Gold and silver traded with a bullish tone in the second quarter of the year. This carried forward to the third quarter as gold reached an all-time high, and silver’s bullish move resembled a vertical line.
Commodities, according to economic principles, have the effect of protecting the portfolio from inflation. As such, the hedge against inflation is the main reason why investors look at gold. The key element is to find the appropriate percentage to be invested in precious metals, so the account benefits from other asset classes diversification.
All of the above is true. However does this rule also apply in a world where taking on debt is so cheap that inflation worries make no sense?
Loading Up Debt Instead of Owning Precious Metals
The argument here is made on the inflation effects side. For instance, investors might be better off by loading up debt under the most favorable conditions in recent history, instead of investing in precious metals.
If inflation is to be feared off, if and when it comes, it will devalue the fiat currency in such a way that the borrower will end up with a much lower cost of debt. However, the advantage equals the opportunity cost – the funds next best use.
Make no mistake; inflation is coming. Only we do not know when and with how big an impact.
However, investors do know that the increase in the M2 money supply in the United States dwarfs anything we have seen in the previous crisis.
During the 2008-2009 Great Financial Crisis, the Fed started the quantitative easing programs. It was viewed and still is, as an unconventional monetary policy tool. The result? A quick rise in the money supply.
However, four months into the Coronavirus pandemic, and it seems impossible to dismiss inflationary scenarios. So how and when will investors know that inflation is about to rise?
The solution comes from the savings rate. The current problem governments and central bankers have is that money, while available in large quantities, sits in bank accounts as households and businesses to not spend, respectively, invest.
Therefore, a solution to the gold/inflation dilemma would be to remain invested in precious metals as long as the savings rate sits at the current high levels. When the savings rate begins falling, a rotation out of precious metals may yield more in a world with historically low cost of debt.