Chart Advisor: Inflation Impact

Articles From: Investopedia
Website: Investopedia

By J.C. Parets & All Star Charts

Tuesday, 14th February, 2023

1/ Inflation Impact

2/ Semiconductor Stocks Set the Stage

3/ Commercials Are Bullish on Gold

4/ Will Dollar Weakness Persist?

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1/ Inflation Impact

Stocks traded in a wide range today as investors reacted to the latest inflation report. As the Consumer Price Index (CPI) came in above expectations, our attention is on the stocks that are impacted most by the market’s expectation of future inflation.

The chart below shows the Metals and Mining ETF (XME) overlaid with the TIPS vs. Treasurys ratio:

Source: All Star Charts, with data provided by Optuma

This ratio can give us an excellent representation of where inflation is headed, as it provides a reliable indicator of breakeven inflation rates. When inflation expectations are rising, TIPS vs. Treasurys and XME also tend to rise.

The reason why the correlation between XME and inflation expectations is so high is because these stocks benefit directly from rising commodity prices. When inflation heads higher, the price these companies can sell their goods for moves higher as well, often leading to higher stock prices. 

If inflation expectations begin to tick higher again, metals and mining stocks could stand to benefit.

2/ Semiconductor Stocks Set the Stage

Semiconductors (XSD) are among the best-performing industry groups in the market right now, particularly over the short term.

When we evaluate the relative trend, semiconductor stocks are currently piercing through the upper bounds of a decade-long base relative to the Nasdaq 100 (QQQ).

Source: All Star Charts, with data provided by Optuma

The semiconductor industry is a bellwether for the global economy, as it fuels some of the most essential industries in the information age.

As such, seeing this pro-cyclical index reaffirm its leadership role can only be viewed as a positive development for global markets. When it comes to the technology sector, semiconductors are among the best-performing subsectors at the moment.

3/ Commercials Are Bullish on Gold

We often discuss the dollar and real yields as critical catalysts for a sustained uptrend for gold and silver. But there’s another key ingredient—commercial positioning.

The Commodity Futures Trading Commission (CFTC) releases its Commitment of Traders (COT) report each week, revealing the attitudes of the strongest hands. We like to think of the COT as a sentiment gauge for the commodities market.

Commercial hedges in gold reached extreme levels last fall, coinciding with significant price troughs in 2016 and 2018:

Source: All Star Charts, with data provided by Optuma

Strong hands move markets, and the strongest hands were very bullish as gold printed year-to-date lows last fall. More recently, an unwind in bullish positioning ignited the rally off the early fourth-quarter lows.

Gold bugs would like to see a similar flip in positioning to the 2019-2020 unwind that led to new all-time highs. This would act as a pivotal catalyst for the next leg higher.

4/ Will Dollar Weakness Persist?

Despite the overarching range-bound trading and intraday indecision, the charts continue to suggest dollar weakness ahead over longer timeframes.

The USD/CHF cross presents a compelling picture of this when we zoom out: 

Source: All Star Charts, with data provided by Optuma

This currency pair has remained in a structural downtrend since the 2000 dotcom bubble peak. We could argue that the past decade represents a bearish consolidation within an ongoing downtrend.

Some may see a potential head-and-shoulders top with the right shoulder nearing the neckline. The implications could point toward a downside resolution.

Remember that without a confirming breakdown, this is only an interpretation. Before we can get behind the next leg lower in the dollar, we need to witness decisive resolutions signaling dollar weakness.

Originally posted 14th February , 2023

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