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Transitory or Not, Inflation Is Here. It Could Be Much Higher Than You Realize

Summary:
I’ve been writing about the possibility of higher inflation for months, and now it looks to have finally made landfall. The headline consumer price index (CPI) came in at 5% year-over-year, the highest in over a decade. The real rate is likely even higher. Energy commodities, and gasoline in particular, jumped the most of any other measured item. Energy increased 54.5% year-over-year, gasoline 56.2%, as oil prices hit multiyear highs this week on strong travel demand. A barrel of West Texas Intermediate (WTI) touched today, a level we haven’t seen since October 2018. Take a look at what happens when you strip out volatile energy and food prices. Core inflation, as it’s called, surged 3.8% compared to last year—which doesn’t sound impressive until you realize that’s the fastest rate

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Transitory or Not, Inflation Is Here. It Could Be Much Higher Than You Realize

I’ve been writing about the possibility of higher inflation for months, and now it looks to have finally made landfall. The headline consumer price index (CPI) came in at 5% year-over-year, the highest in over a decade.

The real rate is likely even higher.

Energy commodities, and gasoline in particular, jumped the most of any other measured item. Energy increased 54.5% year-over-year, gasoline 56.2%, as oil prices hit multiyear highs this week on strong travel demand. A barrel of West Texas Intermediate (WTI) touched $71 today, a level we haven’t seen since October 2018.

Take a look at what happens when you strip out volatile energy and food prices. Core inflation, as it’s called, surged 3.8% compared to last year—which doesn’t sound impressive until you realize that’s the fastest rate in nearly 30 years. The last time we saw core inflation this high, the top films in America were White Men Can’t Jump and Basic Instinct, and General Motors topped the list of Fortune 500 companies.

Transitory or Not, Inflation Is Here. It Could Be Much Higher Than You Realize

I hope no one reading this is in the market for a new car right now. Thanks to the ongoing semiconductor chip shortage, the supply of new vehicles has all but evaporated, pushing up the price of previously owned cars and trucks. The Manheim Used Vehicle Value Index hit a fresh all-time high in May, suggesting a 48% increase in prices compared to last year. Pickup trucks were up a staggering 70%.

Transitory or Not, Inflation Is Here. It Could Be Much Higher Than You Realize

Expectations are mixed for how much longer the chip shortage will last. Goldman Sachs chief Asia economist Andrew Tilton told CNBC this week that he believes we’re in “the worst period” right now, insinuating we’ll see some improvement in the second half of the year. Patrick Gelsinger, CEO of chipmaker Intel, isn’t so sure. He says the shortage could last another two years.

Hope for the Best, Prepare for the Worst

I think policymakers and analysts are just as torn about the potential longevity of this current rash of inflation. The Federal Reserve insists on describing it as “transitory,” mostly in an effort to allay investors’ fears and calm markets.

Only time will tell if this assessment was accurate, but for the time being, the gesture seems to be working: The S&P 500 closed at a new record high yesterday. Meanwhile, gold, historically used as an inflation hedge, barely budged, and bitcoin, a digital version of gold, retreated by as much as 1.8%.

It’s possible that May’s inflation rate was already priced in. That being said, I would still strongly consider adding to my gold exposure, including gold mining stocks. Bitcoin should also be a consideration.

As I’ve pointed out before, I believe the CPI significantly understates the impact inflation has on household wealth. The real rate is likely much higher. An alternate measure, John Williams’ Shadow Government Statistics, shows that inflation could actually be closer to 13% year-over-year. Invest accordingly.

On the Road Again

At the same time that new vehicles are in short supply, Americans have begun to travel as much as they ever have, a key driver behind rising fuel prices. According to the travel industry news website Skift, the number of Americans who traveled in May surpassed those who traveled in February 2020, before the pandemic. More than 42% of Americans said they traveled within the U.S., compared to 40.5% 16 months ago.

Transitory or Not, Inflation Is Here. It Could Be Much Higher Than You Realize

And it’s not just vehicular travel we’re talking about here. U.S. airports have gotten so unexpectedly busy that the Transportation Security Administration (TSA) is seeking internal office volunteers to handle non-screening tasks such as management of security lines

This is hugely supportive of travel industry equities, airlines in particular, as we progress deeper into the busy summer travel season.

Although only 2% of Americans traveled outside of the U.S. in May, compared to 7% in February 2020, I expect this to change soon as vaccination rates improve. This week, France became the latest European Union (EU) member to start accepting vaccinated visitors from the U.S. and elsewhere, and a new travel pass that allows people to move more freely between European countries was finally endorsed by EU lawmakers.

