Inflation Translation: Precious Metals are Trying to Tell Us Something

When I was studying guitar in high school, my focus largely centered on classical music. Primarily, that meant learning tons of excerpts from Bach’s Lute Suites, or pieces by guitar-specific composers like Mauro Giuliani, Isaac Albeniz, and Agustin Barrios.

I genuinely loved both the material and my teacher – an eclectic, colorful gentleman named David Harris. Despite hailing from West Virginia like me, he spoke with an almost Spanish-like accent – think Inigo Montoya in The Princess Bride – and I don’t think I ever once heard him use a contraction once during our lessons.

David was a real Renaissance Man – he once circumnavigated the world on a ship he built himself, pulling into the occasional port to play a concert and help fund the next leg of his journey. And he was hilarious, too. He frequently described Barrios’ masterpiece La Catedral as “pure sex”… an intentionally ironic metaphor, given that he knew darn well it was composed after hearing Bach performed on a church organ for the first time.

In short, he was a lot of fun… and he proved to be a tough act to follow.

For me, transitioning from learning in high school to learning in college was disruptive. First off, the subject matter was harder, there was a ton of work to do, playing collegiate sports soaked up a lot of my day, and therefore I didn’t have quite as much time available to devote to playing.

So, when my college instructor – a nice guy but nowhere near as engaging as David – called me out on my lack of preparation, I realized right away he was right. I was burned out a little, and my heart just wasn’t in it… I needed a change.

Classical guitar was primarily a solo endeavor, and I specifically missed the interaction and improvisation that comes along with playing in groups. So inspired by that idea – and also a fair amount by the 90’s Virginia jam band scene – I opted to switch focus over to jazz.

What I didn’t yet know was that… jazz is really hard.

Transcription Conniption

The kids who study jazz in college generally have some experience of some kind, usually through high school band. Guitar, however, was not a band instrument, so I was starting from scratch.

And upon being handed my first real assignment – transcribing the first pass through the melody of Joe Pass’ arrangement of Autumn Leaves – I realized I might be in over my head.

It sounded a little like classical guitar – in tone and approach – but the harmony and chord voicings were absolutely foreign to me.

And worse, there would occasionally be a word or two my instructor would blurt out that at best registered as word salad. I struggled through the remainder of that semester – frequently adrift, but working hard to keep up – and eventually came to the realization that if I were to ever be competent, I had to at least be able to understand the language.

Fortunately for me, that year – in the very early days of the internet – Netscape Navigator was released and the ability to search the web for topics became more widely available. And when I searched for “jazz improvisation” I happened to stumble onto a primer authored by Indiana University professor David Baker.

Baker, who had some prior experience playing in groups with jazz theory pioneer George Russell, presented jazz harmony on the website in a more simplified manner than I’d ever seen. He emphasized that jazz students should be intimately familiar with the scales and modes of melodic minor – which I’d never before encountered – and he classified each one into three categories: major, minor, and dominant, with a particular focus on the latter.

I later came to learn that his approach was a blend of the “Chord-Scale System” and George Russell’s so-called “Lydian Chromatic Concept”.

Whatever.

More importantly for me, it was the musical equivalent of discovering the Rosetta Stone. Now when I showed up to class, I had questions to ask, and I knew how to ask them…which meant I now had access to even more information.

Unbeknownst to me at the time, I had inadvertently learned how to learn.

Conclusion Solutions

For the bulk of my career, I’ve taken that same approach to new challenges – I get my bearings, I learn the lingo, and I ask tons of questions of people who are more experienced than I am. Because after all, I’ve written before about how a well-presented punchline, chorus, or story becomes way more memorable to the listener.

That’s how I was able to transition from a musician into a coal analyst, from a coal analyst into an iron ore/steel analyst, and from an iron ore/steel analyst into a base & precious metals/financial analyst.

It’s a lot of lingo to learn, for sure, but it makes me aware of messages I wouldn’t otherwise notice.

And what I’ve been noticing these past few weeks is that the precious metals markets have been going crazy.

Source: Bloomberg

Gold in particular had made all-time highs in every major foreign currency since the global COVID outbreak began in earnest back in February.

But this past week, it added an all-time high in US Dollar terms.

Source: Bloomberg

Apparently to some folks, it’s a mystery as to why. But the mechanism is clear to those of us who have learned the lingo over the years.

If gold is at an all-time high in US Dollar terms, it means that people in the US are selling dollars to buy gold. And although the greenback and the yellow metal were positively correlated most of the past year, that relationship seems to have broken down.

Source: Bloomberg

Selling dollars en masse like we’ve seen here lowers the intrinsic value of the currency, and reduces our purchasing power, particularly in regard to foreign goods. And indeed, we continue to see US imports decline despite the US economy opening broadly.

Source: Bloomberg

Taking this one step further, a reduction in purchasing power of the US consumer – combined with capital flight to gold and silver – means that despite what traditional measures might be saying, inflation is here. 

One easy thing we can do to counteract that is to own gold. We already do, but it never hurts to have some more… go ahead and pick up another ¼ stake in Proshares Ultra Gold (NYSEArca: UGL).

To finance it, let’s go ahead and sell our entire stake in Proshares Ultra Silver (NYSEArca: AGQ), which has had a huge run, and is trying to pull back a little today. We’ll be back in it later for sure.

But looking longer term, this is an incredibly significant inflection point for the US Dollar… but it has held this trend-line every single time these past 10 years.

Source: Bloomberg

Because of that, I also want to make a speculative bet with another ¼ stake in the Invesco DB US Dollar Index Bullish Fund (NYSEArca: UUP).

I have a suspicion that weak earnings season plus an increasing COVID caseload – Major League Baseball, for instance, has been visibly affected of late – may cause a liquidity event. And during such times, the US dollar is the primary benefactor.

However, if the dollar breaks that trend-line with gusto, we’re out.

Because after all, why bother to learn all this lingo if we aren’t going to pay attention to it?

All the best,

Matt