Select financial commentators, pundits, and asset managers have stated that during periods of stagflation — low real GDP growth and high inflation — silver has under-performed gold. Therefore, if an investor believes that stagflation is in our future, that gold will be a better purchasing power protector/enhancer (the latter thanks to sustained precious metals price suppression) than silver. Not so fast, alleged smoking gun backtesting claims notwithstanding.
The stagflationary ’70s — recall that Nixon took the US dollar off the gold standard in August of 1971 — suggest otherwise. From December 1969 to December 1979 (if you were calculating an asset’s upcoming 2020 return, you’d begin with the 2019 closing price and end the year with the 2020 closing price), silver went from $1.83 per Troy ounce to $30.13 per Troy ounce, which constituted a composite nominal return over ten years of 1,546%, or a 16.5-fold rise. See for yourself in the 100-year chart of the US dollar-based silver price. Once you’ve clicked on the link, simply hover over the chart with your cursor, and you will discern the same prices I refer to above. In so doing, make sure you uncheck the inflation-adjusted price selection. This is the chart that you’ll see:
Gold, over the same period (from December 1969 to December 1979), went, in non-inflation-adjusted or in nominal terms, from $41.88 per Troy ounce to $455.92 per Troy ounce. This amounted to a nominal return of 988.6%, or a 10.9-fold rise. To confirm the gold price action, please see for yourself in the 100-year chart of the US dollar-based gold price. Once you’ve clicked on the link, simply hover over chart with your cursor, and you will spot the same prices I refer to above for December 1969 and December 1979. Once again, please uncheck the default inflation-adjusted selection. You’ll see this chart:
The silver dollar price from December 1969 to December 1979 logged a stout average annual compound return of 32.3% (which comfortably exceeded gold’s 27.0% CAGR over the same time period in the same currency), immense volatility that silver is known for notwithstanding. Granted, silver crashed thereafter, starkly out-legging gold to the downside post January 1980, but the point is how silver does in a stagflationary environment, the inflationary aspect of which then-Fed Chairman Volcker managed to start deflating as he raised the Fed Funds rate from the mid-teens to the high-teens late in 1979 and kept raising it aggressively into 1980, bringing about a Fed Funds rate that crested at an inflation-eviscerating, economy-drubbing 20.74% by December 1980. (Addendum: the fact that the “fiat currency powers of the day” increasingly conspired to shut down the Hunt brothers’ efforts to drive the silver price higher still resulted in even greater white metal volatility while also highlighting just how small the silver market was/is. More on that later.)
Obviously, silver in USD terms does well in stagflationary times, in both absolute and relative terms, i.e., if the ‘70s are any guide. I believe they are. Why? Because post-August 1971, the USD became a 100% fiat (non-precious metals-backed, unconstitutional) currency, which hadn’t happened since the Constitution was ratified on June 21, 1778. The ’70s, assuming they are an unpleasant stagflationary “blast” from the past about to be revisited, are arguably most comparable to today’s counterfeit currency age. That said, current excesses — including peerless debt, America’s unprecedented $10.9trn net debtor status, America’s huge import dependency, and the Fed’s increasingly bloated balance sheet — may well conspire to eclipse both the economic stagnation and inflation (“stagflation”) of the ’70s in convincing terms. At the very least, the ’20s should rival the ’70s in terms of macroeconomic and financial issues. Plus, in stark contrast to even the early ’70s, today’s stocks, bonds (“figure 8”), and real estate are “priced for perfection” bubbles — prior to an inevitable, pronounced EPS compression — despite our increasingly unsustainable, counterproductive economic and financial trajectory. It is this double whammy — negative fundamentals juxtaposed against mania valuations — that suggests a possibly unparalleled asset revaluation (a valuation reset of all assets and currencies relative to gold) draws ever closer; a reset which may well make the ’70s stock, bond, and real estate valuation carnage extending into the early ’80s pale in comparison.
