The stars are aligning for the return of inflation in 2021. Not fake inflation either, but the real stuff.
Inflation’s return could thus fuel a migration into tangible, short-duration assets, which would be a major shift from the dominant market configuration of the past few years.
Before we get into what that means (which may actually require a follow-up piece), let us address the world’s premier inflation hedge: Bitcoin.
As of this writing, Bitcoin has surged to new all-time highs yet again. As we complete this note, it is trading above $23,000 per coin.
There is very much an “inflation hedge” angle here, according to Ruffer.
What is Ruffer, you ask? It is a large U.K. investment firm with $27 billion under management.
Ruffer announced this week it holds approximately $750 million worth of Bitcoin — that is three quarters of a billion dollars — as an inflation hedge. (Their stake is likely worth more now, as Bitcoin has risen substantially since the announcement.)
So Ruffer, a sizable institutional player running tens of billions, has enough conviction in Bitcoin — as an inflation hedge, per their own stated reasoning — to put 2–3% of their investable assets in BTC.
Another money manager who made Bitcoin-related news this week is Scott Minerd, the Chief Investment Officer (CIO) of Guggenheim Partners, a leviathan-sized investment firm with $230 billion in assets.
In a segment on Bloomberg television this week, Minerd said his research team’s findings suggest Bitcoin should be worth $400,000 per coin. And again, that is not some minnow talking, but a whale of whales — a man who stewards $230 billion.
The news from Ruffer and Guggenheim comes in the wake of Massachusetts Mutual, a 169-year-old life insurance company, with $235 billion in assets, announcing they had purchased $100 million worth of Bitcoin.
These mega-whales don’t care about the current Bitcoin price. Why would they, with potential upside of 10X to 20X or even more? They just want to build a small position and then sit on it. The upshot is that the mega-whales are so big, their “small” positions turn out to be huge.
More than 18 months ago, we explained in detail to TradeSmith Decoder readers how a point would come when institutional investors would start allocating a low-single-digit percentage of their portfolios to Bitcoin, and that the risk-reward relationship would shift in such a manner that owning Bitcoin, at some modest allocation level, would be an absolute imperative.
That is exactly what’s happening now — which is why Bitcoin is doing its thing (smashing old highs), and why Bitcoin, along with an assortment of Bitcoin-related equities, has long been the largest position in the TradeSmith Decoder portfolio.
But getting back to inflation: There is a consensus building among large-scale money managers that Bitcoin is a high-quality inflation hedge, and may even be a superior inflation hedge to gold.
And inflation is very much on their minds, for reasons that are visible in the U.S. dollar chart below:
The U.S. dollar index has broken a bull trend of nearly 10 years’ duration (dating back to mid-2011). The dollar’s weakness in recent months has been remarkable, and there are clear signs the downtrend is likely to continue.
By various trade-related metrics, the U.S. dollar looks very oversold right now — possibly more oversold than it has been in decades, with respect to the trading community leaning hard into a bearish positioning stance.
And yet, as things stand now, traders and money managers may not be the relevant group. The real question is what’s happening with central bank reserve managers and sovereign-wealth-fund investment managers all around the world.
Central banks have historically held a large portion of their foreign exchange reserves in dollar-denominated assets. That means assets like U.S. treasuries, U.S. corporate bonds, and U.S. equities. All such assets, being dollar-based, can instantly be liquidated for dollars in a pinch.
Sovereign Wealth Funds (SWFs), which manage hundreds of billions in assets on behalf of trade surplus nations — think Norway, Qatar, Singapore, and so on — have also historically had a large chunk of their capital in dollar-based assets, again ranging from U.S. treasuries to U.S. equities.
Here is our view: Central banks and SWFs the world over are “lightening up” on their dollar asset positions. That does not mean they are abandoning their dollar holdings. It does not mean they are making a dollar crash call or declaring the end of the U.S. empire. It just means they are cutting back in a meaningful way.
Central banks and SWFs are collectively the largest asset holders in the world. Their collective baskets run into the trillions, making all other players look like minnows.
So, ask yourself what happens when this group, collectively, decides to cut back its dollar asset weighting from, say, 60% of portfolio assets down to 40%?
The net result is a collective dollar outflow measured in the trillions. That is trillions’ worth of dollar-denominated assets — again, U.S. treasuries, U.S corporates, U.S. equities, you name it — getting sold on the margins rather than bought.
And this is happening not because the dollar is being abandoned, in our view, but because dollar assets were so dominant for the past few decades it is a normal adjustment to see things go the other way.
But what it means for global markets, practically speaking, is that the U.S. dollar downtrend could last for quite a while. If we are witnessing the footprints of a major sea change in terms of the world’s willingness to sit on U.S. dollar assets, we could see the dollar overall trending down and down for months or years to come.
But where would the capital be flowing to? If central banks and SWFs are selling out of their overweight U.S. dollar positions, what are they buying?
Well, as you may have noticed, there is a vaccine-powered global recovery en route. That is hugely bullish for Asia. It is hugely bullish for emerging markets in general. And it is hugely bullish for commodity-producing countries, and all kinds of entities that see higher prices as the result of a weakening dollar.
Meanwhile, in the United States, one-third to one-half of the country is experiencing Great Depression-level economic conditions. That economic pain will require lots of ongoing monetary and fiscal support.
But the top third of the U.S. economy is doing fine economically — possibly better than fine, thanks to home prices booming again.
This means that, as the U.S. economy recovers in 2021, the stimulus and “help” directed at the struggling lower half of the economy will juice the top half, as such that well-off consumers, casting off their pandemic shackles, will go into a spending frenzy.
When upper-half consumers go into their celebratory spending frenzy — think post-pandemic boom mentality, like the 1920s after World War I and the Spanish Flu — there are going to be substantial goods shortages due to demand, thanks to pandemic-related supply-chain disruptions and trade disruptions that still haven’t been repaired.
As if that weren’t enough, the Biden administration is very pro-labor, and the incoming department heads are very, very knowledgeable in terms of figuring out how to work the levers of the system. At the same time, finding ways to raise wages is good public policy, whether Republican or Democrat.
This means that, in addition to all the above, wage and labor costs will be going up. And investors will see it, and workers will celebrate it.
So, yes. Inflation is coming. Big inflation. Expectations are the first factor. A falling U.S. dollar is the second factor. Rising commodity prices will be the third factor, an overly stimulated top half of the economy clamoring for supply-chain goods in short supply will be a fourth, real upward momentum in wages and labor costs a fifth, mushrooming deficits a sixth, and on and on.
Tomorrow we’ll explain what that means for market regime change and “tangible, short duration assets” versus what we’ve seen the past few years.