My first article on this website was over 5 years ago, Inflation Destroys Dollars. I certainly did not have any idea that the price inflation would be triggered by the government’s response to the COVID-19 pandemic. I certainly didn’t anticipate the lockdowns and supply chain disruptions back in 2016.
I know the fiscal and monetary policy pursued by the United States and virtually all the world: money printing, onerous regulations, taxes and spending, would eventually result in significant price inflation. Government response to COVID-19 has made the situation worse and pulled the day of reckoning forward but it certainly isn’t the largest factor.
Timing is always a challenge and I was quite early.
Price inflation is here and it is happening fast enough where people notice it and are actually talking about it. Depending on who you trust and how you measure it, prices are rising at a rate of 6-10% per year now. I think what is interesting is that the government’s own numbers (the CPI-U) shows inflation at 6%. This is far beyond the 2% the Federal Reserve has been calling for.
Gold and Silver as an Inflation Hedge
In Inflation Destroys Dollars I write about how gold and silver are an inflation hedge. On 16 May 2016 when I wrote that article, gold was trading at $1,252 per ounce. As I write this it is currently up to $1,864.61, an increase of 48.9%. That is an annualized return of roughly 7.5%.
On 16 May 2016 Silver was trading at $17.14. It is now trading at $25.29. That is a 47.5% increase for an annualized return of approximately 7.3%.
So, if you think that inflation has been somewhere between 4% and 8% over the past five and a half year, gold and silver have on just kept up with inflation during this timeframe. Not bad but also not great. Gold and silver remain the boring reliable hedge and that is a good thing.
Value Stocks as an Inflation Hedge
Value stocks are another asset class I mentioned in Inflation Destroys Dollars. I didn’t mention specific funds. I have made some of my own individual value stock picks with some fantastic picks, but also some not so good picks.
Vanguard’s Selected Value fund (VASVX) is a mid-cap fund that could serve as a proxy for “value stocks”. It was trading at $26.41 on 16 May 2016. It is currently at $33.39. This is a return of 26.4% and an annualized return of 4.3%. Not stellar as I would not say this has kept up with inflation.
The Vanguard Value Index is a large cap value fund (VVIAX). It started this period at $32.49 and is up to $56.68. This is a return of about 74.5% and an annualized return of 10.65%.
A final example to look at, Vanguard’s Mid-Cap Index Admiral Shares Fund (VIMAX) started in this timeframe at $150.33 and is now at $320.62. That is a total percent return of 113% and an annualized return of 14.7%. Much better.
Compare those to the Vanguard 500 (VFIAX), which started this timeframe at $184.53 and is now at $432.9. The total return of this fund was 134.6% an an annualized return of 16.77%.
So while value stock fund did beat the rate of inflation and are a good hedge, they didn’t outperform your vanilla S&P 500 index fund.
Bitcoin as an Inflation Hedge
Compared to gold and silver, Cryptocurrencies, particularly Bitcoin has had all the action.
On 16 May of 2016 a Bitcoin was trading at about $454. Today Bitcoin is trading at $64,346. That is an astounding increase of 14,073% or an annualized return of about 146%.
Clearly Bitcoin has outperformed Stocks, Gold and Silver during this timeframe in an astounding way.
I own Bitcoin and I’m not anti-bitcoin. But I’m also not a Bitcoin maximalist. I think it is possible and perhaps even likely that Bitcoin will be replaced with a superior cryptocurrency that has some combination of faster transactions, higher transaction throughput, anonymity and or additional features. In my view Bitcoin in its current state is too slow and transactions are too costly for it to work as a medium of exchange for day to day transactions. These views are very unpopular with Bitcoin maximalists that ignore or downplay Bitcoin’s weaknesses.
However, Bitcoin has provided an incredible return and far outpaces inflation.
The 14,073% return is not just a result of inflation, although it is increasingly being viewed as a safe haven alternative investment.
Bitcoin has had several great tailwinds 1) It is an emergent asset class 2) It is trendy and popular and gets media attention 3) It is viewed as a Federal Reserve / dollar debasement hedge in place of gold.
Protecting one’s wealth and purchasing power from inflation is important. Just keeping up with inflation is not ideal either, if the assets are not tax advantages, the government will tax the “gains”, and so purchasing power is eroded.
Let’s look at a simplified example. Say you frequently buy a widget or pay a service that costs $100 per year. Say the price goes up 5% per year due to monetary inflation. You also have a $100 investment that also goes up 5% per year. You’re still not keeping up with inflation because of taxes. If your $100 investment goes up 5% to $105, the government is going to want some taxes on that $5 gain. Say you’re on the hook for 15% capital gains taxes, the government is going to take their share and leave you with a $4.25 gain.
