You cannot scan the financial press these days without tripping up over an article on global inflation and central banks’ responses to same, typically through aggressive interest rate hikes. One after the other, the financial journalists entertain their “we-already-knew-that” followers with stories about how much more a basket of basic household goods costs today versus 12-months ago. “In November 2021 you were paying ZAR15 500,00 per month on your ZAR2 million home loan, today you pay ZAR6 170,00 per month more,” they lament, making sure to compare the best rate with the worst.
Predict inflation, interest rates at your peril
Journalists excel at waxing lyrical over the soaring price of bread, electricity, meat, fuel, milk etc, but they rely on their ‘economic guru’ contacts to inform them of when the interest rate hiking cycle is likely to turn. Some experts will venture a guess; most are more guarded. “It is difficult to make predictions, but it does seem as if we are closer to the top of the interest rate cycle than the bottom,” said Andries Kotzee, Chief Investment Officer at Celerity Investments, just days after the May 2023 decision to hike South Africa’s Repo rate by 50 basis points, to 8.25%. The Monetary Policy Committee of the South African Reserve Bank (SARB) is clear that interest rate decisions are data-dependent, and that inflation trends are considered alongside many other factors.
When pushed to explain the rising inflation and interest rate phenomenon, Kotzee shared a wonderful inflation-linked (the writer begs pardon for this phrasing) anecdote, which we quote verbatim in italics below.
“One of the first references to inflation comes from the late 15th Century, when Christopher Columbus returned to Spain from the Americas. He told stories of great empires with enormous riches, particularly in silver.
“The Spanish then sent fleets of ships across the Atlantic armed with military strength to go and conquer these nations and mine these rich silver deposits. A great example of this is Cerro Rico in Bolivia, which was then popularly conceived of as being ‘made of’ silver ore, and became famous for providing vast quantities of silver for the Spanish Empire.
“This [conquest] caused a sudden increase in the money available – silver was the most important monetary metal, although gold was used for coins of high denomination – without a commensurate increase in goods and services produced. Since there was more money available to pay for the same goods and services, prices went up, or in today’s context, a period of high inflation ensued”.
You can thank government for today’s craziness
Inflation hiccups can often be traced back to government bungling of fiscal and /or monetary policy. Case in point, the 40-year highs in inflation seen in the United States (US) and much of Europe recently stem from a combination of lower-for-longer interest rates following the 2008-9 Global Financial Crisis (GFC) and the USD6 trillion or more in financial support provided by the US to businesses and households through the COVID-19 pandemic. “Printing money that is not accompanied by increases in productivity contributes to inflation,” Kotzee said. “If South Africa wants to fight high inflation, we need to find a way to be more productive in future than in the past, and also more productive when measured against our trading partners and global peers”.
As prices soar and the purchasing power of each dollar, pound or rand erodes, Jane and Joe Average love considering gold or other precious metals as long-term, inflation-proof stores of value. To play devil’s advocate, this writer added cryptocurrency to the mix, and proceeded to interrogate some fund manager types about the role bitcoin and gold might play in household savings. Andrew Dittberner, Chief Investment Officer at Old Mutual Wealth Private Clients warned against lumping these assets into the same basket. “Bitcoin is often referred to as digital gold, but it should not be confused with gold, the metal; these asset classes are far too different to be comparable from an investment perspective,” he said, adding that bitcoin was far more volatile than gold. PS, his comments were for a piece in the FAnews June 2023 magazine, but it seemed fair to reuse them here.
Jason Welz, the resident crypto expert at Jaltech, commented that bitcoin and gold share many features that make them suitable as long-term stores of value including scarcity, divisibility and fungibility. “Bitcoin shares these properties with gold; it might mature into an asset that behaves similarly to gold, but we are currently far from that point,” he said. Case in point: gold has been on steady run over the last six months, climbing from around USD1 600,00 per ounce to USD2 000,00 per ounce, whereas bitcoin has bounced all over the place from USD15k per coin to USD25k, then back to USD20k, before surging 50% to USD30k, and finally settling at USD27 000,00 or so early in June 2023.
It seems easier to make the case for gold…
“Year-to-date 2023 is turning out to be a year of heightened uncertainty and this is most definitely playing into the hands of gold investors,” said Dittberner, around end-May 2023. “The clearest driver of the gold price over time has been real US yields; typically, when real yields are very low the gold price tends to do well”. His simple explanation was that real yields represent the opportunity cost of holding gold because gold pays no income. Or in other words, gold flies when real yields get clobbered.
Welz said there were two key factors driving gold strength midway through 2023. First, moderating inflation combined with global recession fears and expectations of rate cuts from the US Federal Reserve in response. He repeated Dittberner’s assessment as follows: “Gold tends to do well when real yields are low [and] the risk-free real yield available on dollars plays into the opportunity cost of holding gold”.
The second reasons for gold’s current strength derives from the US banking crisis and the ever-present US debt ceiling standoff. “People are holding gold as a hedge against disruption to the financial system,” Welz said. “The US Fed has responded by injecting large amounts of liquidity into the banking system which has [once again] led to support for equities and alternative assets like gold and bitcoin”.
Gold may be in a sweet spot, but it struggles to match bitcoin’s allure. Jaltech believes that retail investors should include some crypto asset exposure in their discretionary investment portfolios. Bitcoin, for example, has proven to be uncorrelated to most other financial assets, making it vastly superior to gold as a portfolio diversifier. According to Welz, most cryptocurrency experts will recommend purchasing bitcoin on a trusted crypto exchange before withdrawing that bitcoin into a hardware wallet controlled by the investor.
“We advise against storing any significant value in crypto investments on a crypto exchange because holding assets on-exchanges exposes your investment to risks such as hacks, insolvency and mismanagement,” he said. “It is better to use a professional custody service”.
Physical gold too costly to hold
Global investors have taken to purchasing bitcoin and gold exposure using exchange traded funds (ETFs). However, South African investors do not yet have a bitcoin ETF option. “The most cost-effective method to gain gold exposure is through a low-cost gold ETF,” said Welz. Buying physical gold is an option for those who cannot shake the horror of a doomsday scenario from their minds, but it comes at a cost: you pay a premium to the gold dealer when you buy gold; take a big discount when you want to sell it; and you incur costs to insure and store the precious metal.
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