Monday, January 31, 2011
Price Inflation
As we discussed in podcast a couple of weeks ago, the common definition of inflation is incorrect and obfuscates the real cause. Inflation, until recently, has always been defined as an increase in the money supply. Increasing the money supply, or inflating, has the consequence of increasing prices throughout the economy, whether these are consumer goods or capital goods.
Most mainstream economists wrongly define inflation as being an increase in the price level. First of all, defining a “price level” is quite an impossible and futile task. Measuring consumers’ subjective valuations and aggregating those in an average cannot be done. For example, as people get older, they tend to consumer more medical services, which in the US, have been going in prices at a very fast level. In other words, the “price level” for somebody in their 70’s-80’s is quite different from the “price level” of somebody in their 20 or 30’s.
Many people dismiss that having a proper definition of inflation is important at all. What they don’t see is that by wrongly defining inflation they are concealing the source of these price increases, which is always the central bank increasing the money supply. The mainstream media always blames price inflation on some other cause, rather than blaming the monetary authority. Whether it’s the “evil speculators”, “greedy OPEC” or other boogiemen of the day, the media hides the true source of these price increases. The CNNMoney article below is a clear example of this:
On a monthly basis, CPI rose 0.5% in December, from 0.1% growth the previous month -- the largest monthly move since June 2009. Economists surveyed by Briefing.com had expected a 0.4% rise in December.
Most of that increase was due to gasoline prices, which surged 8.5% in December alone, as commodities rallied.
Most of that increase was due to gasoline prices, which surged 8.5% in December alone, as commodities rallied.
The U.S. Consumer Price Index, a key measure of inflation, increased 1.5% over the past 12 months ending in December, up from 1.1% in November, the Bureau of Labor Statistics said.
Core CPI, which strips out volatile food and energy prices, is still at a historic low, after rising a mere 0.8% for the entire year, and only 0.1% for the month.
“Core CPI” applies to you if you don’t drive and don’t eat. I guess there isn’t that many people who can live without transportation or food. This measure of price inflation is completely bogus and tries to obfuscate the real cause as mentioned earlier.
When all prices rise, it is not a matter of the supply of goods, or another good, like gasoline rising in price, cause price increases. When all prices rise, it simply means that the currency is depreciating (in other words, the supply of money is increasing).
More importantly, people have adjusted to the fallacy that price inflation is a “fact of life”. Quite the contrary, in a growing economy, price decreases every year are a result of higher productivity in the economy and should be welcomed. The 19th century in the US was a period of unprecedented economic growth accompanied by appreciation of the currency. In fact, a dollar in 1900 bought as much as double the amount of goods that it did in 1800.
http://research.stlouisfed.org/fred2/graph/?s[1][id]=BASE
As the money supply keeps increasing, the dollar will continue to depreciate vis-à-vis goods, in particular commodities. As a hedge for the next couple of months, it is indeed a very good idea to invest in agricultural commodities. And don’t forget, the mainstream 90% of the time misses the point and outright lies to the public, so don’t believe most of the news out of the media.
Monday, January 3, 2011
2011 Themes
2011 Themes
Municipal Bond Market is due for a correction
State and local governments, unlike the federal government, cannot print their way out of the financial troubles. With an estimated unfunded pension liability of $1-$3 trillion, declining revenues from lower property valuations, higher unemployment and thus lower income taxes, state and local governments are going to be in a lot of trouble in 2011.
Gold will definitely reach new highs
Although in the short term gold will have a meaningful correction, gold will reach a record high, probably in the $1700-$1900 range. Also, if due diligence is performed, many gold mining stocks will outperform the underlying resource itself.
Silver will also have a good year
If you like gold, silver is also a good buy. The most attractive thing about silver is that it hasn’t hit its nominal peak of $40 in 1982. As an industrial metal, it is used from electronics to special metallurgy to window panning. Moreover, the silver/gold ratio, although still not as cheap as before, it still makes silver a bargain.
Natural gas will likely outperform crude oil this year
Everywhere in the news media we hear about shale gas driving prices lower than before. For the past 2 years, natural gas has been one of the worst performing commodities. Many analysts are bearish on natural gas, which as contrarians encourages us. Lastly, the oil/gas price ratio is sitting at a 24-year high, making natural gas very attractive.
2011 will be a bad year for US treasury bonds
On November 2nd, when Ben Bernanke announced, “Quantitative Easing part II” (euphemism for money printing), he claimed that long-term interest rates would go down, but they have actually risen. More and more investors are catching up to the fact that investing in a market that has been in a bull market for 29 years is not a good idea. For the first time in a long time, corporate bonds from AAA companies are paying less than treasuries. More over, even foreign central banks are slowly reducing their holdings (either by outright selling or not buying at the same pace as before). A good example is China, which had a peak ownership of Treasuries in October 2009. Add to this fact the fiscal position of the US government with unfunded liabilities of anywhere from $40 trillion to $80 trillion, an overtaxed population and demographics problems with baby boomers retiring, and it’s certainly not the best market to be in.
Agricultural commodities
If you are a value investor, look no further than agricultural commodities, specifically rice, coffee, sugar. Even though they’ve hit recent intermediate highs, they are still the biggest bargain out there. Sugar hit at an all time high in 1975 of 55-56 cents per pound , and that’s in nominal dollars ( in today’s dollars, that would be $2.17/lb), sugar is currently selling for 33 cents. Coffee had its all time high in 1977 at $3/lb ($11.82/lb in today’s dollars) and now is selling at $2.40/lb. And rice is only 40% higher from its all-time low of $.10/lb. With weather conditions more unpredictable (droughts and floods more common) and inventories running very small, agricultural commodities and land look more appealing than ever.
Conclusion
From a value perspective, except for agriculture, nothing looks inexpensive, especially with the Federal Reserve printing money and depreciating the dollar. With the current market cycle favoring commodities for the next 5-10 years, and with a better price inflation hedge than stocks, commodities should certainly be in investors' holdings for the coming year. To sum up our thoughts for the new year, the best investments are agriculture and precious metals while the worst will be bonds.
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