“Travel companies need to be prepared” for the summer surge, commented Haixia Wang, VP of research at Skift.

That’s precisely what domestic and international airlines continue to do. Air France is set to bring 22 aircraft out of storage in order to significantly increase flights to the U.S. Air Canada will reportedly resume a number of international flights this month, from Canada to India, Mexico, the Caribbean and more.

Watch my six reasons to invest in airlines before the make a full recovery from pandemic lows. Click here! 

Transitory or Not, Inflation Is Here. It Could Be Much Higher Than You Realize

Index Summary

  • The major market indices were mixed this week. The Dow Jones Industrial Average lost 0.80%. The S&P 500 Stock Index rose 0.33%, while the Nasdaq Composite climbed 1.85%. The Russell 2000 small capitalization index gained 2.05% this week.
  • The Hang Seng Composite lost 0.26% this week; while Taiwan was up 0.39% and the KOSPI rose 0.29%.
  • The 10-year Treasury bond yield fell 10 basis points to 1.45%.

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Blockchain and Digital Currencies

Strengths

  • Of the cryptocurrencies tracked by CoinMarketCap, the best performer for the week was Amp, rising 95.31%.
  • El Salvador’s legislature voted in favor of recognizing Bitcoin as an official legal tender. The nation’s president, Nayib Bukele, signed the bill into a law, making it the first country to adopt the largest cryptocurrency as a legal tender. In a Twitter space conversation, President Bukele pitched his vision as an effort to increase financial inclusion in the nation where only 30% of citizens have access to financial services. He added that the government will act as a backdrop for businesses that do not want to take on the risk of a volatile cryptocurrency by setting up a $150 million trust at the Development Bank of El Salvador to instantly convert Bitcoin to U.S. dollars.
  • MicroStrategy Inc., led by CEO and crypto bull Michael Saylor, raised $500 million through a junk bond sale to buy more Bitcoin. After announcing the sale of junk bonds to raise $400 million, the debt offering was raised as the company got orders for more than $1.6 billion. The technology company that provides business intelligence, analytics and cloud-based services has been touted as a proxy to Bitcoin, as the company currently holds more than 90,000 coins which it plans to store under a subsidiary named MacroStrategy LLC. The chart below shows that Bitcoin and MicroStrategy’s stock price have moved in tandem.

Transitory or Not, Inflation Is Here. It Could Be Much Higher Than You Realize

Weaknesses

  • Of the cryptocurrencies tracked by CoinMarketCap, the worst performer for the week was Internet Computer, down 44.36%.
  • Government of the Qinghai Province in China issued an order instructing all cryptocurrency miners to shut down their operations, following similar orders in Xinjiang and Inner Mongolia. The mandate, issued by the Qinghai Industry and Information Technology Department, stated that cryptocurrency miners will not be approved to operate in the province and that the provincial government may also randomly inspect businesses to ensure compliance with new guidelines. China’s crackdown on crypto mining is seen as part of a broader move to curtail the country’s carbon emissions as the Chinese electricity grid remains heavily reliant on coal.  
  • Chainalysis, the blockchain analytics firm, reported that Ryuk, a cybercriminal group, has collected more than $100 million in cryptocurrency ransoms in the last year alone. The Wall Street Journal estimated that Ryuk had struck 235 U.S. hospital facilities with its ransomware attacks, disrupting medical care and endangering patients. Although cryptocurrencies are not the main reason for the growing popularity of ransomware attacks, it does a play a major role in allowing such groups to carry out attacks and receive the ransom.

Opportunities

  • ForUsAll, a 401(k)-provider based in San Francisco, is partnering with Coinbase to allow its clients to invest part of their retirement plans in cryptocurrencies. According to the details of the partnership, employees enrolled in plans administered by ForUsAll will be able to invest up to 5% of their contributions into cryptocurrencies using Coinbase’s institutional crypto platform, with the option to invest in over 50 cryptocurrencies. Currently, ForUsAll has around 400 employer clients and manages $1.7 billion in assets.
  • Atlanta-based Invesco, the investment management giant with $1.5 trillion in assets, is planning on launching two cryptocurrency-focused exchange-traded funds (ETFs). According to a filing with the U.S. Securities and Exchange Commission (SEC), around 85% of the proposed Invesco Galaxy Blockchain Economy ETF and Invesco Galaxy Crypto Economy ETF will invest in crypto-linked equities and the rest will be in trusts or funds that hold cryptocurrencies.
  • The Texas Department of Banking announced that it will allow state-chartered banks to custody crypto assets on behalf of their customers. The state regulator also noted that the banks can only provide crypto custody services if there are adequate protocols, compliant with existing legal frameworks. Individual banks will have the opportunity to decide what type of custody services they can based on their expertise, risk appetite and business model, and could range from storing copies of customer’s private keys to controlling their crypto assets. 

