At Rush we think the future is bright, especially for those who are defending their wealth by owning precious metals. The path to get there, however, is not likely to be a straight one.
In our annual outlook we try to comment on the longer-term forces that affect markets.
In our view, gauging and protecting against the erosion of purchasing power is Job One in this market environment. This means we need to analyse the forces, inflationary and deflationary, behind the tug-of war in the prices of everything, from shares to houses to avocados and school fees.
Is the inflation genie really going back in his bottle?
To answer that, let’s look at some of the macro-economic clues going into 2024:
The Effects of Globalism Are Waning
The deflationary benefits of globalism (think cheap Chinese goods) may be mostly behind us. Middle class wage growth rates in the developing world now far exceed those in the developed world. Goods that used to be dirt cheap are now just cheap. So this long-term, secular downward pressure on prices is abating.
Net effect: modestly inflationary
The Money Supply is in Transition: The money supply torch is being passed from central banks to governments. Post-2008, central banks expanded their balance sheets to the breaking points. The U.S. Federal Reserve balance sheet, for example, went from $800B to $9 Trillion.
Now that interest rates have risen, the bonds they purchased have dropped in value dramatically. The Reserve Bank of Australia, for example, is currently sitting on $45B in losses on the bonds they bought during their “quantitative easing” experiment.
As this task of keeping the money supply growing shifts from central banks to governments, they have been borrowing money at a torrid pace, as shown in the chart below. The U.S., for example, added more debt in 18 days in October than it had in all the years between its founding and 1975.
And because they are governing today by “continuing resolution,” rather than by the legislative and formal budget processes, there is currently no real brake on this government borrowing.
Net effect: inflationary.
Government Borrowing Now Depends on Investor Sentiment: Every dollar of that borrowing must now be financed by investors buying government bonds, rather than central banks paying non-market prices for those bonds. And previously central banks could simply hide those bond purchases in opaque programs with names like “QLTRO,” whereas now those purchases are priced on open markets.
If government bond investors now go on strike (demanding higher interest from governments because their finances are looking increasingly shaky) there is no choice but to pay those higher borrowing costs.
Net effect: potentially deflationary.
Interest Payments Are Rising Fast: Interest on debt already costs 45% of all U.S. government non-discretionary spending, and that cost is starting to crowd out spending on government services in the U.S. and elsewhere.
The chart below shows this rapid growth. Entitlement (welfare and retirement) promises, made in bygone eras when financial conditions were much more favorable, are likely to be broken.
Net effect: potentially deflationary, as transfer payments to individuals decrease.
Military Conflicts Consume Massive Quantities of Resources: Armed conflicts have risen sharply since 2020. Armies and navies are far and away the largest consumers of fossil fuels. And apart from very tragically destroying lives, they also destroy large quantities of raw materials.
Net effect: highly inflationary
Election Years Rarely See Significant Rate Rises: 2024 is an election year in the U.S. Central bankers are very reluctant to raise rates in an election season (which could result in an economic slowdown) and risk the wrath of politicians. This means that interest rate rises are unlikely, even if further inflationary pressures reignite.
Net effect: potentially inflationary
Innovation Drives Costs Down: Technological innovation, in everything from nuclear fusion to precision farming to AI, continues at mind-bending speed. The history of the 20th and 21st century so far is of technological advancements improving productivity. Fewer and fewer people, for example, are required to grow food or build automobiles.
Net effect: potentially highly deflationary
Lastly, recall that deflation (a fall in the prices of goods and services as productivity rises) used to known by a different name: “Progress.” It is mostly central bankers and economists who want to convince us it’s a bad thing. Most people, by contrast, would be happy to pay less for the same good or service over time.
Keeping an Eye on the Inflation Rate
Inflation rates are dropping from the peaks of 9 months ago but seem stuck at higher levels than before, i.e. 4% versus 2%.
But the way inflation is officially measured, as the chart below shows, amplifies the effects of small discretionary purchases like electronics. And it discounts the effects of large and non-discretionary purchases like food and shelter.
So, as anyone who has paid a school fee or checked out a shopping cart at Woolies recently can attest, the actual inflation rate is higher than the official reported rate. This means that your real buying power is declining faster than you’re being told.
Putting It All Together
The list above contains four main inflationary forces as against three main deflationary ones. So we think the bias is for inflation to remain a stubborn factor going forward.
The RBA official target rate, which seems unlikely to be hit anytime soon, is 2% inflation. But recall, as shown in the chart below, that even a relatively modest inflation rate of 5% means that your buying power is almost halved in 10 years.
Amid these crosscurrents, precious metals continue to stand out as a premier wealth preservation asset class. Their historical role as a hedge against inflation and economic uncertainty means they are a beacon for investors navigating the complexities of the coming year.
Here’s to a bright and shiny 2024 and beyond.