To paraphrase
Einstein, not everything worth measuring is measurable and not everything
measurable is worth measuring. The purchasing power of money falls
into the former category. It is worth measuring, in that it would
be useful to have a single number that consistently reflected the
economy-wide purchasing power of money.
However, such a number doesn't
exist.
Such a number
doesn't exist because a sensible result cannot be arrived at by
summing or averaging the prices of disparate items. For example,
it makes no sense to average the prices of a car, a haircut, an
apple, a dental checkup, a gallon of gasoline and an airline ticket.
And yet, that is effectively what the government does – in
a complicated way designed to make the end result lower than it
would otherwise be – when it determines the CPI.
The government
concocts economic statistics for propaganda purposes, but our point
here is that even the most honest and rigorous attempt to use price
data to determine a single number that consistently paints an accurate
picture of money purchasing power will fail. It will necessarily
fail because it is an attempt to do the impossible.
The goal of
determining real (inflation-adjusted) performance is not completely
hopeless, though, because we know what causes long-term changes
in money purchasing power and we can roughly estimate the long-term
effects of these causes. In particular, we know that the purchasing
power of money falls due to increased money supply and rises due
to increased population and productivity. By using the known rates
of increase in the money supply and the population and a 'guesstimate'
of the rate of increase in labour productivity we can arrive at
a theoretical rate of change for the purchasing power of money.
This theoretical rate of purchasing-power change will tend to be
inaccurate over periods of a year or less but should approximate
the actual rate of purchasing-power change over periods of five
years or more.
We've been using the theoretical rate of purchasing power change,
calculated as outlined above, to construct long-term inflation-adjusted
(IA) charts for almost two years now. Here are the updated versions
of some of these charts, based on data as at the end of May.
1. In current dollar terms, the oil price peaked at just under $200/barrel
in 2008 and at around $170/barrel in 1980. It is now only slightly
above its 40-year average.
We doubt that oil will ever again trade below $50/barrel in nominal
dollar terms. Also, the 2008 peak was almost certainly the secular
variety, so we probably won't see the IA oil price trade above its
2008 peak any time this decade. If oil does make a new high in IA
terms within the next few years it will be because of a major Middle
East conflagration that greatly reduces the global supply of oil,
not because of rising demand or geological limitations on supply.
2. As is the
case with oil, in IA terms the copper price probably made a secular
peak in 2008. As is also the case with oil, the IA copper price
is now only slightly above its 40-year average.
Falling demand due to a global recession over the next 12 months
could cause the copper price to drop back to $2.00, but we doubt
that it would stay that low for long because economic weakness always
prompts central banks to boost the money supply.
However, future
rounds of QE (or whatever other name they give to the money pumping)
probably won't do anywhere near as much for the IA copper price
as the earlier rounds did. Another way of saying this is that copper
probably won't be one of the main beneficiaries of future monetary
inflation. One reason is that China's construction boom is turning
to bust. Another is that the high prices of the past six years have
increased the current and future supplies of this metal.
In 2012 dollar terms we think a copper price in the $2.50-$3.50
range is about right. We would therefore steer clear of copper mining
projects that required a copper price of much above $3.00/pound
to be economically robust and we would be wary of low-grade copper
projects with unknown economics.
3. In early
2008, the combination of fear that electrical power shortages in
South Africa would severely disrupt the global platinum supply and
fear of Fed-sponsored dollar depreciation drove the IA platinum
price above $3000/oz (about $2300/oz at the time, which is the equivalent
of just over $3000/oz in terms of today's dollar). This will probably
turn out to be a secular peak for the IA platinum price, although
platinum stands a better chance than either oil or copper of exceeding
its 2008 peak in IA dollars.
There are two reasons for this. First,
platinum supply is more concentrated and therefore more vulnerable
to disruption than oil or copper supply. Second, we expect that
platinum will benefit from the continuing upward trend in the IA
gold price.
We may be interested in buying platinum if it drops to $1200/oz.
4. The IA gold
price continued its long-term upward trend following a normal intermediate-term
correction during the 2008 crisis. It is yet to experience a major
upside blow-off like it did in the lead-up to its January-1980 peak
and like the oil, copper and platinum markets did leading up to
their 2008 peaks.
5. In nominal
dollar terms, silver's April-2011 peak was a test of its January-1980
peak. In IA terms, however, silver's highest price in April of 2011
was only slightly more than one-third of its 1980 peak.
Silver's January-1980 peak was so extraordinary that it will possibly
never be exceeded or even seriously challenged in IA terms, but
there's a high probability that silver will handily exceed last
year's peak in IA terms before its long-term bull market comes to
an end. This is largely because although industrial demand plays
a much bigger role in the silver market than in the gold market,
investment demand is still the primary driver of silver's long-term
bull market. Furthermore, the same factors that should continue
to boost the investment demand for gold (government and central
bank stupidity in all its forms) are likely to do the same for silver.
6. Because
the official "inflation" indices chronically understate
the reduction in currency purchasing power, using these indices
to calculate inflation-adjusted performance overstates the performance.
That's why Malthusians such as Jeremy Grantham are able to use CPI-adjusted
charts of the CRB Index to support their theories that the world
is about to run short of valuable agricultural and industrial commodities.
These CPI-adjusted charts suggest that the ultra-long-term downward
trend in "real" commodity prices has ended, an implication
being that commodity supply is now in a long-term downward trend
relative to real commodity demand.
The picture is very different if our preferred method is used to
adjust for the effects of inflation. As illustrated by the following
chart, the IA CRB Index made a new all-time low in 2001 and then
peaked in 2008 at well below its 1974 and 1980 highs. There is no
evidence that its long-term downward trend has ended.
Reprinted with permission
from The
Speculative Investor.
June
18, 2012
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