Threats

  • Banks in Kenya have been issuing alerts to customers who have used debit and credit cards to buy cryptocurrencies on various exchanges, citing that virtual currencies like Bitcoin are not legal tender in the country. BitcoinKE, a community and media advocacy company in the blockchain and cryptocurrency space in Kenya and East Africa, reported that some banks are also advising customers to not buy, hold or trade cryptocurrencies. Furthermore, BitcoinKE added that the NCBA Bank Kenya sent an email to its customers stating that no protection exists for any customer if a platform that holds cryptocurrency or facilitates cryptocurrency trading fails or goes out of business.
  • The U.S. Securities and Exchange Commission (SEC) issued its second warning regarding risks of investing in Bitcoin futures-focused funds, reiterating that the largest cryptocurrency remains a highly speculative investment. It also highlighted that due to Bitcoin’s volatility, it may not be safe yet to approve an exchange-traded fund (ETF) under the Investment Advisers Act of 1940. 
  • WazirX, an Indian cryptocurrency exchange that was acquired by Binance in 2019, came under scrutiny by India’s Enforcement Directorate (ED) for alleged violations of the nation’s Foreign Exchange Act (FEMA). The ED tweeted that cryptocurrency transactions worth more than $389 million are under investigation, which the ED came across during a money-laundering investigation into illegal online betting applications, which involved Chinese nationals. The ED is also alleging that WazirX failed to gather the required information to vet its clients and transactions, failing to meet the country’s Anti-Money Laundering and Combating Financing of Terrorism Laws.

Gold Market

This week spot gold closed the week at $1,877.53, down $14.06 per ounce, or 0.74%. Gold stocks, as measured by the NYSE Arca Gold Miners Index, ended the week lower by 0.53%. The S&P/TSX Venture Index came in up just 0.17%. The U.S. Trade-Weighted Dollar rose 0.43%.

Date Event Survey Actual Prior
Jun-8 Germany ZEW Survey Expectations 86.0 2.5% 2.0%
Jun-8 Germany ZEW Current Situation -28.0 -9.1 -40.1
Jun-10 ECB Main Refinancing Rate 0.000% 0.000% 0.000%
Jun-10 CPI YoY 4.7% 5.0% 4.2%
Jun-10 Initial Jobless Claims 370k 376k 385k
Jun-15 Germany CPI YoY 2.5% 2.5%
Jun-15 PPI Final Demand YoY 6.2% 6.2%
Jun-16 China Retail Sales YoY 14.0% 17.7%
Jun-16 Housing Starts 1640k 1569k
Jun-16 FOMC Rate Decision (Upper Bound) 0.25% 0.25%
Jun-17 Eurozone CPI Core YoY 0.9% 0.9%
Jun-17 Initial Jobless Claims 360k 376k

Strengths

Transitory or Not, Inflation Is Here. It Could Be Much Higher Than You Realize

  • The best performing precious metal for the week was silver, up 0.45%, but still finding resistance trying find a level above $28 to hold for the last month. De Beers has raised some rough-diamond prices by about 10%, as the world’s top producer cashes in on rampant demand from cutters and polishers. The global palladium market is expected to be in deficit on a rebound in the auto industry, tougher pollution controls and an unexpected tightening of supply after the world’s largest producer said flooding at its Arctic mines will curb output. Gold prices are increasing as comments by Treasury Secretary Janet Yellen on inflation raised expectations for inflation, which is positive for gold. Recently reported CPI data indicated a surge in inflation in May. Demand should also be strong, as one in five central banks intend to increase reserves over the next year, according to the World Gold Council (WGC). One in three central banks in emerging markets are likely to increase gold holdings in the next year.
  • SSR Mining Inc. announced that it has amended its existing undrawn revolving credit facility on favorable terms, increasing the Facility size from $75 million to $200 million. The term of the Facility has been extended by four years to June 8, 2025.
  • A junior Australian miner is confident that its gold discovery in the nation’s Pilbara region – more commonly known as the world’s premier iron ore province – will propel the company into the ranks of the nation’s top bullion producers. De Grey Mining Ltd. has seen its market value surge to A$1.9 billion ($1.5 billion) from just over A$45 million in about 18 months because of optimism surrounding its Mallina project. The company has set itself the goal of becoming a top 10 producer in Australia with output seen at over 300,000 ounces a year for at least a decade.

