Inflation Fears Meet Reality

The Bureau of Labor Statistics reports that consumer prices fell by 1.3% over the past year:

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.3 percent in May before seasonal adjustment, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. Over the last 12 months the index has fallen 1.3 percent. This is the largest decline since April 1950 and is due mainly to a 27.3 percent decline in the energy index.

cpi-may-20091

As can be seen this CPI-U measure applies a rise of 0.5% for “Housing”. How realistic does this appear? It is obviously a mirage. It is a result of the fact that the so called owners’ equivalent rent (OER) has replaced real home prices in the index. It contributes 24.433% to the current CPI-U and is included as a component of “Housing”.

This prevented the CPI from raising red flags during the housing boom, and it is now skewing price declines significantly

When we replace OER with the Case-Shiller home price index, which most recently indicated a year on year drop of 18.7%, prices overall actually fell by 6.3%.

As I said 11 days ago:

…this is not the stuff from which inflations are made.

I expect a reversal of market data to adjust to real conditions sooner or later. I think Treasury Notes will be a good call. The dollar should start to rise again against other currencies. I think gold is likely to do fine. It is merely back to where it was before the inflation fears began. Silver’s excessive gains, however, may have partly been fueled by these inflation expectations. I would advise caution here. It may be time to ring the register on some silver gains and buy at another low.

Treasuries have rallied since then. Stocks have fallen. The dollar has gained, albeit rather moderately. Gold saw a minor drop while silver fell by about 6%. Virtually all inflation expecation indicators that I posted in that article have begun to change direction. I expect this to be a pervasive and extended trend over the next weeks and months with gold beginning to bounce back stronger than silver. Whenever expectations are so out of whack with reality, a market correction tends to be due … time will tell.

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