So you now have to come up with another $0.75 to pay for the item or service. Scale this up to include all of your expenses for the year and you see that you need to not only keep up with inflation, but exceed inflation so you have the money to pay the taxes on the gains.
In order to keep up with inflation your investment would need to be in a tax advantaged account that would lower or eliminate the tax burden owed or (again assuming a 15% gains tax) you’d need the investment to go up by about 5.9%.
This also shows how insidious inflation is. Not only is money worth less, but the government taxes the gains, even if there was no gain in terms of purchasing power.
One other thing to keep in mind, in the United States at least, realized gold and silver gains are taxed at the generally higher income tax rate rather than capital gains tax rate.
Are Gold and Silver Great Inflation Hedges Anymore
Gold and silver might not be very good inflation hedges anymore. If I owned gold or silver I wouldn’t sell unless I needed to rebalance my portfolio. I would expect these assets to at least keep pace with inflation, but unless the demand for gold and silver increases in excess of new supply, I don’t think gold and silver will beat inflation in the way needed in order to truly hedge for inflation when accounting for taxes. While it has produced a positive return in excess of inflation, it certainly hasn’t been a fantastic play over the last five and half years since I started HowIGrowMyWealth.com.
Gold isn’t supposed to tarnish but it has certainly lost its luster in my eyes so far in 2021. I have determined that for me, having 10-20% of my liquid net worth in precious metals makes sense as a protection against dollar debasement. Right now we’re in the kind of environment in which I would expect gold to shine (that should be it for the gold puns in this article.).
However, gold has not fared well so far in 2021.
What kind of environment am I writing about? Rising interest rates and helicopter money. Interest rates, while still historically low, have been rising. There has also been “helicopter” money where the treasury is directly sending people checks.
The Economic Environment
The latest round of these “stimmy bucks” should be coming soon, as President Biden is expected to sign a $1.9 trillion bill, which among many other things includes a $360 billion bailout of state, local and territorial governments and $1,400 check to anyone making $75,000 or less.
The blue team currently controls taxes and spending in the United States. While the reds are spendthrifts in their own right, and these stimmy checks were initiated under Trump, the blue team is worse. I’m not aware of a party which practices fiscal discipline in the United States. I expect this to be the first of many trillion dollar spending bills passed during the Harris-Biden Administration.
I understand that if the government is going to make it illegal for a lot of people to work and a lot of business to operate that creates problems, such as unemployment, less available goods and services and a lack of economic resources for individuals and families struggling to make ends meet. So this spending bill is no doubt an attempt to try to fix the some of the problems created by the lockdowns.
Whether these lockdowns were necessary to prevent people from dying from the Wuhan Coronavirus frequently referred to as COVID-19 should be debatable. However, thanks to censorship we all just have to click our heals and accept that without lockdowns the bodies would have piled up in the streets, hospitals would be overwhelmed and furthermore, that the increase in deaths due to undiagnosed cancer, suicide, etc., simply don’t exist or don’t matter. But I digress.
In an environment in which it has been illegal for people to show up to work to produce goods and services, and which the government is sending people checks, you expect rising prices. Prices have been rising. We’ll ignore the CPI, which seems to be designed to not measure rising prices. Lumber is up, oil is up, many commodities are up.
Gold is Not Rising
Even though many commodities are up, gold and silver are not up. Why is that?
Gold Price Action over the last Ten Years
After making new highs in the wake of the 2008-2009 financial crisis, Gold had been in a bear market from September 2012 through November 2015, where it made a low of $1,045. It pretty much traded sideways and slightly up for the next four years, until 2019, when gold rocketed up, finally making that new high in August of 2020, reaching $2,089 per ounce. It then proceeded to sell off and is currently trading around $1,721. I think $1,800 was an important price level, but the yellow metal zipped right through it.
There does seem to be some support around $1,700 but it doesn’t look super strong. I’m definitely biased to the upside, but my guess is gold bounces between $1,700-$1,800 unless and until the Fed does something to manipulate interest rates back down. Why would the Fed do that? An economic recession or a stock market selloff.
In February of 2020, the S&P 500 was trading around $3,350 or so. This was before the lockdowns and the panic. Now, after having shut down a lot of the global economy, after unemployment going upwards, the stock market has recovered, but are things better than they were in February of 2020? The stock market thinks so. The S&P 500 has made a new high of roughly $3,950.
I would think that if interest rates continue to rise there will be a significant correction in the stock market. The Fed would then step in and do what it can to lower interest rates back down which would prop up stocks. So far the market had shrugged off rising rates, however.
Why Hasn’t Gold Performed?
There are three main reasons. Reason #1 why gold hasn’t performed: rising interest rates. If bonds are yielding nothing, then it is easier for gold (which also yields nothing) to compete.
