Since March 2022, the Federal Reserve has hiked rates faster than any other time in U.S. history. Record deficit spending (to the tune of $5 trillion) during the pandemic required this historic response. Just yesterday, the Federal Reserve began lowering interest rates.
Markets and politicians alike are pressuring the Fed to lower as fast and as much as possible.
Many experienced investors are suspicious of whether the Fed is coming to its own conclusions or bowing to pressure, and I don’t blame them. The Fed tries to pretend it’s all-knowing, second only to a super AI. In reality, it’s seven people with names like Lisa, Philip, and Christopher.
It’s impossible to know.
And that means we need to ask ourselves a very important question: What if the Fed is wrong?
Today, I’ll share data you’ve likely never seen. It’ll help us understand the past, so we can better prepare for the future. And I’ll give you a concrete – and surprisingly simple – way to protect yourself against inflation. And it works whether the Fed is making the right call or not. After all, we are responsible for growing and protecting our wealth. And Wide Moat Research’s No. 1 objective is to help you do exactly that.
Today’s U.S. Dollar is Yesterday’s Pennies
Can you guess what that gold line represents? It’s when President Franklin D. Roosevelt forbade “the hoarding of gold within the U.S.” Regular people and institutions were forced to surrender their gold to the Federal Reserve. That was the first of many steps that led to the fall in the value of the U.S. dollar shown above. And now, the dollar has never lost value like it has in the past four to five years. The line since 2020 has gone nearly vertically downwards.
That’s the erosion of our buying power staring us right in the face. Less than 100 years ago, the dollar was worth 10 times more than it is today. And if current trends continue, this problem is only going to accelerate. The government now spends trillions every year that it doesn’t earn. So, where do investors turn?
The Gold Standard
When it comes to fighting the government’s hardworking money printer, an obvious choice comes to mind: gold. But is it really the best? Let’s find out.
The chart above shows the relationship between the price of one ounce of gold (in USD) and the total number of U.S. dollars in circulation (M2 Money Supply). The Fed’s M2 metric isn’t perfect, but is the best available. If the see-sawing ratio above looks odd, you aren’t alone.
Since 1971 when Nixon dropped the gold standard completely (about where the chart begins), the ratio has been extremely volatile. Gold’s value should adjust with the amount of dollars floating around in predictable fashion. It doesn’t.
Other factors affect gold’s value much more than inflation or the money supply. Investors looking to hedge against those risks using gold believe they are taking the safe route. In reality, they are rolling the dice in a casino.
And just like in Vegas, sometimes they succeed. When inflation is on an absolute tear, gold does perform. That was the case between 1973 and 1979 when stagflation took hold and the price of gold rose at almost four times the rate of inflation. But the problem is that these periods are rare. Gold usually underperforms the other 95% of the time, and you have to be a true market wizard to time it right.
After that historic bull market in gold, prices rapidly crashed from over $600 to $300 an ounce (>50% decline). But inflation never went negative. It only slowed.
But for the sake of argument, let’s say an investor timed it perfectly. They waited to buy gold at the bottom of $300 an ounce in the early 1980s and avoided the entire crash. Even here, there is a major problem: the price of gold was lower 20 years later. Over those two decades, the dollar lost just over half of its purchasing power. Not only did the price of gold in U.S. dollars fall, but so did the currency gold was priced in. That’s 20 years and multiple economic cycles. No cherry picking here.
Adjusted for inflation, gold’s all-time high was in February 1980. Those investors have been waiting over 40 years to return to even. Don’t get me wrong; gold is certainly better than cash over the long term. And there are select periods where it beats inflation and just about every investment alternative handily. But the data doesn’t lie. Gold’s value relative to inflation and the money supply is extremely volatile, and it isn’t the magic solution many people wish it was.
Fortunately, there is a better and more reliable way to combat the unending money printing and decline of the dollar.
Battle Royale: Stocks vs Precious Metals
The value of the U.S. dollar has fallen from $1 to $0.14 in the past 50 years. An investor would need about a 600% return to break even after inflation.
The performance of the S&P 500 (red), Dow Jones Industrial Average (DJIA) (blue), gold (gold), and silver (silver) are shown in the chart below over the last 50 years.
Holding silver preserved buying power but with no margin of error. Gold did a little better, and thanks to the magic of compounding, its total return 50 years later was roughly double the inflation rate. Moving to stocks, the DJIA did three times better than gold over the period. The S&P 500’s performance was five times stronger than gold’s. And over almost every 10-year period, both stock indexes combatted inflation better than gold.
If you believe a 1970s-style stagflation nightmare is on our doorstep, some gold isn’t a bad idea. But you better buy and sell at the right times. In every other situation, the S&P 500 is a superior and more reliable way to beat inflation than all the major precious metals. That’s because the businesses behind stocks operate in the real world.
If the price of agricultural goods rises, you can expect to see that effect on the McDonald’s menu and on price tags in your local grocery store the very next week. Same with coffee beans and your favorite latte at Starbucks. Companies have a million different ways to deal with inflation. And since the billion-dollar companies in the S&P 500 index have the most resources and financial flexibility, they are better suited to deal with inflation than effectively everyone else.
So, if believe the Fed is lowering rates too fast – or not fast enough – history tells us that U.S. stocks are still a great place to invest long term.
Regards,
Stephen Hester
Chief Analyst, Wide Moat Research