A Rare Opportunity to Get Ahead…

A Rare Opportunity to Get Ahead…

You can feel the pessimism and even despondency in the mainstream media as they talk about the economy, the financial markets, and what to do to make ends meet. They try to dress it up, but it rings hollow when you compare it to the conviction they used to write about the economic recovery.

Search online for inflation and the economy; there are articles providing commentary on how inflation is starting to bite, and hard times are coming.

Nowadays, any public official who tries to talk up the economy is clearly out of their minds. They only expose themselves as being out of touch.

But never look past US President Joe Biden giving it a go last Friday as he talked about the strength of the US economy under his watch after the release of the May jobs data. Not only was much of his speech seeking to gaslight the people, but those who know where to look for proof can show how his self-praise was devoid of facts.

Such ignorance is not accidental. Not when they pushed their perspective so persuasively for so long and mocked or derided any dissenting views as ‘conspiracy theories’, ‘fearmongering’, and engaged in grandstanding. The fact that they walked back on their perspective so suddenly as the harsh reality hits tells me it can be nothing but a deliberate and premeditated act.

It’s not just happening in the US, of course. The screws are tightening as central banks worldwide coordinate this together.

Back at home, the Australian people are starting to brace for challenging times too. The Reserve Bank of Australia raised the interest rate on Tuesday by 0.5%. It’s now sitting at 0.85%. Two months ago it was 0.1%, and it had been at this historically low level for almost 18 months.

Worse still, the Board of Governors indicated that it was expecting to raise rates every month for the rest of the year.

This is the same Board of Governors who only four months ago indicated that it was in no hurry to raise rates.

We can condemn them for breaching the people’s trust (clearly misplaced). But the reality is that many households find themselves in a very awkward financial position now. Worse still, things are going to get nasty real soon.

Let’s focus on the immediate priorities and leave the finger-pointing and reprisals for later.

Buckle up…brace position

Since last November, markets have been falling. One by one, their bull runs came to an end. The mood suggests that we are about to see the next round of declines.

To exacerbate this, households face the brutal reality of rampant inflation. Food, rent, housing, energy, petrol, etc. are getting more expensive. And those who are struggling to make ends meet from their salary/wages are no longer able to supplement their income from their investment assets.

I wouldn’t be exaggerating to say that there is a financial storm ahead.

The US may be seeing inflation peak if bond yields are indeed pointing to inflation starting to slow down as a result of the hurried rate rises and talk of more coming up. You’ll see what I mean in the chart below showing the Federal Reserve Funds Rate and the Inflation Expectations (calculated by the difference between US 10-Year bond yields — nominal versus inflation-adjusted):

Fat Tail Investment Research

Source: Federal Reserve, St Louis

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The figure shows inflation may soon give way to deflation as price levels in both the economy and financial markets cave into further rate rises and currency tightening. This could lead to an overshoot on the downside, sparking a sharp market decline.

Expect the contagion effects of this decline to go global.

Australian households to feel the bite from debt and inflation

Australia’s not up to the stage of peak inflation, in my view. Have a look below at the chart from the RAB below for where we’re at:

Fat Tail Investment Research

Source: ABS, RBA

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I expect that the RBA’s tough stance on raising rates every month into the end of the year is because it dithered on controlling inflation. It doesn’t surprise me that the RBA Cash Rate could raise rates above 2% very quickly.

Can you imagine where the interest rate on home loans would be sitting in the coming months? For example, the Commonwealth Bank of Australia has announced that it will increase its home loans borrowing rate by 0.5% next Friday. The rate for a standard variable home loan will be up from 4.8% to 5.3% p.a. for owner-occupiers and from 5.38% to 5.88% p.a. for investment property borrowers.

Sure, not many borrowers are signed up on a standard variable rate home loan. Banks have lured borrowers with attractive packages offering lower rates, honeymoon periods, offset accounts, and other bells and whistles.

It’s been an easy ride for many until recently.

And many know that it’s going to get worse before it gets better.

Seeking refuge in the impending storm

You probably can sense that central bank rate rises, governments reeling back from massive spending, and the looming debt and inflation crisis are now coming together to a head.

Where should one take refuge and bunker down?

To be clear, deflation will cause the price of everything to fall. But it’s about which is the last one left standing — the survival of the best quality asset.

You’re familiar with what I’ve said about gold being a good place to seek refuge. I think it’s important to have some on hand or at least have exposure to the price movements via a gold ETF.

I also see taking a punt on gold stocks for the recovery after the crash. It has been declining longer than most other asset classes. So it is closer to the bottom and the bounce afterwards could deliver handsomely if you pick the right companies.

In the chart below, I compare the ASX Gold Index [ASX:XGD] against the ASX All Ordinaries [ASX:XAO] and the US S&P 500 Index [SPX] since the start of 2019:

Fat Tail Investment Research

Source: Thomson Reuters Refinitiv Datastream

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Everything fell during the flash crash in early 2020 in the wake of the global virus outbreak. Gold stocks recovered the quickest but peaked in August 2020. It has been falling for almost two years, punctuated by false rallies. The US S&P 500 Index appears to have peaked around November 2021, while the ASX All Ordinaries Index in April 2022.

Could gold stocks fall further?

Yes. But they’re closer to the floor than the others.

There’s a class of gold stocks that are offering even better value but you need nerves of steel to ride it.

Check it out here. This could be one of the best investments you make.

God bless,

Brian Chu Signature

Brian Chu,
Editor, The Daily Reckoning Australia