We’re going to respond to a great question from the reader mailbox today. If you’ve sent in questions, don’t forget to include permission to publish them!
But before we get to the question and response, we have a quick request for you. Please add your reviews and ratings to our Fortune & Freedom podcast here, including to the recent episode on Rishi Sunak’s plan for our most important industry, and exclusive content with John Butler on whether central bankers will be “behind the curve” again.
Here’s the question which needed answering. It’s from a subscriber to several of our publications at Southbank Investment Research:
Dear Southbank editors,
Next week there are the US CPI and PPI reports and it looks like there will be renewed confirmation of trend inflation.
Do you think this is significant for equities, already looking very toppish, and in which direction?
Notably, your recent posts have been very slanted towards the possibility of a massive correction. If there is another whopping increase in inflation, will there be a sell-off in markets on both sides of the pond?
And if so, will this benefit gold and gold stocks, still trying to get back to a sustained rally, even if the price goes down with equities initially?
Very best wishes
SGC
Since SGC sent that email, markets have been very volatile, including the fourth worst market open ever according to Zerohedge.
But the inflation data hasn’t even come out yet…
The US’s consumer price inflation (CPI) and producer price inflation (PPI) numbers come out today and tomorrow US time.
They’ve recently spiked very high, but this is partially due to the unusual year of comparison in 2020. The questions now are:
- Whether the inflation will persist or not, and
- How this will affect financial markets.
The trouble with this discussion is that inflation is only part of the equation when it comes to asset prices.
And there are many different types of inflation too. Stagflation is very different from an inflationary boom, for example.
But let’s focus on how the inflation figures themselves do not provide enough information.
The question that truly matters is: what happens to interest rates relative to inflation?
The key measure to watch is the real interest rate: that is to say, the interest rate, adjusted for inflation.
If inflation is left unchecked by central banks, with no interest rate hikes to come, that may well be good for equities and gold.
In that sense, asset prices will rise, because of inflation and a boom.
But if inflation is judged to be a trigger for interest rate increases, a higher inflation print could trigger a selloff in both gold and stocks in anticipation of higher rates.
Conversely, if inflation disappoints, it could signal a disappointing recovery, or it could make interest rate increases less likely.
So, the outcome for stocks and gold isn’t certain there either…
To sum up, the answer is just not that simple.
The real distinction for both gold and stocks will be whether the central bank(s) are behind the curve or not.
In plain English, this means whether central bankers will raise interest rates faster or more slowly than inflation rises.
That is crucial because that defines the trend of the real interest rate – the interest rate adjusted for inflation.
Gold expert John Butler and I recorded a video about this recently. It’s available exclusively on the Fortune & Freedom podcast here.
In the early 2000s, the central banks were behind the curve.
Inflation rose faster than interest rates.
This inflated the housing bubble, stocks and gold together.
But in the 1970s, we got stagflation. Stocks fell in real terms (and sometimes in absolute terms) because of the disruption from inflation.
However, gold rose in both scenarios…
What makes gold diverge from stocks is gold’s monetary and opt-out function.
In other words, when people want to avoid money and the financial system, they buy gold and shun stock markets.
If you expect that there really is inflation ahead, gold wins, either way.
Nick Hubble
Editor, Fortune & Freedom
