By David Schassler
Portfolio Manager and Head of Quantitative Investment Solutions
Van Eck Associates Corporation
In the U.S., the year-over-year change in the CPI now stands at 7.9%. It was up 0.8% in February, which represents an acceleration in inflation. Year-to-date, the VanEck Inflation Allocation ETF (“RAAX”) is outperforming the S&P 500® Index by nearly 20%. We expect the relative outperformance of real assets to continue based on: 1) persistently high inflation; 2) deeply negative real rates; 3) geopolitical tensions; 4) the chances of a Fed policy error as it attempts to combat inflation; and 5) the structural supply side issues associated with transition from traditional to renewable energy sources.
Inflation is everywhere. Russia’s invasion of Ukraine and the resulting sanctions are likely to add to the inflationary pressures. The U.S. and Europe have imposed expansive new sanctions designed to hobble the Russian economy. The severity of this approach risks knock-on effects to the stability of global markets and a retaliation by resource-rich Russia.
Commodity prices are experiencing upward pressure as a result of Russia’s invasion of Ukraine. Most notably, the price of Brent oil reached nearly $130 per barrel. According to the IMF, a 10% increase in global oil increases, on average, domestic inflation by about 0.4%.
The chart below demonstrates the significance of Ukraine and Russia as commodity producers:
Percentage of World Exports
Data as of December 31, 2020. Source: Bloomberg and International Energy Agency
The timing of the Ukraine conflict leaves the U.S. Federal Reserve (the “Fed”) in a difficult situation as it pursues its battle against inflation in the midst of significant uncertainty. The confusion in the fixed income markets is evidenced by the U.S. 10-Year Treasury note yield, which fell from 2.04% in mid-February to 1.75%, despite the consistent rhetoric of rising rates from the Fed. The economic headwinds resulting from the invasion may lead to a less aggressive Fed and, as a result, more inflation.
Previous generations have had their inflation stories and today younger generations are in the process of creating theirs. A recent New York Times article noted that in the 1920s, during the hyper-inflationary period in Germany, patrons at beer halls would purchase two beers at a time. They expected the price of the second to rise while they were still drinking the first. Baby boomers have their stories from the 1970s of long waits at the pump in their gas-guzzling Pontiac Firebirds.
This past weekend my family had the pleasure of enjoying a ski trip in Vermont and we came home with many inflation tidbits. Labor shortages caused lift and trail closures, no housekeeping services, long waits at the restaurants and chicken wings are practically being sold like lobsters (“market price” to account for rapidly changing prices). The market price for wings was $18 for eight bone-in wings and an additional $0.75 for sauce! For me, chicken wing inflation is bearable because my price sensitivity allowed me to pivot to the more heart-healthy salad options, but the lack of housekeeping resulted in a pile of towels waist high (two adults + four young kids) and constant begging for clean linens and garbage removal. Yet, regardless of the reduction in amenities, the cost of our accommodations was significantly higher than in previous years. And it didn’t end there. The ride home included eye-popping gas prices and massive advertisements on the back of tractor-trailers offering new truckers $2,500 per week.
Much like my personal experiences with inflation, Americans are already crafting their own inflationary memories. As this continues, inflation risks become further entrenched, increasing the attractiveness of assets that benefit from higher inflation.
We continue to encourage clients to further hedge their portfolios using a well-diversified and dynamic allocation to inflation-fighting real assets. Consider RAAX. From our perspective, we are likely in the early stages of a period of elevated inflation. As time progresses, we believe that the diversification and return benefits of real assets will become more and more apparent.
Originally published by VanEck on March 10, 2022.
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CPI – US CPI Urban Consumers YoY NSA Index measures US consumer prices (CPI) as a measure of prices paid by consumers for a market basket of consumer goods and services. The yearly (or monthly) growth rates represent the inflation rate.
Commodities – Bloomberg Commodity Index is made up of 23 exchange-traded futures on physical commodities, representing 21 commodities, which are weighted to account for economic significance and market liquidity.
Gold – Gold spot price in U.S. dollars per troy ounce.
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