Inflation Premiums Are Rising Indicating Higher Commodity Prices in the Making

Is the inflation trade really in trouble? Apart from looking just at the performance of commodity prices themselves what other tools do we have at our dispersal that would indicate inflationary or deflationary conditions? There are a number but we will discuss one of our favourites now. We look at the performance of inflation protected bond mutual funds relative to the US Ten year. Yes we could look at the performance of TIPs relative to the US ten year but we find that a lot of volatility is ironed out by looking at the performance of the mutual funds instead. Below is the performance of two of the bigger inflation protected bond mutual funds relative to the US ten year. Outperformance suggests that the inflation premium (expectation) is rising.

The top two charts suggest that there has been no change in inflation expectations over the last few months with multi-week highs in both relatives being recorded within the last three weeks.

Also note how the basic shape of the top two charts resembles the bottom chart but with a three month lag. We have found that the bond market is a much more efficient market than the commodity market and the behaviour of the inflation premium attached to inflation protected bonds is a consistent leading indicator of the behaviour of commodities themselves.

So contrary to what the deflationist “school” is touting, the message is still clear – the smart money continues to bet on rising inflation over the coming months. We are positioned accordingly.