There has been significant dialogue and speculation in recent months over the impact of Covid-19 and the economy, specifically related to inflation. Regardless of the conjecture, there are certain economic indicators that almost guarantee an inflation response in the very near future.
History repeats itself...
In history class, the one thing I remember being driven home is that history repeats itself. We study history so that we can predict and prevent future events from occurring.
In the US there are two things that have accurately predicted inflation and those are Debt to GDP ratio of over 90% and rising deficits. If you examine the debt to GDP over time, you will see that the current ratio is nearly 130%. Deficits are also extremely concerning. Our current budget deficit is more than double the budget deficit of the recession in 2008. In fact, there has never been a greater budget deficit in the history of the US.
Another bit of education we can glean from US history is the fact that inflation can skyrocket in a flash. We tend to think of inflation as slowly creeping up on us, similar to the frog that is placed in a pot of lukewarm water. As the water is heated and starts to boil, the frog can’t feel the slow rise in temperature and stays in the pot until it is cooked. Inflation however, doesn’t typically behave in this manner. It tends to rush in like a flash flood. There are three historical time periods where we have seen flash inflation over a short two-year time period.
In 1915, inflation was at 1%. By 1917, it was an astounding 17%.
Let’s look at two more…
1945 – 2%... 1947 – 14%
1972 – 3%... 1974 – 11%
These are significant inflationary jumps in only two short years. In fact, if the current economy follows the historical trends indicated in the above table, we could see a jump in inflation as high as 28.9% by 2023.
Now that we have established the historically based likelihood of future inflation, the more pertinent question is what do we do with this information?
Given that the average age of a hedge fund manager is 51 years old, very few investment managers have any if at all experience with inflation and lack the experience on how to “inflation-proof” a portfolio. The last time we have experienced inflation of such levels here in the US, it was 1976-1980. Which means, most hedge fund managers were less than 10 years old.
The Fed has made it clear that the goal of their stimulus measures IS inflation. They are encouraging levels over 2%. To them, inflation is a sign their measures are working. However, Americans are not adequately prepared for the changes in their standard of living and the decrease in purchasing power of the mighty dollar. With such lack of experience in an inflationary investment environment, panic could ensue and investors may be taken by surprise.
What can be done to inflation proof a portfolio?
Historically, most investors will turn to 1 of 4 common options when the inflation barometer is increasing and those are:
Stocks, real estate, TIPS, and commodities. However, most of these assets have skyrocketed in extraordinary ways over the past decade and are unlikely to offer the hedge of protection investors are seeking. If you examine each of these assets individually:
Stocks: are up 275% since 2009.
Real Estate: is up 67% in the past decade
TIPS: rely on the government to correctly calculate inflation, and since CPI is biased downward, TIPS are unlikely to provide desired protection against inflation.
Commodities: up 2-3x.
Considering how these assets classes have risen, and the downplaying of the CPI, these assets are unlikely to inflation proof a portfolio in the ways we’ve seen in the past.
What is the solution to imminent inflation?
Given the likelihood of inflation looking in the near future, there has to be a way for investors to be prepared for what’s coming. Again, if we examine historical trends, there is a clear solution.
Silver and gold…
Silver, especially has had an immediate response to inflation every single time it rears its ugly head. If you examine the inflationary period of ’76-’80 you’ll notice that silver gained 1,063%. A ten-fold increase. Again, from ’08-’11 we see silver spike once again by 446%. Gold also has responded well in time of inflation. During those same time periods gold creased by 717% and 164% respectively.
As investors, we can learn a lot from history and the historical data suggests inflation is on its way. The best way to protect yourself given the current economy is by building a significant hedge around your portfolio in silver (primarily) and gold as well. However, there is a current supply and demand crunch for physical metals and many orders are being backlogged. No one knows the exact timing of when run away inflation will occur, but if you hope to protect yourself, you need to jump on the precious metal bandwagon today while supplies last.