Brace Yourself For The Great Inflation

Published in Investing on 13 January 2011

Is your portfolio prepared for rising prices?

2011 has started badly for us Brits thanks to the VAT hike, accelerating fuel costs and runaway rail fares. Oh, and rising food prices. 

Inflation is back, even if the Bank of England is pretending it isn't. 

Is it here to stay, and if so, what does that mean for your portfolio?

The Great Inflation

You could call inflation the elephant in the room, except more people are now talking about it. The latest is Tom Becket, chief investment officer at Psigma Investment Management (pdf file). We may be moaning about price rises in the UK, he says, but we have it easy compared to consumers in the industrialising world.

The real inflation rate in countries such as China is close to 10%, driven in particular by soaring food prices. With the oil price motoring towards a headline-grabbing $100 a barrel, and copper and other metals at record levels, it is hardly surprising that consumer products are getting more expensive.

Latest data from the UK shows input prices are increasing at the fastest pace recorded. Becket warns of "clear and present danger for the global economy", and makes a decent stab at coining a name for what is coming our way: the "Great Inflation".

I wonder whether it will stick.

Don't worry, 'bout a thing

If you think we hate inflation in the UK, we have nothing on China. 

Rising food prices usually leads to rioting in the countryside, and panic in Beijing. Central government will cheerfully sacrifice its double-digit GDP growth in a bid to keep costs under control, spreading panic in Western stock markets, which are cravenly dependent on the East.

Becket predicts "periodic bouts of China-inspired nerves" in stock and commodity markets on the year ahead, but mars his credibility by attributing his concluding words Don't Worry, Be Happy to "the great Bob Marley", when you, me and Wikipedia know it was one-hit wonder Bobby McFerrin.

Let's hope he is wrong about inflation, too.

You say CPI, I say RPI

The chances of inflation are growing rapidly as central bankers play fast and loose with the money supply. Cheap money is flooding the world, thanks to rock bottom interest rates and QE2, creating asset bubbles wherever it goes.

This has bailed out those greedy, unreformed bankers, and some hard-pressed homeowners, but we could pay a heavy price for taking inflationary prospects too lightly.

In early 2010, the Bank of England claimed CPI inflation would end the year at 1.5%. Wrong. It ended the year at 3.3%, while the benchmark we really should be using, RPI, stood at 4.7%. 

The Bank once again refused to raise base rates this week, even as analysts warn it could soon top 4%, but that first hike is surely moving closer.

Agflation or stagflation?

Fund manager GAM thinks it has spotted an inflationary trend, and is planning to launch an inflation-focused fund to cash in on price rises. Its key themes will include agriculture, as rising living standards put pressure on limited arable land, and fuel inflation, where it plans to invest in companies supplying oil field services and equipment.

It believes metals, mining and transportation will all benefit from inflation, and will target these sectors. The new fund will also focus on companies that have real pricing power.

Hot commodity

Private investors are also pouring into commodities. Sales of commodity funds hit the highest level on record in November, when retail investors invested £208 million in the sector, according to the Investment Management Association.

My worry is that commodities are heavily cyclical, and tend to overshoot both on the upside and downside. Last year, they had a stormer, and I largely missed it. I'm wary about diving into these choppy waters now, because I don't want to end up riding the down wave.

That said, the long-term story for commodities should be good, as rapid growth in the developing world boosts demand for energy, food, and metals. But I prefer to buy on a dip, not a surge.

The Great Conflagration

You don't need me to tell you that high inflation will be bad for bonds. There might be some better news for cash, if the Bank of England concedes defeat and is forced to push up base rates, but securing a real, inflation-busting return will remain next to impossible.

Rising interest rates could also spell bad news for property, consumer spending, the retail sector and British exporters, if it forces up the value of the pound.

Stock markets may be a better place to sit out the Great Inflation then many of the alternatives, but that could change if the oil price surges past $100, without OPEC taking the necessary action to bring it down. This could single-handedly bring the post-credit crunch recovery to a juddering halt, leading to a sharp reversal in our appetite for risk.

