Focus on Core Inflation Is Misguided. Increased Food And Energy Costs Will Drive Ongoing Inflation

Is the current rate of "core inflation" transitory? Maybe. But not including food and energy in inflation calculations is misguided. Food and energy are excluded from core inflation because they are volatile. But excluding food and energy due to volatility only makes sense if the prices are bouncing up and down. Both food and energy costs are on a long term upward trend. So even if Jerome Powell hits his target of two percent core inflation, the cost of living coming out of consumers pockets is going to be greater than two percent. 

It seems ridiculous that after today's Consumer Price Index (CPI) report (9/14/2021), so much attention was given to that fact the Core CPI was only up 0.1% and below consensus expectations. Headline CPI rose 0.3% month-over-month, boosted by a 2.0% surge in energy prices and a 0.4% rise in food. While the headline CPI percentage year-over-year edged down to 5.3% from 5.4% it's hard to see how anyone can continue to claim inflation is transitory.

Climate change (or more accurately "global weather weirdness") is going to continue to play havoc with food production. Food shortages are a real threat in the near term, and highly likely in the future. As decribed in this article, "A world of hurt: 2021 climate disasters raise alarm over food security, human-driven climate change is fueling weather extremes — from record drought to massive floods — that are hammering key agricultural regions around the world. And has Jerome Powell been grocery store shopping lately? Grocery product prices are increasing and package sizes are shrinking. (Google shows 189,000 results for "shrinkflation")

Energy costs are also going to continue rising. The combination of reduced exploration spending and environmental regulations are curtailing oil and gas production much faster than clean energy is able to serve as a replacement. While oil is up to over $70 a barrel, natural gas prices are spiking even faster, particularly in Europe. According to the Wall Street Journal, "at their peak, U.K. electricity prices had more than doubled in September and were almost seven times as high as at the same point in 2020. Power markets also jumped in France, the Netherlands and Germany."

And as far as consumers perception of inflation goes: 1) prices at the grocery store, 2) the cost of filling a tank with gasoline, and 3) heating bills, are all extremely high visibility items. Consumers may not notice a 2% increase in core inflation, but they sure as hell notice increases in food and energy cost.

Thus, anyone that pretends that inflation is transitory based on "core inflation" is either wrong or knowingly attempting to put a spin the data. Keep your focus on the rise in headline inflation.

  

Transitory Inflation? Green Regulations, Global Weather Weirdness Crop Failures, Higher Wages, Will Lead to Persistent Inflation

There is no question that the 5.4% rate of inflation in the U.S. may come down as some of the factors leading this rate will drop. The semiconductor chip shortage is unlikely to last forever, and used car and rental car prices are almost certain to fall, as are other inputs leading the to current rate of inflation.

But in addition to the Fed's money printing, the following are all factors that will lead to persistent inflation, well above the Fed's 2.0% target

Green regulations will lead to suppy squeezes in oil, natural gas and key raw materials, including silver, and increase the costs of production for many manufacturers. Inflationary carbon taxes may also be coming down the road.

Global Weather Weirdness is leading to crop failures around the world. Drought and wildfires in California, frost in Brazil, and flooding in Europe and Asia are on the verge of creating food shortages. Global weather weirdness is not going away. The cost of food is going to continue increasing at a significant rate.

Wages in the U.S. are rising. The current labor shortages may or may not be transitory, but ongoing increases in the minimum wage are persitent and sticky.

The widely accepted myth that inflation is transitory will be proven to be wrong over the next 12 months. It may be elevated, but it is not transitory.

Will Silver Supply Deficit Lead To Biggest Short Squeeze Since Gamestop?

Did you miss the Gamestop short squeeze? For most investors, a rational fear of getting in too late and being the greater fool that paid the higher price for an overvalued stock and being stuck with a money loser with no buyers left at the purchase price saved them from over paying for Gamestock during the $400 per share height of the squeeze.. .

Well, there is another short squeeze in play. This one is moving at a slow pace, and is focused on a  deeply undervalued asset. The asset is silver. Silver is in a supply deficit and there is a huge short position in silver. At some point, the supply deficit will lead to an increase in price, and short covering may rocket the price higher.

The Supply Deficit

My forecast is that demand for silver in 2021 will exceed supply by at least 20%. 

The deficit in silver in 2021 will be due to three sources:1) an increase in commercial demand for silver due to growth in the new energy era products, including use in EV's, solar panels, and electronics, 2) investment demand as an inflation hedge; and 3) a short squeeze from purchases being fueled by the Reddit crowd.

Supply

1.0187  billion - Mining and recycling will produce slightly over 1 billion ounces of silver in 2021. 

