The Fourth Horseman of the Apocalypse
The end is near! There should be no doubt about that by now, as more Horsemen of the Apocalypse are coming (see chart below). The first was Pestilence. Two years ago, the COVID-19 pandemic plunged the world into a Great Lockdown and the deepest recession since the Great Depression. At the end of February 2022, Russian troops brought war and death to Ukraine.
Also say hello to Famine, another rider. To be clear, I’m not talking about “hunger” in the United States or other developed countries (although the people of besieged Mariupol lack drinking water and food), but rather scarcity and high prices. In other words: inflation.
That doesn’t sound very optimistic, indeed. As you can see in the table below, The directory CPI accelerated from 0.2% in May 2020 to over 8.0% in March and April 2022. Importantly, the core CPI, which excludes food and energy prices, has also jumped recently, from 1.25% two years ago to over 6.0% now.
It is a very sharp increase in the cost of living that is hitting society, especially the poor. There are already reports of people skipping meals or taking desperate measures to save on heating costs (e.g. setting fires in homes or, in the UK, pensioners taking the bus to keep warm and save on heating).
As shown in the chart below, the March reading was the highest since December 1981 for the headline CPI and since August 1982 for the core CPI, as shown in the graph below. And inflation rates were already falling then, while they are still rising today. Inflation rates were already falling then, while today they are still rising.
Are they? Well, April’s inflation numbers are slightly lower than March’s, so it’s possible that inflation has already peaked. However, the rate was still above the consensus estimate of 8.1%, and this may only be a temporary pullback, similar to what we saw in the summer of 2021. Inflation was less scorching as gasoline prices fell 6.1% in April. , but they rose again in May (see chart below), which will help the inflationary reading ahead.
Moreover, as shown in the graph below, the housing index, which is the most important component of the CPI, has been steadily increasing (as well as the producer price index), so that there is continued upward pressure on prices. Additionally, widespread shutdowns and an economic slowdown in China would again hit global supply chains, adding to inflationary forces. Last but not least, private savings boosted by the pandemic are still high, so consumers have resources they can tap into. Therefore, high inflation should stay with us for some time..
For how long? This is a great question that everyone is asking right now. On the one hand, the pace of money supply growth has slowed down recently, as shown in the chart below, raising hopes for a normalization of inflation in the future.
On the other hand, the pace still hasn’t returned to pre-pandemic levels, so inflation won’t just go away. What else, there is still a huge overhang in the monetary “bathtub” waiting to come out through the pipeline as inflation. You see, broad money increased by about $6.4 trillion between February 2020 and March 2022, while real GDP only increased by $2.5 trillion.
In other words, the money supply has grown much more than could be absorbed by economic growth, and the rest of the newly created money must be accumulated by higher prices (and increased demand for money, but not let’s not complicate things here). Thus, the fall in the inflation rate in April should not be considered as the start of disinflation. High inflation should stay with us this year, and possibly in 2023 as well.
Good news for gold?
What does this mean for the gold market? Theoretically, this should be great news, as gold typically shines during periods of high and accelerating inflation. However, “usually” does not mean “always”. As we all know gold has failed to rise in line with current inflation so far and has not been able to break free from the $2000 level. As shown in the chart below, the yellow metal has remained in a downtrend since March 2022, or even August 2020.
One of the reasons for gold’s disappointing behavior is that rising inflation has been accompanied by higher interest rate expectations. Given the Fed’s already hawkish stance, prolonged inflation could only increase the Fed’s tightening cycle even further. This is why real interest rates have jumped recently despite rising inflation, which is clearly not good news for the yellow metal.
The only hope for gold is that either inflation or the US central bank’s response to it will eventually trigger a recession. Well, it will happen someday, but not yet – with all that money still in the tub and generating spillovers in the form of price inflation, the economy still seems to be overheating. This is likely another reason why gold hasn’t rallied like it did in the 1970s. To be clear, the economic outlook has darkened recently and the risk of stagflation has increased. However, the end is not near – unless it is…
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Arkadiusz Sieron, PhD
Sunshine Profits: Efficient investment through diligence and care.