Category Archives: inflation

Gold and Inflation

As the price of gold increases and more talk of inflation permeates into our lives we thought it would be a good time to review a data set going back to 1790 for some insight on where we might be in the cycle of gold and inflation.

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Reader Question & Answer

Q: “Wondering if the key is to watch for divergence w commodities and equities?”

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Dow & Nikkei Watch

We’re watching with a sense of awe as the Dow Jones Industrial Average and Nikkei 225 Index gravitate toward the same closing price.

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The last time the two indexes were at or near the same level (on the way up) the Nikkei embarked on an epic boom.

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This coincides with the apparent inflation cycle that we are entering (versus the disinflation period of 1980-2015).  As we said on SeekingAlpha, the inflationary period was good for Japan and we may see something similar this time around.

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See also:

Twitter Tape: Inflation Forecasts

The question is asked:

“What’s your CPI forecast for tomorrow?”

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To answer this question, the context matters.  There is little in the way of debate.  As we’ve outlined since the beginning of the pandemic (February 25, 2020), inflation has a specific trajectory.

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Nothing that we’ve seen, either for the stock market or inflation, has been inconsistent with the extensive history of Plagues or Pandemics.

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Inflation Outlook

Below, we review expectations for inflation. Continue reading

Buffett Buys Japanese Brokerages; Rate Thesis Intact

It was announced that Warren Buffett has accumulated shares of Japanese brokerages.

As we’ve long stated, the secular trend in rates is up:

  • “A single rate increase by the Federal Reserve in no way makes for a trend.  However, markets often lead the way and what initially seems “bizarre” is only a natural change in regime, a change that we haven’t seen since the early 1940’s (December 16, 2015.).”

  • “We’ve only included the point in the interest rate cycle that corresponds to the phase that we are entering, coming from an all-time low to an eventual all-time high (November 15, 2015.).”

  • “Investors anticipating a general rise in interest rates should feel some comfort in knowing that most manager(s) in the utility sector are ready for what is to come.  Rising interest rates are not an automatic death sentence for utility stock prices or earnings.   In fact, the early stages of rising interest rates may see utility stocks match or exceed the returns of non-interest rate sensitive stocks, on a total return basis.  Only when the outlook is cloudy will it become difficult to offer projections that are in line with prior expectations (September 4, 2014.).”

We’ve also said that Japan outperforms under such conditions.

With this is mind, maybe this is what Buffett & Co. are seeing for the future of the secular trend and beyond.

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Inflation Rate: America 1670-2012

Below is the inflation rate in America from the colonial period to 2012.

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source:

  • The Value of a Dollar, Colonial Era, edited by Tony Smith, Salem, 2016. Salem Online.
  • The Value of a Dollar, 1860–2014, edited by Scott Derks, Salem, 2016. Salem Online.

Chart of the Day: Price Index 1290-1950

Below is a chart of the price index of Southern England from 1290 to 1950.  Highlighted in the chart is the formation of the Bank of England in 1694.

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Additional reading: Interest Rate Policy: Bizarre to the Uninitiated

Utility Stocks and Rising Interest Rates

Every stock market investor should be concerned about the impact that rising interest rates might have on future investment returns.  The prevailing theory is that when interest rates rise then stock prices should decline due to the impact to earnings from higher borrowing costs.  Since we are at or near the lowest level in interest rates, conventional wisdom suggests that eventually interest rates will rise.

With rising interest rates, investors should expect that stock prices will decline as per share earnings are reduced.  One industry that borrows heavily for going operations is the utility sector (electricity, water, gas etc.).  This article will give a cursory examination of utility stocks from the beginning of a rising interest rate cycle to the peak (1939 to 1980).  We will attempt to determine if the conventional thinking on rising interest rates and their impact on utility stocks is correct.