Demand

1.237 billion - Demand for silver will exceed supply in 2021 by at least 218 million ounces

Components of demand

- 600 million - Commercial users will consume about 600 million ounces in 2021

- 174 million - Demand for silver for jewellery will consume 174 million ounces

- 257 million - Purchases of bars and coins were forecast to take 186 - 257 million ounces off the market. But this was prior to the Reddit launch of a silver squeeze movement. The silver squueeze movement has vastly increased consumer demand for silver. 

- 200 million - The launch on Reddit of the silver squeeze in late Januuary has expanded the number of silver buyers and significantly increased demand. This new horde of buyers is buying both physical (coins and bars) and paper investments (Silver ETF's and futures). And the flood of new buyers has energized long time silver bugs, who are increasing their purchases of silver..The subreddit, WallStreetSilver, has grown to 64,000 members since it's creation just four months ago and is adding 100's of new members every day.. A leading ETF/Trust, PSLV, has had to add almost 40 million ounces of silver to their inventory already in 2021 in order to have sufficient supply to meet potential redemptions . At this pace, PSLV will take over 100 million ounces off the market in 2021. . 

The impact of the increase in demand for this precious metal with a limited supply is evident in the retail market. Local coin shops and online dealers are short on supply and are adding huge premiums to the price for coins and bars.  The price for silver coins and bars is 20% above the futures market price of silver, currently in the $25-27 oz. range. (The futures market is based on 1000 oz bars) This divergance in the price of coins and bars versus the price of 1000 oz bars and futures is unsustainable. The arbitrage opportunity is simply too large to remain is place. And not surprisingly, the inventory of 1000 oz bars is being drained from the vaults of the Comex and the LBMA in London. The Comex (silver futures exchange) inventory of silver available for delivery has declined from 151 million ounces in mid Febuary to 117 million ounces as of April 26.

Potential Short Squeeze

Silver is the most shorted commodity. As shown in the chart below, the 8 largest traders of silver on the Comex are short 170 days of production. Currently, sellers of Comex futures are short 860,000,000 ounces of silver (172,000 SI contracts @ 5000 troy ounces per contract). And this is just the transparent shorts on the Comex. The total numbr of ounces sold short worldwide is an opaque number but could be a significant multiple of the shorts on the Comex. 

There are many commentators that are skeptical that the silver shorts can be squeezed. However, even if the skeptics are correct, silver remains a good investment opportunity. Pandemic fueled fiscal deficit spending and monetary injections by central banks are debasing fiat currency. The Fed is actively working to increase inflation into an environment where prices are already rising. The Fed's assumption that inflation will be transitory seems short sighted. Further, the Biden administration announces a new spending plan every week. And don't even get me started on how absurd and dangerous MMT (modern monetary theory) is. Has MMT promoter Stepanie Kelton ever heard of the Weimar Republic? 

Conclusion

There is a strong likelihood that the price of silver is headed higher. There is a supply deficit and an increase in demand. The question is not whether the price will increase, but whether it will A) rocket higher due to a short squeeze, or B)  slowly grind higher due to increased demand. 

Which Is More Insane: Powell's "Inflation Will Be Transitory" or Kelton's MMT?

U.S. fiscal and monetary policy is being run by fools that seem oblivious to the dangers of hyper-inflation. I would suggest that the physical gold and silver buyers that want lower prices so that they can add more to their collections will soon be disappointed. Inflation is coming, and with it, even the price of gold and silver should rocket upward.

Jerome Powell and the Fed are actively working to increase inflation. The Fed's monthly purchases of $120 billion of bonds during a time when the price of everything is going up, the US govt. is disbursing helicopter money, and vaccinations may release a tidal wave of consumer spending, is almost certain to get the job done. However, Powell claims that the upcoming inflation will be "transitory". Maybe he is correct, but my guess is that once the inflation genie has been released, it will be impossible to put back in the bottle. And the Fed does not have the tools that Paul Volcker utilized to tame inflation. A taper in bond buying would lead to a stock market crash, and a significant increase in interest rates would lead to the US deficit exploding.

But I judge that Modern Monetary Theory (MMT) is even more insane than unbottling the inflation genie. At least Powell has a chance or being correct that an increase in inflation to greater than 2% per year may be transitory. Stephanie Kelton's theory that the Federal defict doesn't matter is truly insane.

My crystal ball on when US inflation will start exploding and what impact it will have on the price of gold and silver is cloudy. But I'm all in and judge that $2,500 gold and triple digit silver is coming in the fairly near future.

On a short term basis, I would not be surprised if the spot price of gold and silver fell even more. The dollar debasement by the US is being matched by other central banks around the world, particulary the EU and Japan. This is allowing a widely followed dollar index, the DXY to rise, and precious metal traders typically sell spot when the DXY is going up. It seems to be a race to the bottom, but only a matter of time before the US pulls ahead in this fiat currency race to the bottom and the dollar resumes its decline.

If the price of gold and silver continues its short term decline, this offers the benefit of allowing precious metal investors to dollar cost average down. Gold and silver investors will come out on top in the medium and long run.