During Times of Inflation, Precious Metals Are the Perfect Fit
There are times when it seems like something is missing when nothing on the menu looks appealing. Then the waiter reappears and reveals the main course on special that sounds delicious, even though it wasn't anywhere on the regular menu. This is where precious metals are today - like a delicious special that sounds better than anything on the regular financial menu. Whether trying to find a home for newly-minted savings or shelter gains from other investments that have done well in the past, precious metals today offer a unique combination of safety and growth challenges to find elsewhere today. Today we will survey the investment landscape and discuss why gold, silver, platinum, and palladium belong in every saver and investor's portfolio.
Real Estate Challenges
Real estate is one of the sectors often mentioned in the same breath as precious metals. Real estate is one of the tangibles often discussed as something real with a limited supply. But there are some issues with real estate that prevent it from being a risk-free investment choice for many savers. In the commercial sector, challenges remain due to a tight labor market, with office workers demanding "work from home" options after being forced to work remotely during the Covid 19 pandemic lockdowns that shuttered many office properties. While the lockdowns have mostly ended here in the United States, working remotely appears to have become a semi-permanent trend. As such, the vacancy rate of office properties today continues to be 36% higher than it was in 2019, before the pandemic. Higher vacancy rates mean fewer paying tenants and downward pressure on prices.
The residential real estate sector is also in danger of lower asset prices due to interest rate increases. Unlike the office property sector, there is great demand for affordable housing. But the problem is related to rising interest rates. Coming off of a period of record home prices, interest rate increases might be the pin that pops the bubble. The reason for this is a question of math, as most residential real estate is purchased with financing. When mortgage rates rise from 4% to 6%, it requires a 20% reduction in the price of a home to make the mortgage payment. For example, if you can afford a mortgage payment of $1,909, you could borrow $400,000 with a 4% mortgage interest rate. But when rates rise to 6%, you could only borrow $318,515 for the same $1,909 payment - a reduction in the price of over 20%.
Bond Market Challenges
If we look at bonds, which are traditionally thought of as being one of the safer places to invest, we find they are currently fraught with danger. Financial commentator Jim Bianco recently warned investors that carnage in the bond market was currently "epic." Even vaunted US Treasury bonds have been influenced by this carnage, falling the most since 1994 (see chart). When "stability" means losing 10% of what you have, what does instability look like? Unfortunately, it doesn't take long to figure out. The inflation rate in the United States as of 3/31/22 is 8.54%. This means prices are rising more than 3x as fast as they were only a year ago. I was shocked recently, for example, to purchase a 1lbs package of roast beef (sliced for sandwiches) for nearly $11 at the grocery store. You can probably offer other examples unless you haven't shopped in a while.
Stock Market Challenges
What about the stock market? If the most stable investment securities (bonds) are increasingly unstable and subject to the highest losses in 20 years, that doesn't bode well for less stable investment securities, such as stocks. There are several challenges for stocks in a stagflationary environment, many of which are related to the causes of difficulty seen in the other categories already discussed. We see an economic slowdown due to inflation and higher interest rates on household budgets. When it costs more to live in the same house (by either higher mortgage payments or higher rent), more to drive to work (record-high fuel prices), and more to buy food and pay utility bills, there are fewer funds available for discretionary purchases. Consumer spending plays a significant role in the American economy and helps support the stocks of American corporations.
When people are forced to spend more to purchase the same amount, but they don't have enough, they spend less. The Purchaser Price Index (PPI) measures inflation experienced by companies producing goods for sale. At 11.2%, this is the highest measurement since records began in the United States and imply that further increases in the CPI (Consumer Price Index) are probably on the way. When PPI is 11.2% higher than the previous year, the costs to offer a good or service have increased by that amount. Corporate revenues will be squeezed without a corresponding increase in price for the finished product. Since consumers are already being squeezed, it will be hard to pass all the cost increases on to consumers. This means that corporate profitability and extension stock prices are likely to come down.
Historically, lower stock prices are what we would expect to see during stagflation. For the last 60 years, stocks (as measured by the S&P 500 Index) have dropped 2.1% per quarter during stagflationary periods such as during the 1970s. Recovery from these losses took nearly ten years for those who stuck it out. Many couldn't stomach the losses and get out of the market before recovering. Current conditions suggest it might be a good time to lighten up on stocks before most of the losses occur during this period of stagflation.
Today's Special - Gold, Silver, Platinum, Palladium
If nothing on the menu above sounds appealing to you, you're in luck. Because precious metals just so happen to be some unique items not on the menu, such as precious metals. Even though the current environment is challenging for every asset class we have mentioned today, including others we didn't - such as cryptocurrencies, it has traditionally been an excellent environment for gold and silver. All four of the metals we cover in this column move higher but still at a distance from record highs. While other asset classes are at or near record highs and downward, precious metals are trending higher, with plenty of room to run. In today's environment, I believe precious metals are a perfect fit.