After spending months in the doldrums after the U.S. dollar spiked on the night of May 1 when Seal Team 6 killed Osama bin Laden, and inadvertently killed the springtime commodities rally, the entire complex has started perking up again this week.
There are two big drivers of this. The first is that traders, armed with heavy cash reserves thanks to the “risk off” events of the past few months, are on the hunt for gains — but are keen to avoid the turmoil in equity and bond markets. The chart above shows just how much the DB Commodities Tracking Index (NYSE: DBC) has outperformed both the S&P 500 and the iShares iBoxx High Yield Corporate Bond Fund (NYSE: HYG) over the last two weeks.
The second, and much more important reason, is that the Fed’s monetary policy stance is becoming increasingly inflationary. Yes, I know that the $600 billion “QE2” money printing operation just ended. And I know that Fed Chairman Bernanke told Congress this week that while a “QE3” would always be an option the central bank currently has no plans to implement one. In fact, the focus of recent Federal Reserve meeting minutes has been on the strategies and methods by which the Fed will tighten policy.
So, how is this inflationary?
It’s because for all the tough talk against inflation, the Fed is likely to be on hold well into next year — pushing the run of near zero interest rates to an unprecedented four years. With inflation rates creeping higher, all this monetary policy stimulus is pushing “real” or inflation-adjusted interest rates down into territory that was seen in the run up to the Great Inflation of the 1970s. And that fueled the massive commodities rally that didn’t end until former Fed Chairman Paul Volcker killed it with 20%+ interest rates.
I think we’re in the midst of a similar scenario now. And that explains why commodities are rebounding with such verve right.
Even if the Fed does nothing, it’s already on the path of another Great Inflation, though we should see in the near term a temporary reprieve from a drop in energy prices. A QE3 would just add to the problem by printing more money and injecting it into the economy.
Wall Street is already pricing in this reality. Precious and industrial metals are on the move. Agricultural commodities are breaking out. And of course, energy prices are rising again.
The easiest way for investors to play the rebound in commodities is through the DB Commodities Tracking Fund. But let’s focus a little more and earn some extra returns. In precious metals, silver looks set to outpace gold — a condition which will benefit the iShares Silver (NYSE: SLV) and the leveraged ProShares Ultra Silver (NYSE: AGQ).
In the agriculture space, I’ve already recommended the PowerShares DB Commodity Trust Agriculture Fund (NYSE: DBA) to my newsletter subscribers, an ETF that invests in things like coffee, cocoa, sugar, and corn futures. And finally, in the energy space I like the PowerShares DB Commodity Trust Energy Fund (NYSE: DBE).
Disclosure: Anthony has recommended AGQ and DBA to his newsletter subscribers.
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