Weaknesses  

  • The worst performing precious metal for the week was palladium, down 2.41%, perhaps on news that a project in Russia has received funding that is projected to produce 4.2 million palladium ounces per year. Fed up with years of political dysfunction and wracked by the world’s worst per capita COVID death toll, Peruvians have made a radical new choice for president. The results of Sunday’s runoff appear to show that Pedro Castillo, a Marxist-leaning former schoolteacher, has edged out Keiko Fujimori, the authoritarian-minded daughter of the country’s former dictator. Castillo has ambitious policy proposals, which his supporters say most Peruvians want: rewrite the constitution, spend 10% of GDP on education and health, and redistribute mining profits to fund social programs.
  • Centerra Gold’s Kumtor Gold Company Chapter 11 hearings have started. The company’s strategy is to pursue Ontario Superior Court proceedings against former CG Director Tengiz Bolturuk by seeking to prevent him from having any direct or indirect contact with Kumtor Mine management. They want to start international arbitration in Stockholm as provided for in the 2009 Investment Agreement. Additionally, the Chapter 11 bankruptcy proceedings are seeking a Worldwide Automatic Stay in the Southern District of New York.   
  • A drive by mining companies to hire more women has lost momentum, leaving the industry as one of the world’s most male-dominated professions. In the U.S., 14.3% of people employed in mining in 2020 were women, only 0.3 percentage point higher than in 2015. In other news, gold imports by India plummeted in May. This is due to the recent surge of COVID in India and restricted mobility. Only 11.3 tons of gold were imported, compared to 70.3 tons in April.

Opportunities

  • Endeavor Mining recently had an analyst meeting with several positive developments. The company highlighted balancing near-term growth projects Sabodala-Massawa Phase 2 and Fetekro, as well as exploration, and returning more capital to shareholders via dividends and opportunistic buybacks. Endeavour expects to achieve its targeted $250M net cash position in the near-term. The company expects annual production to average 1.4-1.5 million ounces thorough 2023, before increasing to 1.5 million ounces in 2024 and 1.6 million ounces in 2025. Endeavour is targeting 30% lower emissions by 2030, and net zero by 2050. To achieve this, a focus area is implementing solar power at the mines. The company has identified potential to add up to 150MW solar power across its portfolio.
  • Aya Gold & Silver reported very positive drilling results. The results were 6,437 grams/ton Ag over 6.5m incl 24,613 grams/ton over 0.5m, 12,775 grams/ton over 0.5m and 11,483 grams/ton over 0.5m. This newly discovered high grade zone is only 35m from surface and 75m east of the current resource.
  • Newcore Gold announced the positive results of an updated independent Preliminary Economic Assessment completed for the Company’s 100%-owned Enchi Gold Project in Ghana. Average annual gold production in years two through five may be 104,171 ounces gold, with 983,296 ounces gold recovered over an 11-year life of the mine. Operating costs are estimated at $923 per ounce of gold, with cash costs estimated at $1,043 per ounce of gold.  

Threats

  • Gold will surge to fresh highs next year, but investors seeking currency alternatives as global debt balloons should look to Bitcoin, according to a $7.5 billion hedge fund, SkyBridge Capital. Former Treasury Secretary Lawrence Summers says cryptocurrencies could stay a feature of global markets as a form of digital gold.
  • Royalty company streaming business models in part rely upon incorporation in U.S. and Canada, while receiving production and profits in a low-taxation jurisdiction. The risk of increased minimum corporate taxation applied to G7 countries could affect the streaming business’s offshore taxation structure, which has the potential to affect existing streaming transactions in place and the pricing of future transactions. The nature of implementation and timing of potential changes are not yet clear, and various key questions are outstanding, including how deductions for stream deposits will be implemented and whether a corporate tax rate >15% will be sufficient to avoid this taxation being applicable.  
  • Sarah House and Shannon Seery of Wells Fargo & Co. note that inflationary pressures may not be as short-lived as the Fed contemplates. Core inflation over the last three months has increased to 5.2%, the largest jump since 1991. If the Fed starts raising interest rates too early in this recovery, that could hurt gold’s chances to make further gains.

 

Read the full article at https://www.usfunds.com/investor-library/investor-alert/transitory-or-not-inflation-is-here-it-could-be-much-higher-than-you-realize/

June 11, 2021

By Frank Holmes
CEO and Chief Investment Officer
U.S. Global Investors

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