Inflation, Gold, Silver and Related Equities –  50-Years of  Observations’

By Rod Blake

“Inflation is the decline of purchasing power of a given currency over time. A quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a basket of selected goods and services in an economy over some period of time. The rise in the general level of prices, often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods.” – Investopedia.com

Rising inflation, mainly nonexistent for the past 30-some years, recently became a hot topic after the U.S annual inflation rate broke a multi-year trend of about 2^% and rose in November to 39-year high of 6.8^%. Think about that for a moment. In North America – anyone under the age of 40, or two generations of businesses, consumers, families and workers, until this year, have not experienced prices rising by much more than 2^% in any given year. Now 6.8^% taken by itself may not seem like a big number, except that for last 40-years, inflation has been controlled by central bankers at rate of about 2^%. I say controlled because that is just what they did. Government central bankers such as The United States Federal Reserve (Fed), The Bank of Canada, The Bank of England and others would raise or lower short-term interest rates to speed up or slow their economies in order to keep the average rate of inflation steady at about 2^%. This 2^% rate was considered optimum as it would allow the economy to grow at a rate that let businesses, workers, consumers and families to keep up with the cost of living without any untoward hardship. As a matter of fact, it became so systematic that the phrase “Cost of Living Adjustment” was written in to or was expected in many price or employment discussions. This controlled inflation also negated many costly work stoppages and supply disruptions. When you think about it – over the past 30-some years, (except for the recent covid induced supply problems), there have been very few major workers’ strikes or supply disruptions. Most strikes or labour issues have been over work conditions or benefits as employees and employers generally agree on something near an annual 2^% cost of living adjustment. Meanwhile, retailers and suppliers found that price increases could be kept to a minimum if inventories were kept small and goods arrived on time as needed. Meanwhile consumers and families could budget with some confidence for the year ahead.

This controlled cost of living worked very well, even in the financial crisis of 2008-09 Here, the central bankers quickly dropped interest rates to zero and injected great amounts of money into the system to spur their economies forward in a time of great economic uncertainty. The lower interest rates and cash worked as anticipated and by 2010 most economies were growing and inflation was once again tracking the desired rate of 2^%. All was going well economically until March 2020 when Covid-19 became a world-wide pandemic that ground economies to a virtual halt. Central bankers, working off of the their success in 2008-09, once again dropped interest rates to zero and injected even more cash into the system. And this time economies came back even quicker as vaccines allowed businesses to reopen, employees to work and consumers to spend sooner than expected. For the most part the recovery mirrored that of 2010 except that this year inflation started to rise above the desired 2^% level. The Fed and other central bankers  assured us this bump in inflation was transitory or temporary and that it would drift back down to the optimum 2^% range sometime in 2022. Those assurances were all good until the above mentioned jump in annual inflation to 6.8^%. In a few short months those assurances of a return to 2^% inflation by next year now seem somewhat suspect. Why is this important and what if inflation doesn’t drift lower? Higher inflation by itself is not that terrible as long as the rate is stable. As a matter of interest, many countries are handling inflation rates that are above 2^%. The problems begin when inflation rates persist on climbing higher. The Fed and other central bankers have seen this situation before and certainly do not want to see it happen again.

To really speak of rising inflation one has to go back a few more years in time to the early 1970s. You see, while those under 40 have never experienced rising inflation, those of us over 40 can remember it well. This recent bump up in inflation seems eerily familiar to what began somewhat unnoticed back then but persisted unchecked for about 10-years through to the early 1980s. Up to the early 1970s, the post World War Two cost of living was much like we’ve experienced for the past 3-decades before covid. That is, inflation was tracking at a year over year rate of about 1^% – 2^% while the economy grew and there were few labour or supply disruptions. Then in about 1972 there was a bump in inflation up to about 5^% and a year later up again to 8^%.

Now the thing about major changes in economic trends is that they tend to last longer and go further than most expect. The Fed and other central banks were slow to recognise the dynamics of this rising inflation trend and were behind the curve in trying to slow it down. The net result was that this rising trend persisted until inflation peaked in 1981 at about 13^%. This spiraling rise in inflation was only stopped and reversed when central banks finally brought the economies of the world to a virtual halt by raising interest rates up to about 20^%. Yes – the interest rate on mortgages in 1981 were at or near 20^%. But mortgages were only part of the problem. During this time, workers fell noticeably behind in their standard of living, which  resulted in prolonged strikes and supply disruptions as they demanded cost of living increases of 12^% or more. Not surprisingly, benefits and working conditions weren’t the primary employment issues anymore. It was all about the cost of living or as according to Investopedia above – “the decline in the purchasing power of a given currency over time.”  Which brings me to gold & silver.

That amazing 1972 – 1981 period of rising inflation, saw the price of gold surge up from about US$150 an ounce before peaking out at about US$850, an increase of about 465^%.Meanwhile, silver rose by 900^% from about US$5 – US$50. To better understand why -  refer once again to the decline in purchasing power above. In times of rising inflation hard assets come into favour as investors want to protect themselves against declines in the value of their currencies. Nothing focuses ones attention to the devaluation of their currency more than to seeing their mortgage rate jump up from 6^% to 20^%. Think of it – A mortgage rate in 1981 that was comparable to that of a credit card. So investors sought out gold and silver as the ultimate investments that increased in value in times of rising inflation. Gold is considered the one true non fiat currency of which all other currencies are compared. Silver has similar properties albeit with a greater industrial component. Gold and silver held their true value while the fiat currencies of the world declined. The other asset closely associated to gold & silver are the public companies that mine and produce those minerals . So while gold and silver rose by 465^% and 900^% respectively, many gold and silver stocks soared by many multiples higher than that of their underlying metal as investors factored future earnings and growth into the equation. Interestingly, the stock price to earnings multiples (PE) of gold and silver stocks in 1981 were extended to much the same levels as those of the tech sector today. A much different picture than what we see today.

The central bankers finally won and the price of gold & silver rolled over in 1981 along with a drop in interest rates and easing inflation. Gold worked its way all the way down to about US$275 in the late 1990s as inflation finally bottomed and stabilized at about 2^% and the current cycle began. From there gold climbed by over 650^% to the current 2020 all-time high of US$2,075. Silver came back down again to US$5 in the same period and then rose once again to US$50 in 2011 before settling out to today’s US$23 for a peak gain of 900^% and a net gain of some 360^%. So even in a times of low inflation gold and silver have still managed 20-year respective gains of some 650^% and 360^%. Unfortunately, gold and silver equities have not fared quite so well. Gold and silver securities ran up from with the price of the metals from 2000 to 2020 but for the most part, have not held the impressive gains of the minerals and some are trading back at multi-year lows or PE ratios. It would seem that that gold and silver stocks need rising metal prices to really capture investor interest.

Half a century of history shows that the price of gold and silver increases in value over time. It would seem that while their price goes up in times of low inflation they tend to increase at a greater rate in periods of rising inflation. The only time they saw a long-term drop in price was when interest rates dropped and inflation eased post 1981. Surprisingly – the price of gold and silver equities are not closely correlated with the price of their underlying resource. In a rising gold/silver market – the price of gold & silver equities greatly outperform the metals to the upside while in times of consolidation, such as the past year, the equities retreat to multiples that would suggest the mineral prices were about to collapse as they did post 1981. Historically however, this has proven to be one of the best times to buy gold and silver stocks. And if today’s central bankers are wrong or are slow to react and this current 6.8^% bump up in inflation proves to be less that transitory or a precursor of higher inflation to come, then this period of time could be looked upon as one of the best in the past 50-years to invest in gold & silver and to a greater extent – in gold & silver equities.