Top Advisors Corner

2021 and the Reflation Rally


It sure feels and looks a lot like 1999 and 2007. Time will tell, but markets have divorced themselves from reality, and that usually leads to a reversal.

An example of speculative excess: Elon Musk told his followers to "use Signal," leading to an 1,100% surge in unrelated stock with similar name.

Watching the U.S. Capitol being overrun, something that has not happened since the War of 1812, while the Dow and S&P 500 are both up and the volatility index down, makes little sense. We have been living with the worst pandemic since the Spanish Flu in 1918, with countries around the globe locked down and economies stalled while millions of Americans are unemployed, yet markets moved to new highs. Jobs continue to be lost. A new COVID variation is now spreading. Millions of people and business are behind on their rents and mortgage payments. 

Yes, I know, the markets are forward-looking. Yes, the Fed and other central banks are printing money. Yes, there will more fiscal and monetary stimulus. Yes, M2 money supply is up massively and growing. But the reality is that most of that money ends up sitting on the balance sheet of the big banks, not circulating through the economy, the velocity of money continues on a downward path.

The rallying cry is "REFLATION!!" Yes, I hear it. It's the new religion. It has been fully embraced by the hedge fund community (large speculators) who are sitting with record positions in a "reflation" bet – long grains, metals, softs while short dollars and bonds.

M2 MONEY STOCK, % CHANGE FROM YEAR AGOSource: Federal Reserve Bank of St. Louis, 1/09/21

VELOCITY OF M2 MONEY STOCK, % CHANGE FROM YEAR AGOSource: Federal Reserve Bank of St. Louis, 1/09/21

COPPER, LARGE SPECSSource: CFTC, BullMarkets, 1/09/21

SOYBEANS, LARGE SPECSSource: CFTC, BullMarkets, 1/09/21

CORN, LARGE SPECSSource: CFTC, BullMarkets, 1/09/21

DOLLAR, LARGE SPECSSource: CFTC, BullMarkets, 1/09/21

Will these large specs be right? Time will tell. But if they are wrong, and I think they are too early, there will be a large reset and unwinding of these massive bets. 

Taking the current environment into consideration, this is what I am watching for in the markets: 2021 will be a dangerous year as volatility rises and economic data continue to present headwinds. Remaining defensive will be key as risk/reward is not favorable. Keeping stops close and trading around positions will be central to being successful in 2021. Buy-and-hold passive investing will be challenged and investors should place more emphasis on protecting their portfolios in 2021.

Comments and questions are always welcome,

Tim Taschler, CMT

Sprott USA

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