At the end of last year, we held the opinion that the arrival of the much feared taper was a positive development for corners of the market most influenced by inflation expectations - or lack thereof. Commodities, commodity currencies, TIPS, emerging markets, Chinese equities - they had all followed the strong disinflationary trend that was established in Q2 2011 and were buttressed by additional Fed interventions.
With the Fed signaling to the market last year that they would be gradually removing these extraordinary measures, we felt inflation expectations would normalize as well in its wake. While many had looked for another maelstrom to develop in emerging markets and sectors such as precious metals and commodities, we read the tea leaves to indicate an opposite dynamic and one that could reverse their respective downtrends.
Throughout the year we have followed three risk ratio proxies that have illustrated the staggered start that has unfurled in these reflationary trends since the initial taper was declared last December. Precious metals were the first to put in what we perceived to be a cyclical low at the end of last year, followed by the broader commodity sector - with emerging market (iShares MSCI Emerging Markets (ARCA:EEM)) and Chinese equities (iShares FTSE/Xinhua China 25 Index (ARCA:FXI)) following their leads in Q1.
With the final taper on deck this October, we expect the second staggered stage for these reflationary trends to be well on their way higher. 
- Despite the shake-out last Thursday in long-term Treasuries and precious metals, support is in place for the second stage to develop. From a long-term pattern perspective, the recent retest of this years low is derivative of the broader structure - with respect to inflation, commodities and long-term Treasuries (see chart >) relative to equities.
- Similar to the structure of the precious metals sector - which tested the lows (relative to equities) coming into June, the broader commodity space has followed in its month-old footprints and is poised to begin the next leg higher.
- Throughout the year we have favored emerging market (EEM) and Chinese equities (FXI) and have followed their lagged pivots higher with these other reflationary trends. Considering the leading structure present in precious metals and commodities, an interim high may have been made this past week.
- Going forward, the next leg in the US dollar and long-term yields appear to be the hinge points for both precious metals and the broader commodity sector. Despite its recent retracement move higher, which exceeded our own expectations, the big picture macro view - which includes the set-ups in long-term Treasuries, commodities and the burgeoning reflationary trends in emerging markets and China - should maintain pressures on the dollar from a long-term perspective.
