While some of the worst credit market conditions in modern history occurred as recently as 8 months ago, it seems that enough time has passed for the market to substantially get over its fears of deflation and drastic economic contraction. At least, that is the sense I get from reading the news ...

IN PICTURES: 20 Tools For Building Up Your Portfolio

Inflation Worries Dominate Recent Headlines
A June 24, 2009 MarketWatch article reports that "a vocal group of economists is more worried about inflation. They believe the central bank has created so much money that it will soon be used by consumers to chase fewer goods."

Also, a Reuters article from June 21, 2009 sports the headline, "Inflation sparks glowing on the horizon" and goes on to state that "with mounting evidence that the recession is loosening its grip on the economy ... investor focus is shifting to inflation."

And a June 19, 2009 Wall Street Journal article seems to capture the tone of the market's collective worry with a headline reading: "Let Federal Reserve Beat Inflation"

Contrarian Investing Decodes Misinformation
The prevalence of these types of articles in financial media today tells me that the overall market perception is primarily a concern for inflation. This sentiment exists while we are still less than one year into a much-needed correction of a credit-based inflationary bubble that took several decades to build up to its recently completed peak.

This reality has me wondering if it is really possible that the credit crunch has in fact been solved so early on in the game that deflationary risk is all but a passing memory. In other words, are the headlines really correct that inflation is the enemy to fear right now?

To answer that question, let's first look at the raw data to determine if it's possible (or dare I say, likely) that the market's collective inflation fears are mistaken.

Using the consumer price index (CPI) as a measure of inflation, look at what is happening to the CPI's rate of change, as reported by John Williams' ShadowStats.com. Regardless of whether you prefer the government's official CPI number, or the "alternate CPI" espoused by ShadowStats.com, the trend is obvious - the rate of inflation continues to decline more rapidly than at any other time in the last 30 years.

So, what is causing individual investors and financial pundits to worry about inflation? If the CPI data continues to fly in the face of this inflationary sentiment, eventually that sentiment will be forced to correct itself. Should that happen, countless investors will flee inflationary trades and jump back into deflationary positions.

Gold Short ETFs Are the Place To Be, For Now
If that scenario unfolds as I expect, I think we will see a repeat of what we saw last October - when deflation and depression worries overwhelmed the market in the short-term, causing gold prices to plummet while the U.S. dollar saw considerable strength. If that sounds far-fetched, consider that the SPDR Gold Shares ETF (NYSE:GLD) closed at $89.90 on October 9, 2008, and just two weeks later it had fallen 21% to close at $70.65 on October 23. If you were in GLD as an inflationary hedge at that time, those losses would be pretty difficult to swallow. Even more so if you happened to be aggressive and holding the PowerShares DB Gold Double Long ETN (NYSE:DGP), which seeks to return twice the daily percentage change in gold prices. (For more, see Does It Still Pay To Invest In Gold?)

For the time being, I see a pretty big divergence between economic and monetary reality and investor expectations. I am expecting that gap will likely be closed by a reversal in investor sentiment towards deflation, not by improving economic fundamentals or inflationary conditions. In the long-term, I do accept that increased rates of inflation are likely to manifest, but in the short run, I don't think it is unreasonable to conclude that gold prices could fall 25% from current levels, trading down to below the $700 mark.

Buying gold short ETFs such as the PowerShares DB Gold Short ETN (NYSE:DGZ), which essentially seeks to provide returns that are the inverse of the daily percentage change in the price of gold, are an easy way for the individual investor to protect themselves from this scenario. An ETF like this can be especially useful for trading in registered or otherwise restricted trading accounts that may not allow for direct short-sale trades. (For further reading, see Inverse ETFs Can Lift A Falling Portfolio.)

The PowerShares DB Gold Double Short ETN (NYSE:DZZ) seeks to provide twice the percentage return of DGZ, so it can be useful for aggressive investors looking to speculate on this scenario, or for those looking to hedge long positions with the leverage utilized by DZZ.

The Final Word
When it comes to investing, following the crowd can often get you into serious trouble. After all, it was irrational optimism and a general willingness of market participants to dramatically increase credit levels and asset prices that led to this financial bubble in the first place. Many investors must surely remember being told during the consumer credit bubble's peak, "buy a house now or you risk being priced out of the market forever!"

Well, that line of thinking could just as easily be applied to the present day situation as, "buy gold now or be inflated out of the market forever!" It's the same wolf, just in a different sheep's clothing. (For further reading, see Coping With Inflation Risk.)

Related Articles
  1. Mutual Funds & ETFs

    3 Fixed Income ETFs in the Mining Sector

    Learn about the top three metals and mining exchange-traded funds (ETFs), and explore analyses of their characteristics and how investors can benefit from these ETFs.
  2. Chart Advisor

    Agriculture Commodities Are In The Bear's Sights

    Agriculture stocks have experienced strong moves higher over recent weeks, but chart patterns on sugar, corn and wheat are suggesting the moves could be short lived.
  3. Investing News

    Top Tips for Diversifying with Mutual Funds

    Are mutual funds becoming obsolete? If they have something to offer, which funds should you consider for diversification?
  4. Professionals

    Top Stocks to Short, Go Long On to Beat the Market

    A long/short portfolio can help weather a variety of market scenarios. Here's how to put one together.
  5. Mutual Funds & ETFs

    Top 4 Asia-Pacific ETFs

    Learn about four of the best-performing exchange-traded funds, or ETFs, that offer investors exposure to the Asia-Pacific region.
  6. Mutual Funds & ETFs

    Top 3 Japanese Bond ETFs

    Learn about the top three exchange-traded funds (ETFs) that invest in sovereign and corporate bonds issued by developed countries, including Japan.
  7. Mutual Funds & ETFs

    What Exactly Are Arbitrage Mutual Funds?

    Learn about arbitrage funds and how this type of investment generates profits by taking advantage of price differentials between the cash and futures markets.
  8. Savings

    Become Your Own Financial Advisor

    If you have some financial know-how, you don’t have to hire someone to advise you on investments. This tutorial will help you set goals – and get started.
  9. Investing News

    Ferrari’s IPO: Ready to Roll or Poor Timing?

    Will Ferrari's shares move fast off the line only to sputter later?
  10. Investing Basics

    6 Reasons Hedge Funds Underperform

    Understand the hedge fund industry and why it has grown exponentially since 1995. Learn about the top six reasons why the industry underperforms.
  1. What are the risks of annuities in a recession?

    Annuities come in several forms, the two most common being fixed annuities and variable annuities. During a recession, variable ... Read Full Answer >>
  2. Can mutual funds invest in IPOs?

    Mutual funds can invest in initial public offerings (IPOS). However, most mutual funds have bylaws that prevent them from ... Read Full Answer >>
  3. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  4. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  5. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  6. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!