Arguably the only thing more benign than the ’70s as we start the ’20s is producer and consumer goods and services inflation. Yet our understated consumer inflation statistics are substantially falsified. For example, the consumer price index (CPI) is comprised of unrepresentative housing and healthcare cost allocations (too small compared to real world consumer spending share), “steak to hamburger substitution,” and hedonic quality adjustments — all politically motivated, of course. In a nutshell, if consumer inflation was still defined as it was in the ’70s, it would be in the high single-digits. Plus, our increasingly widespread financial repression-enabled misallocations (e.g., deficitary redistributionism of various sorts) are much more threatening to future productivity growth, economic growth, income growth, and price stability than the clouds on the ’70s’ horizon. And “all that” is prior to the monstrous monetary base bloat shifting decidedly from financial assets to real assets in a “crack-up boom,” in which economic participants and investors of all stripes seek to dump fiat currency before it loses (yet more) purchasing power, in the process triggering a self-reinforcing snowball effect. This “buy it now” inflationary bias boosts the money multiplier, which declined into late 2014 and only started to slowly emerge from its decade-old asset bubble stupor as of 2015. For graphic flavor, please see below, and while you do, note that the series has “conveniently” been discontinued by the Fed (perhaps the multiplier was getting “too lively?”):Source: https://fred.stlouisfed.org/series/MULT
When combining a reviving money multiplier with a rapidly expanding Fed balance sheet, which is nearly back to record size, or 4.7 times early January 2008’s footprint, monetary inflation begins a migration from asset prices to goods and services prices. If sustained, the money supply (whatever flavor) surges, and monetary inflation (true inflation) can no longer be contained in asset bubbles — especially if foreign creditors “go on strike.” And as the song goes, “we have only just begun” what will likely prove to be a self-reinforcing rise in producer and consumer price inflation, much of it triggered by changing inflationary expectations (in essence from don’t purchase “today” for it will be cheaper “tomorrow” to buy “today” before it costs more “tomorrow”), something which a plummeting dollar would obviously spike materially as regards both the US price landscape and its real economic growth rate. This rings all the more true given how deeply entrenched foreign components have become in goods sold in the US (quite the historical contrast!), whether imported or domestically assembled, on the one hand, and given the tapped-out nature of American consumers on the other hand. Said differently: making less yet spending more isn’t sustainable forever, even in America — is it?
For more perspective, let’s briefly revisit the stagflationary ’70s. This was a decade during which consumer price inflation averaged 7.4% p.a. (vs. the “teens”‘ ended in December 2019, a decade during which consumer price inflation averaged 1.7% p.a). Moreover, the ’70s also constituted a decade during which the US “only” ran a net export of goods and services deficit of $206bn, or an average of $20.6bn p.a. (vs. the current annual net export deficit of $653bn, a deficit which is broadly representative of the past 15 years!). This pointed to a ’70s economy that was not materially dependent on foreign-sourced goods, making it less susceptible to swings in the value of the dollar and to external financing costs, despite the issuance of Carter bonds. It was also an economy which, in December 1979, featured only $4.4trn in aggregate debt (vs. $76.4trn today) while America was still a $232bn net creditor nation (vs. today’s $10.9trn net debtor status). This meant that Americans’ collective income in the ’70s wasn’t facing the same interest expense as is currently the case (“back of the envelope:” $4.4trn at approximately 10% back then was $440bn; $76.4trn at about 3% today is $2.3trn). Moreover, the US’s ebbing net creditor position as of December 1979 still nominally bolstered or augmented domestic income courtesy of positive net overseas investment returns. Said stands in contrast to the current predicament, in which “America, Inc.” is increasingly paying interest and sending dividends to overseas investors in order to run deficits and to “buy stuff.” It’s loosely akin to burning furniture to keep warm.
Given America’s outstanding debt, just think of what will happen if average borrowing costs go up by only one percentage point? How does a fat $760bn, or 3.5% of US GDP, in additional interest expense sound just based on today’s aggregate debt outstanding, much less reverting beyond the 4% mean on 10-year Treasuries with a risk premium of at least a percentage point or two for the other domestic borrowers due to those debtors lacking broad taxing power AND a printing press? Reversion beyond the mean always happens, eventually — the benchmark 10-year Treasury yield crested at 15.3% in September of 1981 — given the manic-depressive nature of markets (people).
