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LAWRIE WILLIAMS: Gold – your protection against stagflation

According to Investopedia the term stagflation refers to a period of slow economic growth and relatively high unemployment—or economic stagnation—which is at the same time accompanied by rising prices (i.e. inflation).   Recognise anything here? 

Maybe economic growth may pick up as we exit from pandemic-related restrictions – but it is certainly damaged – while we are probably suffering from far higher price inflation levels than governments and central banks seem prepared to accept as reality.  Meanwhile unemployment levels seem to be remaining remarkably high.  No doubt these statistics will be massaged to indicate better levels by dropping those who seem to have exited the official workforce on their own account and seem unwilling to return – apparently quite a considerable number.  Nevertheless the world does seem to be showing all the characteristics of stagflation and the financial strictures that that brings with it.  So the big question facing investors is what they should do?

Inflation certainly seems to be strengthening according to the most recent data, exacerbated by goods shortages as the supply chain has so far failed to catch up to itself as many COVID-related restrictions are ended.  There is port congestion in many places around the world, while labour shortfalls are contributing to transportation and goods handling problems.  This is partly due to unemployment which is still at high levels despite job vacancies and pay scales trending ever higher.  The fallout from COVID is having some unanticipated consequences increasing the likelihood of perhaps an expanded period of stagflation.

Equities do not do well during periods of stagflation – indeed they tend to weaken and bonds don’t do much better.  According to analysis by the World Gold Council, gold and commodities tend to do best under these kinds of financial circumstances and gold certainly seems to be making a move on today’s increased inflation figures out of the U.S. and is rising close to regaining the $1.800 mark, which would be a hugely significant milestone after the metal’s recent period of weakness.  Copper, that industrial bellwether is rising too, while equities are flat, or in decline pretty much across the board in Asia, Europe and, as I write in the U.S. too.  The dollar index is slipping too, which is probably another factor in apparent gold and commodity price advances, although the oil price does appear to be falling.

All in all it certainly looks as if a stagflation scenario is developing and both price and wage inflation seem to be rising all around the world which creates a particular problem for central banks like the U.S. Federal Reserve.  The Fed is the most important here as developments in the U.S. at the moment seem to be dominant in setting the course of precious metals price.  It has a mandate for keeping inflation under control, while at the same time managing the unemployment figure and bringing it down to the maximum accepted percentage level.  The solutions for doing this tend to be diametrically opposed - raising interest rates to combat inflation, while at the same time keeping them low to stimulate employment levels.

Consequently the Fed has been following a policy of wishful thinking on inflation – by saying it is ‘transitory’ – and is hesitant to raise rates for fear of prompting an equity market crash and probable consequent dive in employment levels as, if an equity market crash ensues, and is severe, companies could be forced into liquidation with a disastrous effect on labour.   One suspects therefore it will put off raising interest rates for as long as it can, while attempting to talk down inflationary trends.  It’s so called tethering programme may not be much interrupted though, although it might reduce some of the liquidity sloshing around and keeping markets rising.

What this all means for gold, and perhaps as a knock-on for silver, is that real interest rates – in other words the difference between interest receipts and the inflation rate rise – will become increasingly negative.  The higher inflation is allowed to rise, the ever-greater will be the loss of buying power of the domestic currency.  This will, in turn, lead to those looking to protect whatever wealth they may have turning to tried and tested safe havens like gold.  Gold is always reckoned to benefit from negative real interest rates and the more negative they become the better gold should perform.

The above paints a pretty depressing picture and may not occur at all, but one should probably play safe and eschew traditional equities and fly-by-night unproven assets like bitcoin in favour of what has proven itself as the ultimate safe haven over the centuries and put your trust in gold.

13 Oct 2021 | Categories: Gold, Silver, Dollar, US, Bitcoin, FOMC

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