Big Inflation Will Spur Gold

Big Inflation Will Spur Gold

Adam Hamilton    
June 10,
2022     2821 Words

Gold
investment demand should be soaring with serious inflation raging,
catapulting gold way higher.  Yet recently it has greatly lagged
fast-rising general price levels, confounding contrarian investors. 
But history argues this anomaly won’t last, that eventually big
inflation will spur gold.  Today’s terrible inflation super-spike
fueled by extreme Fed money printing is the first since the 1970s,
when gold rocketed up by multiples.

The
most-widely-followed US inflation gauge is the Consumer Price
Index.  While its components and calculation methodologies have been
changed countless times, the CPI’s history extends back well over a
century to 1913!  For an entire decade prior to April 2021, the
monthly headline CPI averaged modest 1.7% year-over-year gains. 
That long span didn’t see a single 4%+ print, even with
pandemic-lockdown disruptions.

But
something changed in April 2021, when the CPI suddenly accelerated
up 4.2% YoY.  That proved its hottest read since September 2008,
emerging from that year’s brutal stock panic.  The Fed itself blamed
that mounting inflation on supply-chain disruptions.  The Federal
Open Market Committee’s monetary-policy statement released late that
month argued “Inflation has risen, largely reflecting transitory
factors.”

That
“transitory” dismissal of fast-rising general prices was last year’s
buzzword.  It was an oft-repeated mantra of top Fed officials, high
government officials, and Wall Street economists whenever inflation
was discussed.  But they were all dead-wrong, as CPI
inflation kept relentlessly rising.  Answering a question at a
Senate hearing in November, the Fed chair himself admitted “It is
probably a good time to retire that word.”

In
the 13 reported CPI months since April 2021, headline inflation has
averaged huge 6.4%-YoY gains!  That proved one hell of an
inflection, nearly quadrupling the prior 120 months’ mean. 
Reaching inflation-super-spike status, the CPI’s recent high-water
mark so far is March 2022’s shocking 8.5%-YoY surge!  That proved
the hottest CPI read since all the way back in December 1981, a
dreadful 40.3-year high!

Yet
the same people who claimed this raging inflation was transitory for
most of last year now dismiss it as supply-chain-driven.  But during
the last three quarters of 2020 when pandemic lockdowns and their
severe economic disruptions peaked, the CPI averaged just 0.9%-YoY
gains.  Remember the widespread shortages and empty shelves then? 
Even massive government-stimulus-goosed demand didn’t stoke
inflation.

While artificially-elevated demand and constrained supplies can
certainly force up specific prices, those spikes are temporary. 
Lumber prices skyrocketed about 6.4x from April 2020 to May 2021 on
these very factors.  Yet once those passed, lumber cratered by
nearly 3/4ths and remains back down near relatively-low July-2020
levels.  Blaming inflation on supply chains is a red herring
to mask the Fed’s culpability in this!

Legendary American economist Milton Friedman summed up inflation
perfectly in his famous 1963 quote.  He warned “Inflation is always
and everywhere a monetary phenomenon.”  General price inflation
solely results from central banks ramping fiat-money supplies much
faster than their underlying economies.  Far more dollars chase and
compete for much-slower growing goods and services, inexorably
bidding up their prices.

The
Fed itself
spawned today’s inflation super-spike with extreme money printing. 
Fed officials panicked during March 2020’s brutal pandemic-lockdown
stock panic, when the S&P 500 plummeted 33.9% in just over a month! 
They feared a negative-wealth-effect-induced depression, so they
rushed to flood the US economy with an epic deluge of new dollars
conjured out of thin air at a radically-unprecedented scale.

Between late February 2020 and mid-April 2022, the Fed expanded its
balance sheet a ludicrous 115.6% or $4,807b in just 25.5 months! 
Since that is effectively the monetary base underlying the entire
US-dollar supply, redlining those monetary printing presses more
than doubled it in just a couple years!  Suddenly vastly more
dollars were injected into the system, cheapening their value
relative to goods and services.

