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The current Monetary System has been able to perpetuate the asset price inflation game over the last 40 years because inflation has struggled to gain any traction. Although government statistics undereport inflation by design, Federal Reserve policy has not been forced to address the toxic side of inflation while the economy has been propped up on monetary stimulus. 

They are entering a period where the Federal Reserve and other Central Banks are feeling the political backlash from their expansionary efforts of increasing their balance sheets. Inflation of goods and services is forcing their hand to cut back on liquidity. Keep in mind it is this liquidity that has expanded stocks, real estate and fixed income securities over the years. The volatility we are seeing in the stock market is a pure function of liquidity being removed and excessive margin debt and leverage being liquidated. 

From the following Bloomberg chart, the amount of negative yielding debt outstanding has fallen to the lowest since 2015. Currently sitting at $5 trillion. This says two things. The level of speculation and central bank intervention to keep interest rates negative is fading and the higher rates of inflation are forcing yields to rise.

As markets are adjusting to a rate tightening cycle, speculative assets across the board have seen liquidation. Momentum investing strategies which were all the rage the last year, have seen a significant retracement. 

Normally, bond prices react positively to stock market volatility. However, interest rates have continued to move higher and this has caused price declines in fixed income securities. Please remember, since the peak in interest rates in 1982, the bond market and stock market have both been in massive bull markets. Interest rates have gone from all time high levels (1982) to all time low levels (2020), while the stock market has simply gone vertical in price. Is this sustainable? This chart on 30 year US Treasury Yield illustrates these long term moves in interest rates and the S&P 500. Keep in mind, income inequality is the highest we have ever seen while the purchasing power of our currency has declined materially over time. 


The method the US government has used to melt up asset values such as stocks and real estate has been by taking real rates of return very negative. In other words, allowing the Federal Reserve and US government to inflate away the debt and pump up the economy at the same time. Initially, this inflation is well received since asset values rise and the household’s wealth effect benefits. Eventually, the cost of living rises as well. And this is where the Federal Reserve stands at the moment. They are being forced to address inflation at the expense of asset values. In their view, taking away the liquidity from the markets, will have an impact on the supply chains and demand for goods and services that could impact inflationary prices. The following FRED chart shows changes in the real rate of return measures against total financial household assets per US GDP. The inflationary effect of declining real rates has propped up assets since 1982.  However, looking at the 1970’s, we experienced hotter consumer inflation that had negative effects on household wealth. The Federal Reserve seems to be trying to thread a needle. Reducing liquidity in a highly leveraged environment, can apply very powerful pressures on the financial markets in a very quick period of time. We have seen the effects over the last few weeks.   

Finding long term value is getting more and more difficult. The following may be a very important chart for the next few years. This measures the Commodity index against US Treasury Index. This 40-year chart bottomed in 2020 and appears to have made a generational low. If this is correct, the inflation theme is alive and well, fixed income, as well as, currencies may be seeing the beginnings of a major long term shift towards hard assets. 

History does not look at the sophisticated trading strategies or models used in the lead up to the 1929 crash or the Japan market in the 1980’s. When reviewing the actual reasons for these melt ups, they tend to be very simple. Greed and the illusion of “its different this time”. It takes years of experience and lots of losses to understand this simple concept. We have all gone through it. This latest generation of traders and “investors” have lived in a world of Quantitative Easing (money printing) and down markets that last for weeks not years. If the Federal Reserve’s punchbowl is taken away due to rising costs of living that are having material effects on the population, we can still have inflation from all the residual excess money printing. However, paper asset prices could have very well peaked, or are in the process of putting in a generational top. Basically, the positive effects of inflation have been priced into the market. Now that inflation is here, this could be an old case of buy the rumour and sell the news. Inflation is the news. 

Demand for necessities of certain commodities may be the theme moving forward. This will show up in commodities’ prices since we may need these to survive or protect our purchasing power. Also, as the population ages, their ability to maintain their earnings stream diminishes due to retirement. Here is an interesting fact, 40% of US Government employees are within 5 years of retirement. As costs of living rise, many may look at assets who have a history of protecting purchasing power over time while factoring in increases of political stress due to rising costs of living. 


For precious metals, the media and Wall Street want you to believe a rising interest rate cycle is negative for gold and silver. Oddly, gold tends to bottom around the start of a Federal Reserve rate hike cycle. If one looks at the previous rate hiking cycles over the last 50 years, all but one period formed a significant bottom. Most recently, in 2015, the first rate hike since the 2008 market crash, gold bottomed at $1,050 and never looked back. 

The media would like you to believe the Federal Reserve can normalise interest rates when the US government is $30 Trillion in debt? The math is frightening when factoring in the debt servicing obligations, impact of higher rates on the economy, and potential loss of tax revenue from any negative effect on asset prices. All it takes is human behaviour and confidence to recognise the $30 Trillion debt will never be paid off with NONinflated dollars. The moment that happens, history tells us that gold and silver will take on a monetary role of protecting purchasing power.   EG

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