There was a thorough debate during the early days of the COVID-19 crisis about whether the government and central bank should intervene in markets. After it became clear that the intervention would occur, investors turned their attention to the tactical decision of where to put their capital.
One area that was of immediate interest to these investors was a safe haven asset that could provide protection from inflation.
As I wrote last year, the fear of inflation is much more powerful than the inflation itself when looking at the flow of capital. If investors think it will happen, they will make changes to their asset allocation in anticipation of the event.
Whether the inflation actually occurs or not doesn’t matter, because investors will have already moved their capital into the inflation-hedge positions.
In hindsight, we got some of the highest inflation levels in years over the last 12 months. The official June CPI number was 5.4%, which is the highest in 13 years, and the core inflation number was 4.5%, which is the highest in 30 years.
So how did the various inflation hedge assets perform during a higher inflation environment?
Real estate has absolutely exploded in price. If we look at the house price index, we can see the highest levels since the 1990s, both measured on a nominal and real basis.
If we look at the rate of growth, we see a very similar chart that dwarfs anything we saw during the housing bubble of 2007-2008.
The drastic increase in prices was not exclusive to residential real estate either. Here is the growth in commercial real estate, which shows a very similar pattern.
It is fairly incredible to see such a severe increase in real estate prices, but it becomes more obvious when contextualized with historic monetary stimulus, low interest rates, significant labor shortages, and disruptions in the supply chain. So if real estate exploded vertically in prices, that would have made it a great inflation hedge with the benefit of hindsight.
Next, let’s take a look at financial assets like gold and bitcoin. Both assets have the sound money principles of (a) being outside the system and (b) immune to any person or group creating more of the supply. Gold is the analog application of sound money principles and bitcoin is the digital application.
While they share the sound money principles, their performance during the last 12 months couldn’t have been any different.
Bitcoin is up nearly 250% over the last 12 months, while gold is down 10%. The nominal returns are shocking. The real returns are even worse. Gold is down over 15% in real returns given the recent inflation numbers. Not exactly a great store of value, nor a safe haven asset.
This brings me to an interesting point — we may potentially be watching the destruction of a narrative in real time. Gold has served as an inflation hedge and a store of value for thousands of years.
That narrative is based on the collective buy-in of millions of people around the world. Once the narrative changes though, the underlying asset can be damaged long term. Think of this as a financial asset serving at the whim of the people.
As we can see retroactively, investors were better off allocating to digital sound money principles compared to the analog version. As an entirely new generation of investors internalize this fact, it will likely have long lasting impact in future economic crisis.
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