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Should You Invest in Gold and

After my previous article on inflation, I got a lot of questions regarding the chances of stagflation. For those who are not familiar with this economic term, stagflation is the period when the economy is shrinking, but inflation is high and the unemployment rate is high. An example would be the 1970s, when inflation was running in double digits, the unemployment rate was close to 10% and the economy was in recession twice.

To avoid stagflation, the current central bank sets its monetary policy directly based on the economy and the unemployment rate. It is likely that they will be successful. With everything going back to “normal” after the pandemic, the unemployment situation will be getting better.

In my first-hand experience, it is now much harder to hire engineers than before the pandemic, and the salary has increased dramatically. This situation is going to last for at least a few years. I believe that the unemployment rate will stay low, and there is a labor shortage in many sectors of the economy.

The price of almost every commodity is going up – corn, wheat, oil, lumber. The price of lumber is close to an all-time high and has quadrupled over the past 12 months as the housing demand went up dramatically.

Is it a good time to invest in these commodities or commodity-related companies? Commodities did well in the high inflation years of the 1970s, but will they do well again?

Will gold do well again, like in the 1970s?

Gold has traditionally been considered a safe haven and a vehicle to preserve wealth, and will continue as such, although there is some competition from digital currency. I am inclined to think digital currency is more likely a fad and will lose its attention after a major market correction. Legendary investor Jean-Marie Eveillard and his successor Matthew McLennan at First Eagle Funds always keep a percentage of the portfolio in gold.

Will gold prices climb significantly in the next several years amid inflation?

To me, it is unlikely. To climb significantly, gold prices need to be much lower than they are now. Gold is not cheap at its current price. Adjusted for inflation, gold is now traded only slightly lower than the peaks in 1980 and 2011.

The time to invest in gold is when it is at inflation adjusted lows. The best times historically were in 1976 and the early 2000s. In 1976, gold was traded at an inflation adjusted low of $527. Then the inflation hit, and the price quadrupled in less than four years. In the early 2000s, gold prices were even lower. The loose monetary policy in the great recession of 2007 pushed gold prices much higher, then only fluctuated at high prices.

Gold prices are evidently very cyclical. Buying near the peak, as it is now, will result in poor returns and it defeats the purpose of inflation.

How about other commodities like copper, corn and lumber?

The principle is the same. We want to buy when the prices of those are at inflation adjusted lows. If the price is at the higher end of the inflation adjusted price of the commodity, it is more likely the future return will be low or even negative.

This is the price of copper, both the historical price and the inflation adjusted historical price:

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Clearly the current copper price is very close to the high end of the inflation adjusted historical prices. Only during the peak inflation of 1980, the housing bubble of the late 2000s and 2010 were the prices higher.

Similarly, the inflation adjusted price of corn is also closer to the higher end of the inflation adjusted price. The price is mainly driven by the imports of China.

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A similar chart can be drawn for oil:

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The price of oil is now lower than it was during most of the time after 2005. This makes investing in oil-related companies less risky, but there are some fundamental changes in the energy industry, which makes investing in the oil industry very tricky.

Major oil companies such as ExxonMobile (XOM) and Chevon (CVX) were hurt badly by the low oil prices, and they were having hard times covering their dividend payments with the cash flows they generated. If the oil prices stay low for an extended period of time, they may have to cut their dividends, which they want to avoid badly.

Investing in commodity related industries is tricky. You not only want to buy at the right time, but also sell at the right time. That is hard.

I would rather buy the companies that are more predictable so that I can buy and hold for a long time.

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