Our Four Star Inflation-Deflation Model Update.

In my book Safe Strategies for Financial Freedom, we argued both sides of the inflation-deflation argument.  We established four indicators that would help us track inflation and initially I reported  those indicators in Tharp’s Thoughts newsletter each month.

However, I became unsatisfied with the four original indicators because many of them could be manipulated by the Federal Reserve.

These four indicators for inflation are:

1)      The CRB index

2)      The price of Gold

3)      The CPI and

4)      The trend in interest rates.

I now believe that we are in an inflationary bear market and that our inflation rate is simply masked by government statistics. My biggest problem with the above indicators, which have suggested inflation since we’ve been using the model is that all of the figures (with the exception of the CRB index) can be easily manipulated by the government.

The second problem I have with these four indicators is that you can look at the data and find some sort of trend that might support your conclusion. 

So let’s look at some new indicators that I have been using since mid-2006. These indicators that are less likely to be manipulated by the government.

1) The CRB Index

2) The Basic Materials Sector (XLB)

3) The London Price of Gold and

4) The Financial Sector (XLF)

Since the description of the model we’re now using is not in any of my books, I’ll  give it here.

1)  The CRB Index.  I believe that the CRB index is the one we have currently that is the least manipulated by the government.  But what’s the best way to measure it?  For consistency, I plan to give two measurements. 

·     Is the CRB index higher than it was six months ago?  If it is, we are on track for inflation.

·     Is the CRB index higher than it was two months ago?

Now there are several ways to monitor these two indices.

·     If both differences are higher, we’ll count one star for inflation. 

·     If the six-month change is higher, but the two-month change is not, then we will only count ½ star for inflation. 

·     And if both the two and six month changes are lower, then we’ll be minus one for inflation.

·     However, if the six-month change is lower, while the two-month change is higher, then we’ll be minus ½ star for inflation.  Obviously, the two minus scores will point to deflation.

2) The Basic Materials Sector ETF (XLB).  In an inflationary environment, basic materials will definitely go up and this sector, to the best of my knowledge, is not manipulated by the government.  Thus, we will use this sector to monitor inflation and we’ll use the same measurements use for the CRB.  (1) Is the XLB higher than it was six months ago?  (2) Is the XLB higher than it was two months ago?  These two measurements give us four possible results.

·    If both differences are higher, we’ll count one star for inflation. 

·    If the six-month change is higher, but the two-month change is not, then we will only count ½ star for inflation.

·    And if both the two and six month changes are lower, then we’ll be minus one for inflation.

·    However, if the six-month change is lower, while the two-month change is higher, then we’ll be minus ½ star for inflation.  Obviously, the two minus scores will point to deflation.

3) The London PM Gold price at the end of each month.  Although the government can manipulate Gold, I still like to look at monthly gold prices.  However, to be consistent, we’ll use the same two measurements that we’ve used for the other indices that we are monitoring.  (1) Is the price higher than it was six months ago?  (2) Is the price higher than it was two months ago?  Again, these two measurements give us four possible results.

·     If both differences are higher, we’ll count one star for inflation. 

·    If the six-month change is higher, but the two-month change is not, then we will only count ½ star for inflation.

·    And if both the two and six-month changes are lower, then we’ll be minus one for inflation.

·    However, if the six-month change is lower, while the two-month change is higher, then we’ll be minus ½ star for inflation.  Obviously, the two minus scores will point to deflation.

4) The Fourth Measurement we’ll use is related to the Financial Sector of the S&P 500.  The financial sector (XLF) tends to do well when we have deflation and poorly when we have inflation.  Martin Pring, in fact, has used an index in which he divides the XLB by the XLF.  Since we already use the XLB, we’ll use the XLF by itself as well.  Again, we’ll use the change over six months and over two months.  However, the four possible outcomes with give us a different interpretation.

·    If both differences are higher, we’ll count one star for deflation (i.e., minus one for inflation). 

·     If the six-month change is higher, but the two-month change is not, then we will only count ½ star for deflation (i.e., minus ½ for inflation). And if both the two and six month changes are lower, then we’ll be plus one for inflation.

·    However, if the six-month change is lower, while the two-month change is higher, then we’ll be plus ½ star for inflation.  Obviously, the two minus scores will point to strong inflation.

 Back to Newsletter List