Despite the Wall Street happy talk about the Federal Reserve winning the battle against inflation, that battle has not been won.
Headline CPI (the kind Americans actually pay) was 3.1% in January - lower than December but notably above expectations. However, 'core' and 'supercore' were more problematic - up 3.9% YoY (flat from December) and up 4.4% YoY (highest since May 2023) respectively.
In other words, inflation is not gone and may even be on the rise with higher oil prices lately due to geopolitical concerns. The Fed will not raise rates, but they will not be quick to cut them given continued inflation.
Inflation has a way of sneaking up on investors in small increments and can do a lot of damage before investors see it for what it is. Sure, 3.4% inflation is a lot better than 9% inflation.
But a 3.4% inflation rate cuts the value of a dollar in half in 21 years and half again in another 21 years. That’s a 75% dollar devaluation in just 42 years or the course of a typical career from age 23 to age 65.
(By the way, I’ll be live tomorrow at 7:00 p.m. ET as part of the Zero Hedge debate series on the future of the U.S. dollar. If you want to check it out, go here to learn how.)
That’s one of the main reasons I recommend gold. Gold is priced in dollars. Inflation means the dollar is worth less in terms of purchasing power. That means it takes more dollars to buy gold, so the dollar price of gold goes up.
What you may lose in the rest of your portfolio in terms of dollar purchasing power is made up in part or all from the profits you make on the higher dollar price of gold. Owning gold will protect you from the ravages of inflation. You’ll have your inflation protection in place 24/7 and won’t be caught off-guard.
Get Diversified!
Geopolitical conflicts and political turmoil often result in unforeseen consequences. These consequences can include supply chain disruptions, economic sanctions, asset seizures and freezes, bond defaults, bank failures and inflation. Oil prices can spike if key waterways are closed, or a vessel is sunk.
Economic sanctions and financial warfare can cause recession or a banking crisis almost overnight. Assets such as stocks, bonds, real estate and alternative investments can be adversely affected by such changes without warning.
Gold tends to be insulated from such shocks because there is no issuer, no creditor and no country involved. It’s just gold. That means you can hold it safely and wait out the turmoil without adverse effects.
Gold prices do not correlate closely to stock prices. Gold and stocks are driven by separate factors. That makes gold a good diversification asset for portfolios that are heavily in stocks. When a portfolio is highly diversified, it can produce higher expected returns without adding risk.
The difficult part is finding asset classes that really are diversified. Buying 50 different stocks is not diversification since you only have one asset class — stocks — and the behavior of various shares will be highly correlated in times of stress. Gold is genuinely diversified from stocks and will improve portfolio returns.
Golden Tailwinds
Gold prices have been trending higher lately with some volatility along the way. Gold hit an interim bottom of $1,831 per ounce on Oct. 5, 2023, and then rallied to $2,089 per ounce on Dec. 1, close to an all-time high.
Gold retreated slightly and then hit another high of $2,093 on Dec. 27. The rally from Oct. 5 to Dec. 27 was a 14% gain in just under three months. That’s an excellent performance.
Today, gold is around $2,033 per ounce, still close to the recent highs. These trends toward higher prices have been driven by lower interest rates; continued inflation; geopolitical concerns about the Middle East; and continued buying by central banks, especially Russia and China.
All those trends will continue. One of the principal drivers of the gold price rally is the steep decline in interest rates in recent months. The interest rate (expressed as a yield-to-maturity) on the 10-year U.S. Treasury note plunged from around 5.0% to 4.0% in a matter of weeks at the end of 2023.
Don’t mistake a 1.0% move for something small. That’s an earthquake in bond markets, especially in such a short period of time (47 days). A 1.0% move in that short a period of time has only happened in the Treasury market six times in the past 30 years.
Rates have backed up slightly in the past month, but that’s to be expected. Nothing moves in a straight line. The decline in rates will resume in the months ahead as the U.S. economy moves into disinflation and recession. That will give a boost to the dollar price of gold since notes and gold compete for investor allocations. Lower interest rates generally make gold relatively more attractive since gold has no yield.
Meanwhile, Russia and China and other central banks have been adding to their gold reserves consistently since 2008. Total gold reserves have increased from about 600 metric tonnes to 3,000 metric tonnes in Russia, and over 2,000 metric tonnes in China (although there is good reason to believe that China’s gold reserves are much higher, perhaps double the official figures or more).
That increase in gold holdings will continue and probably accelerate as the U.S. threatens to seize Russian reserves in the form of Treasury securities and as progress is made on the new BRICS gold-linked currency.
The 10% Rule
Every investor should have an allocation to gold in her portfolio. It’s an excellent diversification and can be a powerful asset to have in the face of natural disaster, infrastructure collapse or social unrest.
I recommend a 10% allocation of investable assets to gold. In calculating investable assets, you should exclude home equity and the value of any private business. Don’t gamble with your house and livelihood.
Whatever is left (stocks, bonds, real estate, alternatives) are your investible assets. Allocate 10% of that amount to gold. That allocation is high enough that you’ll make significant profits (and protect against losses in the rest of your portfolio) if gold soars, but small enough that your overall portfolio won’t be hurt badly if gold goes down.
A 10% allocation is the sweet spot for both profits and downside protection. The bottom line is gold is like an anchor for the rest of a diversified portfolio. It is physical so it is not easily frozen by government fiat.
It offers diversification because it does not correlate to other asset performance (except Treasury notes on occasion). It is the best hedge against inflation.
Gold should not dominate any portfolio, but it should be part of every portfolio.