The
Fed’s extreme monetary excess directly spawned and fueled today’s
inflation super-spike.  So it will continue raging until the
majority of those colossal QE4 monetary injections are drained back
out via QT2 bond selling.  That is just starting here in June, at
$47.5b per month for a quarter before doubling to its terminal
velocity of $95b monthly in September.  Even at that pace
a mere half-unwind would take 25 months!

That’s a long time for raging inflation to fester, and gold’s
investment demand and prices to soar to reflect the Fed’s horrific
currency debasement.  And QT2 actually running to completion is
doubtful.  The Fed
prematurely caved
on QT1 after it nearly hammered the US stock markets into a new
bear in December 2018.  QT1 only unwound 22.8% of QE1, QE2, and QE3,
so at least half-reversing QE4 would be a tall order.

The
deeper the S&P 500 is forced into serious bear territory by QT2 and
the Fed’s aggressive rate-hike cycle, the greater the odds Fed
officials will once again fold way early.  A major stock bear would
trigger a severe recession if not a depression, leaving the Fed
universally villainized as its cause.  The resulting intense
political pressure would threaten the Fed’s precious independence,
forcing its officials to capitulate.

So
the great majority of the epic $5,016b of total QE4 money-supply
growth is likely to stay, continuing to bid general price levels
higher in coming years.  The longer high inflation vexes
investors, the more they will flock back to gold.  Unlike fiat
money, global gold-supply growth is hard-limited by mining
constraints.  Regardless of prevailing gold prices, it usually takes
well over a decade to develop gold deposits into mines.

So
the global above-ground gold supply only grows on the order of 1%
annually, which is dwarfed by money-supply growth rates orders of
magnitude larger.  That leaves relatively-far-more money
available to bid up the prices on relatively-much-less gold.  So the
Fed effectively more than doubling the US-dollar supply in just a
couple years is exceedingly-bullish for gold, which will eventually
reflect that monetary excess.

But
since that inevitable higher-gold-price adjustment hasn’t arrived
yet, the yellow metal remains a heck of a buying opportunity for
contrarian investors.  Gold is really lagging this first
inflation super-spike since the 1970s, as evident in this chart.  It
overlays real inflation-adjusted gold prices on annual CPI changes
over the past five years or so.  Gold has yet to meaningfully
respond to this Fed-unleashed inflationary monster.

Ridiculously gold has mostly ground sideways on balance during this
latest inflation super-spike.  While April 2021 was that initial 4%+
CPI print, technically inflation started marching higher well
earlier after a super-low +0.1%-YoY headline read in May 2020. 
During those initial pandemic lockdowns, general price levels
flatlined on weak demand despite serious supply-chain snarls. 
So that’s the trough of this inflation cycle.

In
the 23 months since then, the CPI has soared 70.0x higher to April
2022’s +8.3%-YoY read!  While I’m penning this essay the day before
the hyper-anticipated May CPI report, it will be published by the
time you read this.  Again this massive inflation super-spike is
unlike anything witnessed since the 1970s, with that +8.5%-YoY
March-2022 peak being the hottest CPI print since December 1981
fully 40.3 years earlier!

Yet
in monthly-average-gold-price terms from that CPI trough
month to the latest-CPI-report month, gold merely managed a little
12.6% gain.  That’s pathetic given this crazy monetary backdrop,
crushing investors’ confidence in gold’s historical inflation-hedge
status.  Gold investment demand is heavily momentum-driven, and the
yellow metal has sorely lacked upside kinetic energy for much of the
last couple years.

That’s partially because gold skyrocketed to

extremely-overbought levels into August 2020 following that
pandemic-lockdown stock panic.  Gold soared 40.0% higher in nominal
terms to $2,062 in a blistering 4.6 months! 
Colossal
investment demand to chase those big gains stretched gold way up
to 1.260x its 200-day moving average.  That record gold high
rendered in today’s dollars inflated by the April-2022 CPI is
$2,293.

That
powerful upleg extended gold’s secular bull to 96.2% nominal gains
over 4.6 years.  But bulls are an alternating series of major uplegs
followed by major corrections, taking two steps forward before
sliding one step back.  With speculators’ and investors’ buying
exhausted by that lofty near-parabolic peak, gold had to correct
to rebalance sentiment.  That left gold deeply-out-of-favor with
investors as inflation started surging.

