Ned Naylor-Leyland, head of strategy for gold & silver, discusses higher inflation, the connections between monetary metals and digital currencies and the role they may play in the evolution of the financial system.

 

Inflation is on the rise in Europe, the U.S. and China, at both the retail and producer level. Many investors and consumers are rightly concerned about what effect higher prices will have on investment returns and purchasing power.
The market seems to be assuming inflation is transitory rather than permanent, but I disagree. My view is that the inflation we are seeing is principally a monetary phenomenon, and that central banks won’t be able to shrink their massive balance sheets anytime soon.

 

There have been periods of history where central banks have behaved in a similar way – and they haven’t ended particularly well. What’s unprecedented this time is the global nature of the balance sheet build up. I would also argue that inflation is an under-priced variable in markets today even after the Federal Reserve’s (Fed) June commentary.

Printing and spending

I believe the current macroeconomic environment makes gold and silver a compelling investment. Many of the factors that led to gold’s rise last year — money printing and fiscal spending — continue unabated. Gold and silver are sometimes called a hedge against inflation, but it’s more accurate to say they are a hedge against the loss of purchasing power. This is reflected in real interest rates – or, for example, the yield of a bond after accounting for inflation. For many US Treasury holders, real yields are negative.

 

We think nominal yields will struggle to keep pace with inflation, that the Fed won’t be able to lift interest rates much and that real yields will continue to fall with the US dollar. A small allocation to an actively managed gold and silver strategy can protect against negative real yields and can be a good diversifier for portfolios.

 

There’s another asset class that’s capturing everyone’s attention right now: crypto currencies. Recently I had a conversation with Daniel Masters, chairman of digital asset platform CoinShares, that touched on the similarities and links between monetary metals and crypto currencies.1

Populist assets

Monetary metals and crypto currencies are populist assets, in my view, meaning they aren’t so reliant on trusted third parties such as banks, and they appeal to retail as well as institutional investors. Bubble valuations, the Gamestop narrative, digital finance and decentralisation — all these themes are connected to populism and intersect with crypto currencies and gold and silver.

 

There was the silver squeeze, a surge in retail demand earlier this year, and I don’t think we’ve seen the last of it. Silver has through history been a populist form of currency. The common people have used it as legal tender through the ages. This continues and I’ve noticed this year more cash buying of physical silver, whereas in previous peak demand periods the white metal was mostly bought on margin.

Dollar special

Gold and silver and digital currencies have a role to play in the evolution of the global monetary system. How long will the dollar retain the special benefits of being the global reserve currency? Will technology further rewrite the rules on how we spend and invest?

 

We may be on the cusp of changes to the global monetary system, and the enormous growth in digital currencies will be part of that. Gold also has a prominent role to play. Proposed reforms in Basel 3 regulatory rules set to take effect in January 2022 would upgrade physical gold from a Tier 3 to a Tier 1 asset, placing it on par with cash and US Treasuries from a capital risk weighting perspective.2

 

Another Basel 3 change would raise the amount of long-term funding banks, including London bullion banks, are obliged to hold against gold trades. These would be important structural changes for the gold market, and they would potentially boost demand for the precious metal, which is relatively supply constrained.

Real value

I can foresee that gold becomes the ‘stablecoin’ of the new fully digital monetary system. Indeed, the entrance of genuinely sound (and traceable) money into the decentralised financial space will catalyse and accelerate the process of distribution and the usage of crypto assets and solutions. I think the state would accept this and encourage it because governments through their central banks hold gold as a primary reserve asset, and there is an increased need globally for apolitical money to perform the risk-free function that the dollar currently holds.

 

This arrangement would underscore the traditional role of gold and silver as risk-free real money — apolitical currency that is not issued by a government or central bank. It would also highlight what gold and silver have always been: stores of true value.

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