Dow Theory: Applied to Poultry Prices

On the Costco (COST) conference call dated October 9, 2013, executive vice-president and CFO Richard Galanti had the following to say about their rotisserie chickens:

“keep in mind the return – I used the example of the rotisserie chicken in the past. We get more positive press out there from keeping that incredible giant chicken at 4.99 and over the last year, year and a half, the underlying poultry price have skyrocketed so we've – the underlying price has skyrocketed such that there's very little margin on it right now although it looks like there is some relief in terms of where pricing is going over the next few months based on poultry future's cost. It doesn't mean we're raising price, it means that we'll at least make a little margin. (source: Seeking Alpha. Costco Wholesale’s Management Discusses F4Q 2013 Results-Earnings Transcript. October 9, 2013. internet link here)”

The reference to poultry prices caught our attention because, in an October 2012 discussion on EconTalk with Russell Roberts, economist Steve Hanke mentioned that chicken prices are a useful way to measure inflation rates in countries that have discontinued reporting their internal data.  There is much more to the discussion with Roberts and Hanke and it is recommended that you get the full story at the following link (Hanke on Hyperinflation).  Hanke says the following:

“…when you get the big plunges they've [Iran] experienced in September [2012] and October [2012], of course that leads to the implied inflation rate being very high. And then I can go back and just look at the press and the price of a key commodity--chicken. And it matches up almost perfectly with the calculations I'm making from going from the black market exchange rate to the implied inflation rate. And I've done this with a number of countries.”

We’re not ready to make the connection with the price of poultry and inflation rates.  However, we’d like to see if Dow Theory has the capability to anticipate what the downside targets could be if the price were to decline in the next several months.  To get us started, we need an overall view of how poultry prices have vacillated in the past.  Below is a chart of poultry prices from September 1983 to September 2013 (source: www.indexmundi.com):

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The black ascending lined is the mean of the overall trend while the upper and lower blue lines indicated the extremes of the overall trend.  On the far right hand side of the chart, we have indicated the points A and B where we’ll be doing our Dow Theory analysis of the current trend in the chart below.

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Based on the latest data available, it appears that poultry prices are topping out as indicated at point B.  If this is the case, then Dow Theory suggests that the following are the downside targets from point A:

  • 98.38
  • 94.32
  • 90.26

Additionally, the parabolic nature of the above trend increase in poultry prices suggests that declining back to point A is not out of the question.  We aren’t clear as to what might bring about such a dramatic decline however we want to observe whether any substantive inferences are gained from this general overview when applying Dow Theory.  We’ll re-examine this topic in several months to see if these projections are meaningful in any way.

Warren Buffett Leverages Up on Inflation Hedge

On February 14, 2013, Berkshire Hathaway and investment firm 3G announced a deal to buy H.J. Heinz (HNZ) for $28 billion, or $72.50 per share. Naturally, Warren Buffett, not being one to get the short end of any stick, is investing only $4.4 billion in Heinz common stock and another $8 billion in preferred shares yielding approximately 9%.  The rest of the purchase  is being financed through investment group 3G and bank borrowing.

According to the Wall Street Journal,  Warren Buffett “…has previously expressed disdain for private-equity buyouts that employed excessive leverage.”  However, as the details of the acquisition have unfolded, it becomes apparent that the leveraged nature of the transaction is on par with the deals that Buffett has spoken out against.  So what is the motivation of Warren Buffett to engage in such a transaction? In this case, the allure of an inflation hedge that performs much better than gold in high inflation environments and that is proven to succeed after the high inflation period ends.

In the past, we have been outspoken on the matter of investing in food processing companies instead of gold and gold stocks if you want to beat inflation.  On December 17, 2008, we pushed the idea that Sysco Corporation (SYY) is an inflation hedge that will beat gold and gold stocks. Our closing remark were, “…if you're of the mind that inflation is coming down the road, with all this liquidity being injected into the economy, then SYY might be a good "long-term" hedge against inflation (found here).” 

In a December 1, 2010 article we re-iterated that value of inflation protection provided by food processors by comparing ConAgra (CAG), to Newmont Mining (NEM) during the gold bull market from 1974 to 1980.  This was a time when ConAgra exceeded Newmont Mining by 10 times.  Again, this was within the gold bull market from 1970 to 1980 (found here).

One article published as recently as September 20, 2012 was titled “Gold Stock Investors: To Beat Inflation Look to Food Processors, Producers and Distributors (found here).” In that article, we said, “As an alternative to the ‘mines’ of precious metal stock investing, we’ve recommended investing in food processors, producers and distributors that have a history prudent of dividend increasing policies to take advantage of the expectations of high inflation down the road.”