By toying with inflation, central bankers are playing with fire. Make sure you don't get burned.

More from Harvey Jones:


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BarrenFluffit 13 Jan 2011 , 5:33pm

Not only does it reduce the real cost of debt for the borrower it also increases the tax take from CGT....

UncleEbenezer 13 Jan 2011 , 5:46pm

This inflation is down to the debasement of the currency: banks conjuring it out of thin air[1] in the boom years. The real inflation - previously manifested in house prices - coming home to roost.

Stephen Bland's article today shows there's some great value to be had among highly-indebted companies who stand to benefit from inflation.

[1] aka fractional reserve banking + financial innovation.

mcturra2000 13 Jan 2011 , 6:09pm

The fact that the BoE didn't raise rates today pretty much says it all. They've got no belly for it. I'd be surprised if interest rates were even as much as 1% by the year end. Despite all the evidence of inflation, the BoE just will not raise rates. They're too scared to. Simple as that.

I bet those holding shares in supermarkets and gas producers will come out smiling by the year-end.

mcturra2000 13 Jan 2011 , 7:02pm

Gotta love this quote in the Guardian by British Chambers of Commerce: "we urge the MPC not to over-react to temporary increases in inflation"

OVER-REACT? Even if you stuck firecrackers under their posteriors I still don't think you'd get a reaction.

F958B 13 Jan 2011 , 9:13pm

Looking at commitment of traders reports for various grain contracts, it appears that a lot of the agri-inflation is down to speculators taking long positions.
Speculative open interest has ballooned in the last six months, while the commercials have taken the short side of the trade.
The commercials are usually correct in the medium term, when it comes to long/short positions in commodities.

But....if we see significant inflation, I expect that gold will continue to move higher. Gold is considered to be in a bubble by many people, yet its advance has been no more dramatic than many other commodities.
I have a fair amount of gold - useful in case of currency instability or inflation. I don't plan to sell it yet because I think that there is more trouble to come, over the next few years. Possibly a lot more trouble.

If we're in a commodities bubble, then the commodity-share-dominated FTSE100 may be in for a battering when the bubble pops.

Funny that the FTSE was dominated by banks, just before the 2007-9 crash.....and dominated by tech just before the 2000-3 crash.
Funny also, how money now seems to be pouring out of "defensive" sectors and into commodities and financials.

Will it pop? When? Who knows.
The market has proven that it can remain irrational for longer than you can remain solvent betting against it.

mcturra2000 13 Jan 2011 , 10:16pm

@F958B Haven't commodities and financials gone in opposite directions, though? For instance, BLT is up 161% over 5 years, whilst the Footsie has been flat. Banks like BARC are down 50% over the same period. Pyad's much-favoured AV. is down 40% over that period, too. So investors must be applying different logic to the different sectors: buying commodities because the prices are expected to go even higher, and financials because a recovery is expected.

Curiously, RDSB has performed in line with the Footsie (I refrain from quoting BP for obvious reasons). If you had to guess, you'd probably have thought oilies would be way up.

I'm also interested as to who (i.e. is it private investors or fund managers) and why people are abandoning defensives - surely now that we've had a two-year bull market, and in light of current economic uncertainty, getting into defensives seems a good bet. Defensives seem pretty good value, too: BATS is trading on a PE of 13, TSCO at 12, and ULVR at 15, and so on.

Enlighten me.

F958B 14 Jan 2011 , 9:16am


When I spoke of financials, I meant that they had recently climbed, alongside the commodities (and also since the 2009 bottom) - say the last few months, as risk appetite improved, the big miners are where the action *has been*.

....and as risk appetite improved recently, defensives got dumped.
Neil Woodford of Invesco is bullish on these sensibly-priced defensives and his long-term track record is good. He'll be proven right, in due course. But probably not until he's been mocked - yet again - as "out of touch with modern investing".

