Inflated Introduction
Inflation is the insidious silent tax that robs the purchasing power of money over time. Sure, it has a useful purpose from the government’s point of view. However, as a holder and earner of government issued currency, it really sucks. We see and experience inflation when the goods and services we buy go up in price each year, while our incomes do not.
From a simplistic view, inflation happens when the money supply, or the sum of all dollars within an economy rises. In all cases of high or hyper-inflation the money supply is growing too quickly relative to other economic measurements. However, just because the supply of currency is rising, this does not necessarily mean inflation will happen.
For example, if the economy grows faster than the money supply, the monetary inflation will actually become deflation as the supply of dollars is actually contracting in a relative sense. However, in all cases with out-of-control inflation, the money supply is growing much too fast and citizens feel motivated to spend their money quickly rather than save.
The Money Supply
It should come as no surprise to us that since the start of the COVID-19 pandemic lockdowns and associated government assistance programs, that the money supply has risen. However, it may surprise you to know by just how much it has risen.
Let’s see how much the money supply gas grown from Feb 2020 to Feb 2021.
You are reading those charts correctly. In February 2020, the total M2 money supply of US Dollars was 15.4T and it has risen to 19.6T as of February 2021. This is an annualized increase of 27.3%. If you’re skeptical, go to the federal reserve website and look at the M2 money supply data. For this is exactly where I got these numbers, this is their data!
Zoom Out
Before we go any further, let’s put this into perspective. Here is the same chart for the last 20 years. Here you will see the 2000 dot com bubble and 9/11 market crashes, and the 2008 great recession and the associated increases in supply to try and stimulate out of those two slumps. They are marked with the grey box highlights.
All the Way Out
And the same chart for all time, all the way back to the 1960’s.
Nothing Compares
At no other time in the history of the United States has the Federal Reserve increased the money supply in such a dramatic way. Yet their official CPI report is that in March, 2021, inflation stood at only 2.6%.
So why hasn’t inflation risen in lock step with such a massive supply increase? To understand this, we need to look at the velocity of money.
Velocity is the Missing Catalyst for Inflation
The velocity of money is the measurement of how quickly money changes hands. For example, if everyone safely and securely stored their money away and never spent it, then in theory the prices of goods would never rise. It’s only when there is an insatiable desire to spend money as fast as possible that inflation really takes flight. It just so happens that the velocity of money can be tracked, reported, and charted.
Never Been Slower
With widespread travel restrictions and much of the country still in lockdown, the speed of money changing hands has been slow. In fact, it is an all time low. What this chart is telling us, is that all this new money is essentially being hoarded, saved, and stored away and it is not being spent.
Why is Velocity Important?
The original theory on inflation only considered money growth, which is the increase in the money stock supplied by governments. However, a rising stockpile of money will not cause inflation unless it is spent. Thus, the velocity of money, or the speed at which it is spent, must be considered. So now we take the money supply and multiply it by the velocity at which it moves.
To put it simply, we have a mountain of money just waiting to hit the economy. Once the freeze is over and people begin spending again we could see inflation rise substantially.
Evidence of Inflation Today
Myself, and most of my readers, live in either Canada or the United States so this will be the area of focus for the following sections. However, with that said, there’s no reason to believe similar actions and patterns are not happening in other countries around the world.
Here in Canada, the CPI is currently quoted at being 2.2% year over year, while in the United States it is at 2.6%. Both governments have publicly stated they are fine with this number and anticipate further rises. They believe there will be an initial spike when we get back out of the COVID-19 restrictions, but that things will subside and return to normal healthy inflation numbers later this year.
I would believe this narrative too, it it weren’t for the following data points which are showing massive price swells in almost every known commodity, or production input, which will have to be passed along to consumers eventually.