We cannot emphasis enough the fact that there are vastly superior alternatives to gold and gold stocks if you want to beat inflation.  Additionally, investment in companies like Heinz will be richly rewarded even as the period of inflation comes to an end.  This will not be the case for gold and gold stocks, as found out by gold permabulls in the period from 1980 to 1999.  This explains why Warren Buffett would be involve in the Heinz transaction, it is the appropriate alternative to buying gold or gold stocks if runaway inflation is expected down the road.

Source: 

Gold Stock Investors: To Beat Inflation Look to Food Processors, Producers and Distributors

We’ve long maintained the view that in order for long-term investors to beat inflation, the conventional wisdom of investing in gold and silver stocks is not the most advantageous way to benefit from what almost everyone believes is coming as a consequence of QE4ever.  While we favor the physical metals (especially silver) and their paper derivatives like (GLD) and (SLV), we’ve also claimed that a specific strategy is needed in order to get the most mileage out of gold and silver stock investing.  However, in order to really beat inflation, forget gold and silver stocks and instead consider companies involved in food processing, producing and distribution industries.

Before we can tackle our food processors, producers and distributors, we need to examine the well documented wealth destruction that has occurred in the gold stock sector in the last year despite the relatively slight decline in the price of gold. Below is a table reflecting the percentage range that many gold and silver stocks have experienced between their one year high and low.

Symbol Name 1-yr % range
NG NovaGold Resources Inc. -69.33%
MUX McEwen Mining Inc. -68.23%
SSRI Silver Standard Resources Inc. -57.35%
PAAS Pan American Silver Corp. -56.19%
KGC Kinross Gold Corporation -55.98%
BAA Banro Corporation -53.55%
AUQ AuRico Gold Inc. -53.13%
AEM Agnico-Eagle Mines Ltd. -51.78%
HMY Harmony Gold Mining Co. Ltd. -44.81%
ABX Barrick Gold Corporation -41.79%
GG Goldcorp Inc. -41.74%
NEM Newmont Mining Corp. -40.69%
AU AngloGold Ashanti Ltd. -37.81%
GFI Gold Fields Ltd. -36.32%
BVN Compania de Minas Buenaventura SA -34.03%
SLV iShares Silver Trust -30.46%
GLD SPDR Gold Shares -15.50%

In all instances, those who had invested in these stocks did not expect that they’d face the prospect of –30% declines in value before they’d realize a gain. In fact, many of these stocks are not at a break-even point if purchased a year ago. Naturally, this should lead inflationistas and gold bugs to feeling a high level of frustration with the belief that gold stocks are a true inflation hedge.

Some perpetual gold bull analysts/marketers argue that gold junior and exploration companies provide better investment opportunities as compared to the many large cap gold stocks like Barrick Gold (ABX), Agnico-Eagle (AEM), and Newmont Mining (NEM). However, the last year has been unforgiving to the larger junior and exploration companies as represented by the Market Vectors Junior Gold Miners (GDXJ) in the chart below:

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As early as 2008, in an article titled “Why Gold Will Decline More than the Markets,” we’ve cautioned gold stock investors to be prepared for gold stocks to decline by a greater percentage whenever the general stock market, as represented by the Dow Jones Industrial Average (DIA) or S&P 500 Index (SPY), declines -10% or more.

Within the last year, the closest the Dow Industrials and S&P 500 came to a -10% decline was from April 2nd to June 1st when the indexes fell –8.63% and –9.93%, respectively.  Unfortunately, the Philadelphia Gold and Silver Stock Index (XAU) was already in a declining trend after having lost -22.85% from the April 8, 2011 high until April 2, 2012.  Despite this fact, the XAU Index managed to lose an additional –20.87% from April 2, 2012 to the May 15, 2012 low.

As an alternative to the “mines” of precious metal stock investing, we’ve recommended investing in food processors, producers and distributors that have a history prudent of dividend increasing policies to take advantage of the expectations of high inflation down the road.  Among the many companies that we’re currently following closely  in this sector are Hershey (HSY), ConAgra (CAG), and Sysco Foods (SYY).

