You cannot turn on the TV or read a news feed without hearing dire warnings of surging inflation.
The U.S. Consumer Price Index rose 6.8% year on year in November, the fastest pace since 1982. Meanwhile, while Eurozone inflation climbed to a record 4.9%.
More than three-quarters of countries analyzed by Pew Research had higher inflation in the third quarter of 2021 than in the same period in 2019, the Financial Times reported.
Inflation worries push investors toward government bonds
Not surprisingly, investors are positioning themselves for higher inflation. Investors are buying into assets that may profit from or at least hedge them against rising inflation.
Typically, that would be hard assets like gold. However, a leading gold ETF has seen outflows of more than $10 billion so far this month. Investors appear to have preferred inflation-linked paper assets, such as inflation-protected government bonds, commodity funds and real estate investment trusts.
The Financial Times reports this year a record $66.8 billion has flowed into funds holding Treasury Inflation-Protected Securities, U.S. government bonds that are indexed to inflation.
In Britain, demand is also robust. The sale last month of £1.1 billion in inflation-adjusted government gilts maturing in 2073 drew the lowest yield — and highest price — at auction on record.
What about commodities?
So why are we not seeing more interest in commodities?
Certainly, rising metals prices are seen as an inflationary pressure themselves. That was the case building for much of this year.
However, they can also be seen as a hedge against inflation if the expectation is metal prices will continue to rise.
Commodities exchange-traded funds have certainly seen the demand. Invesco’s $4.5 billion fund, which holds copper, crude oil and agricultural products like soybeans, has seen $2.4 billion of inflows this year. That is more than double that seen in 2020.
There have been some funds pulled out this month, possibly in reaction to a recent softening of metals prices and concerns improved supply of crude oil may mean oil will not continue to be the one-way bet it had been for much of this year.
Metals have largely failed to react so far to inflation fears. However, inflation-driven rising commodity prices like oil, if it picks up next year, could be an unexpected support for energy-intensive metals like aluminum, zinc and nickel.
Higher oil prices typically drive higher natural gas prices, which typically increase cost pressures on power production. In turn, it supports prices for energy-intensive metals, particularly when the supply market for those metals is looking constrained as is it is for aluminum and zinc.
Inflation and demand expectations
The key issue seems to be the balance between inflation expectations and demand expectations. If the market believes inflation is here for 2022 and they believe demand will not be impacted, particularly in top consumer China, then higher metals prices should naturally follow.
Currently, the area not joining up the dots is anxiety that is demand in China. Hit by construction and power production woes, it could be in for a period of lower growth. As such, those conditions are sapping investor confidence in metals. It would seem fears inflation will impact demand are trumping confidence demand will continue and scarcity of supply will benefit those holding metals positions or ETFs. That could change. The Fed will likely move early in 2022 to end QE tapering by March and move to raise rates from Q2 onwards.
The Financial Times reported Fed officials are expected to signal their support for two rate increases next year. That would be a far more aggressive path than just a few months ago. Three or four more adjustments are set to be penciled in for 2023, with another round in 2024.
Signals are one thing. Rate changes are another.
Simply by signaling, the Fed is hoping to influence the market. The pace and severity of rate increases are by no means a given. Rates will have to rise to tame the current inflationary trend. Commodities of all kinds will likely be supported as investors seek to use a variety of tools to hedge their exposure.
By AG Metal Miner
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