Yet
bull-market sentiment acts like a giant pendulum, perpetually
swinging back and forth from greed and fear extremes.  Sooner or
later some catalytic news will ignite
big gold-futures
buying, quickly forcing gold prices sharply higher.  That will
put the yellow metal back on investors’ radars, who will start
returning to chase those gains accelerating them.  Then higher
prices will fuel growing demand in a strong virtuous circle.

This
dire general-price backdrop of the first inflation super-spike since
the 1970s will supercharge gold investment demand.  The
longer the Fed tarries in draining the majority of that vast QE4
money spewed, the longer high inflation levels will fester. 
Investors will increasingly flock back to gold as they worry about
inflation crushing corporate profits and bludgeoning stock markets
lower.  That will become self-feeding.

While price targets aren’t important, gold ought to at least
double before this latest inflation super-spike gives up its
ghost!  Gold averaged $1,719 at that May-2020 CPI trough, so a
doubling would ultimately carry it near $3,450.  Such heights would
probably prove fleeting, climaxing another parabolic spike on big
upside momentum fueling extreme greed.  That sucks in all available
buyers exhausting their capital firepower.

An
inflation super-spike doubling gold sounds like a stretch with its
monthly-average prices only clocking in an eighth of those gains so
far.  But the stunning examples of gold’s outperformances during the
previous couple inflation super-spikes in the 1970s reveals that is
conservative.  This next chart superimposes April-2022-CPI-inflated
real gold prices over the headline CPI’s year-over-year changes
during that decade.

Once
investors really start fearing serious inflation and doubting the
Fed’s resolve to sufficiently combat it, gold investment demand
soars.  The 1970s’ first inflation super-spike was born at a
June-1972 CPI trough up 2.7% YoY.  Over the next 30 months into
December 1974, that leading headline inflation gauge kept marching
higher on balance to a +12.3%-YoY peak.  Monthly-average gold prices
soared 196.6% in that span!

You
read that right, gold nearly tripled in that first inflation
super-spike after the US dollar was severed from the gold standard
in August 1971.  That was partially because fast-rising general
prices slammed the S&P 500 down 37.9% in monthly-average terms
during that span!  With raging inflation forcing corporate earnings
and stock prices lower, investors flocked to gold fueling
momentum-driven self-feeding buying.

Gold
proved highly-correlated with headline CPI inflation trends during
that decade, falling between its pair of inflation super-spikes. 
The second one proved much bigger, igniting at a +4.9%-YoY CPI in
November 1976 then running 40 months to a soul-crushing +14.8% YoY
in March 1980.  Those nominal monthly-average gold prices
skyrocketed a colossal 322.4% during that span,
literally more than quadrupling in it!

So
gold doubling in this current inflation super-spike seems
conservative compared to historical precedent.  Again today’s high
inflation is likely to fester as long as the majority of the Fed’s
insane QE4 monetary injection remains in the system.  Even if the
FOMC can stomach QT2’s resulting serious stock bear and severe
recession, it will take a couple years at full-speed to just unwind
half of that $5,016b new dollar supply.

That’s a long time for high inflation to ravage corporate profits
and crush stock prices lower, motivating investors to prudently
diversify their stock-heavy portfolios with counter-moving gold. 
And even if today’s CPI has already seen its year-over-year peak at
March 2022’s +8.5%, that doesn’t affect gold’s bullish outlook. 
This current CPI iteration is heavily-manipulated and lowballed
compared to the 1970s version.

Real-world inflation is already surging much-hotter than this
politically-charged headline CPI indicates, as all Americans running
businesses and households know.  Contrarian economists who have
studied how the CPI is computed over decades have estimated today’s
inflation under the 1970s methodology would be about double
current headline-CPI levels.  Your own experiences with rising
prices probably corroborate that.

My
own family has had no major life changes over this past year.  We
live in the same house, eat mostly the same foods, do similar
amounts of driving, and enjoy the same lifestyle we have for years. 
Yet my wife and I estimate our living expenses are about 25%
higher this year than last!  I hear similar accounts from
friends and newsletter subscribers.  We all wish general prices were
only up 8%ish YoY, reality is far worse.

