About Me

Retired chief investment officer and former NYSE firm partner with 50 plus years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!

Thursday, December 11, 2008

Inflation Hedge Trade

What I call the inflation hedge trade goes as follows: Be short the
US dollar and be long oil and perhaps a PM like gold or silver.
This has been a popular trade from time to time over the past
35 years, and was a dominant one in this decade so far. It is a
tricky business, more like a 3 cushion billiard shot than a straight
pop of the 8 ball into the corner pocket.

There is evidence over time that a weakening of the dollar goes
with a rise in the oil price, while a sronger dollar pairs up with a
weaker oil price. The US tends to be a cyclical leader and when it
cuts short rates to bolster growth, the trade deficit may widen
relatively, leading to a weaker US$. In turn, US oil import demand
picks up, and the price is shaded to the upside as a way to hedge
a weaker dollar. Timing is far from exact and markets psychology
plays a major role. This trade was a powerhouse over most of
the decade and was spectacular once it became evident that the
Fed would cut rates to ease a gathering financial crisis in 2007. It
came acropper this year when spreading global financial market
turmoil triggered a flight to the dollar and when oil subsequently
crashed on lower demand and a powerful US dollar rally.

One other fact, the pools of money in this game -- hedge funds,
pension funds with "alternative" investment authority and a
bevy of mutual funds and ETFs devoted to these sectors -- is
huge and far larger than anything seen in modern times. It's not
just primary dealers and old line speculators anymore.

The $USD has weakened so far in December (seasonally typical)
and sure enough oil is rebounding and gold and silver have come on
board. Importantly, oil refineries have run their heating oil and
are set to shut down for maintenance in Jan. to get ready to run
gasoline for the spring. So early in the year can be seasonally
strong for oil. Thus, the guyz have the trade going -- short the
dollar, long oil and maybe gold for good measure. Traders know
oil could rally to $60 + in Jan. without challenging the downtrend.
Moreover the $USD is at trend support and a break here during
the month will whip up the oil pit. This can be crazy stuff, since
there can be little change in bedrock fundamentals in the interim.

From a macro economic perspective, this inflation hedge trade is
harmless as long as it runs for a month or two more. But
development of another sustained strong run up in oil will not be
harmless and will eventually punish a weakened global economy
further.

No comments: