Hedging Against Asset Inflation with Gold

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One of the most damaging drops in GDP in history, record unemployment, and impending inflation signals tragedy for the U.S. economy. And with the U.S. Federal Reserve reiterating its dovish stance and refusing to acknowledge inflation in the form of a soon-to-rupture asset bubble, things could be about to get worse.

In the States, core inflation is pegged at around 1.6% — a figure, in the Fed's opinion, which is still too low compared to its target of 2%. This means one thing: the Fed's dovishness isn't going away any time soon. Over the next few years, we can expect interest rates to stay flat and core inflation to creep up to this predetermined level. But as consumer prices — a metric that informs overall inflation — start to creep incrementally higher, asset price inflation, including housing and the equities market, is skyrocketing. 

Year over year (YoY), housing prices are up 5.4% in the U.S., with the market appending a 0.8% increase in the second quarter of 2020 alone. With interest rates near zero, it's not particularly surprising that the housing market is witnessing a boom. Nevertheless, when it comes to core inflation rates, house prices are severely out of whack, and this likely indicates that inflation is already prolific — despite what the Fed may believe.

But housing is just a drop in the water compared to the stock market's monstrous 2020 rally. Buttressed by unabated monetary and fiscal stimulus, the Dow Jones and the S&P 500 have added over 51% apiece since their yearly lows following the stock market crash in March.

The rising prices of both equities and the housing market support the notion that traditional methods of monitoring inflation are flawed. And while higher asset (equities) prices are good for some, not everyone is making out so well. In fact, almost half of all American citizens don't own any equities whatsoever. As such, the asset bubble is only threatening to widen America's already extensive wealth gap.

In the meantime, the U.S. is slumping ever deeper into recession. In Q2, GDP shrank by an annual rate of 33.9% — the most drastic decrease in U.S. history. Simultaneously, unemployment, while down from its record 14.7% high in April, is still touching levels not witnessed in over 40 years. Similarly, attaining new highs is the M2 money supply. As a result of quantitative easing measures, the M2, which includes cash, money in checking and savings accounts, funds, etc., has soared by over 20% in 2020 so far — a sign of further asset inflation to come and yet another example of expanding wealth disparity. 

A Prelude to Stagflation?

With the Fed not likely to back down from its position on low-interest rates and fiscal stimulus handouts any time soon, the stock market bubble, along with the M2 money supply, is likely to keep on growing. A knock-on effect of this is already being seen with the devaluation of the U.S. dollar, especially it's declining purchasing power against hard assets such as gold. The greenback is currently down 5% YoY against a basket of currencies and down almost 10% against the euro since March. And it's creating a potentially inescapable vicious cycle.

Investors, heeding the dollar's gradual decay, are pouring more money into the stock market as a means to hedge against value loss. With additional helicopter money to come,  this bullish bias is bound to continue — creating an even bigger equities bubble and fostering further financial instability and volatility on a dramatic scale.

While monetary and fiscal stimulus measures may not be evident in terms of direct increases to consumer prices, as discussed,  these unconventional policies are causing prices within both the stock market and real estate sector to soar. In July, the consumer price inflation (CPI) reported a 0.6% (1.2% annualized) advance in the states — a much greater climb than anticipated. Consequently, we're starting to witness significantly higher prices that will have an eventual flow-on effect. This is already evident within gas prices, which rose 5.3% between June and July.

With inflation slowly setting in — and even pined for by the Fed — stagflation, an aggregation of inflation, sluggish growth, and high unemployment, could be just around the corner.

Stagflation hasn't been witnessed for many decades. However, given the $12 trillion in global stimulus, across both monetary & fiscal measures, the rise in cost-push inflation, mounting nationalization, and with the wealth divide increasing and causing geopolitical instability, we may have reached a point in which Stagflation is inevitable.

In a stagflation environment, gold will prove to be the hedge of choice. Not only does the precious metal profit from monetary devaluation, but it's historically established itself as a defensive asset amid such extreme inflation — and that includes asset inflationWith investors looking to remove any risk from the table, it's probable —particularly amid stagnant economic growth and volatile markets — that they'll seek out assets providing stability, security, and capital gains opportunities. And gold is the only asset with a proven track record of delivering all three.

Turning to Gold

Earlier this month, Warren Buffett's Berkshire Hathaway acquired 21 million shares in precious metal mining company Barrick Gold, even going as far as to swap out shares in both Wells Fargo and JPMorgan simultaneously. 

Given Buffett's historically dismissive attitude toward gold, the u-turn served as a bullish indication for investors. But Buffett's backtracking isn't at all too surprising when you understand the historical implications of gold. 

During the stagflation of the 1980s, gold cemented itself as a hedge against the much the same inflationary environment we're careening toward today. After the economic boom following the Second World War, unemployment fell to its lowest ebb, and as the standard of living increased, natural inflation rose too. But employers couldn't keep up with this rising standard and were forced to cap wages—leading to an exodus of workers, and unemployment rising in line with inflation.

Adjoined with a lack of spending, and subsequent economic stagnation, high unemployment and the mounting cost of living ushered in one of the worst bouts of inflation ever witnessed. Meanwhile, during the decade-long crisis, gold soared 1,800%, and ever since, it's kept its value, even amid the worst recessionary periods or market collapses.

Gold's narrative as a hedge against inflation continues to show today. In fact, on August 27, shortly after Fed Chair Jerome Powell reasserted his long-term dovishness on inflation, gold rallied 1.6% — climbing back near its previous record highs hit earlier this month. 

The fact that the very talk of increasing inflation causes gold to soar bodes exceptionally well for the market as we head deeper into inflationary territory.

About The Author

Jon Deane is CEO of InfiniGold, technology partner to The Perth Mint who have digitalised their gold reserves via the GoldPass app and Perth Mint Gold Token (PMGT). With an extensive background in the commodities space, having spent nearly ten years at JPMorgan as managing director and head of commodities trading in the Asia Pacific region, Jon can provide macro commentary on the markets.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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