Higher prices are coming to a store near you…
For the first time in years, inflation is picking up.
Inflation measures how quickly prices for everyday goods and services rise. The higher the inflation rate, the quicker prices rise.
Most people don’t like inflation. It means they have to spend more money on groceries, gas, and rent.
Luckily, we haven’t had much of it recently. The Consumer Price Index (CPI)—the government’s favorite measure of inflation—has averaged just 1.4% since 2009. That’s less than half its historical average of 3.5%.
• But inflation started picking up last summer…
It’s now rising at the fastest rate in five years. MarketWatch reported last week:
A string of sharp gains since late summer helped drive up inflation by 2.1% for the full year, marking the biggest increase since a 3% gain in 2011. Americans are pay[ing] more for fuel, housing and doctor visits, countering the biggest decline in grocery prices since the tail end of the Great Recession.
In 2015, we had an annual inflation rate of just 0.7%. In other words, prices for everyday goods and services are rising three times faster than they were two years ago.
• Inflation will likely keep rising…
The chart below shows forward-looking inflation expectations for the next five years. You can see that economists expect inflation to average at 2% between now and 2022.
This might not seem like a big deal. After all, inflation topped 14% during the early 1980s. We’re nowhere near that.
But you have to understand something…
• All we’ve been hearing about since the last financial crisis is deflation…
Deflation is the opposite of inflation. It’s when prices fall.
It sounds like the best thing ever. After all, who doesn’t like saving money?
But central bankers don’t think about deflation like we do. They see it as a sign of a weak economy.
• The Federal Reserve has been doing everything it can to prevent deflation…
Since 2008, it’s printed more than $3.5 trillion out of thin air. And it’s held its key interest rate near zero for nearly a decade.
We’ve said many times before that these reckless policies would eventually generate inflation. We’re finally starting to see that happen.
• Most investors aren’t ready for inflation…
They own too many bonds.
That’s because bonds have been in a bull market since the 1980s. Many people now see bonds as “no-brainer” investments.
We also have had almost no inflation the past few years. And bonds are a great investment when there’s little or no inflation.
Let’s say you own a bond that yields 2%. If there’s no inflation (0%), your “real” return (a bond’s yield minus inflation) would be 2%.
Now, let’s say the inflation rate jumps to 2%. Here your real return would be 0%. You wouldn’t make any money on that bond.
If inflation hit 3%, your real return would drop to -1%. You would actually lose money on that bond.
In other words, bonds are the last thing you want to own when inflation is high or likely to rise.
• It won’t take much inflation for bondholders to take heavy losses, either…
These days, most bonds yield very little.
Take the U.S. 10-year Treasury, which is supposedly one of the “safest” bonds you can own. It currently yields about 2.4%. That’s about half its historical average.
Corporate and municipal bonds are also yielding near-record lows.
This makes them incredibly vulnerable to inflation.
• Inflation could skyrocket over the next four years…
You’ve probably heard that Donald Trump wants to spend $1 trillion on U.S. infrastructure projects.
This sounds like a good thing.
After all, America’s roads, bridges, and powerlines are in desperate need of repair. Plus, Trump’s plan should put thousands of Americans to work.
There’s just one problem.
• The United States is flat broke…
Under President Obama, the U.S. government racked up about $8.5 trillion in debt. The U.S. economy grew just $4.3 trillion over the period.
Government debt as a percentage of U.S. annual output (GDP) is now at 105%. That’s the highest level since World War II.
To “Make America Great Again,” Trump will have to borrow even more money. And the deeper the government goes into debt, the more inflation we’ll have.
• We recommend that you prepare for much higher inflation…
Start by looking at your bond portfolio.
If you own bonds with rock-bottom rates, get rid of them. Any money you stand to make on these bonds could get eaten alive by inflation.
We also encourage you to own hard assets.
These are assets with tangible value. They include commodities like gold, oil, and copper.
Unlike bonds, hard assets often do well when inflation rises.
Think about it. If inflation is rising, it’s going to take more dollars to buy an ounce of gold, barrel of oil, or pound of copper.
That’s why everyone should own hard assets when inflation is rising or likely to rise.
• Commodities took off last year…
The Bloomberg Commodity Index (BCOM), which tracks 22 different commodities, is up 18% since last January.
The price of copper is up 29% over the same period. Palladium is up 55%. The price of oil has nearly doubled.
These commodities could deliver even bigger gains in the coming years if inflation really takes hold.
• If you don’t own any hard assets yet, start with physical gold…
Like other hard assets, gold should do very well if we get more inflation.
Unlike other hard assets, gold doesn’t need a healthy economy to do well. It can rise during economic recession, stock market collapse, or even a full-blown currency crisis. You can’t say that about many other assets.
Chart of the Day
There’s never been a better time to buy hard assets.
Today’s chart comes from MarketWatch. It compares the price of real assets with financial assets. The lower the ratio, the cheaper real assets are relative to financial assets.
If this chart looks familiar, it’s because we first featured it in October. We’re sharing it again because it’s one of the most important charts you’ll ever see.
Right now, this key ratio is sitting at an all-time low. This means assets like commodities, real estate, and collectibles have never been cheaper compared with stocks and bonds.
In other words, we could be looking at one of the best buying opportunities ever. If you don’t already own hard assets, we recommend you get started soon.
Once again, start with physical gold. Once you own enough gold for safety, you could consider speculating on other hard assets.
Delray Beach, Florida
January 23, 2017
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