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Inflation expectations

Monday, November 7, 2016 8:06
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The primary reason for owning gold and silver is the expectation of price inflation.  Inflation, of course, comes from money creation at the Fed.

However, as what is now often called the World Financial Crisis showed, gold and silver do well in times of financial crises.  Here, though, let’s look at a very good indicator of future inflation expectations.

The late Richard Russell, who published Dow Theory Letters for fifty-eight years, used to say that you could see what the smartest money in the world was doing by monitoring the bond markets, which is many times the size of the equities markets.

Late last year, some forward thinking analysts recommended TIPS (Treasury Inflation Protected Securities), which are government-issued bonds that adjust returns based on measured inflation.  They were ahead of their time as inflation remained muted in 2016.  However, now there are indications that higher prospects for inflation in 2017 are on, with buying of TIPS increasing.

Supporting this position is the action in the bond market.  Long-maturity conventional government bonds have taken a beating recently as US “break-even” rates  — measures of investor inflation expectations derived from comparing the yields of conventional bonds to inflation-proofed bonds — have been climbing since the summer.

The US two-year break-even rate rose from 0.92% in early August to 1.42% last week; the 10-year rate rose from 1.37% to 1.69%.  Bond buyers are saying inflation is on the horizon.

Further, Société Générale (a huge French multinational banking and financial service company) has reiterated its call for clients to load up on inflation-proof bonds, on the view that even modest global fiscal stimulus and rising commodity prices in the coming year will accelerate price growth further.

Note that Société Générale is looking for “modest fiscal stimulus.”  What happens with rigorous fiscal stimulus, which would be likely under another Clinton administration and even modest under Trump.

Important in this strategy is the position that some Fed officials seem willing to let inflation “run hot” — accelerate closer to and even beyond the 2% target — before tightening monetary policy.

Be aware that “controlling inflation” is not as easy as turning off a water spigot.  Many factors have to be considered, the most significant being the state of the economy, which really hasn’t looked good for years.  Further, few — if any — economists are predicting robust economic growth next year.

We think that gold and silver are currently priced favorably and that both are excellent repositories for long-term money.


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