This is supported by the chart below. The 10 year treasury yield is in blue. You can see in late July, the yield on the 10 year bottomed and then started rising. At that same time gold peaked and then began to sell off. That inverse correlation looks very tight to me.
Gold has been a safe haven alternative to bonds in a low interest rate environment. Now that there is some yield to be had with treasuries, perhaps gold investors are concerned that zero yield gold will be replaced paltry (but at least nominally positive) yielding US debt.
Reason #2, which is conjecture on my part, is the stock market continues to rise. If there is real economic growth I would expect stocks to outperform gold long term. Gold is a safe haven asset outside the banking system. It does well when there is economic uncertainty, when a currency is in doubt.
Stocks have not sold off despite rising interest rates. As a result there isn’t a pressing need for a safe haven asset and money flows out of it. There was some volatility in the fall of 2020, but for the most part stocks have continued to go upwards. So while rising rates seems to have scared gold investors, it doesn’t seem to have impacted equity investors much.
Reason #3 is cryptocurrencies, specifically Bitcoin, which currently has over a 61% dominance in the cryptocurrency space. Some corporations are now deciding to put some of their money into BTC, and this institutional investment is doubtlessly driving the price up, and some people who are concerned about dollar debasement are probably deciding to go with so-called “digital gold” rather than real gold. You know it is bad when Peter Schiff’s son is liquidating his silver stocks and going 100% into Bitcoin.
From a transactional perspective it is less expensive to buy Bitcoin through an exchange like Coinbase, than it is to buy and ship gold from a bullion dealer. Some people are doubtlessly taking their stimulus checks and using it to buy Bitcoin.
Bitcoin Over Gold?
I won’t bother charting gold next to Bitcoin because Bitcoin has gone up so much that you would hardly even see gold on the chart.
I’ve never had enough confidence in Bitcoin to put a lot of money into it, and as a result have missed out on a lot of gains. The first mover advantage and name recognition seem to be enough to carry Bitcoin despite the existence of other coins that have superior characteristics, such as anonymity, higher and faster transaction throughput and lower transaction costs.
I’ve bought and sold Bitcoin over the years dating back to 2011 or 2012 and I still own some Bitcoin and EOS. Of course if I knew the price of BTC in 2021 was approaching $60,000 I would have bought and held onto more.
Despite the continued price rise to the moon and beyond, I personally have a lot more confidence that gold will be worth something 20 years as compared to Bitcoin which I have less confidence will be worth anything 20 years from now.
The two mains risks to Bitcoin are 1) The widespread adoption of a better alternative to Bitcoin 2) Interference from the Chinese Communist Party.
But, as I’ve written about countless times before, you can own both, it doesn’t have to be either or.
In the meantime I’ll continue to hold onto my gold and silver as a part of my overall asset allocation.
2020 has been a good year for gold. Gold is up almost 18.93% in 2020 compared to the S&P 500 which is only up 12.42%. A new high of $2,089 was made in August. This took out the previous high of $1,923 that was made back in September of 2011.
Over the past five years gold has kept decent pace with the S&P 500. Although the S&P 500 has outperformed gold during that time 77.94% to 53.12%, there have been years in which gold outperformed. In 2018 gold was down 2.61% and the S&P 500 was down 7%. And so far in 2020 (as mentioned above) gold is up 18.93% compared to the S&P 500 being up 12.42%.
It’s was a tough road to get to that new high. Five years ago gold was at a low of $1,045, in November of 2015 to be more precise.
I started buying gold in December of 2012 when gold was trading north of $1,660. I dollar cost averaged in and even bought some gold when it was trading around $1,100.
Gold is trading at about $1,815 as I write this. I believe this is a key price. While reading technicals could be akin to tea leaves, it is one of the few tools we have when evaluating gold price.
As you can see from the chart below, within about $10-20 of $1,800 there was resistance in 2011 and twice in 2012 when gold tried to rally but sold off again. In other words, buyers would bid the price of gold up to around the $1,800 level, but then sellers would come in and drive the price back down.
Fast forward to 2020. In March when things were going crazy everyone was selling. Gold went down along with stocks. But then around the $1,500 level buyers outnumbered sellers and gold proceeded to rally up to it’s latest high of $2,089.
During this time there was resistance more around the $1,750 level. It touched $1,800 in April and then in June. But instead of selling off considerably, it just bumped around between roughly $1,700 and $1,800 before a flurry of buyers sent the price to the new high in the last two weeks of July.
The move in July was fairly rapid and aggressive, moving nearly $300 in just a few of weeks. Since then gold has been trending downwards. Buyers seem rather squeamish at these prices and gold has sold off since August and currently is hovering around $1,815.