The following data is as of April 27, 2021 and is from Trading Economics
Energy & Metals
Energy | Price | Weekly | Monthly | YTD |
Crude Oil | 62.96 | -0.29% | 1.51% | 28.79% |
Natural gas | 2.869 | 4.95% | 7.88% | 12.72% |
Gasoline | 2.0209 | -0.51% | 0.60% | 42.34% |
Heating oil | 1.9063 | 0.80% | 4.71% | 27.70% |
Ethanol | 2.33 | 8.88% | 23.61% | 62.60% |
Metals | Price | Weekly | Monthly | YTD |
Gold | 1776.77 | 0.12% | 3.94% | -6.17% |
Silver | 26.33 | 1.94% | 6.90% | 0.05% |
Platinum | 1229.46 | 4.73% | 5.78% | 16.65% |
Agriculture & Livestock
Agricultural | Price | Weekly | Monthly | YTD |
Soybeans | 1548.5 | 5.84% | 11.84% | 19.23% |
Wheat | 733.5 | 12.24% | 20.06% | 15.61% |
Cheese | 1.706 | 0.12% | 6.43% | 3.65% |
Milk | 17.66 | -0.06% | 9.15% | 11.77% |
Rubber | 228.9 | 2.78% | -8.22% | -14.84% |
Orange Juice | 112.2 | 0.72% | 0.85% | -8.97% |
Coffee | 144.4 | 9.02% | 13.66% | 12.59% |
Lumber | 1,445.00 | 13.01% | 49.71% | 65.50% |
Oat | 408.25 | 5.97% | 9.30% | 13.17% |
Wool | 1,312.00 | 1.63% | 2.10% | 12.04% |
Cotton | 88.9 | 6.12% | 10.45% | 13.80% |
Cocoa | 2,438.00 | 1.63% | 0.08% | -6.34% |
Rice | 13.18 | 2.65% | -0.64% | 7.68% |
Canola | 902.6 | 4.67% | 19.36% | 43.38% |
Sugar | 17.93 | 6.92% | 20.17% | 15.75% |
Corn | 699.75 | 15.29% | 27.89% | 44.47% |
Livestock | Price | Weekly | Monthly | YTD |
Beef | 20.38 | -0.15% | 1.44% | 12.35% |
Lean Hogs | 109.75 | 0.12% | 7.80% | 53.97% |
Poultry | 6.48 | 1.57% | -1.97% | 7.82% |
Industrial Application
Industrial | Price | Weekly | Monthly | YTD |
Copper | 4.4915 | 7.07% | 11.63% | 28.20% |
Lithium | 90,000.00 | 0.00% | 5.88% | 93.55% |
Steel | 5,336.00 | 4.28% | 10.04% | 26.45% |
Coal | 88.02 | -4.43% | -1.38% | 8.37% |
Aluminum | 2,387.75 | 3.22% | 6.12% | 20.55% |
Tin | 27,045.00 | 0.90% | 6.89% | 33.13% |
Nickel | 16,627.75 | 3.46% | 2.83% | 0.45% |
Iron Ore | 189 | 5.00% | 13.17% | 19.24% |
Rhodium | 28,800.00 | -2.37% | 7.06% | 69.41% |
Coca-Cola
So why should we care if the price of Lean Hogs rises? Or Coal? Well, commodities are the raw materials used to manufacture goods. So when their costs rise there is a good chance some of these price increases are passed onto consumers. Take a can of your favorite Coca-Cola beverage. They need aluminum, sugar and corn as inputs into making their product. If all of these input costs are rising they will have little choice but to charge you more per can.
In fact, on April 24th, Coca-Cola along with Proctor & Gamble indicated that in the second half of 2021 they will have to increase prices to offset the rise in commodity prices. They also hope you won’t notice. It will be interesting to see how they innovate their way out of this.
How to Invest Through Inflation
Investing through periods of high inflation can be tricky. Sometimes the best strategy is to simply stay the course and ride it out making sure we have good equity exposure with perhaps some gold. Keep our cash and fixed income low and this should probably fit our needs nicely. It’s when inflation gets higher than expectations or when people distrust inflation reports that things get more difficult. To further this point, when governments report benign inflation of 2% meanwhile people are paying substantially more to heat their homes, fuel their cars and feed their families, they will distrust these reports.
Strategy: Normal Inflation (2-4%) – No Changes
Stay the course, and see things through. So long as you have the majority of your assets in well managed stocks, your fixed income exposure is at or below 20% you should be fine. If you want, increase your gold holdings a touch, and add some cash at the cost of your fixed income allocations. The cash will hopefully capture rising interest rates and gives added liquidity in case things get worse.
Strategy: High to Hyper Inflation (Above 4%)
This is when things get interesting and scary at the same time. Our goals in this scenario are first to preserve our capital or principle investment, and second, see if we can’t take advantage of the scenario and come out ahead.