With all the unexplained pain in the precious metal sector in the last year, companies like ConAgra (CAG), Hershey (HSY) and Sysco Foods (SYY) have continued to increase shareholder value, dividend payments and see steady gains in their stock price.  Although the last two years hasn’t been as favorable for Sysco Foods, HSY and CAG have managed to keep pace with the overall market.

Our belief in the processors, producers and distributors is rooted in the performance of these stocks during the last precious metal bull market from 1970 to 1980 and beyond. In a piece titled “ConAgra: A History of Beating Precious Metals During a Commodity Bull Market,” we compared the performance of ConAgra to Newmont Mining (NEM) and Hecla Mining (HL) at the peak in the market in 1972, before the –42% decline in the Dow Industrials, and the subsequent peak in the commodity bull market in 1980.

What we found was that CAG matched the performance of NEM and HL by the end of the gold bull market in 1980 and went on to out-distance both stocks after the commodity bull market ended, by nearly seven time in 1983.  As a follow-up to our initial ConAgra observation in November 21, 2010, we can see the performance of the same three stock in the chart below:

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The performance of ConAgra over the last 2 years has been exceptional in comparison to Newmont Mining and Hecla Mining. Today, ConAgra reported that first quarter net doubled and raised their full year expected earnings. CAG’s stock was up +6.20% on the news.  The news out of ConAgra suggests that processors, producers and distributors have much to gain from the coming inflation.

Precious metal enthusiasts will likely argue that the less than redeeming attributes of the companies selected (Newmont Mining and Hecla Mining) such as bad management, unprofitable properties, etc. contributed to the poor performance.  Another common refrain is, “look how my gold stocks have done in the last 3 or 4 months.” We believe such arguments are the equivalent of whistling past the graveyard.

Consider the following data points, since June 30, 1972 CAG, HL and NEM have generated the following returns, according to Morningstar.com:

  • CAG: +9,021.62%
  • HL:  -42.76%
  • NEM: +392.29%

When viewed from the perspective of trying to beat inflation, during the only proven gold bull market in recent history, gold and silver stocks don’t have the durability to truly beat inflation. For those that are ardent long-term value investors, you don’t really need to wade into the dark pools of precious metal stock investing where a mine can flood, a strike will break out, management can be slightly off with their estimates or the cost of production increases causing a stock to collapse in the middle of widely recognized gold bull market.  Instead, focus your research and due diligence in the food processors, producers and distributors that are trading near their respective new lows. You will be rewarded far beyond the high inflation period to come.

The Myth of “Inflation Proof” Stocks

As the U.S. experiences record low interest rates, it becomes seemingly obvious that inevitably the next major move is up. What isn’t so obvious is what the impact would be on stocks. Some analysts can definitely see the forest from the trees on this matter. However, having this skill doesn’t automatically mean that navigating that forest is all that easy.
There are two important issues that must be brought to your attention about the forest and the trees in our current investing environment. The first matter (regarding the forest) about rising interest rates is that the bull market in stocks from 1940 to 1966 occurred while rates on 3-month T-bills went from 0.01% in January 1940 to 4.59% in January 1966. The chart below does a side-by-side comparison of rising rates and the Dow Jones Industrial Average. We’re certain that the pervasive thinking is that “this time is different.” However, we wouldn’t want this important fact to remain ignored or glossed over.

The second point (regarding the trees) is that even though inflation is most often represented in the rise of commodity prices, the best investment opportunities may not be in commodity related stocks. To demonstrate this point, we have selected six stocks to compare during a popularly known period of high inflation.

The stocks that we have selected for this comparison are Questar (STR), Newmont Mining (NEM), IBM (IBM), Progressive Insurance (PGR), Intel (INTC), and Walgreen’s (WAG). Two of the stocks are synonymously known as inflation hedges, Questar in the natural gas industry and Newmont Mining in the gold mining industry. The remaining four stocks are a cross-section of almost any economy with insurance, retail, microprocessors and computers being represented.

