Gold has been among the standout performers in the investment world so far this year. The precious metal has gained around 27% in 2016. It is truly impressive when you consider that the S&P 500 has only risen 4.5% for this year. Put into comparative perspective, it means that gold is outperforming the broad stock market index by an incredible six to one. This might lead you to the conclusion that the gold trade has become crowded, but this is not the case.
Demand for gold remains supported by retail buyers in exchange traded products. It is hard to argue with gold’s success. The exchange traded funds listed in the U.S. alone have added $16 billion to their gold holdings because of continuous money inflows. The Chinese have continued to support the yellow metal as their yuan devalues. Other investors have used macro uncertainties like the Brexit financial turmoil as their excuse to buy. These are all valid explanations as for why it has outperformed so well. A more important reason that you should consider gold in your portfolio these days is as a hedge against the now distinct possibility of stagflation.
Former Fed Chair Alan Greenspan Raises the Stagflation Spectre
The long time U.S. Federal Reserve Chairman Alan Greenspan gave an interview in Newsmax Magazine a few days ago where he expressed his concern that the U.S. economy is already experiencing “early signs of stagflation.” Stagflation refers to the interesting phenomenon where growth is low but inflation is still high. The reason for Greenspan’s worry starts with the massive amounts of debt that governments all over the developed world have been adding in the last few years. As it turns out, they have done this at exactly the time when economic growth is already weak and showing signs of slowing down.
Debt does more than simply drive a country and its economy to reduced growth. It also bogs down the country in inflation. The most recent worldwide numbers from 2014 show that the worldwide debt has grown to an astonishing over $200 trillion. This is almost three times as big as the entire economy of the planet. The present numbers are actually worse as governments continued to spend themselves into oblivion in 2015 and the first half of 2016. Sadly none of this debt created any productive capital goods or meaningfully expanded productivity. It was instead used to prop up sagging economies and troubled financial markets, as in Japan and the European Union.
Government Debt Restricting Developed Countries’ Growth
At the moment countries are getting away with this because the interest rates are being kept artificially down by central bank maneuvering. This means that the debt service payments are at historic lows. At the same time though, debt levels have reached all time highs as percentages of the whole economy and in literal dollar terms. When the rates inevitably normalize, government (and many corporate) balance sheets will be stricken with rapidly increasing interest carrying costs.
This is not just Japan or the European Union where unproductive piles of debt are holding back economic expansion either. Since the year 2010, the growth of GDP in the United States rose an average of only 2.1%. The recent figures from last week just showed that the GDP growth rate has dropped to only 1.2% for the last year and an even lower 1% in the first half of 2016. The International Monetary Fund also recently reduced its projected growth rate for the whole world economy to only 3.1%. Lower growth rates like these represent the stagnant first half of the stagflation equation.
Inflationary Policies are Now The Stated Goal of Central Banks
At the same time as growth is declining, central banks are pursuing policies with the stated intention of increasing their inflation rates. Even now, the Bank of Japan and European Central Bank balance sheets are expanding at an incredible combined rate of $180 billion every month. This created out of thin air credit amounts to over $2.1 billion in a single year. The definition of inflation is too much money pursuing too few goods. Central banks believe that they can control this inflationary beast they are trying to unleash at a maximum of 2% per year. With rapidly rising debts to GDPs, wanton deficit spending, and the hard to grasp ballooning of central bank balance sheets, inflation will not stop at only 2%.
Stagflation Is Already Here
The perfect storm of historically record breaking government debt combined with an unparalleled growth of the international money supply will cause stagflation around the world. The problem is that this is not some future threat that may one day happen. By a technical definition it has already arrived. Healthy economies are those which boast a two to one growth versus inflation rate. At the same time that the United States’ GDP has only grown 1.2%, the core CPI (consumer price index) has risen by 2.3%. This means inflation is now at twice the level of economic growth, or growth is half the inflation rate.
In the 1970s era of U.S. stagflation, gold proved to be among the most reliable of asset classes. Part of the reason that it is doing so well now has to do with investors’ intuitive realization that it is returning. Present and future stagflation in the cards means that gold has only begun to shine.