An analogy for markets and price movement are lungs. You can’t breath in (buying) or out (selling) constantly, you need to exhale in order to breathe more. With the rapid price rise we’ve seen in 2020, it makes sense gold would sell off and exhale some.
The question is wether gold will continue to rise in price in the remaining weeks of 2020 and beyond or if it will move down or sideways.
Future Price Guesses
Gold, like any other asset, can either move up down or sideways in price.
It has been trending down over the past few months. At the $1,800 level the resistance encountered in 2011 and 2012 could serve as support and gold could consolidate in price here and make another run at a new high.
Based on the nice rally up to $1,815 that could be the more likely case.
If gold does go back down to $1,750 or lower I think it will continue to go lower until there is another catalyst. I doubt gold would go lower than $1,450.
As I’ll discuss more in the last section, I think a Biden-Harris administration coupled with COVID-19 should be a great environment for gold.
Bitcoin Makes New Highs
Bitcoin has made new highs of $19,625 in November of 2020, taking out the previous high of $19,497 back in December of 2017. It is certainly possible that Bitcoin is taking some of the bidding away from gold as a save haven asset.
Alternative assets like gold are a way of opting out of the traditional financial system. Gold is also often considered an inflation hedge and safe haven asset.
I think it is more likely there will be a Biden-Harris administration in the White House. I think lockdowns are more likely throughout the United States and the world. Governments are paying people to stay home and seem intent on preventing even one more COVID-19 death regardless of other deaths or consequences.
I don’t think there is enough debate or discussion on what the consequences of the lockdowns are or if they are even effective.
Small businesses going out of business, unemployment rising, and other byproducts of lockdowns such as increased depression, suicide and substance abuse should be weighed against the effectiveness and results of lockdowns.
Regardless of their efficacy and consequences, lockdowns means more spending and stimulus. Not only that, but fewer people working means fewer goods and services that are available to buy.
I believe assets like gold and silver will do well in this environment and are an important part of my diversified investment holdings. I think it is important to have 10-20% of my portfolio in precious metals like gold and silver.
Disclaimer: None of the above is investment, health or legal advice.
Today on 27 July 2020 Gold has reached a new all time high over $1,940.
After writing about gold for over four years it is vindicating to see gold reach a new high in dollar terms. I certainly don’t know how high gold will go but as I speculated it would, gold has taken out the 2011 high of $1,920 under Trump.
Silver has been rallying as well. While still far from its all time highs above $50 per ounce, it is trading north of $25 per ounce for the first time since 2013.
Just about four years ago I wrote the first article on HowIGrowMyWealth.com “Inflation Destroys Dollars“. I wrote about how what I do to protect against price inflation and dollar devaluation. Specifically value investing and precious metals. So in retrospect, how did those investments do?
As a control we’ll add the U.S. Dollar Index ($DXY, shown in green), which compares the dollar’s strength against a basket of other currencies. To represents “stocks” I’d added the S&P 500 Index (SPX) (shown in black).
I’m using the Vanguard Large Cap Value ETF (VTV) as a proxy for value stocks (shown in red). You can see how my current and past individual value stock picks have done here. Gold futures are in yellow and silver futures in gray.
As you can see the S&P 500 has been the place to be. To be fair gold isn’t too far behind. Gold was in fact keeping pace with and surpassing S&P 500 this past April. So while gold has been a good hedge and having exposure to stocks has continue to be important.
Value stocks have lagged the S&P 500, particularly in the aftermath of the December 2018 selloff.
Silver is only slightly outpacing the dollar index, up just 7.15%. Silver has had a few failed breakout attempts, but continues to underperform. The gold/silver ratio that some precious metal bugs talk about would suggest that silver is a better value right now.
Costs continue to rise each year as the dollar loses value. But as measured by the DXY the dollar has kept its value against other currencies.
As I wrote back in November of 2016 in “I Own Too Much Gold“, you don’t want to own too much gold as a percentage of your net worth. The performance of the S&P 500 is a good reason why. If gold ever were to take off a 10-25% allocation would be more than sufficient.
We certainly haven’t see broad hyperinflation yet in the US, but my rent, food and medical costs continue to rise each year in excess of the government measured CPI. As I have for the past four years, gold and precious metals remains an important (albeit minority) portion of one’s portfolio.
If you are just starting to buy precious metals emphasizing silver over gold (while still buying both) could be a good approach.
Necessary cookies are absolutely essential for the website to function properly. This category only includes cookies that ensures basic functionalities and security features of the website. These cookies do not store any personal information.
Any cookies that may not be particularly necessary for the website to function and is used specifically to collect user personal data via analytics, ads, other embedded contents are termed as non-necessary cookies. It is mandatory to procure user consent prior to running these cookies on your website.