"The Best Inflation Indicator"

01/06/2006 12:00 am EST


Mark Skousen

Editor, Forecasts & Strategies, High-Income Alert

Mark Skousen indeed wears many hats, as an advisor, economist, professor (at Columbia), and author (his latest book on Ben Franklin is rapidly rising in the Amazon ratings). Meanwhile, as a financial editor, he offers an intriguing new report, "The Best Inflation Indicator."

"For years, I had a fight with The Wall Street Journal editorial board over its front-page summary of market indexes, which highlights a dozen daily indicators, including stocks, bonds, oil, the dollar, etc. Yet it deliberately omitted the single-most significant asset that each day measures the level of geo-political and monetary stability around the world: Gold. Dan Henninger, deputy managing editor of The Journal, wrote me, ‘We do not believe gold is the best indicator of inflation.’

"Since the Keynesian revolution of the 1930s, gold has been relegated to a ‘barbarous relic’. The establishment prefers flat money to the gold standard. It wants government rather than the market to maintain authority over money. It doesn't want to legitimatize a "non-performing" asset that might be warning of trouble down the road. As they say in the commodity trading pits, ‘Gold is just another commodity.’ Wrong! Gold is not just another commodity. Today, let's find out why and what we should be buying right now.

"First, how many other commodities have served for centuries as money? Not oil, soybeans, or pork bellies. Moreover, unlike other commodities, gold is never used up in the production process. Annual production increases at a steady 1%-2% a year and is added to the total stock of gold, creating a monetary Rock of Gibraltar in a sea of instability. As a result, gold has always preserved its purchasing power over the long run. Granted, gold became more volatile as the world moved off the gold standard since the 1930s. But as Steve Forbes told me in a recent interview, ‘Gold is volatile because monetary policy is volatile. Gold is a constant, like the North Star.’

"In my economics classes at Columbia University, I demonstrate the long-term value of gold by holding up a $20 Saint-Gaudens Double Eagle gold coin. Prior to 1933, our grandparents carried this coin in their pockets as money. Back then, they could buy a tailor-made suit for one double eagle, or $20. Today, this same coin, which is worth between $600 and $1,000, depending on its rarity and condition, can buy the same tailor-made suit.

"Gold also has the amazing ability to accurately forecast the direction of the general price level and interest rates. Recently, I ran an econometric model with the assistance of John List, a top economist now at the University of Chicago. We tested three commodity indexes (Dow Jones Commodity Spot Index, crude oil, and gold) to determine which one best anticipated changes in the Consumer Price Index (CPI) since 1970. It turns out that gold proved to be the best indicator of future inflation, as measured by the CPI even better than oil. The lag period is about one year.

"Most of the media and the general public think oil is the premier indicator of economic performance. An energy crisis means a recession, right? Not always! Germany and Japan, for example, import most of their oil, but they avoided the 1979-82 recession. Today, energy prices have doubled, but there's no sign of recession.

"One reason is that the world economy has become more energy-efficient, and thus less dependent on oil and gas as the major source of energy. Douglas Bohi, director of the energy and natural resource division of Resources for the Future in Washington, DC, claims that energy accounts for only 3-4% of the total cost of producing goods and services in the US.

"Our econometric model also suggested that higher gold prices spell higher long-term interest rates. They tend to move together. Will gold stay above $500? Ultimately, gold is an inflation hedge. When gold declines, it means less inflation down the road. When gold goes up, it means more inflation ahead. What is gold predicting now? As the following chart shows, gold has been in a major bull market since 2001, when the terrorist attacks took place in New York and Washington.

Chart: http://www.investmentu.com/bin/c/u/20051212IUB.gif

What does this mean? Four things:

  1. War is inflationary. Since 2001, the Bush administration has dramatically increased government spending to fight terrorism and the war in Iraq. The Fed has been accommodating this increased spending with more money.
  2. Expect more inflation ahead, as measured by the CPI and other price indexes.
  3. Expect higher interest rates as inflation heats.
  4. Higher inflation is bullish for hard assets in 2006. Buy gold and silver coins, mining stocks, oil and gas, and real estate. I suggest RS Global Natural Resources Fund (RSNRX ), with a five-star Morningstar rating."

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