The basics of inflation and how collectible real assets shine when it accelerates

On your last trip to the supermarket or local gas station, you may have noticed that the prices for bread, juice, vegetables, and gas have gone up significantly. Or maybe you went to your favorite restaurant for dinner and noticed that the portion size of the dish you usually order is now much smaller. Back at home, you turn on the TV and watch the media report on the continuing efforts of central banks to gain control over a high rate of price increase in various countries.?

You may be wondering what more expensive groceries have to do with the financial performance of a classic Lamborghini. Well, more than you think. The macroeconomic phenomenon that lies behind the currently high costs of living is called inflation. The following lines take a closer look at inflation, including its causes and effects. A distinction is loosely made between moderate inflation (up to 5 %), accelerated inflation (5-10 %), galloping inflation (> 10 %) and hyperinflation (> 50 %).

At Silverpine, we strive to provide useful information on the topics of alternative asset ownership, car culture, and financial investing. In our recent blog articles, we have often mentioned the term inflation and discussed its impact on the price performance of real assets. As inflation reached 40-year highs in many countries, the major central banks, namely the FED, EZB, Bank of England and Bank of Japan, began to tighten monetary policy in an effort to tame it.

Without a doubt, high inflation rates have a detrimental effect on consumers, companies and investors alike. Inflation itself is a complex field and even the most renowned experts often only make cautious predictions about it. From an investor’s perspective, it is important to know that some assets tend to outperform others when inflation numbers are rising. In a market environment that is disrupted by high inflation, an investment portfolio should be well-balanced to weather the volatility ahead.

COVID and the war on Ukraine fueled inflation

By definition, inflation is a broad increase in the price level of goods and services in an economy. Not only do the prices of individual goods and services rise, but prices in general. As a result, each unit of currency, such as a Euro, US dollar or Chinese yuan, now buys fewer of these goods and services. The currency loses purchasing power and eventually real value.

A country’s inflation rate is calculated to measure the general price increase over a certain period of time. To be more specific, this figure represents the annualized percentage change in the price of a weighted basket of goods and services that an average household would typically buy. The price of this basket is tracked by an index, known as the Consumer Price Index, or short CPI.

The International Monetary Fund (IMF), the major financial agency of the United Nations, dedicates itself to the task of monitoring the international monetary system to secure overall financial stability. The organization regularly provides insight into the inflation rates of its members. Here is a list of a few countries and their CPI changes over the last three years:

As mentioned in previous articles, the year 2022 was marked by sharply rising inflation rates in many countries around the world. In order to fight high inflation, central banks began to gradually raise the key interest rate (a monetary policy action known as quantitative tightening). The initiated measures begin to take effect and prices rise at a slower pace – inflation cools, but still remains at levels far from target rates. But what actually causes general price levels to rise to such highs? Here are some factors that promote inflation:?

• High production costs.?Within the concept of cost-push inflation, companies pass increased production costs on to customers in the form of higher prices. Reasons for higher production costs can be war or natural disasters that lead to a shortage in energy and material. About a year ago, Russia invaded Ukraine and energy prices skyrocketed.?
• High aggregated demand.?A strong increase in overall economic demand can lead to higher prices. Demand-pull inflation happens when consumption increases strongly and too much money chases too few goods. In the past years when COVID hit international markets, central banks issued large amounts of fresh capital to prevent the global economy from collapsing.?
• Price/wage spiral.?If workers expect high inflation in the future, they ask for higher nominal wages to preserve their purchasing power. If successful, employers pass on the higher labour costs to consumers by raising their prices. Consequently, workers might again push for more money as they are also confronted with higher living costs – a vicious circle.?

Unlike traditional assets, classic cars performed well in the high-inflation environment of 2022?

What does a high inflation rate mean for consumers, firms and investors? Well, first of all, consumers suffer from a loss of purchasing power and therefore living standards as they now get fewer goods and services for their money. High inflation is also bad news for savers. If the inflation rate is above bank interest rates, as it is at the time of this writing, savings lose value.?

How do stock markets react to high inflation? At first, the higher prices may allow firms to generate greater profits. In the medium- and long-term, however, companies experience declining demand, since many consumers can no longer afford the goods and services as before. Ultimately, this leads to a drop in corporate profits and share value.

Stocks are put under additional pressure when central banks start to raise the key interest rate, as risk-averse investors start to sell shares and move into assets such as fixed-term deposits, which are now paying more interest. In summary, traditional assets tend to underperform in a high-inflation environment while alternative assets start to shine.?

The chart below compares the performance of major stock indices and bitcoin with real assets over the past year. The precious metals gold and silver, as well as classic cars, are considered safe havens that serve as stores of value in times of market turmoil. Contrary to the popular belief that bitcoin is a safe haven asset, the cryptocurrency actually shows a strong correlation with the performance of tech stocks:

Combining the findings of both tables, it becomes clear that even precious metals barely allowed investors to preserve their capital. Gold underperformed inflation with a gain of only 6%, failing to live up to its reputation as the perfect store of value. Silver proved to be a reliable inflation hedge, allowing investors to protect their capital from loss of purchasing power.

Unlike owners of stocks and gold, investors in classic cars have every reason to celebrate, as their investment ended 2022 with an appreciation of 19.6 %, more than twice the local inflation rate. By investing in classic cars, investors not only protected their capital against loss of purchasing power but actually increased it!

Morningstar, one of the world’s most respected investment research firms, explains that gold has a mixed track record in past periods of high inflation, has historically had a relatively low correlation to inflation, and should not be considered a perfect hedge against it. According to Morningstar analysts, investors who are concerned about rising consumer prices should consider buying alternative assets that provide a much more reliable hedge.

These findings are also consistent with a long-term study published by US investment bank Morgan Stanley, which was conducted over a period of 25 years. The results of this comprehensive study show that adding alternative assets such as real estate, commodities and collectibles to a portfolio can reduce risk and increase returns over the long term.

The famous British explorer James Cook who lived in the 18th?century once said, that “inflation makes the wealthiest people richer and the masses poorer”. Cook would surely be astonished to learn that today’s opportunities allow even smaller investors to protect their capital. And that is what we work on every day at Silverpine: we strive to ease the entry into the world of alternative assets by offering shares of iconic collectible cars, one of the most exciting portfolio hedges, to everyday people.?

Your key takeaways

• Inflation means a broad increase in the price level of goods and services in an economy and high inflation has detrimental effects on consumers, companies and investors alike.?
• In 2022, inflation jumped to a record high in many countries around the world, consequently, central banks started to increase the key interest rate to tame it.?
• While traditional finance suffers from rising consumer prices, gold has mixed track records during past inflationary periods and could not live up to its hype as a potent hedging tool.
• Experts and studies explain that investors who want to protect their funds against the effects of high inflation and stock market downturns should consider investing in alternative assets.