WHAT ARE INFLATION SENSITIVE STOCKS AND WHY HAVE THEY BEEN DOING SO WELL -- ROTATING FROM HOUSING TO COMMODITIES
RESPONSE TO QUESTIONS ... I've made several references to the strong performance of inflation-sensitive stocks. Apparently, there are a lot of readers who don't know what they are. Inflation-sensitive stocks are those that are tied to rising commodity prices. The most obvious are gold (precious metal) stocks, energy (natural resources), and basic materials (aluminum, copper, lumber, steel, etc). Those are stock groups that tend to outperform the general market when commodity prices are the strongest asset class as has been the case for the last four years. Those stocks can be bought individually or through sector-oriented mutual funds. There are also several Exchange Traded Funds that deal with commodity investments that I show regularly on this site. They include the Energy Select SPDR (XLE), Oil Service Holders (OIH), and the Materials Select SPDR (XLB). The Gold Trust Shares (GLD) allow participation in the price of bullion. A new Silver ETF will be available shortly. Every single one of the entities mentioned has shown superior market performance not only recently but over the last year. Charts 1 through 3 show the top performing Fidelity Select mutual funds over the last year. Fidelity Select Energy Services and the Fidelity Select Gold were the two top performers with gains of 70% and 69% respectively. Third place was taken by Fidelity Select Natural Resources (Chart 3) which gained 63%. While that was happening, the S&P 500 gained 7.8%. It's no secret where that strength is coming from. Chart 4 shows the major upturn in the CRB Index that took place during 2002. Commodities have done much better than the S&P 500 since then. So have inflation-sensitive stocks tied to those commodities.
Chart 1
Chart 2
Chart 3
Chart 4
INFLATION ETFS ... The next chart plots relative strength ratios of three inflation-sensitive Exchange Traded Funds (ETFs) that have done much better than the S&P 500 over the last year [Each ETF is divided by the S&P 500]. The top performer was the Oil Service Holders (black line) with a gain of 68%. [The Energy Select SPDR (XLE) not shown here came in second at 49%]. The streetTracks Gold (GLD) ETF gained 34%. The Materials Sector SPDR (blue line) gained only 12% over the last year. That was still much better than the S&P's gain of 8%. The blue line shows, however, that the XLB's ratio line has rallied strongly since October. In the last three months, the Materials SPDR has gained 21% versus 7% for the S&P. The XLB has been propelled by gains in aluminum, copper, and steel stocks.
Chart 5
HOUSING IS NOT AN INFLATION GROUP ... One reader chastised me for not including housing in my list of inflation-sensitive stocks. Sorry but they're not inflation sensitive. In fact, housing is the most inflation-resistant group of all. The flip side of inflation-sensitive (commodity) stocks are interest-rate sensitive stocks. They tend to underperform when interest rates are rising, which is often the side-effect of rising commodity prices. Over the last six years, historically low interest rates have kept the housing boom going. With inflation pressures now building, and bond yields starting to rise, housing stocks have peaked. That doesn't mean that inflation has peaked. The fall in housing stocks is a side effect of rising interest rates and rising inflation. That point is made graphically in the two next charts.
Chart 6
Chart 7
ROTATING FROM HOUSING TO COMMODITIES... The preceding two charts show the reversal of fortunes that has taken place away from housing stocks toward commodity-related stocks. Back on September 20 I posted a headline "Rotating from Housing to Gold" (September 20, 2005) which included an earlier version of Chart 6. It's a ratio of the Gold & Silver (XAU) Index divided by the Housing Index (HGX). At the time, the ratio was just starting to turn up (see circle). Since then, it's broken a three-year down trendline. That means that inflation-sensitive gold stocks have done much better than interest-sensitive housing stocks since then, which is why I suggested rotating from the latter to the former. Chart 7 is a ratio of the Materials SPDR (XLB) to the HGX. Here the rise isn't as dramatic, but it's happening. Notice that the XLB:HGX ratio has just broken its three-year resistance line. The later rise is due to the fact that the XLB has been the last of the inflation-sensitive ETFS to turn up. That's why I've been focusing less on gold and oil stocks recently (which have had strong runs) and more on basic material stocks which are much earlier in their uptrends. So when I write about inflation-sensitive stocks, I'm writing about those that benefit from rising commodity prices.
YOU COULD LOOK IT UP ... And, by the way, that view isn't new. Those of you that own my latest book on "Intermarket Analysis" (Wiley, 2004) might want to reread Chapter 10 entitled "Shifting from Paper to Hard Assets". The major shift to commodity-sensitive stocks was recommended way back then. And I've repeated that theme in numerous messages over the last year. Newer readers might find it helpful to look back through the Market Message archives for those articles. I don't want to give the impression that I'm recommending chasing well-established uptrends in these commodity groups. Hopefully, our older readers have participated in those commodity-related uptrends from much lower levels. Newer readers might want to wait for a pullback or consolidation in commodity stocks before committing new funds. Timing is still the name of the game.