** THIS IS NOT INVESTMENT ADVICE – JUST HOW I WOULD ALLOCATE FOR HYPER INFLATION **
US Stocks – 20%
Rationale: Some of the best managed businesses in the world are based in the U.S. While they operate with USD, they will weather the weak dollar through management, innovation, and pricing power. In addition, much of their profits are realized internationally and this will help them offset softness at home. In the case that inflation happens slowly, the pricing power many of these companies have will help them manage through. Pricing power is critical for companies when managing through inflation. It enables them to quickly pass along price increases to consumers when their input costs rise. Here we want large established companies over small, so pick the S&P 500 and not the total investible market.
Canadians go with XEQT so you have global equity exposure all in one with a large allocation to the U.S. built right in.
Allocation: 20%
Investible Asset: Americans Investors: SPY / Canadian Investors: XEQT
International Stocks – 20%
Rationale: This one should make more sense than the U.S stocks. We want international companies that operate on currencies other than the USD. Again, we hope their management and innovation can weather the storm and generate profits. If the inflation and decline of fiat currencies continues to be slow then the companies can manage through pricing power and leveraged debt. Again we favor large international stocks over smaller issues. The ETF is USD based and if the dollar collapses we anticipate a strong upward surge as the USD tries to accurately price these foreign stock.
Canadians, keep your international allocation squared with XEQT.
Allocation: 20%
Investible Asset: American Investors: IEFA / Canadian Investors: XEQT
TIPS – 20%
Rationale: Treasury Inflation-Protected Securities offer a straight forward inflation protected investment. Yes, these are USD based investments, however their returns are calculated and tied to inflation. Should inflation rise, the natural course of government action will be to increase interest rates and try to increase the value of the dollar. The par value and interest payments will rise to match the reported inflation numbers. In the event of hyperinflation this may not offer the best protection as CPI numbers could be manipulated. However, during periods of low to medium inflation these should offer you fantastic returns.
Canadian investors should pick their CAD equivalent, and we recommend ZRR.
Allocation: 20%
Investible Asset: American Investors: TIP / Canadian Investors: ZRR
Gold – 20%
Rationale: Gold is the naturally sought after asset during periods of uncertainty and political instability. When the dollar collapses investors will rush for hard assets and gold will be at the top of the list. It has held value since the dawn of time and it will continue to hold value well into the future. The dollar falls against gold as gold stands static as a store of value. Given the nature of our prediction, we want physical gold held outside of the financial system so no ETF’s here. Buy the pure physical precious metal such as bars, bullion, or coins. Consider also how you will store and protect it because if things go to pot you will need it.
Allocation: 20%
Investible Asset: Physical Gold. I like buying mine from SilverGoldBull.com and they serve both U.S. and Canadian clients.
Bitcoin – 20%
Rationale: Bitcoin offers what might be the best protection against inflation and government manipulation. It is a digital form of money that is bought and held very easily online and it can also be stored on a physical cold wallet. Due to its global decentralized nature, it cannot be controlled by any one government. Guaranteed funds can be sent electronically to anyone who has a bitcoin wallet. This transaction is completed quickly and without the need of a bank or government institution. In addition, it is a deflationary currency, meaning less and less will be issued each year and this increases scarcity.
If you haven’t read my article on why you should invest in Bitcoin, you should give it a read after this. You can find it here: Four Reasons You Should Invest in Bitcoin. It further elaborates on why this is a unique investment and how it can provide incredible returns against a falling dollar.
Allocation: 20%
Investible Asset: BTC on a cold wallet. I personally use the Ledger wallet.
Portfolio Performance
Portfolio Configuration
- $10,000 into our Inflation Protected Portfolio
- $10,000 into the S&P 500 Index for comparison and a control variable
- No additional contributions
- Rebalance Annually
- No trading commissions
- No taxes
- Reinvest dividends and Interest
- Simulation run at Portfolio Visualize
- Jan 1, 2014 to March 31, 2021
Conclusion
I think its easy to see if we plan for an invest for inflation we can actually make some terrific returns. True, this may not always be the case going forward, but in an environment where interest rates are so low and projected to stay low into 2023 it makes the opportunity cost for holding non-interest bearing assets near zero.
Investors who have planned along with inflation have done very well over the last 20 years and there’s no reason to think this strategy won’t continue for the next 5 years at least. Now, I’ve shared one strategy above, but there are many others such as investing in real estate or rare pieces of art. In other words, buying things that cash has a really hard time keeping up with over the long term.
Again, to finish, this is not investing advice. I don’t make any money with you following this or not so I receive zero benefit regardless of what you do. However, I hope this could give you some ideas of how an investor could plan for and take advantage of inflationary periods going forward. As we have seen, there are some assets that can take advantage of inflation!
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