One thing that I've noticed, is that just before a sector comes back into favour, it sells off hard (which we may be seeing now in defensives), often breaking some key chart support level, or breaking down out of an uptrend channel (price action often takes the shape of a broken-down, flat-topped triangle), as people finally lose heart, or panic, or want a piece of where the action has been.

People see what *was* a good investment in the last year or two and what *wasn't*. Joe Public sells at the bottom of a sector and buys at the top. We're probably seeing Joe Public getting bored of his non-moving defensives and wanting a piece of the "hot" commodities action (and certainly commitment of traders data shows that speculators are heavily involved now, in soft commodities).

On the other side of the coin, just before a sector goes out of favour, it jumps higher, often breaking above a resistance level, or out the top of an uptrend channel. People will recognise this as a "parabolic" spike (bubble).
Mini bubbles and micro-bubbles (and anti-bubbles as in the case of defensives at the moment) happen all the time, as certain sectors come into - or out of - favour. A trend-ending move is often a brief spike higher (or lower).

Remember the "double death cross" coinciding with the FTSE's heavy fall in the summer, which was supposed to signal the death of the FTSE, but actually was a contrarian indicator.

My emotional side wants me to pile into anything related to commodities and dump my "underperforming" defensives. But I lock away my emotional side and generally use the emotions to inspire my logical side to go in the opposite direction.
I retain the gold because, most importantly, it is a hedge against currency/financial instability, in addition to being a commodity.

Netherwood 14 Jan 2011 , 12:47pm

The great smoke and mirrors trick in the debasement of curreny was property prices. People marvelled at the price of their houses going up and didn't think about the fact that their currency was being destroyed. Their currency continues to be destroyed but this time it will be more obvious when they can't afford to eat!!

Fingered 14 Jan 2011 , 1:01pm

For those that followed my previous posts on how to *know* if the BoE would change the base rate or not, they already knew in advance there would be no change. Apart from filled with inaccuracies and false assumptions and bizarre logic, in typical TMF bulish fashion, the article it seems is more a subtle advert for stocks ,, "Stock markets may be a better place to sit out the Great Inflation" What Great Inflation? - Nah, that's not what is really happening.

Fingered 14 Jan 2011 , 1:12pm is coming down nicely.

curedum 14 Jan 2011 , 4:04pm

I'm neither a gold bug nor a chartist, but for those who like such things I believe that gold has a support line at about $1,300 per ounce.

Now I'll just go and check my Tarot cards....

supersol42 14 Jan 2011 , 4:06pm

The policies currently being pursued in the USA, so conventional economics suggests, will sooner or later have the effect of dramatically reducing the value of the $US in real terms.

As gold is priced in $US, while its value will stay the same as it has always been, it will cost more dollars to buy the stuff.

F958B 14 Jan 2011 , 5:36pm


If gold doesn't find support around current prices ($1375), then it may take a trip down to $1275. When gold has a major correction, it particularly likes to bottom-out a couple of percent below its 200dma (currently at $1271 and rising by about $1/day).
Since gold normally peaks in the Feb-May time period (at about 1.3x the 200dma) , it would be unusual for gold to drop back to the 200dma without such an upwards spurt and without seeing a peak in the spring.

Those looking for gold's decline to signal some kind of collapse, should consider that gold is generally very strong in the early stages of a collapse - not weak, as now. Economically-sensitive shares (including commodity companies) will turn down before gold does.
For example, the stockmarket peaked in October 2007, while gold continued higher, peaking at $1000 in March 2008.

curedum 14 Jan 2011 , 5:58pm

Thanks for that, F958B. As I indicated, I tend to regard chartists much like astrologers and for the same reasons. Gold is really insurance against gross currency debasement; no one can know how the world economy is going to develop over the next couple of years.

Remember the old Chinese curse: "May you live in interesting times".

Fingered 14 Jan 2011 , 11:19pm

err I'm confused.....So on bubbleology: What's the difference between a bubble, a mini-bubble and a micro-bubble? What's an anti-bubble?

