Playing Medium Term Extremes in Sentiment… Inflation Fears Continue to Dominate Deflation Woes

The other day, we posted videos of David McAlvany’s interview with Felix Zulauf (of Zulauf Asset Management). He had some fantastic thoughts on global economic and investment trends. An insight that really resonated with us was along the lines of (paraphrasing):


One should have a defensive long-term position, and one should trade the bullish and bearish sides over the medium term.


We are inclined to agree, and we think that the ‘inflation vs deflation’ indicators below can be useful in this respect. Here, we present the latest update of these indicators.


As we have explained in previous updates:


The following two charts use data from google insights (google’s tool for gauging patterns in search) to figure out the prevailing opinion in the inflation vs deflation debate. The idea is to show how searches for ‘inflation’ are competing with searches for ‘deflation’. When people are searching for ‘inflation’ with greater vigor than they are searching for ‘deflation’, it is assumed that inflation fears dominate. Conversely, when people are searching for ‘deflation’ with greater vigor than they are searching for ‘inflation’, it is assumed that deflation fears dominate. The contrarian investor can use these indicators to oppose each conviction at its extreme.


inflation vs deflation indicator chart

Click to enlarge. Source: Google Insights

inflation vs deflation indicator chart relative out-performance

Click to enlarge. Source: Google Insights


[The first chart uses plain search volume indices from google insights, whereas the second chart uses the relative out-performance of those indices (compared to searches about 'finance & investing'). We invert the 'deflation' parts (red) to show how the two search items are competing with each other. When the blue parts are high, people are searching for 'inflation'. When the red parts are very negative, people are searching for 'deflation'. The black line is the aggregate of these two. When it is rising, inflation fears dominate, and when it is falling, deflation fears dominate.]


As can be seen from the charts above, searches for inflation have rebounded somewhat over the past week or so. Indeed, inflation fears remain elevated relative to deflation worries. We’re aware that we’ve been saying this for weeks, but nevertheless the indicators are what they are, and we thank you for your continued patience. As people once more become petrified of deflation, we’ll probably see a swift and harsh decline in risk assets.


We still maintain that the contrarian asymmetry in insuring against deflation may have dissipated (after all, in Feb/March it was seemingly embarrassing to be bearish on inflation assets), however the momentum to the downside is by no means stretched. As the months progress, we’ll continue to watch these indicators. Hopefully, we’ll be able to spot when the deflation/bearish momentum has become stretched so that we might reverse our positions (on the medium-term).

See here for our collection of rare historical economic data.

Posted Jul 17, 2011