The term “inflation” is commonly used to describe rising prices for goods and services. However, this is not technically correct. The monetary economic definition of “inflation” is the rate of increase in the money supply over the rate of increase in economic wealth output. As Milton Friedman famously said,
“inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”
Price inflation is caused by inflation of the money supply. The concept is pretty simple: when the money supply increases at a rate over wealth output, there are more currency units relative to the supply of “wealth units,” where wealth units represent the amount of goods and services supplied by an economic system.
It’s this devaluation of each unit of currency that causes price inflation at every level of the economy. More money “chasing” a relatively lesser amount of goods and services. When this occurs the law of supply and demand dictates that the price of goods and services will rise.
Inflation has infected the global economic system since the central banks embarked on Quantitative Easing (QE) in 2008. However, the price effects of this money printing were largely channelled into financial assets and real estate between 2009 and 2020. It was the massive injection of printed money into the banking system (reserves creation) in 2020 that triggered “Main Street” price inflation at the household consumption level of the economy.
Protection from inflation
Inflation can have a major impact on personal finances and investments. It can erode the value of savings, increase the cost of living, and make it difficult to plan for the future. Inflation is the generic term that references the devaluation of fiat currencies from central bank money printing.
During periods of inflation, it becomes desirable to find ways to preserve the purchasing power of your earnings and wealth. A common investment used as a hedge against inflation is TIPS – or Treasury Inflation Protection Securities. These are bonds issued by the United States Treasury with a rate of return that is indexed to the Consumer Price Index.Even thought the CPI is a highly flawed index inflation when the TIP bond matures, you receive dollars – the dollars that are being devalued by Federal Reserve money printing.
Best investments to make during times of inflation
Investing in a commodities fund is probably a more effective way to hedge your wealth against inflation, or more specifically, fiat currency devaluation. In general, because the broad range of commodities is used to produce non-discretionary consumption items, the cost to produce commodities can be largely passed on from the producer to the end user. Due to this dynamic, the value of commodities for the most part is correlated with the cost to produce them. Thus, in an inflationary environment, investing in commodities more or less should adequately hedge against inflation.
Real estate traditionally has been a good hedge against price inflation. But since World War II, and particularly over the last 50 years when the world went entirely off the gold standard, real estate for the most part has been transformed into a financial asset – think of it like a bond. This is because modern finance has enabled the widespread and prolific use of debt to buy real estate. The value of real estate is thus driven by interest rates and the amount of debt banks are willing to extend for buyers to purchase real estate. As such, the value of most real estate fluctuates with interest rates, like a bond. In my opinion, the obvious conclusion is that, in general, real estate no longer is a good hedge against inflation.
Let’s take a look at the data. The chart below shows the price of gold and silver vs. the CPI and the M2 money supply going back to 1990 (the Federal Reserve has removed the price of gold from its historical database, the St. Louis Fed’s FRED database):
The chart above shows that, over the last 33 years in its totality, gold has worked nearly perfectly as a hedge against both price inflation and money supply inflation. Gold underperformed both inflation metrics from 1996-2001, but this period was the final culmination of a bear market in gold that began in 1980. Between 2001 and late 2011, gold substantially outperformed as an inflation hedge, more than compensating for the previous period of underperformance. Since 2016, gold has performed spectacularly as an inflation hedge.
Silver as well provided an effective hedge against inflation between 1990 and 2013, but since 2013 it has lagged the other three variables. The easy conclusion to reach is that silver no longer provides wealth insurance against inflation. However, over long periods, gold and silver are highly correlated. In my view, the silver price will “catch up” to gold, CPI and M2. In this scenario, silver not only offers a hedge against inflation but also offers the potential to generate investment “alpha,” or an attractive total rate of return investment.
While the government-generated inflation measures are showing a moderation in the rate of inflation, I believe it’s a lull before the storm. That is, based on several indicators for which the rate of price increases has turned higher again recently (cost of labour, gasoline, housing, food), it’s a good bet that price inflation is getting ready for another move higher. This being the case, gold and silver both will provide an effective hedge against inflation. Furthermore, silver offers both a hedge and a total rate of return investment opportunity.
One way to invest and trade precious metals is by opening a Kinesis account. Kinesis’ gold and silver investment accounts are backed by physical gold and silver, along with offering a card that enables you to use your physical gold/silver account as currency. You can also take delivery and possession of your physical metal. Since I hold plenty of physical gold and silver, I use my Kinesis account as a savings account for which I’m highly confident will track inflation and preserve the wealth value of the account.
Dave Kranzler is a hedge fund manager, precious metals analyst and author. After years of trading expertise build-up on Wall Street, Dave now co-manages a Denver-based, precious metals and mining stock investment fund.
This publication is for informational purposes only and is not intended to be a solicitation, offering or recommendation of any security, commodity, derivative, investment management service or advisory service and is not commodity trading advice. This publication does not intend to provide investment, tax or legal advice on either a general or specific basis. The opinions expressed in this article, do not purport to reflect the official policy or position of Kinesis.