Continued Loss of Purchasing Power

What are we to make of this week’s major market moves? With stocks down, it suggests a risk-off week. But then we note that the Commodities measured by the Rogers Raw Materials Index gained 1.17% or nearly what the S&P lost. Thanks to the Rogers Fund gain combined with rises of 0.38% for copper, 4.23% in silver, and 2.46% in oil, my Inflation-Deflation Watch was virtually unchanged for the week despite the above-noted S&P decline and declines of 0.48% in the housing stock index, 0.79% for auto stocks, 0.44% in Indian stocks, and 0.54% in Chinese stocks. 

Here is my hunch as to what is going on. As David Rosenberg noted in today’s “Weekly Buffet with David,” the New York Fed’s leading inflation gauge is now at 2.28%.

 

And while that is down from 2.63% in mid 2019, the 10-Year T-Bill is paying only 1.48%. Not even the 30-Year T-Bill allows you to gain more than the Fed’s inflation gauge. If Treasury rates are negative across the yield spectrum even before stocks start to tank and we enter a recession, what is there to anticipate but continued declining Treasury rates, which means a continued loss of purchasing power not only from failing to keep up with inflation but also in owning dollars. And if you have a doubt about entering a recession, just look at the inverted yield curve above left. Most of 2019 saw an inverted yield curve for the U.S. Treasuries. This has historically been the most reliable predictor of recessions there is. And, yes, the Fed can try more aggressively than ever to pump money into the system to avoid the next 2008-like financial crisis and for a time they can be successful in avoiding the pain. But the pathology of the system can be seen in lower lows and lower highs for interest rates with each recession since 1981. And with much of the world’s savers suffering from nominally negative rates and even more severe real rates, the tide is driving interest rates inevitably lower—until it doesn’t! 

What could stop this seemingly inevitable trend toward ever lower rates? One thing sure to do it is if/when money moves out of stocks and into commodities. Why would that happen? Alasdair Macleod provided a very good answer to that question in an interview I did with him on my radio show last year. He pointed out that everyone has a “time preference rate” for things people own. They are willing to let go of a given asset in exchange for some rate of compensation. For gold the market rate is between ~2½% and 3%. That’s what you get in the market when leasing gold. That may not sound like a very high rate of interest or time preference. But two factors make that interest rate for gold attractive. First, it is almost double the rate for the 10-Year Treasury. Secondly, you get paid back in gold, not dollars. Gold doesn’t lose purchasing power over the longer term but dollars most certainly do. And keep in mind that it isn’t just gold that has a time preference rate. Virtually all tangible assets from the most liquid—like gold, to fixed assets—like real estate, have time preference rates attached to them.

The bottom line: I’m suggesting an increasing number of investors are starting to see surging central bank easing to fund deficits will inevitably lead to a massive increase in monetary inflation, which in turn is leading to negative real and nominal negative interest rates. That in turn is causing investors to opt out of financial assets and into real assets so that they can have control over their time preference rates, which are being stolen by government funded printing press money. I realize one week does not a trend make. But all the signs of a global recession or worse are on our doorstep. Stocks are about as overpriced now as at any time in history and experienced investors know that when bubbles pop, only the first out end up ahead of the game. I believe these are some of the dynamics that drove this week’s much stronger gold price and our Model Portfolio to edge ahead of the S&P in year-to-date gains.