Fingered 15 Jan 2011 , 12:13am

err I'm more confused ....yeah ok, so on trader futures commitments the commercials are on the shortside ( supply side oriented) so what? I expect them to get it right, they are smart and very close to the real underlying market supply and demand fundamentals, Yeah of course the large speculators are positioned on the long side for most of them and yeah, they invariably position for pure technical reasons and small speculators are a mixed bag and are invariably all over the place depending upon the commodity and often wrong. .......The latter to be expected cos he ain't got much of a speculative clue and he knows even less about the fundamentals of the commodity itself......More to the point is how a) how the large speculators have been and are currently positioned? b) ditto for the small speculator ( that's us folks ! ) and they ( that's us ) usually get it all wrong relative to the big boy speculators? and c) if we are dealing with a falling price, and the commercials and the large and the small speculators are all on the net short side then the risks dramatically increase that you won't get paid out on closing a short position isn't it ?

Fingered 15 Jan 2011 , 12:22am

err confused again...... those looking for a decline in gold as signal for a collapse in what exactly ? The Dollar? Wheat? Oil ? Mining stocks? Defensive's? 100yr Bonds? Yen? Euro? DAX? China? Gold priced in Sterling?

Fingered 15 Jan 2011 , 3:06am logically and oh so clearly treat technical market chartists, astrologists, palmists, taroists, tealeafists, crystallists, blasphemists, soothayers, pixies, romans, palm readers, dorothy's, tin men and yellow brick roaders, with the utter,utter contempt of that they may or may not not deserve ..... hey bravo. A word of advice..... be careful with your contempt.... the wizard(s) of a very very much higfher order could easily seek revenge upon you with a septic cauldron of frog's legs. :-)

FXEconomist 15 Jan 2011 , 10:00am

Econ 101. And yes I am being paternalistic re the simplistic comment son monetary policy above.

1) There is no UK generated inflation to speak of once external inflation and tax rises are considered. It is running at about 1%

2) Why should a rational Bank of England raise rates when there is no inflation to suppress.

3) Not only is most the CPI imported inflation, but that imported inflation acts like a Base Rate rise in suppressing the economy.

F958B 15 Jan 2011 , 10:42am


So many things that you, one at a time.
I'll include a suggestion of a definition of the kind of chart shape that you'd expect from the various bubble types.
The key thing about a bubble of any type, is that it usually comes right back to where the parabolic stage started.

Micro-bubble: measured in days or weeks.
Just a little over-excitement in an uptrend - often associated with price breakouts above resistance.
BATS share price, February 2010.

Mini-bubble: measured in weeks or months.
An uptrend in need of a correction.
NWG share price, May2010-Nov2010.
Gold in spring 2006, spring 2008 and at present.

Bubble: measured in months to years.
A clearly overstretched asset, with price far outrunning operating performance.
TSCO share price May2006-Oct2007.

Super-bubble: measured over many years.
An asset that long ago detatched from logic.
VOD share price, 1997-2000.
Gold 1977-1980.

Anti-bubble: price that spikes downward, against the logic of the fundamentals. Often with considerable underperformance.
TSCO May2002-Feb2003

F958B 15 Jan 2011 , 10:53am


When the "speculators" take heavy long positions and "commercials" take heavy short positions, there is usually a nasty correction not far off. The speculators, on balance, are generally wrong and get taken to the cleaners.

For example, take corn (because it's near the top of the alphabet list!).

The steep uptrend begain in July 2010.
At the beginning, the commitment of traders was roughly:

Commercial long: 560000
Commercial short: 560000
Speculative long: 300000
Speculative short: 150000

Commercial long:short ratio = 1
Spec long:short ratio = 2

As of recent data:

Commercial long: 640000
Commercial short: 1020000
Speculative long: 580000
Speculative short: 120000

Commercial long:short ratio: 0.6
Spec long:short ratio: 4.8


That's a big shift in long:short ratios. The commercials have the best "in the loop" information and are likely to be best positioned - although very occasionally they take the wrong side of a trade.

ronat42 15 Jan 2011 , 6:16pm

I think I'll just put my few quid under the bed.

