Rick Rule - Institutional Buyers to Ignite Precious Metals Bull Market

Speaking with Wall Street Silver earlier this week Rick Rule argued that it will take more than one year of 7% CPI expansion for main street to jump on the inflation fear train. The last forty years of declining real interest rates and highly accommodative monetary policy have meant that investors don’t fear inflation or the consequences of higher interest rates. Inflation hasn’t been here for long enough to really scare people, two full generations of institutional money managers haven’t experienced it, so why would they be afraid?     

Gold holdings of institutions are at historic lows, approximately 0.5% of portfolios. Reversions to the mean of 1.5-2% would see a tripling of demand amid fixed supply from existing mines in operation. If major funds such as the Saudi Sovereign Fund, Norges Bank or Stanford Endowment etc were to start increasing their holdings in precious metals from zero to the three decade mean, then the buy pressure would be immense.

Rule sees the other major fire under precious metals to be the rapidly reducing argument for fixed income in institutional funds. Whereas conservative portfolios for sovereign wealth funds, pension funds or family offices that only need to preserve purchasing power without taking on unneeded risk have been able to maintain a 60/40 stock to bond portfolio split, the 40 in that split continues to deteriorate. 40% of the portfolio generating a loss has inspired the moniker “TINA” - There Is No Alternative - that is to say, one can only allocate to stocks. Rates would need to rise to 7% for bond holders just to break even - 28 times current levels. Larger institutions finally moving out of fixed income altogether due to the combination of low nominal rates and high inflation (i.e. negative real rates of return) will be the major shift that brings major cash flows into the precious metals boosting spot prices.

A significant cause of the faith in the “transitory” narrative is that many people blame price rises on Covid, and that they expect that the perpetual state of panic will subside suddenly. There is an expectation that debt levels will act as a deflationary force, tempering the monetary expansion in a tug of war. Rule pushed back on this saying that debt inspired deflation would prevail in a free market, but given that the biggest bag holders are governments, deflation is not politically feasible. Voters won’t tolerate a short term crash to wipe out the debt with liquidations and reallocation of resources from weak to strong hands. Rather than be in office during an almighty crash, politicians and the central bankers that enable them, would prefer to defer the day of reckoning and kick the can down the road. 

There is also the expectation in the mainstream that when we are released from restrictions, that supply chains, production and as a result prices will come down in tandem. As an example, rising gasoline prices were up 49.5% in 2021, while not helped by supply chain shortages, lack of exploration and delays in bringing new supply into production due to lengthy environmental approval processes. Those looking forward to discounts of 33% are coming to the petrol pump once lockdowns are over are going to be “Waiting for Godot”.

Rule argues that it will take a second full year of 7%+ interest rates for the danger of persistent and growing inflation to ignite the fear trade on main street. Seeing their bank balances returning almost no interest at all, savers will begin questioning the value of their principle in terms of its purchasing power. Many individuals have been able to avoid thinking about their money in these terms though because they have been fully invested in the stock market, real estate or both. Enjoying the capital gains leads to a wealth effect that easily overtakes the losses from wages that are now reducing by 7% in real terms.

With the Fed taking a ‘triple-threat’ stance with talk of 1. tapering QE to zero 2. raise rates three times and 3. reduce the balance sheet by selling assets, many are going to be looking at other places to park funds as it’s been an open secret for many years now that the stock market is being kept afloat with easy money.