Jump in inflation spooks markets

Jump in inflation spooks markets

Friday, 14 May 2021

US inflation numbers surprised this week, with the year-on-year CPI number for April coming in at 4.2%, much higher than the anticipated 3.6%. Markets are currently not positioned well to experience an inflationary environment, so the US stock market sold-off -2% on the news. The bond market sold off too, pushing yields to 1.68% on 10Y notes and hence gold failed to react positively on the day, giving up some ground to trade back to USD$1,820.

The questions on investors’ minds will be: is this the first sign of things to come? Or just a short-term blip higher in the CPI?

We would argue it is not the first sign, but that there have been many indications and warnings for investors to position their portfolios to prepare for a coming inflationary period which will catch most off-guard. This will be just the beginning for higher CPI numbers to start feeding through globally, as the investment landscape is set to change, and the end of the ‘money for nothing without consequence’ era since the GFC will likely come to an end.

We have mentioned inflation a lot in our recent updates, only due to thinking that we are setting up for a period where inflation will likely dominate investment themes and headlines over the next few years. One chart that should give you confidence that ‘this time is different’, is the M1 money supply in the US, which shows an abnormal and unprecedented rate at which new money was created in 2020, (although normal by global standards for that year). Every Central Bank had the printed presses on overdrive last year and we expect to finally have some dramatic consequences after such an event.

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Despite inflation fears usually being a bullish tailwind for precious metal prices in the very short term we saw a flight to ‘safety’ into the US dollar for some bizarre reason, which most likely won’t last too long. The USD index rallied back to 90.77 and spot silver dropped back to $27.00. Most market participants will most likely look over this inflation beat, until we see a trend start developing over several months.

Elon Musk made headlines yet again this week, turning off bitcoin as an accepted form of payment for Tesla vehicles citing “the great cost to the environment” of bitcoin mining. That was enough to send the crypto market a peg lower with bitcoin dropping back to $50,000 USD, or some 10% on the news. Ending with the comment ‘we are also looking at other cryptocurrencies’, it is only a matter of time before Tesla likely starts buying another cryptocurrency on their balance sheet before pumping it higher to sell at a profit. Then they can be honest about their business model relying on pump and dump schemes and regulatory credits to be profitable. Their holding in Bitcoin is said to remain the same, so if we see bitcoin crashing back to earth in the next few months, Tesla could be sitting on a paper loss that dwarfs their annual net income. Are they a car company, an ‘energy company’ or a cryptocurrency trading company at that point?

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We have warned in recent updates that the price action in Bitcoin was giving major warning signs of a top firming, as we are in a distribution phase after a parabolic rise. Another interesting point is that cryptocurrency has been said to be a hedge against inflation, yet I think the market is clearly more concerned about which tweets and memes Elon Musk is posting on twitter, and not at all concerned about inflation numbers in the US.

Budget Deficits for 10 Years

To the budget numbers this week and the Australian government is looking to follow in the footsteps of the US and others by taking deficits deeper in the next 12 months. Forecasting a deficit of $106 billion this year and consistent deficits for the next decade at least. Something to keep the Modern Monetary Theorists happy. The idea of a budget surplus is well and truly abandoned as we drift further and further into debt, which eventually needs to be monetized and not actually paid back.

What it means for long term gold investors is that the higher the government debt to GDP ratio, the more pressure on the RBA to keep interest rates lower for longer, and also to grow their balance sheet through expanding the money supply and buying government bonds. Australia’s money supply measured by M3 is below and expect that trend to continue.

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The ultra-low interest rate policy of the RBA has combined with reckless lending standards to see an unapparelled rise in housing prices. The latest contribution to the price explosion of the last 12 months has been credit growth to owner occupiers. As the chart highlights below, in the past 12months annual credit growth has risen by an unprecedented 55.3 percent, eclipsing the previous all-time high of 37.8 percent during the Rudd government grants of 2009. A pandemic rush towards buying houses at ever increasing prices is no doubt the result of major banks dropping their lending standards to owner occupiers, as we haven’t seen a rise in average incomes, and rates have remained somewhat stagnant in the past 12 months after bottoming at 0.10% at the RBA level.

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Since March last year and its recent peak in January, the number of first home buyers getting into the market rose by 68.6 percent. The higher property prices go, the more eager people are to get into the market as they fear they will miss out forever. The size of the loans being dished out relative to household income is at record highs. The household debt to income ratio in Australia is currently close to 200%, which completly dwarfs the levels of debt at the peak of both the Spanish and US housing bubbles right before the GFC. Our whole economy is reliant on interest rates staying where they are and employment remaining healthy. The risks ahead for Australia if we go through a global inflationary period are enormous. A very large percent of first home buyers taking out record-breaking mortgages would be completely under water if we see rates moving higher at any point in the next few years. Those who are already in the property market from previous years with much lower mortgages might be fine, but the ones jumping over each other right now, and receiving loans that are much higher than they should be, will be the ones that will take a hit

From a wealth transfer perspective, the policies of the RBA since 2012 have disproportionately benefited the previous generation who own their properties outright, and have one or more investment properties without too much debt. The current generation of first home buyers jumping into the market today are going to have to dodge every possible economic headwind and pray for no CPI inflation and low interest rates for the next 30 years.

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Until next week,


John Feeney

Guardian Gold Sydney

If you have any feedback or questions about this report, you can contact John Feeney direct at johnf@guardianvaults.com.au

Or on Twitter @JohnFeeney10


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