The
government chronically underreports real-world inflation for
political reasons.  Higher inflation angers voters, endangering
ruling-party incumbent politicians as evident in their plunging
approval ratings.  It also forces interest rates higher, burdening
the heavily-indebted US government with soaring interest payments. 
Resulting ballooning deficits worsen more on bigger entitlement
payments after cost-of-living adjustments.

But
trying to downplay reported inflation doesn’t change the reality
Americans face.  A third of the CPI is devoted to shelter expenses,
owning houses and renting.  The Bureau of Labor Statistics
responsible for the CPI uses a fiction called owners’ equivalent
rent to underreport shelter expenses.  That is a fanciful survey
asking homeowners to guess how much they’d expect to pay in rent
for a house of similar quality.

The
latest April 2022 CPI reported shelter costs only rose 5.1% YoY. 
Yet various real market measures and indexes of nationwide house
prices and rent are showing increases ranging from 12% to 20%+. 
If shelter costs alone were reported honestly in today’s CPI closer
to up 16% YoY, its headline read would surge over 12%!  That’s
already near lofty mid-1970s levels, and there is plenty other
lowballing illusionism.

So
there’s no doubt today’s inflation super-spike is already
comparable to if not exceeding those 1970s ones!  Eventually
gold prices have to respond to vastly more US dollars in existence
now thanks to the Fed’s extreme money printing.  Following the Fed’s
earlier QE1, QE2, and QE3 campaigns, prevailing gold prices
permanently adjusted much higher to reflect far more money sloshing
around in the system.

The
full QE4 campaign proved way bigger and faster, totaling $5,016b
over 2.5 years compared to those earlier campaigns’ collective
$3,625b total over 6.7 years.  Again QT1 only unwound less than a
quarter of that QE1, QE2, and QE3 money printing.  There’s
little reason to expect QT2 to prove more successful, as it will
slaughter these
QE4-levitated bubble-valued US stock markets fomenting a severe
recession.

The
deeper aggressive Fed tightening crushes the US stock markets into
bear territory, the more gold investment demand will mount.  The
higher that drives gold prices, the more investors will rush back to
chase the yellow metal’s upside momentum.  So seeing gold prices
double during this first inflation super-spike since the 1970s
doesn’t seem like much of a stretch.  That will eventually spur
big gold investment demand.

The
Fed’s thirteenth rate-hike cycle of this modern monetary era since
1971 accompanying QT2 isn’t a threat to gold either.  During the
exact spans of all dozen previous Fed-rate-hike cycles, gold
averaged impressive 29.2% gains!  My years-old

gold-thrives-in-Fed-rate-hike-cycles research thread is getting
increasingly noticed.  Earlier this week I did a
half-hour
video interview on that topic with Palisades Gold Radio.

With
this secular gold bull destined to power much higher in today’s
Fed-money-printing-driven inflation super-spike, gold stocks will be
huge beneficiaries.  The fundamentally-superior
mid-tier and
junior gold miners will amplify gold’s upside to massive
outsized gains.  Able to grow their outputs on balance while mostly
holding the line on costs, their earnings will soar.  So the
out-of-favor gold
stocks are screaming buys.

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The
bottom line is today’s big inflation will spur gold investment
demand, driving gold prices much higher.  This first inflation
super-spike since the 1970s is fueled by the Fed’s extreme QE4 money
printing.  That effectively more than doubled the US-dollar supply
in just a couple years, forcing general price levels way higher! 
While QT2 is getting underway, even at full-speed just
half-unwinding QE4 will take over two years.

And
all that monetary destruction will hammer stock markets into a major
bear and force the economy into a severe recession, so the Fed will
likely capitulate early again.  Either way, high inflation will
persist for a long time with most QE4 money remaining in the
system.  After nearly tripling then more than quadrupling during the
last inflation super-spikes in the 1970s, prevailing gold prices
should at least double this time around.

Adam Hamilton,
CPA    
June 10,
2022    
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