Now, increasing consumption-related indebtedness in a hard currency (precious metals-backed) world is deflationary simply because you “can’t print money to repay debt or to finance new debt,” meaning consumption declines as debts are amortized, exerting downward pressure on demand, and thus on prices. But the opposite happens in a fiat currency world until confidence in a serially-abused currency, most especially such as the reserve currency dollar, is lost (after which a crack-up boom ensues, which typically sets the stage for an eventual deflationary collapse).
Thus, the less than bizarre takeaway currently on offer in the US: consumer price inflation is virtually predestined to rocket higher. Why? Because with rapidly increasing debt, gaping federal and (US) trade deficits, outsized overseas financing needs, and a dollar which will ultimately reflect domestic and foreign creditors’ continuously increasing value at risk thanks to their financing of a perpetually and materially “negative free cash flow” nation that principally pays its bills via either taking on more debt if it’s cheap enough or via the printing press if it’s not, both accelerated dollar weakness and debasement are all but assured. Foreign creditors will eventually reduce their dollar holdings. Dollars will “come home,” chasing too few domestic goods and services. Long before that, the Fed will “sacrifice” the dollar in even more marked terms than is currently on display in order to protect the solvency and humongous profits of its shareholders, i.e., the member banks that own it — and because of intense political pressure. And speaking of the dollar, consider that even as both US trade deficits and federal deficits have generally soared (both in absolute and in relative to GDP terms) since the late ’70s, the trade-weighted dollar index has also soared, going from 35.89 in December 1979 to 129.36 in December 2019! How does one spell “disconnect?” Haven’t market participants been irrational long enough, Mr. Keynes?
And, once again, stagflation, which got its name during the inflationary recession between 1973 and 1975, not only refers to pronounced consumer price index (CPI) inflation, but it also refers to low or negative real GDP growth. Real US GDP declined from Q2:1973 to Q1:1975 by 2.7%. The consumer price index over the same time period surged at a 10.6% annualized rate. From Q4:1969 to Q4:1979, real US economic growth slowed from 4.4% p.a. in the prior decade to 3.3% p.a. during the ’70s. Back in the day, from a post WWII perspective, 3%-ish annual real growth was rather sedate compared to the 4%-plus norm of the prior two decades, which also featured a consumer price index that was increasing at an average 2% annual rate, a stark contrast to the CPI inflation of the ’70s, when it averaged 7.4% p.a.
In today’s misallocated, expanding government, increasingly deficitary, regulatory compliance ($1.9trn p.a. in America alone, or nearly 10% of US GDP) and US litigation cost insanity, productivity-drooping global economy featuring an aging population and growth-killing financial repression (no incentive to save, stock buybacks over cap ex), re-achieving sustainable 3% real GDP growth in the US or in the OECD world would be akin to the eighth wonder of the world. Yet, to sustain the deeply entrenched bureaucracy (statism), to protect the kleptocracy’s immense power and wealth, and to re-elect redistributionist politicians dealing with high youth unemployment while pronounced pension underfunding increasingly threatens OECD baby boomers’ “golden years,” the printing press(es) will be doubled down on until confidence in fiat currencies turns into flight from them, which is also known as hyperinflation. We are already seeing the initial doubling down unfold in both the US and in the EU — it never stopped in Japan. A case or two in point: just the threat of a lingering or deepening stock market correction (as in Q4:18) or the recent repo “flare-up,” which threatened to upend/trump the Fed’s short-term cost of funding diktat (the Fed Funds rate), are enough for the Fed to take out the proverbial money printing fire hose in order to protect its crony Wall Street owners.
