Golden Soda

WINDERMERE, LAKE DISTRICT – Right on cue as our 2021 Gold Summit heats up (don’t miss today’s Keynote Address), Charlie Morris over at The Fleet Street Letter Wealth Builder has recently turned even more bullish on the metal. He already had some gold stashed in his “Soda” portfolio for some time (his cautious portfolio – Whisky is where he keeps his risky plays) – but for reasons he’ll go into below, now he’s adding some more.

I’ve got to dash off now to record some extra content for the Summit – do make sure to tune in when you have a moment – but before I go, I’d like to show you a snippet of Charlie’s bullish gold thesis. I can’t show you it all of course – but there’s plenty of goodies for goldbugs in the passage below…

Adding gold to the Soda portfolio as bond yields fall

By Charlie Morris, editor of The Fleet Street Letter Wealth Builder

I have recently highlighted my increased enthusiasm for precious metals. Where gold leads, the other precious metals follow. Recent evidence from the bond markets shows that conditions are swinging in favour of precious metals.

The bond yield has turned down, while inflation expectations have risen. That combination has reduced the real yield (bond yield less inflation) significantly.

Lower real yields have historically been very bullish for gold (and inflation-linked bonds). If the reduction in the bond yield continues, then markets will start to favour more defensive assets – this would be a major shift in the narrative that has built up over the past year, from value back to gold.

Recall, gold has generally enjoyed falling real rates, since late 2018. The more recent upticks in real rates caused downward price pressure for gold. However, those upticks appear to be behind us.

It is not just the lower real rate that drives gold, but higher inflation. I expect higher inflation, largely because I see higher oil prices if and when the lockdowns ever really end.

Successful investors must be prepared for change. If inflation were to stabilise, then value assets would swing out of favour, and quality assets would return to vogue. That would see both inflation and bond yields fall together.

I want to explain why we should be prepared for a change in the outlook for inflation, which may run out of steam later this year.

Inflation and loo rolls

In recent months, we have seen bottlenecks build up in lumber prices (wood), Suez Canal blockages and microchips to make cars. These are disruptive and cause prices to rise, but the lessons of the 2020 loo roll crisis should remind us how systems adapt.

Try not to visualise this, but the first great bottleneck in the UK economy in the Covid-19 era was the great loo roll crisis of March-April 2020 when millions of workers found themselves unexpectedly working from home.

At regular times each day, these workers sought sanctuary, and for many, that time of day would occur during office hours. With millions of people at home at that same time, there was a loo roll crisis. There was no shortage of paper, it was just in the wrong place at the wrong time.

It took a few weeks for the loo roll supply to be re-routed to the homes, while mountains of the stuff sat idle at the workplace. This supply crunch crisis ended within weeks. That is not something to be sniffed at.

Bottlenecks are temporary

A similar situation has occurred across global supply chains, and I am certain that this will come to a resolution. Some hardworking people with excavators and tugs unblocked the Suez Canal recently. Lumber prices (timber), which have ballooned, will fall again as there is no shortage of trees, merely of processed trees. And the car factories will get their microchips. All of these bottlenecks will pass.

The case for inflation will need to move from the cyclical element, caused by supply-constrained bottlenecks, to monetary inflation (debasement due to lack of confidence in money).

This may or may not happen, but I believe it remains a heightened risk. If I was sure, I would radically increase [our] gold position. Since I am not yet certain, I believe that we should move with caution.

One reason I am uncertain is because the drop in bond yields, albeit one that has happened in the short term, is warning us that monetary inflation will be avoided. It would be irrational for markets to have no confidence in money yet have confidence in bonds – which have many of the same characteristics as money.

Monetary inflation would see bond yields rise in tandem with inflation, as investors sold bonds en masse. That would need to coincide with inflation rising even faster than bond yields. Quite obviously, and despite what you might read on the internet, we are not there (yet).

Gold tends to perform best at times of low real rates. This means that, provided inflation falls more slowly than or in line with bond yields, real rates will remain flat or falling, which is good for gold. The risk to gold is a spike in real interest rates, which we tend to see at times of shocks in financial markets.

One reason we are seeing bond yields fall goes back to the creation of money, which is now slowing.

Money supply growth is slowing in the United States

There are two great “M2s” in the world. The greatest is a road from London to Kent; and the other is the money supply. That fine motorway can deliver either tanks or tourists to the continent, depending on our relations with the French at any given time: at the time of writing, tanks may be more likely…

The other M2 is the US money supply (which includes notes and coin in circulation, demand and savings deposits with banks as well as money market funds). Last year, the above chart did the rounds, convincing people to buy high-risk assets. The idea was that money printing would inflate asset prices.

It did, but don’t count it to continue indefinitely.

M2’s rate of growth has started to slow, and this has coincided with the fall in the bond yield. In the same way stock markets took a while to respond to the surge in M2, I suspect they will do the same in reverse. Markets will shrug off the slowdown in M2 growth in the short term, but at some point, they will wake up to the fact that it has happened…

All the best,

Boaz Shoshan
Editor, Capital & Conflict

Category: Investing in Gold

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