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Minyan Mailbag: Deflation or Stagflation?


If the dollar rally unfolds... commodities will give up some of the jig they've enjoyed the last few years.



As always, I enjoy your commentary as well as the other Minyanville Staff.

There is no doubt in my mind that we're just in the beginning of a long and severe recession that will bring "asset-class deflation" to the US with strong contagion in the UK, weaker in Eurozone and more minimal impact on emerging markets. But I'm confused by the obvious discrepancy between the way the commodities markets behave (pointing to inflation) and the bonds (pointing to deflation). The real yield on10-year notes is already negative.

I always respect the charts and never assume the market is "wrong." The technical picture on daily/weekly charts on bonds and commodities are both bullish, which doesn't make sense to me. Can I assume that this situation is abnormal and is likely to "normalize" soon (either by falling bonds or by falling commodities)? Trying to reconcile between the two, I thought of the following possible scenarios:

1) Commodities prices are dictated mostly by emerging markets that continue to grow rapidly. Even with severe US recession and some contagion as I wrote above, the demand for commodities will still overwhelm supply, pushing commodities prices higher, causing global inflation to rise. "Peak Oil" may be part of this scenario. Under this scenario, bonds will fall.

2) Commodities markets are quite narrow and prone to speculation.As investors (i.e. hedge funds) move out of other asset classes and out of carry trades, they move into commodities, pushing prices higher. Under this scenario, further deterioration in the financial markets will cause deleveraging and redemptions in HFs that will deflate the commodities markets. (This didn't happen so far.)

Personally, I lean towards #1 (and position my portfolio accordingly), but reading financial blogs, I get the impression the most influential economists/bloggers favor #2. (Last one is Nouriel Roubini in his 2008 forecast.)

Thanks in advance,
Minyan O.W.


Excellent (and timely) question as I was just discussing this with a reporter. She asked me for some information regarding stagflation and I pointed her to one of Pep's articles, which is far superior to anything I've written on the subject. I also told her that Pep has shifted into the deflation camp and, for my money, I don't wanna take the other side of that bet.

We've seen a ton of issuance lately from Citigroup (C), Merrill Lynch (MER) and others of late and, by definition, that is deflationary (more supply in the marketplace). Further, given the ratchet protection that Minyan Peter talked about yesterday--which was likely the only way the deals would get done--the terms of that issuance will reset lower should more capital be needed in the future.

To your question, if the dollar rally unfolds (one of our ten themes for 2008)--whether by cause or as an effect--commodities will give up some of the jig they've enjoyed the last few years. That's one of the reasons I'm looking for consumer non-durables and pharma to out-perform on a relative basis, quite conscious that we can't spend relative income.

So, net/net, if you asked my for my honest take, I would say Scenario Deux is more likely, although it would likely be more painful.

Thanks for taking the time,


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No positions in stocks mentioned.

Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at

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