INFLATION IS BECOMING A WORLDWIDE PHENOMENON

And it is getting worse as the U.S. and
European economies slip into recession

by Monty Guild
Guild Investment Management, Inc.

January 15, 2008

 

Thus far, the developed world is not thinking with an inflationary psychology, but such a psychology is gripping the developing world.

As Hamlet said “…there is nothing either good or bad, but thinking makes it so.” With inflation this is especially the case. Inflation can be moderated or exacerbated by the psychology of consumers. An example of inflationary psychology is that when prices are expected to rise, people buy and hoard. They tend to buy more raw goods, finished goods as well as fixed assets like gold and other commodities, and if interest rates and prices are low they buy real estate.

It is partially the fear of this inflationary psychology that encourages politicians and political functionaries to fudge the numbers on inflation, change the accounting for the cost of living, and to hide, minimize or divert attention from the advent of inflation using an impressive panoply of creative deception.

There is a general dishonesty displayed by government statistical functionaries pretty much world wide, in presenting the statistics regarding inflation and economic growth. The first is usually understated and the second often overstated.

INFLATION HIGH AND RISING = GOLD HIGH AND RISING

Clearly, the consumers in Russia, China, India, and many other countries are reacting to the bad inflation numbers that have been published in their countries in recent months, weeks, and days. They are seeking to protect themselves, and they are doing so by buying gold and other commodities.

 

AN EXAMPLE

Just last week, the Shanghai Gold Futures Exchange opened for business. Gold opened at the equivalent of about $997 an ounce. At the time of this writing, gold is trading for about $943 per ounce on the Shanghai Gold Futures Exchange versus about $895 per ounce on other world exchanges.

Why would gold sell for 5% more in Shanghai than elsewhere in the world? It is because the Chinese are worried about inflation, and thus far the amount of gold imported into China to fill the need does not meet the demand. So gold will flow from the rest of the world into China, which will push world prices up and Chinese prices down until they meet. It is our belief they will meet above $920 per ounce soon and above $1500 per ounce in the next couple of years. 

THE RECESSION IS NOT SLOWING GOLD DEMAND

 

The fact that a recession is looming in the developed world would in normal times divert investors’ attention from purchasing gold. The logic is that recessions lead to lower demand and lower prices for goods and services, so gold is not demanded. But today is no ordinary recession. Today, we have stagflation brewing. Wise investors who see this prospect on the horizon are protecting against inflation while expecting stagnating economic growth.

 

SOME RECENT NEWS ITEMS

• Russian inflation was 11.9% in 2007.
• Ukraine’s inflation was the highest in seven years.
• China’s inflation is accelerating, causing some political unrest due to higher gasoline diesel and food prices.
• The Chinese government institutes price freezes on key goods including fertilizer, food energy and etc.
• Inflation in Latin America ranged from 3.3% to the high teens in 2007.
• The Chinese agree to let their currency rise faster than in 2007 to combat inflation.
• We see headlines like these appearing all over the world. Eventually, they get into the people’s awareness and change behaviors, which can cause more dislocations, and finally a big breakout in inflation world-wide.

Thus far, the U.S. and some other markets have started the new year on a declining note. However, if you have been in food, gold, or foreign currencies the news has been good.

We expect this year to be much like the first week. It maybe difficult for some parts of the world economy, but not difficult for those who are well positioned to benefit from the inflation, weak dollar, and poor U.S. economic activity that will make headlines this year.

FOR THOSE OF YOU WHO LIKE TO THINK ABOUT THE MONEY SUPPLY AND ITS RELATIONSHIP TO LIQUIDITY, PRODUCTIVITY AND INFLATION…

 

Here are some scary money supply growth numbers for you for 2007:

Brazil M3 +17.0%
Canada M3 +12.9%
China M2 +18.5%
Euro zone M3 +12.3%
Hong Kong M3 +31.5%
India M3 +21.5%
U.S. M3 +15.8%

In our opinion, the commodity macro cycle is all about population of the world and its growth. In 2005, the world population was about 6.5 billion people, and it has been growing slightly more than 75 million people per annum since 2000, or about 1.2% per year.

If we assume that 1.2% more people are added net to world population each year, it is easy to see that the demand for raw materials will continue to rise at a substantial rate. Add to this the fact that about 50 million more individuals per year join the global developing economies and begin to make enough money to demand more goods, more services, and a richer diet. Using these figures, it is easy to see demand for grains and industrial commodities rising at 2-3 % per year. This is huge growth since the global production of energy, grains, and raw materials has not typically grown more than about 1% a year, if at all. 

PRICES WILL RISE

 

As we all know if demand rises and supply is relatively flat, price is the mechanism by which goods are rationed. Prices must rise…and rise they will.

Many argue that prices have already risen, so price increases must be over. In our opinion, prices can fall for a few weeks, or even months in some cases, but long-term price decreases are looking extremely unlikely, especially if you believe the money supply growth figures mentioned above. In our opinion and in the opinion of many economists rapidly expanding liquidity leads to more price inflation.

 

FEAR AND LOATHING IN GLOBAL MARKETS

 

Stocks that are not connected to the commodity cycle could be hurt.

People fear that the Fed will not lower rates fast enough due to the fact that the Fed knows it will eventually have to raise rates in order to slow down the rise in commodity prices. The Fed may be slow in lowering rates, but they will undoubtedly be slow raising rates later when they try to slow price inflation. This should give inflation plenty of time to take root.

Every behavior the central banks and the governments themselves are currently undertaking is inflationary longer term. For example, with bailouts of companies [Northern Rock], the injections of capital by sovereign wealth funds and other investors, and lowering interest rates to spur lending and growth. These, plus the growth of the money supply worldwide is sowing the seeds of inflation.

Further, the growth of world population and the rising standard of living of the existing population both argue persuasively for higher commodity prices over the long term.

 

OUR STRATEGY

 

We will continue to keep our eye on the global landscape and find areas that we think offer investment profit potential. We are long gold, energy, food, and related companies. We have very small positions in one or two fast growing countries and will add to these positions on market weakness, not today, but in coming weeks and months. 

 

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