Ronald Peter Stöferle, a partner at asset management firm Incrementum AG, made the prediction that the global economy has been characterized by deflation and falling interest rates since the early 1980s; but that trend is now changing, and in the coming years we will see inflation and rising interest rates.
Stöferle cautions that no one is still ready for inflation, and investment managers have never had to deal with an environment of rising inflation.
He believes that there is an imminent outflow of capital from the bond market and a potentially more accommodative monetary environment. Soaring inflation and massive capital outflows from the bond market will benefit commodities, especially gold.
In an in-depth conversation with The Market NZZ, Stöferle explains the role of precious metals in a diversified portfolio, as well as his views on gold, silver and bitcoin. Here is the original interview.
The evidence is overwhelming that inflation is no longer “crying wolf”
The Market NZZ: Inflation warnings have proven to be a false alarm many times in recent years, so why is this time different?
Stöferle: After the global financial crisis in 2008, central banks were trying to compensate for the collapse in demand for bank credit. They had some success in doing so, but at the same time it led to a sharp rise in asset prices. So, to some extent, we can say that this is inflation that is not included in the consumer price level.
And now in response to the new crown epidemic, we see a shift from monetary policy to fiscal stimulus. First, fiscal policy can create credit bypassing the central bank with the instrument of government loan guarantees. As a result, the broad money supply, as measured by M2 or M3, is now increasing compared to the aftermath of the financial crisis in 2018, with M3 in the U.S. recently increasing by 24% year over year.
Second, monetary authorities have deliberately allowed inflation to rise when it has been too low in recent years. Third, government debt is too high. History tells us that the higher the government debt, the stronger the desire for inflation by politicians.
The Market NZZ: You don’t think the emergency fiscal policy tools will be withdrawn once the crisis is over?
Stöferle: No. As President Reagan once said: Nothing lasts longer than a “temporary” government program.
The Market NZZ: The broad monetary aggregates may have expanded, but at the same time, the velocity of money circulation has declined. In such an environment, what would happen to inflation?
Stöferle: During an epidemic embargo, the velocity of money circulation drops. But as vaccinations begin and business operations and personal lives return to normalization over the next few months, the velocity of money circulation will resume. There are already signs of this shift. A greatly expanded money supply combined with a return to a normalized rate of money circulation could soon create inflationary pressures. We will see inflationary pressures caused by base effects alone by early next spring.
Also the impact of the dollar cannot be ignored: in the decade following the financial crisis, the dollar strengthened and had a deflationary impact on the global economy. And now, the dollar is weakening. If the dollar now steps into a long-term trend of weakness, then global inflation will occur.
The Market NZZ: What other signs do you see that this shift is indeed happening?
Stöferle: Inflation-sensitive asset prices are one piece of evidence, such as inflation-linked bonds, precious metals such as gold and silver, commodities including energy and uranium, agricultural commodities, and inflation-sensitive currencies such as the Canadian and Australian dollars.
I wouldn’t be surprised if the US and Europe hit 4% to 5% annual inflation, but that’s not an effective way to reduce government debt.
The Market NZZ: What will happen to financial markets assuming an inflation spike occurs in the next year or two?
Stöferle: First of all, it will be interesting to see if Fed officials will counteract inflationary pressures by raising interest rates. Inflation is a “tax”, so to speak. There is also the question of how high bond yields will rise, or whether central banks will intervene or introduce yield curve controls.
Currently, $19 trillion in bonds have negative yields, and rising inflation could cause a lot of money to be pulled out of the bond market and into inflation-sensitive traditional assets.
The Market NZZ: Will the stock market benefit from this outflow of capital?
Stöferle: It’s possible. There are studies that show that the inflation rate that favors the stock market is between 1% and 3%. But the question is, what happens to the stock market when inflation spikes above 4 percent? What will the Fed do if that happens in both the bond and stock markets? Will it buy stocks and step in to bail out the market? I don’t think that’s likely, so it’s time for gold to win.
Gold is good. Silver is better.
The Market NZZ: So you think gold is the winner in inflation, not stocks?
Stöferle: Yes. Of course, you have to do your homework and pay close attention to the company’s ability to fight inflation. My main point is that real interest rates will remain at negative levels and that negative real interest rates are the most important driver of gold prices.
The Market NZZ: In a traditional 60/40 portfolio, bonds are a hedge against equities. Will this portfolio still work in an inflationary environment?
Stöferle: It won’t work. Bonds have been in a bull market for 40 years and are now coming to an end, as part of a trend shift.
And gold can replace bonds. gold has performed exactly as expected in 2020. It has acted like a good defender, holding the line and stabilizing the portfolio at the same time. This year gold is up 24% against the dollar, 14% against the euro and 13% against the Swiss franc. In a portfolio, gold is usually used as a pair of instruments rather than a speculative instrument for short-term gains.
The Market NZZ: Gold hit a record high against the dollar at the beginning of August this year and has been consolidating since then, what do you think will happen next?
Stöferle: The main reason for the consolidation is the small rise in real interest rates in the US, from around -1.1% to -0.8%. But in the short term, January and February are usually the months when gold rises. I expect inflation to rise in the spring, so I have a bullish outlook for both gold and silver in 2021.
Longer term, we expect gold to reach $4,800/oz as inflation rises, financial policy tightens, and central banks rein in the yield curve. A key driver is the growing physical gold demand in Asia. in 1989, China and India accounted for only 10% of total demand; by 2019, that share is 56%. Asia is likely to be the region with the largest demand in 2020.
But also note that a significant rise in real interest rates and a controlled debt situation for sovereigns could dampen gold prices. But to be honest, I don’t see any signs of these factors emerging at the moment.
The Market NZZ: So what are your thoughts on silver?
Stöferle: Compared to gold, silver is clearly too cheap. Last year we wrote, “Silver is unpopular and neglected, and for savvy contrarian investors, now is the best time to invest in it.” Since then, the silver price has indeed risen 60%. The market for silver is small, so if demand returns, silver prices could rise sharply and silver will outperform gold.
If the gold price rises in the next few years as we predict, it is possible for the silver price to exceed $100 per ounce. We need to take the opportunity to get in.
Bitcoin is fragile, don’t just put it in one basket
The Market NZZ: But Bitcoin is outperforming both gold and silver, wouldn’t it be better to go with Bitcoin?
Stöferle: I like both gold and bitcoin, but bitcoin is very volatile and you have to use instruments like options to hedge against that volatility. Bitcoin is a very small market with a market cap of only $400 billion, while gold has a market cap of over $10 trillion. Of course, gold is 5,000 years old and it’s very resilient to risk, something that Bitcoin, which is only 10 years old, can’t match. But for me, bitcoin is an equally inflation-proof asset, so they should both be included in a diversified portfolio.
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