By Stephen Leeb
The Complete Investor
Inflation is high, rising and likely to be with us for the foreseeable future. The Consumer Price Index, is at levels seen only at brief moments since the 1980s. And The Producer Price Index - which tracks prices businesses pay other businesses for goods and thus foreshadows consumer inflation trends - is at a 26-year high. But in contrast to 1981, when Paul Volcker was determined to slay the inflation monster whatever the impact on the economy, today anti-inflation zealots are nowhere in sight.
Volcker tamed inflation by bringing on a recession that by many measures was the worst downturn since the Depression. Today, with leverage in our economy infinitely greater, policymakers don't dare emulate him. Instead, they're pulling out all the stops to stimulate the economy, which should mean even higher inflation lies ahead.
Luckily, though, high and rising inflation isn't all bad. Low interest rates and high inflation translate into negative real rates, which should stimulate the economy. That's because when rates are negative, holding onto money is a losing proposition. This gives businesses and consumers alike every incentive to spend and invest.
Past periods of decidedly negative real rates - 1975 and 1980 - occurred as inflation was starting to wane and led to strong economies. This time, too, we're expecting a strong economic recovery. That's the good news. But in contrast to those past periods, this time around the recovery will go hand in hand with rising, not falling, inflation. That's why we continue to recommend gold as a primary hedge for what we think will be a very turbulent period.
To truly understand the dynamics behind inflation today, start with China. Its massive demand for raw materials is squeezing the markets for many commodities, with no end in sight. China's growth rate this year is expected to exceed 10 percent for the third year in a row, with stagnant growth in the U.S. apparently unable to make a dent in China's amazing boom and its effect on commodities.
The physical evidence of this growth can be seen in all the skyscrapers being erected across China, a building boom that is driving up the prices of both steel and its main ingredient, iron ore, Mining conglomerates such as BHP Billiton (BHP) and Rio Tinto (RTP) are benefiting as lump iron ore prices have tripled in recent years.
In turn, higher iron ore prices combined with rising demand have caused steel prices to surge 40 percent just since October. The Middle East has also been a big factor in rising demand, with more of the same expected in the future - according to the Gulf Organization for Industrial Consulting, steel demand in the Middle East will rise 30 percent in 2008 and double by 2010. In an effort to cut volatility in the steel market, the London Metals Exchange is rolling out a futures contract for steel - the first of its kind - allowing steel consumers to hedge against higher future prices. It also could result in large-scale speculation in steel, which up to now hasn't been a factor in the higher prices.
Price increases in steel and in a range of industrial commodities drive up overall inflation. In January, prices in China rose 7.1 percent year over year, the biggest one-month jump in 11 years. As Chinese demand pushes prices of raw materials higher, industries in China are raising prices to cover the higher costs as well as the higher wages they've had to pay. And this puts more pressure on prices in the U.S., a big importer of Chinese goods. No wonder we're urging you to buy a range of inflation protection, from gold to the following franchises Berkshire Hathaway (BRK/A), Coca-Cola (KO), Google (GOOG), Procter & Gamble (PG), and Schlumberger (SLB).
Editor's Note: Stephen Leeb is editor of The Complete Investor, P.O. Box 248, Williamsport, PA 17703, 1 year, 12 issues, $72. www.completeinvestor.com.
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