Posted by Davy Bui on December 14th, 2007 in Market Commentary
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Unexpectedly (unless you read this blog and other like-minded sites), inflation has come back with back-to-back scary PPI and CPI numbers, even despite the government massaging.

In response, gold and oil has sold off, which makes little sense. Maybe people are discounting the inflation-fighting response already. Who knows? One can waste a lot of time trying to (not) figure this out.

I’m trying to stay focused on the long-term. There is nothing the central banks can do in the short term to fight inflation. There is very little they can do in the intermediate term to fight inflation without killing dead most of the developed (and debt-laden) OECD economies.

The western central banks have to cut rates. The Fed needs the cover of the European central banks in order to keep aggressively cutting; otherwise, the rate spread divergence will speed the dollar’s demise. But cutting rates overseas may be tricky since Europeans are more consciously aware of inflation, IMO. Check out today’s Financial Times to get a feel of inflation expectations in England and processed food inflation in the Eurozone (as high as 11% in Slovenia, 6% in Germany & Spain). It seems the Germans still remember the Weimar Republic, even if Americans have forgotten the Great Depression or the stagflating 70s.

At some point soon, I would expect some sort of “funny business” in the energy and/or gold markets. Perhaps something akin to the Goldman Sachs rejigging an index or two (though GS sold that index). I’m not making any predictions — just gird yourself for an unexplainable hit to those markets and don’t panic.

The other big problem brewing is the agricultural commodities market, which may be more problematic. Americans are more insulated from food inflation but even we are starting to notice the big price increases.

These trends make for very dangerous waters for exclusively bottoms-up investors, IMO. I wouldn’t make investment decisions based solely on US economic exposure but definitely, I would weigh the macro situation into the evaluation process.

2008 is shaping up to be an interesting year.