Gold! Gold! Gold!
It’s gold’s time to shine. Right now, inflation worries are rising around the world. They should be. Bond yields are going up in response.
Sometimes, this can be from the market detecting stronger economic growth coming.
Other times it’s a signal that bond holders are bailing because they know inflation will cut down the value of their holdings. We don’t have to guess too hard to see which one it is right now.
We have the general chaos presenting itself across the world. China and India have pitiful reserves of coal to feed their power plants.
Natural gas has skyrocketed and puts pressure on Europe. And supposedly, US President Biden’s approval rating has already dropped to less than 40%.
All this places central banks in an impossible bind.
Here’s the problem: Central banks can lower interest rates and print money.
However, what’s happening in the natural resource market is not solved directly, or at least rapidly, by either of these.
Lowering the discount rate hasn’t helped coal mines come into production in the last few years.
The problem is that the equity and credit markets responded to their constituents and decided they didn’t want to be a part of it.
Nobody thought coal was going to be much in demand anyway. The business case looked grim.
Now the world finds itself short on coal and mines don’t just switch on or ramp up because we need them all of a sudden. Cue higher energy prices as a problem with no easy fix.
These are, effectively, a tax on consumption and margins for everyone except those that benefit directly (coal miners, gas firms).
This dynamic hurts the US market because technology firms suffer when discount rates are raised and inflation looms as a threat.
The outlook for the ASX is more complicated.
It’s higher commodity prices driving this inflationary surge. We are a natural resource-based economy, especially as far as foreign investors are concerned.
Commodities, and commodity stocks, are a known inflation hedge as well. This gives the ASX a structural tailwind it really hasn’t had for the last 10 years.
That brings us back to gold. Of all the commodities, it’s been decidedly lacklustre over the last six months. There is something decidedly odd about that.
A cynic might suggest the powers have been fiddling with the futures market to keep the price down.
A rising gold price would be a signal to the markets that inflation is a problem they should be worried about.
The traditional response to this was to choke off demand by raising rates.
Central banks dare not raise rates prematurely. They have guided them further out than now.
The economic recovery from COVID is fragile and incomplete. The world is also saturated in debt. Rising rates would place another headwind in the path of all of us.
And yet, inflation cannot be wished away or reasoned with. Look what it did to the economy — and stocks — in the 1970s.
And just on that…
Here is what veteran energy analyst PK Verleger wrote last week:
‘The current energy crisis is on track to be among the worst in half a century — almost as bad as the crisis of 1973-1975 or 1978-1980 and worse than the one preceding the Great Recession of 2009. The consequence will be a severe recession.’
Energy is a vital cost for manufacturers. Higher commodity prices put pressure on margins everywhere — even firms with the gargantuan buying power of Costco.
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Here’s a snippet from a report I read from my colleague Dan Ferris in the US…
‘Costco reported financials for its full fiscal year ending August 29. The results were solid and generally in line with our expectations.
‘However, the fourth-quarter call with analysts was especially interesting. That’s because we learned just how much inflation is accelerating.
‘Chief Financial Officer Richard Galanti reminded analysts that back in March, his best guess of the inflation built into Costco’s selling prices was 1% to 1.5%. That increased to 2.5% to 3.5% on the third-quarter call in May. Then, in September, Galanti upped it again to 3.5% to 4.5%…
‘Unfortunately, the inflation on Costco’s buy side is much higher. For perspective, Galanti told analysts that plastics pricing was up between 5% and 11%. Pulp and paper goods were up between 4% and 8%, respectively. Many commodities, like nuts and coffee, remain at or near five-year highs. And container-shipping costs from Asia are reportedly between 2 and 6 times higher than a year ago.’
Hello! Your Daily Reckoning editors have been warning about this all year. Now we’re living in the middle of it.
And yet we have the strange situation of Aussie gold miners minting money but traded on tiny multiples of their earnings this year.
So while they’re no doubt risky, I cannot think of a better time to back gold stocks.
The spark might just be the realisation from the investing public that central banks can’t solve a commodity crisis by talking or fiddling the cash rate.
And financing more government deficits will only crank up the demand when shortages are the problem.
My oh my. What a spider’s web we are ensnared in. At this point, I’ll hand you over to my colleague Brian Chu — our gold expert. Every time his favourite gold names drop; he tells his subscribers the same thing: buy more!
And, as you can see from today’s Reckoning, it’s not hard to see why. Go here to learn more about the gold stocks Brian says to accumulate.
Editor, The Daily Reckoning Australia
PS: Our publication The Daily Reckoning is a fantastic place to start your investment journey. We talk about the big trends driving the most innovative stocks on the ASX. Learn all about it here.