Gasoline prices have been climbing steadily since 2009. But it’s about the only commodity that’s sustained such a strong upward price trend these past four years.
We’re clearly in a deflationary environment, with debt deleveraging and falling asset prices. At the same time, the Fed’s stimulatory efforts are brewing inflationary pressures just below the surface. So I stay on the lookout for any sign of the resurgence of inflation.
I do this by watching two things: commodity and bond prices.
Commodity prices increase with inflation. Bond prices decrease with inflation. By taking a ratio of the two I have a handy inflation indicator. When inflation is increasing, the ratio increases.
As you can see, gasoline clearly signals the building inflationary pressure since 2009.
Yet, crude oil, corn and wheat all point to deflation.
This trend has been in force for some time and shows no sign of reversing. So while the hyperinflation fear mongers may have their day eventually, anyone investing on the expectation of inflation is getting crucified… gold bugs – who buy gold as an “inflation hedge” – can tell us how this feels.
Instead, you should invest for deflation.
That means buying bonds (which go up in price as deflation takes hold) and selling commodities (which slump under the weight of deflationary forces).
And with gasoline prices temporarily inflated, it’s the logical choice to bet against.
One way to play this is with a spread trade: selling gasoline and buying Treasury bonds.
The U.S. Gasoline Fund ETF (ARCX: UGA) is up 12% in the last six weeks. This makes for a good short-sell opportunity.
Meanwhile, the iShares 7-10yr Treasury Bond ETF (ARCX: IEF) is down 8% since the beginning of May, making it a good buy.
As a spread trade, you’ll want to invest equal dollar amounts in each side. And consider unwinding the trade if the net loss on both positions reaches 10% to 15%. (Note: just because this is a spread trade doesn’t mean there’s no risk.)
Over the long run, we should see gasoline prices come down… joining the deflationary trend we already see in oil, corn and wheat.