Unfortunately, our bias towards non-traditional inflation hedges is easily shown when we selected the period from November 1974 to November 1980. However, we wanted to show the performance of stocks, in general, at their lowest point so that there is little confusion about the outcome.

The chart below depicts the total return of all six stocks over the given period in time. Not surprisingly, the stocks most associated with being the best inflation hedge turned out to be among the worst performing. The best performing stock was Intel (INTC) with a gain of 860%. Not far behind Intel was Progressive Insurance (PRG) with a gain of 600%. Walgreen’s came in third with a gain of 287.5% followed by Newmont Mining (NEM) at 184.44% and IBM with 53.7%. Last among the stocks was Questar (STR) with a gain of 47.85%.

While some could rightfully contend that our approach is biased and our conclusions are flawed, we highly recommend that anyone who does their homework and compares the performance of almost any stock with a history of consecutive annual dividend increases to any commodity stock that existed back in the 1970 to 1980 period (on a total return basis), then you’ll be able to arrive at the same conclusions that we did in distinguishing the forest from the trees.

By the way, IBM does not have a long term history of consecutive annual dividend increases which might explain why it couldn’t keep pace in the 1970s.

Please revisit New Low Observer for edits and revisions to this post. Email us.

Games People Play…with Statistics

In an article titled "'Avatar' could blow 'Titanic' out of the water on weekend" the Marketwatch.com stretches the imagination of revenue generated by the movie Avatar as compared to the "other" highest grossing movie Titanic.  So far, Avatar has grossed $1.7 billion as contrasted with Titanic's $1.84 billion. 
The oddity is the fact that Titanic was produced in 1998 and although inflation has been very low in the years since, the inflation adjusted value of the $1.84 billion is now $2.4 billion.  MarketWatch.com as part of the Wall Street Journal, now owned by News Corp., should exhibit better quality in their financial journalism. The fact that MarketWatch.com doesn't mention inflation at all only furthers the misinformation that is widely diseminated by the media.  Anyone who may be uninitiated about the nuances of inflation will take fantasy as fact. 
On our site, in the righthand column, you can find two inflation calculators in our "Guaranteed" Rates section.  The first calculator is from the Bureau of Labor Statistics that starts in 1913 ( in an ironic twist the starting year almost implies that inflation began when the Federal Reserve was created.  Of course, we know this isn't true but it seem odd to begin the data in 1913.)  The second calculator goes as far back as 1800 and is based on the CPI figures from the Historical Statistics of the United States.
A good resource for discerning inflated or skewed statistics can be found in the appropriately titled book, "How to Lie with Statistics." -Touc.

Inflation and Equity Investors

Back on 8/24/09, I wrote about Warren Buffett and his view on equity investment during inflationary time. Today write up offers an extended commentary and example of the situation.

Why Moderate Inflation is Beneficial
Let's assume you are an owner of a basketball team. You've just picked up a great young player and decided to sign him for a 5 years contract for $5 million per year (cost). You have a fixed cost of $25 million. It's now time to sell tickets (revenue). You do not fixed your ticket price. Every year, you raise them by inflation rate. As a result, your revenue increase at a faster pace than your cost which is fixed!
I understand that not all business is set up like a sports team, but most business operate using fixed cost model and thus the Fed try to target a moderate inflation rate.

Inflation and the Dow
What happen when stock price stay stagnant or trade in a range for years while economy slowly improve? Value are being created! Price stagnant while earning begin slowly improve. Market now become cheaper every year as earning slowly begin to improve because of moderate inflation. At some point, earning exceed a certain threshold creating an undervalued market which attracts buyers. This creates the beginning of bull market. The chart below shows the Dow plot against CPI.

You can see that the Dow did nothing until it broke to the upside in 1982.
Another illustration is when I compare the Dow to the GDP. Think of the Dow as the Price (P) then using GDP as the earning (E) of our entire economy. What you have is a P/E of our entire economy. The chart below shows that the Dow fluctuated while GDP rose slowly.

As are result, this is why our government wants inflation. However, the government cannot control the stock market. The market will move up with the right value is established. Most notable range is from 4%-6% dividend yield on the Dow. During the Great Depression, yield reached 10%. The Dow reached 4% yield during the March low and is now sitting around 3% yield.