inflation and commodity prices.
Investment Implications
Will the cure for higher prices be higher prices? So often in the past this was the case as commodity producers rushed to expand capacity and killed their own boom. My answer now is "No." Those private firms were profit-maximizers; the state firms increasingly dominating resource production are revenue-maintainers. They tend to distribute their revenue back to their governments or, as noted last week, to Swiss banks.
We could be in for years of higher prices barring a global economic implosion. If that's the case, close your eyes and overweight basic materials and energy stocks, both in the U.S. and abroad. Sometimes it is just that simple.
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