As I have described before, there are two asset classes that I have tied the fate of my portfolio to. The first is agriculture, which makes up 60% of my portfolio. The second is gold, which makes up another 30%.
These two asset classes are tied together, at least in part, by a single thesis. To paraphrase David Roche from a book I just finished, called the The New Monetarism, this thesis is:
“We have been in a 25 year period of disinflation. From 1982 onward, global price increases slowed year after year. That period is now ending, and a prolonged period where inflationary pressures dominate has now begun.”
In New Monetarism, five reasons are given for the 25 years of disinflation that we have experienced:
1. Beginning in 1982, central bankers started to target low inflation as a priority in monetary policy;
2. Globalization empowered producers of cheap goods and services to sell their product to rich folks;
3. The internet created global competition in consumer markets that shifted the pricing power from the producer to the people;
4. Technology developed to make it easier for business to manage its global supply chain;
5. Government began to empower rather then strangle markets.
I would add that changes in global trade flows created a situation where surplus dollars in developing countries were re-invested in developed world assets, helping to keep interest costs down, which in turn helped keep inflation expectations down.
The disinflationary dynamic is changing. Inflation is sneaking back into the global system in many ways. This argument was condensed by Donald Coxe by describing four shortages that are underlying inflationary pressures. Taken from his Basic Points publication, ”Bye-bye Bond Bull,” written in April of 2007, these shortages are:
1. Energy: The Asian Century’s first creation of global scarcity— energy—came out of nowhere. The IEA’s high-priced roster of tax-exempt Parisian boulevardiers was shocked… shocked.
2. Metals: The next to be shocked were managements of major mining companies who were happily shorting copper at 90 cents a pound, only to learn that China had created its second global scarcity.
3. Grains and Oilseeds: The third Asian-spawned scarcity—feed grains and oilseeds—has just arrived... The coming rises in prices for meat, eggs, and dairy products will reflect the overall supply/demand imbalance of coarse grains and soybeans while the soaring middle class in China, India and elsewhere in the Third World expands its diets (and midsections) with non-vegetable proteins.
4. Workers: The fourth shortage story is the multi-decade collapse in reproduction. Before the industrial world began outsourcing jobs to China, it had begun a process that would ultimately ensure that outsourcing and soaring trade deficits would not lead to widespread unemployment. The worker never born is the worker never unemployed.
Again, Coxe made these arguments in April of 2007. Since that time, events have unfolded that, in my opinion, add two new pillars to the inflationary structure.
At the time of the Basic Points publication, central bankers were still acting vigilantly against inflation. This is no longer the case. Central bankers are now being forced to abandon their inflation-hawk bent because the global system is in dire need of liquidity, and banks are in dire need of low interest rates.
The second recent phenomenon is that Asian export prices are rising. As Andrew Hunt points out, "as the Asian domestic recovery has gained momentum, the pressure on the region's productive resources has increased and inflation has emerged. Crucially, these inflationary pressures have extended to the region's export prices and this exportation of inflation is already placing upward pressure on consumer goods prices in the Western economies."
There is not a consensus on what this means; some commentators, like The Economist, believe the rise in export prices is more the result of currency adjustments then the beginning of an underlying inflationary trend in Asia. But while the degree of inflation in evidence is debatable, what is less debatable is that Asia will not be exporting deflation to the degree that it has in the past.
Meanwhile, the four original pillars have only gotten stronger. Oil is over $100. Copper has risen, not fallen, even in the wake of a global slowdown. Grain prices have gone hyperbolic.
And the birth rates trend will not reverse itself quickly. I was reading another book this weekend, Sherry Cooper's “The New Retirement.” She points out that labor force growth rates in Canada will half from 1.4% to 0.7% by 2011. And by 2020, labour force growth rates will be 0.02%. In the United States, by 2030, the skilled labour shortage could be as much as 30 million workers!
In the classic book Reminiscences of a Stock Operator, the fundamental thesis of Larry Livingstone was to examine the underlying conditions and invest accordingly. This has been put in other ways, such as the common precept that 85% of your returns come from sector selection, while 15% come from the selection of individual stocks.
In my opinion, this is the underlying trend. This is the long-term story. There will be bumps in the road. We may see the deflationary forces brought on by the housing collapse win out for a time. We will not move straight up to high single-digit interest rates or inflation rates. But the pressures are undeniable, and the trend has clearly changed.
To read more work by liverless, visit his blog at Reminiscences of a Stock Blogger.
This article was written by a member of the Stockhouse community.