Inflation is Here

It is official (other than in the US), inflation is here. World food prices hit a record high this week and look to accelerate higher unless the world can magically grow another 2% of supply. With the growth in the wealth of the emerging nations there is a huge demand for "new" staple foods such as corn and wheat over the "old" staple food of rice. This is driving demand for the "new" staples plus pushing demand for cattle and poultry higher. In addition oil broke through $90 a barrel this week and looks like it will take a run at $100.

Now why does the Federal Reserve think that inflation is under control? Well they use the CPI as an indication of inflation. Essentially this is a basket of goods and services that represents (in their eyes) a good proxy for price increases. Digging into this number and how it is derived reveals some very obvious mistakes, the most obvious of which is that it does not weight food or energy correctly. In fact energy is a sub-category of transportation and housing (apparently it will feed into the numbers if it gets high enough - and no I did not make that up)! Maybe everyone in Washington DC and New York does not cook food or drive to work, but the rest of the world does. In fact there are billions of people who do not own a house but need to eat.

Currently the top 6 US CPI weightings are:

1. Housing at 42%
2. Transportation at 17%
3. Food and Beverage at 16%
4. Recreation at 6%
5. Medical Care at 6%
6. Education and Communication at 6%

With the cratering of the US housing market it is easy to see why the Federal Reserve thinks that inflation is benign. In fact if (or should I say when) the number does grow out of control then they change how it is calculated. Since 1996 they have changed the methodology 9 times. I wonder why?

In an inflationary environment bonds will perform poorly so look to exit or short those. Furthermore this could be the year of the farmer so agriculture, live stock, feedstock and oil products should provide you an excellent return.