Well, there’s just no denying it anymore: The Federal Reserve’s cheap-money pumping isn’t going to stop until inflation kicks up in a big way.
This was the takeaway from Wednesday release of the latest Fed meeting minutes, which the market initially viewed as “hawkish” since it indicated that the tapering of the ongoing QE3 bond purchase program would continue despite some recent softening of economic data.
But digging in, I believe the more important takeaway was that the Fed was preparing to move further way from its old 6.5% unemployment rate threshold on hiking short-term rates and was considering alternative goalposts for a strategy that has been dubbed “forward guidance” — such as focusing on measures like wages, inflation, etc.
That suggests the Fed plans to keep rates lower for longer and will wait until inflation becomes a real problem before tightening policy.
Remember, although the Fed is tapering, it is still maintaining an aggressive easing bias, with the monetary base expanding toward $4 trillion. Once QE3 ends, the Fed will be neutral. Only by contracting the monetary base will it actually start tightening policy. However, the Fed is now saying outright that policy won’t go to neutral, let alone be tightened, unless inflation increases from its current annual rate of around 1.1% to 2.5%.
Back in 2011, when the Fed last went neutral when the QE2 program ended, the inflation rate peaked at nearly 3% a few months later.
When inflation peaked, gold hit a peak of $1,924 an ounce. That would be worth a gain of 46% from current levels. Crude oil had peaked at nearly $115 a barrel earlier that year. And silver was trading at double current levels.
So while inflation hedges took a hit on Wednesday, as the market focused on the likelihood that the Fed keeps tapering QE3 by $10 billion at each of its policy meetings, I think it’s a buying opportunity ahead of what could be a long, hot summer of higher prices.
Extreme weather — especially the historic drought in California — looks ready to pinch consumers at the checkout stand. The situation in the Golden State is so severe that communities are considering trucking in drinking water as the mountain snowpack stands at just 12% of normal, setting the stage for a parched summer.
This is a problem because of how critical California’s farms are to the nation’s food supply. According to data from the California Department of Food and Agriculture, the state is the nation’s largest producer by value of agricultural goods, produces nearly half of U.S.-grown fruits, nuts and vegetables, and dominates the production of many items.
It maintains an 80% or greater share of U.S. production of the following items: Artichokes, almonds, broccoli, celery, processed tomatoes, nectarines, strawberries, cauliflower, garlic, leaf lettuce, plums, apricots, grapes, figs, kiwifruit, lemons, olives, pistachios, dates, lemons, walnuts and peaches.
That’ll be a big deal if the drought conditions don’t end soon.
And finally, it is worth noting that the cattle market looks set to tighten as well with the U.S. herd at its smallest size in 61 years with prices up more than 11 percent from their 2013 lows.
Here are three ETFs that should be the cornerstone of any inflation protection strategy, allowing investors to profit from, and protect their capital from, the Fed’s desire to further diminish the dollar’s purchasing power.
U.S. Oil Fund (USO)
Click to Enlarge Tracking the price of West Texas Intermediate, the U.S. Oil Fund (USO) holds a portfolio of short-term oil derivative contracts to give investors exposure to the underlying movements of crude. The ETF is large and actively traded, with nearly 5 million shares traded on Wednesday as shares continue to break out of a five-month consolidation range as crude moves towards the $104 a barrel level for the first time since October.
I’ve added USO to the Edge Letter Sample Portfolio.
SPDR Gold Trust (GLD)
Click to Enlarge The SPDR Gold Trust (GLD) is the largest and most well-known “paper” gold holding, with each share representing a stake in a physical gold bullion cache. With gold prices on the mend this month, the GLD pushed above its 200-day moving average for the first time since early last year. As mentioned above, gold prices have a long way to climb if the Fed successfully hits its 2.5% inflation target.
PowerShares DB Multi-Sector Commodity Trust Agriculture Fund (DBA)
Click to Enlarge The PowerShares DB Multi-Sector Commodity Trust Agriculture Fund (DBA) holds a collection of commodity derivatives including sugar, live cattle, corn, soybeans and cocoa. Shares are pushing higher in a huge way, with the most significant uptrend initiation since late 2010, as everyone prepares for the sticker shock on food prices coming out of California that’ll be exacerbated by the Fed’s tidal wave of cheap money.
A return to the 2011 inflation peak would be worth a 32% gain from here. I’m also adding a position in DBA to my Edge Sample Portfolio.