Big inflation will spur gold

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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.

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.

(By Adam Hamilton)

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