Inflation, Deflation…Or BOTH?

May 27, 2022

So … Will we have a rerun of the great depression or are we re-living the inflationary nightmare of the 70s? I have heard arguments on both sides and I am led to believe that we are likely to have the worst of both worlds where many assets see their value DEFLATING while many others will continue INFLATING.

The first and most likely candidates for DEFLATION are those assets that have been artificially propped up by low interest rates like stocks, bonds and real estate. This type of deflation will likely lead to many feeling far less affluent and will likely lead to far lower spending by most. This may already be showing up in some numbers as Bloomberg reported that Nordstrom and other high-end retailers are not seeing the same problems that other stores like Walmart and Target are seeing. The high-end retailers are able to pass along price increases more easily, so they are keeping up with inflation- so far-while those retailers that cater to lower to middle-class Americans are not able to pass along price increases as easily as their clientele simply cannot afford it.

In the housing market the biggest drop in sales occurred in homes that were $400,000.00 or less indicating that affluent buyers are still active while the higher interest rates are deterring marginal buyers.

We should not forget that crises always seem to start with the weakest links and move up the food chain. So far, the supposed affluent are still spending while it appears that the rising costs of food and energy are severely crippling those that were just getting by.

I also believe that when people have to pay nearly $100.00 to fill up their gas tanks and food costs are rising the allure of luxuries gives way to the need of necessities. I don’t believe that many young people will be looking to become debt slaves in homes that are WAY overpriced. How do I know they are WAY overpriced? NEVER has it taken so much labor to purchase a home in the history of our country. Currently, it takes over 6.5 times one’s annual income to afford an average home.

When interest rates were lower many took the plunge while now, as rates are rising, the mortgage applications and new home sales are what is taking the plunge. According to the MBA (Mortgage Bankers Association) applications for new home purchases dropped 10.6% year over year and 14% from March to April. That is not surprising since 30- year mortgage rates have doubled in the past 6 months. This makes home affordability a much larger part of the calculation.

My guess is that we will also see price deflation in assets that are not deemed necessary like shoes, clothes, big-screen TVs, new cars, travel and other luxuries that give way to spending on necessities like food, fuel, and electricity. Basically, it is ECON 101 as supply and demand determines what goes up and what goes down. The demand for luxuries is indeed transitory while the need for necessities is constant.

This is why I believe that the price of food, fuel, energy and electricity are likely in the early stages of increases that many of us will not believe. There are many reasons for this.

  • The US dollar as the world’s reserve currency appears to have its days numbered. This is likely to lead to FAR less purchasing power than we have had in our recent past leading to FAR higher prices for virtually everything.

  • Because of supply chain disruptions and lack of production there are currently deficits in many areas. This is leading to many nations not exporting what they normally do. This is leading to further supply constraints and rising prices as the nations turn to securing themselves before exporting and this will most likely lead to supplies being sent to the highest bidder. There couldn’t be a worse time to see the value of our currency fall.

  • With energy prices skyrocketing we are likely to see all prices rise as most of our consumption is based upon imported goods. Not only are prices for goods and production likely to rise but the cost of delivery is likely to be another problem. A friend of mine runs a diesel truck in his business that costs $450.00 per DAY to run. OUCH!

  • While the move to green energy may be a good idea the path there is littered with idiotic decrees and environmental rules that make our path there VERY rocky. It appears there is no plan other than to make fossil fuels so expensive that people will stop using so much and those that are able will buy other things like electric vehicles, solar panels ,and windmills.  All of the rules and regulations have led to less exploration for mainly oil, gas and coal, less production, less refining capacity and far higher prices. There is a path to a cleaner energy future but the current path leads to far too much pain for all of us.

The current economic system has been able to, so far, keep going far longer than I could have imagined. Debts and deficits are at levels that the world has never seen before. I believe that this was accomplished by countries and central  banks working in concert with each other. Now that national economies are in distress you see central banks and governments looking out for their own interests which are diverging quickly. There will be winners and there will be losers. The winners, in my opinion, will be those that produce commodities and finished goods and the losers will be those that have counted on others to produce what they need. (Like the USA whose major exports are dollars conjured up out of nowhere and weapons of war).

I believe that we should all be prepared for some unprecedented hard times that appear to be coming our way. Also, while investing it may pay to keep these ideas in mind. I believe that hard assets and commodities are likely to FAR outpace the former high-fliers that were based upon hopes and dreams rather than reality.

In the recent past some of the worst run companies with some of the worst prospects and lack of profits have provided the best gains. In some cases, there were no profits whatsoever and yet companies were valued in the billions. Just like in the year 2000 those that were swimming naked are being exposed. Just because valuations didn’t matter for a long time (mainly because of ever-decreasing interest rates and virtually free money) it appears that now valuations may be the most important thing going forward.

I believe that many will start looking at revenues, net income and assets vs. liabilities as all serious investors SHOULD have been doing all along. Any company that cannot service its debt with revenues may be in BIG trouble as rates rise. There are FAR more companies like that out there (zombie companies) than many realize. If I were to name a few I am sure many would be stunned that many are household names. Don’t forget that the first asset class to be wiped out is the common stock shareholder.

As rates rise look for distress in the bond markets also as many cities, states, companies, individuals and even our Federal government are relying on new debt to pay interest on new debt. This gets increasingly harder the more rates rise.

I believe that once the dominoes start to fall that gold, in particular but also most hard assets will become far more attractive as most people will then be aware of what “counterparty risk” means. It means that if the person or entity on the other side of your supposed winning trade can’t pay – you lose anyway.

Gold, silver and hard assets of most kinds are ASSETS rather than liabilities and you don’t have to count on anyone else’s promise to repay. In addition to gold preserving purchasing power for 5000 years the fact that you own it rather than owe it will likely become a key factor in our near future.

What is the value of a promise that cannot- or will not- be kept?

Be Prepared!

Any opinions are those of Mike Savage and not necessarily of those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice. The information in this report does not purport to be a complete description of securities, markets or developments referred to in this material. The information has been obtained from sources deemed to be reliable but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct.

Commodities are generally considered speculative because of the significant potential for investment loss. Commodities are volatile investments and should only be a small part of a diversified portfolio. There may be sharp price fluctuations even during periods when prices are overall rising.

Precious Metals, including gold, are subject to special risks including but not limited to: price may be subject to wide fluctuation, the market is relatively limited, the sources are concentrated in countries that have the potential for instability and the market is unregulated.

Diversification does not ensure gains nor protect against loss. Companies mentioned are being provided for information purposes only and is not a complete description, nor is it a recommendation. Investing involves risk regardless of strategy.


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