News Analysis date published New: 
Tuesday, September 4, 2012 - 16:30
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Tuesday, September 4, 2012 - 16:30
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Tuesday, September 4, 2012 - 16:30

This Gold Trade Could Be the Best Way to Protect Against Inflation

Tuesday, September 04, 2012 4:30 PM

Last week, my 26-week rate of change (ROC) system signaled a sell for bonds, an indication that risk has increased in the fixed-income markets. While I follow the signals, I also try to understand what causes each signal. One of the biggest drivers of interest rates is inflation, which seems to be steady, but according to policy makers, there is nothing to worry about on that front.

After every Federal Reserve meeting lately, the official statement includes a phrase about "temporary price pressures," which means we shouldn't worry about inflation. But, not worrying about inflation can be difficult for consumers who are forced to pay higher prices that feel more and more like they are permanent.

Traders also seem to be concerned about inflation, which has led to increased interest in commodities, which can be traded with ETFs. However, traders need to realize that ETFs will not precisely follow the changes seen in the futures markets.

Drought conditions have pushed corn prices to record highs, and the futures contract for corn is up more than 42% since the beginning of the year. Teucrium Corn (NYSE: CORN), an ETF that tracks corn prices, is up just 20%. From the bottom in June, corn futures are up 70% while the ETF CORN is only up 44%.

There are a number of reasons an ETF can lag a futures contract. Management expenses of 2.55% for CORN plus trading costs almost guarantee some underperformance in the ETF. However, it is likely that most of the difference results from the fact that CORN holds futures contracts for different months. Futures contracts have an expiration date. CORN splits its holdings into three different contracts, and more distant expiration dates have seen smaller gains than the contract that most futures traders are using to profit from corn.

Despite the performance differences, the ETF and the futures contract follow the same general trend. Corn prices appear to be forming a top and the stochastics indicator is already pointing down. For corn, the price pressures do seem to be temporary, although elevated food prices are possible for some time.

Gasoline prices tell a similar, but less dramatic, story. Traders can use the United States Gasoline Fund (NYSE: UGA) to gain exposure to this commodity. Futures, with a 25% year-to-date gain, once again beat the ETF, which gained 19%, but only by a small amount. UGA has an expense ratio of only 0.84%, which decreases the tracking error, and uses only the near-term futures contract.

The stochastics indicator is also bearish for gasoline, again pointing to the probability that the uptrend may be over for now.

Corn and gasoline prices will affect official inflation measures, and there may very well be temporary upward pressures on retail prices. But it looks like after these temporary pressures recede, new pressures may develop from livestock. Reports indicate that ranchers and farmers are decreasing the number of cattle and hogs they feed because of higher grain prices, and supply decreases could lead to higher prices later. Inflation seems to be rotating between commodities for now, explaining why they could be called "temporary" while feeling permanent.

Gold, a commodity that does not directly affect consumer prices, shows a completely different picture. Here, the SPDR Gold Trust (NYSE: GLD) ETF has slightly outperformed the futures since the start of the year. Gold futures have gained about 4.9% while GLD is up 6.5%. The very low-cost ETF holds gold bars, and physical gold has slightly outperformed gold futures.

Action to Take --> Gold futures and GLD have recently broken out of consolidation patterns. That makes gold the best buy right now for traders looking at an inflation hedge. GLD has been in the ROC system portfolio for several weeks now and looks like it will continue to offer some defense against inflation.

There are no changes to the portfolio this week. The system remains invested in:

Michael J. Carr does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.