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Inflation and investing

2020-08-05, Michael Thompson

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Inflation and investing

At the time of this writing, the US government is considering a second COVID-19 stimulus package, likely amounting to 1-3 trillion USD. Such spending has prompted fears of runaway inflation in much of the general public. This and other developments have driven gold prices up almost 20% (relative to the US dollar) in the last 3 months while silver has risen almost 50% in the last month alone. A recent survey indicated that 16% of Americans have purchased precious metals in the last 3 months and 23% are considering it now. In this article, we discuss the viability of investing in precious metals at this time, and briefly discuss other investments to hedge inflation.

First and foremost, unbiased economic experts do not think runaway inflation is the most likely outcome. Inflation has actually decreased significantly this year from 2.5% to just over 0.5% at last check. Experts believe inflation will creep back up over 2% but is unlikely to reach 4% in the foreseeable future. Weakening globalization is a primary reason cited for increased inflation. Vanguard's chief economist Joe Davis was asked about this in a recent interview you can read here. While you can undoubtedly find experts predicting mass inflation, we recommend you check their motivations. Some have a vested interest in precious metals or Bitcoin and use inflationary fears to lure buyers.

Of course, no one can predict inflation with 100% accuracy. This is why the same experts that predict it’s unlikely still recommend you have a portion of your investment portfolio hedged against inflation. So how do you do this? There are a number of assets that do well in an inflationary environment including stocks, precious metals and inflation-protected bonds. What many people find surprising is that gold and silver have not hedged inflation as well as foreign stocks historically. In fact, using reasonable metrics, gold is not even half as good as foreign stocks at hedging against inflation. Gold is a decent inflation hedge over decades/centuries, but not for the shorter time horizons most of us focus on.

We want to be clear - we are not saying no one should buy or hold gold. Gold has played a useful role in storing value (but not growing it like stocks and bonds) over very long periods of time. It's risen 1% per year (after inflation) for the last century and surged sevenfold in the stagflation of the 1970s. It's not hard to imagine further increases in gold prices now, given that equity valuations are historically high, bond yields are below inflation and polls indicate so many Americans are considering buying precious metals. However, we want to ensure our readers are aware that gold is not risk free and is historically not the best inflation hedge.

So how much gold (including gold mining stocks) should an investor hold? As with any other asset, this depends on the personality and goals of the investor. An often-cited rule is to keep less than 10% of your portfolio in precious metals, and 5% appears to be a rough average. We’ve seen some experts exceed this, nearing 15%. Some investors like Warren Buffet recommend against holding any gold as the asset is not productive and purely speculative. Ray Dalio’s (highly diversified) all weather portfolio is 7.5% gold.

In summary, gold and silver have historically acted as an inflation hedge and long term store of value. Foreign stocks have been a much better inflation hedge. Predictions of future gold/silver price movements are almost pure speculation - the current rally may come to an end tomorrow or 10 years from now. A general rule of thumb is to have no more than 10% of your portfolio in gold.

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