How Inflation Begins ~ market folly

Tuesday, April 13, 2010

How Inflation Begins

Raymond James Chief Investment Strategist Jeff Saut is out with his latest weekly missive and this time around he is addressing inflation. Right off the bat, he cites commodity prices that have increased by obscene amounts since January of 2009. Oil is up 118% and copper is up 185%. This is something we've touched on the past in a post about commodity inflation versus asset deflation. Below you will find Saut's investment strategy that details how inflation begins.

To illustrate his point, Saut turns to a first hand account from an industrial hardware importer. The story focuses on inventory levels and emphatically notes that they aren't all that busy on a business level, yet they are seeing prices skyrocket higher.

Saut writes, "Why are we so sure inflation will return? It is because for decades that has been the easiest political solution for the debt accumulation of our citizenry and our government. To wit, pay back the debt with 'cheaper' dollars. Given the recent geometric rise of debt, we see only three ways out for our government: sovereign default (unimaginable); severe economic contraction (unlikely); or, currency debasement (read: inflation)."

So, Saut feels that inflation is the method the government has selected and many won't disagree with that assertion. East Coast Asset Management recently came to the same conclusion in their deflation-reflation continuum research. The question then becomes: how do you protect from inflation? There are many ways to do so, and we'd point you toward Oaktree Capital's Howard Marks on how to play inflation. Also, legendary hedge funder Julian Robertson had been betting on higher interest rates via constant maturity swaps (CMS). We've of course seen plenty of hedge funds in the curve steepener trade. These investors are of course preparing for inflation because they share the same viewpoint as Saut.

Embedded below is the weekly investment strategy from Jeff Saut at Raymond James on how inflation begins:

You can directly download a .pdf here.

While many out there will agree with Saut's assertions, keep in mind that there are still some investors planted firmly in the deflation camp as well. So, it will be interesting to see how things eventually play out as a compromise of views would be deflation in the short-term followed by longer-term inflation. For a brief primer on this topic, head to investment scenarios of inflation versus deflation. And for more commentary from strategist Jeff Saut, you can view his past insight where he stated he was short-term cautious, long-term bullish.

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