Fingered 15 Jan 2011 , 7:35pm

F958B .ok that explains your bubblology terminolgy, not quite how I would refer to things but no matter. On Corn, I think we are saying same thing then in effect, this corresponds to my scenario a) where the *large* professional big-boy speculators, such as hedge funds, have been progressively positioned steadily and heavily on the long side for months and, no surprise the speculation has driven up price. Oh where and when the eventual forming corn bubble will go pop and go anti-bubble as you describe is another matter ..... the *small* amatuer retail speculators, have got it bnasically though got it all throughout this period where, on balance they have been positioned more net short and been on the *wrong* side of the corn market.

Fingered 15 Jan 2011 , 7:39pm

ooops...<< have got it basically all wrong throughout this period >> ........

Fingered 15 Jan 2011 , 10:33pm

A nice little story on how you get ripped off as the naive Mr Joe Public -Apart from Osborne nicking extra vat from your wallet, all the big energy companies have been jacking up their domestic energy prices recently as also have petrol retailers, Ever wondered why it is they rarely come down? ...The industry continues to nick a big share of your wallet too. If they are not winging about crude or gasolene commodity prices, they are winging about the pound, but note *not* the Nat Gas commodity wholesale price, (well not yet) Now I wonder why??? .........mmmmh... So checkout the Natural Gas, Heating Oil and Gasolene , and the dollar / sterling charts over the last few years and checkout what is going on here with prices in sterling.....mmmh ...... I think you will find you have been very subtley but suredly and repeatedly hoodwinked. So with all this "wallet share" nicking going on, Joe Public, if he doesn't lose his job in this age of austerity , he will be lucky, and he will just have to be grateful to have less and less to spend and eat cake. Pooouf ... he will be ecstatic if his luck extends to a pay rise so he can just about stand still and not regress. So much for the green shoots of recovery eh? Nah, it has brown twigged, you have been hoodwinked again merely with fancy QE debt monetization smoke and mirrors. Of course this doesn't apply to you if you are a hoodwinker, such as a politician or a banker. :-)

Fingered 16 Jan 2011 , 3:03am

@ Harvey.....The Great Inflation - time for a happy moment :-) Of course, if you care to look at a good example of a very illiquid housing......then you just possibly might have seen from UK housing stats that the market hit a post crash recovery brick wall *last* june and iturned downwards. ooops-a-daisy! Happy days! In the USA, there's scores of millions of folk underwater with their mortgages, and the numbers are growing. No problemo, banksters wont lose on repo's and firesales - QE 1 and 2 have heavily bailed out the banksters by the FED loading up its balance sheet basically with impaired Mortgage Backed Securities from the likes of Goldman Sacks in some very dodgy behind-the-scenes manouveres. Oh the US tax payer will pick up the bill just as we will here for our banksters naughtiness. So, other than initially stuffing emergency liquidity into banks to provide crisis coverage in the early days of QE1, then *no* , QE has *not* sent helicopter Ben's hot greenbacks all over the globe creating bubbles everywhere. No more so than King's QE has not showered the country with crispy new tenners. Where's the £100 or the £1000 toilet-paper bank note? Nah, not just quite yet me thinks. The hot money flows is a convenient bullish stock market peddler's myth. That's not what the banksters have been doing at all! They have been doing debt monetization which is very different, and a very important difference. No matter, the silent unseen crash continues unabated - Now in the USA, house prices have fallen for * 53 consecutive months and by 26% * ...well matey that exceeds the housing collapse during the Great Depression and it still hasn't finished. - so what Great Inflation? .... Oh it's a "Great" alright , and its a " 'flation " for sure.....but it just doesn't have an "In" in it.

compound200 17 Jan 2011 , 12:07pm

my local corner shop

can of coke .75p

Fingered 17 Jan 2011 , 1:20pm

Wow 75p ! ....won't be long folks for the next bullish TMF article on Warren Buffett to come out....stay tuned.

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