(MENAFN- Sunshine Profits) Inflation! The Republic crumbles under the attacks of the ruthless Supply Lord, Count Shortage. Expensiveness is everywhere. Will gold save the galaxy?

If George Lucas were to make a movie about 2021 instead of the Jedi Knights, he’d probably call it Revenge of the Supply. After all, the past year will be remembered as a time of semiconductor shortages, production bottlenecks, disrupted value chains, delivery delays, rising job vacancies, rising inflation and soaring energy prices. This might be a shocking finding for Keynesian economists, who focus on aggregate demand and believe there is always slack in the economy, but it turns out that supply matters too!

As a reminder, state governments could not deal with the pandemic any smarter and introduced lockdowns. Then it turned out – what a surprise! – that the shutdown of the economy, well, shut down the economy, so the Fed and the banking system boosted the money supply, while Congress passed a gigantic fiscal stimulus, including sending checks to almost all Americans.

In other words, 2021 has shown us that you cannot close and reopen the economy without negative consequences, because the economy does not simply return to the status quo. After the economy reopened, people started spending all the money that was “printed” and given to them. Consequently, the demand increased sharply and the supply could not keep up with the increase in expenditure.
It turned out that economic problems are not always linked to demand, which needs to be “stimulated”. We also learned that there are supply constraints and that production and delivery don’t always go smoothly. The contemporary economy is truly global, complex and interconnected – and the proper functioning of this mechanism depends on the proper functioning of its zillions of elements. So shit happens from time to time. That’s why it makes sense to have gold as portfolio insurance against tail risks.

Evergiven, the ship that blocked the Suez Canal, disrupting international trade, was a perfect illustration of this. However, the importance of supply factors goes beyond logistics and relates to regulations, taxes, incentives, etc. government should become the top economic priority.

Another negative surprise for mainstream economists in 2021 was the revenge of inflation. For years, central bankers and analysts dismissed the threat of inflation as a thing of the past. In the 1970s, the Fed was still learning how to conduct its monetary policy. He made a few mistakes, but he’s a lot smarter now, so stagflation won’t happen again. Moreover, we live in a globalized economy with strong product competition and weak unions, so inflation will not get out of control.

Indeed, inflation remained stubbornly low for years, despite all the accommodative monetary policy, and did not want to meet the Fed’s 2% target, so the US central bank changed its regime to be more flexible and inflation tolerant. That was in 2020, just a year before inflation hit. The Fed absolutely did not expect this – which shows the intellectual poverty of this institution – and called it “transitional”.

Initially, inflation was supposed to be short-lived because of “base effects” and later because of “supply bottlenecks”. It wasn’t until November that the Fed admitted that inflation was more widespread and would be more persistent than it had previously thought. Well, better late than never!
What does the tradeoff of supply and inflation mean for the gold market? One would expect gold to perform better last year amid all the supply issues and a surge in inflation. We’ve learned that gold doesn’t always shine in times of inflation. The reason for this was that supply shortages did not translate into a full-fledged economic crisis. On the contrary, they were caused by a strong rebound in demand; and they mainly contributed to higher inflation, which reinforced the Fed’s hawkish rhetoric and expectations of higher interest rates, creating downward pressure on gold prices.

On the other hand, one could also say that gold prices have been supported by high inflation and have not fallen further thanks to all the supply disruptions and inflationary threats. After all, during the 2011-2015 economic expansion that followed the Great Recession, gold plunged about 45%, while between the peak of 2020 and the end of 2021, the yellow metal didn’t lost only about 13%, as shown in the chart below.

So the worst may be yet to come. I don’t expect the decline to be as deep as in the past, especially since the Fed tightening cycle appears to be mostly priced in, but real interest rates may normalize somewhat. So, I have bad news for gold bulls. The supply crisis should ease in the second half of 2022, which would also ease inflationary pressures. To be clear, inflation will not go away, but it could peak this year. The combination of an improving supply side of the economy, inflation peaking and a more hawkish Fed does not bode well for gold.

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Arkadiusz Sieron, PhD
Sunshine Profits: Efficient investment through diligence and care.


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