Phase Change

"You're afraid of our fleet. Well, you should be. Personally, I'd give us one chance in three. More tea anyone?"
--Captain Marko Ramius (Hunt for Red October)

Are the probabilities shifting from deflation towards severe inflation? For some time now, I've assigned greater chances of deflation than extreme inflation. The massive debt overhang from the popping of a worldwide credit bubble has favored prolonged credit contraction.

However, one can't ignore the gargantuan amount of monetary stimulus being created by central banks around the world aimed at reversing the deflationary trajectory. The coordinated nature of this action, designed largely to prop up asset prices (and thus mute the mother of all margin calls), is truly unprecedented and must be respected.

What's on my mind today is the lagged cause and effect nature of monetary intervention. Typically, when monetary policy is altered, it takes 6-18 months for economic effects to be realized. As such, just because we haven't observed inflationary effects from all this intervention yet doesn't mean we won't. Because the printing presses weren't really ripping till last Fall, we shouldn't expect significant consequences of these actions till this Spring at the earliest--and perhaps much later.

One thing's for sure. Financial markets will sniff building inflationary pressures out ahead of their material appearance.

In my personal forecast of macro conditions over the next couple of year, I'm dialing up the chances of extreme inflation:

extreme inflation 50%
'normal' inflation 20%
deflation 30%

I'm rebalancing my portfolio accordingly to better reflect inflationary possibilities. Mainly, I've been decreasing cash and adding to commodity positions. Given the sector's pounded down nature--and it's increasingly attractive (in my view) fundamentals, I've been particularly focused on energy-related commodities, using ETF and ETN instruments such as DBE, DBO, and RJN.

The idea is to boost chances of preserving purchasing power in a world that's tilting more towards a fiat money confetti-fest.

position in DBE, DBO, RJN