The upshot: the ’70s stagflation, revisited we’re staring at — especially in the US — threatens to make both the ’70s real growth and inflation numbers look good by comparison. Translation: flight into the only true and portable wealth preservation assets/true money over thousands of years, namely scarce gold (about $140bn mined p.a. at the current gold price) and extremely scarce silver (about $15bn mined p.a. at the current silver price), ought to be even more pronounced than was the case in the ’70s as global central banks initiate even more conspicuous, “beggar thy neighbor” currency debasement. This is all the more true when juxtaposed against global investable/financial assets (mainly in bubble valuation bonds and stocks) in the $200trn range featuring approximately 1% exposure to precious metals (virtually all gold), a level that is quite the contrast to the 2.7% exposure in 1980 or 5% exposure in 1960. Just a 0.5% global reallocation to precious metals at current price levels would overwhelm current mining output for approximately six years, meaning that any reallocation would be principally driven by much higher precious metals equilibrium prices. When this sentiment shift comes, it will utterly overwhelm the long-standing, well-known gold and silver price suppression. In fact, that very suppression (effectively, massive naked shorting of both metals) will likely conspire to vault both gold and silver prices even higher, courtesy of “short-covering.”
Finally, a few more indications as to why silver ought to again outperform gold (in USD terms) as we draw ever closer to 1970s stagflation “on steroids.” The silver-to-gold ratio back in December of 1969 was 23:1; it’s currently nearly 87:1. This suggests that silver has HUGE catch up potential not only because of how silver comes out of the ground relative to gold (it has fallen to 9:1), but because over the course of history it has been Persia’s money, Rome’s money, “the people’s money,” and constitutional money in the US until 1964. Moreover, because silver mining output has lagged silver demand by an average 23% for a decade. Plus, because of the growing and widening industrial/medical use applications for silver. In addition, because of how little above ground silver is actually “salvageable/reclaimable,” economically speaking: somewhere between the 2bn Troy ounce consensus and my much more conservative 16bn Troy ounce guesstimate, or between $36bn and $290bn at today’s silver price, the latter number a mere 3% sliver of reclaimable gold (the vast majority of all of it ever mined). All said, how does one spell additional catalysts underpinning stout silver dollar price outperformance relative to the gold dollar price, which, as I’ve pondered and attempted to rationalize elsewhere, should exceed $10,000 per Troy ounce of gold (p.10) simply given the huge global monetary base expansion that has ALREADY occurred.
Doesn’t sound much like a silver underperformance story ahead, wouldn’t you agree? More likely is a material silver-to-gold outperformance story. And if you find it plausible that gold, prior to even more pronounced money printing (QE) likely in the wings, both domestically and abroad, is currently worth north of $10,000 per Troy ounce on the one hand, and that sooner or later the silver-to-gold ratio (87:1) has to move more closely towards how it currently comes out of the ground (9:1) on the other hand, then silver ought to substantially outleg gold when the dollar price of gold reenters a secular bull market that takes out the July 24th, 2011 $1,838 gold price high. Of historical significance in this regard is the UK silver-to-gold ratio, which fluctuated between 10:1 and 20:1 for some 600 years prior to the advent of silver demonetization in the late 1800s. This was a multi-hundred year era during which an approximate 15:1 silver-to-gold ratio in Pound sterling terms reflected aggregate extraction costs as well as relative demand for the two precious metals. In such a world, if only partly revisited, a multi-hundred dollar silver price per Troy ounce is entirely possible. And do recall, there is no fever like gold fever — except, of course, silver fever!
Dan Kurz, CFA, DK Analytics
FYI: Edits and select link inclusions to buttress post claims continued after publishing date. Post substance remained unchanged.
This commentary is not intended as investment advice or as an investment recommendation. Past performance is not a guarantee of future results. Price and yield are subject to daily change and as of the specified date. Information provided is solely the opinion of the author at the time of writing. Nothing in the commentary should be construed as a solicitation to buy or sell securities. Information provided has been prepared from sources deemed to be reliable but is not a complete summary or statement of all available data necessary for making an investment decision. Liquid securities can fall in value.