Alongside Russia-US tensions and crisis-driven spikes in the oil price, suddenly inflation is back making headlines. The Pound’s Brexit slump doesn’t explain this global upturn in the cost of living. In truth it has long been coming, and its momentum could pose a bigger threat to UK investors’ income than it does to real wages.
2017 so far has seen consumer prices in the UK show their quickest year-on-year acceleration since early 2011. Following the global deflation scare of the banking crisis however, the Billion Prices Project from MIT’s Sloan School of Management said inflation had already “turned a sharp corner” in 2015. Underlying US inflation, according to the Federal Reserve’s index of “sticky price” good and services, has been trending higher since 2010.
So like last June’s Brexit vote, early 2017’s pop in oil prices can’t take all the blame either. Indeed, the cost of Brent crude fell last month by one-tenth against the Pound, yet annual inflation in the UK’s Consumer Price Index held at February’s 3.5-year high.
Beating the Bank of England’s official target of 2.0% annual CPI inflation for the second month running, that rising cost of living has pushed average earnings growth down near zero in real terms according to the ONS. It has also pulled the purchasing power of the average weekly wage back down to a level first reached at the start of 2006.
That’s another reason why the Bank shows no sign of daring to raise interest rates from near-zero any time soon. So the cost of inflation’s 2017 upturn is hitting savers and retirees as well. To balance this out, income investors might have to consider buying the ultimate non-yielding asset – gold bullion.
Because gold pays no income, financial advisors rarely suggest buying it. That search for yield misses the role gold can play in a diversified spread of investments, smoothing returns from other, typically better-performing assets. Looking at the last 40 years of total annual returns, a model portfolio of 60 per cent UK shares and 40 per cent Gilts would almost have halved its worst year of losses (2008) by switching 10% into gold. That same allocation would, over the last two decades, have nudged total returns up from 7.8% to 8.0% per year on our analysis.
People more commonly see gold as a hedge against inflation. They’re half wrong. Gold fell throughout the 1980s and 1990s, even as inflation held near its strongest peacetime levels on record. Only the 1970s ever saw the cost of living rise faster. What mattered was that, in contrast to the 1980s and ’90s, the ’70s also gave investors negative real rates of interest.
From 1971 to 1980, bond yields repeatedly lagged the pace of inflation, paying an average annual rate of minus 1.9% on 10-year Gilts. With those negative real rates eating as much as 11% of your money in 1975 alone, gold prices leapt. Bullion jumped 15-fold across the decade in Sterling terms, beating RPI inflation four times over.
Gold’s more recent bull market also came as real rates of interest fell below zero. Priced below £160 per ounce when Gordon Brown began selling half the UK’s reserves in 1999, gold peaked near £1200 twelve years later. Ten-year Gilt yields meantime sank from 4.1% to minus 3.1%, rallying as gold prices then retreated but falling back to minus 2.0 per cent this March. Gold has recovered to £1025 per ounce this Easter, and has only been higher for 18 months in total for UK investors.
Back at gold’s previous peak of 1980, wringing inflation out of the system meant jacking up interest rates, as US Fed chairman Paul Volcker proved in the teeth of fierce political and corporate opposition. Bond prices sank as returns from new fixed-income debt jumped, but hard-won stability followed, with 10-year Gilt yields paying an average 4.5 percentage points more than inflation between 1981 and 2000. Gold prices fell accordingly, dropping by two-thirds in real terms by the turn of the millennium. Because who needs the ultimate hard money when you’ve got strong real yields and inflation-beating interest on cash? And who shouldn’t consider an allocation to gold if they fear yields and interest rates will now lag inflation by an ever-worsening margin?