Gold and silver outperform stocks and bonds during stagflation

As turmoil in financial markets unnerves investors, a larger economic crisis may be starting to unfold. 

The Federal Reserve’s first steps toward tightening monetary policy are exposing vulnerabilities in the highly leveraged economy. The Fed spent years injecting the economy with artificial stimulus. Now it is trying to take that stimulus away without causing a crash.

On Wednesday, the Fed raised its benchmark interest rate by 50 basis points. That was the central bank’s biggest hike in 22 years.

Fed officials are trying to restore their wrecked credibility on fighting inflation. At the same time, they are trying to engineer a “soft landing” for the economy. Achieving both objectives may prove to be impossible.

As wrong as Fed chairman Jerome Powell was about inflation being transitory, he may be just as wrong about the economy avoiding a recession. 

Steve Forbes warned Fox Business viewers that the central bank’s manipulation of interest rates may induce the economy to go from Fed-fueled boom to bust.

Steve Forbes: When they use the word “soft landing”, that's Fed speak, they hope to slow the economy, but not push it into a recession.

Jerome Powell: It's a strong economy, and nothing about it suggests that it's close to or vulnerable to a recession.

Steve Forbes: What it (the Fed) should be doing instead of trying to manipulate the activity of the economy and this idea that if we have a lot of people doing things that's bad for inflation because prices go up, it's nonsense. History shows it's nonsense. Just focus… they should say… "We're focusing on a stable value of the dollar. We're looking at commodity prices. We're looking at the gold price."

Gold and silver had another rough week, but platinum has shown some relative strength.

Other markets are faring far worse than precious metals this year.  The bond market has put in its worst performance in decades. And stock market indexes are at risk of moving from correction to crash under the weight of higher interest rates, higher inflation, and a deteriorating economy.

Last week’s shocker of a GDP report showed the economy contracting by 1.4% in the first quarter. While some dismiss it as a statistical fluke, other signs of a slowing economy are gathering. 

This week’s report on productivity showed hourly output per worker plunging at a 7.5% rate – the worst reading since 1947. 

Meanwhile, the U.S. trade deficit grew to a record $109 billion. 

The extreme swings being evidenced in markets and the economy are the result of monetary policy shifting from ultra-accommodative to less accommodative.  

Every time the Fed embarks on a rate hiking campaign, it causes booms to go bust. Easy money policies that enabled and fostered the booms never get fully unwound, though. There is only so much pain Wall Street and Washington, D.C. will tolerate before imploring the Fed to begin easing again.

The Fed will never get to the point of conquering inflation and promoting true price stability. The incentives for policymakers to continue pursuing excess currency creation are simply too great. 

That doesn’t mean Fed policies won’t continue to inflict damage to the bond market, the stock market, and the economy. Powell has all but promised additional rate hikes in future Fed meetings.

With rates heading higher, at least for the time being, inflation continuing to rage, and the economy sliding toward a contraction, there are few places for investors to hide. During periods of stagflation, most asset classes lose value in real terms.

That’s what happened during the stagflationary 1970s. Rates rose, bond values fell, and stock market indexes showed negative real returns.  In fact, when adjusted for inflation, the Dow Jones Industrial Average lost 75% of its value from its pre-1970 peak to its 1982 low.

There were few places to hide during the 1970s besides precious metals. From 1970 through 1979 – which included periods when the Fed was hiking rates aggressively – gold surged 15 times higher. That was more than enough to generate positive returns after inflation!

Silver during the late 1970s performed even better, leading to a spectacular price spike that has never been exceeded.

Even if we don’t see another precious metals bull run of similar magnitude this decade, there is still a good chance that gold and silver will hold up better in this challenging environment than both stocks and bonds. And there is still time for investors to position themselves in physical bullion before it becomes too scarce or too expensive to obtain.