LearningMachine

@no_free_lunch, I agree imminent inflation is not a 100% certain scenario, and thus you shouldn't hold 100% cash. The amount of cash or gold you hold should be based on what probability you think will holding that result in a win (p), how much is the expected increase in your investment (b), probability of your loss (q), and how much is the expected decrease in your investment (a), i.e. the Kelly Criterion, i.e. p/a - q/b. In the simplest form for even bets where a=b=1, that percentage weight reduces to p-q. Overall, here are the possibilities we're discussing: Scenario 1. Mild inflation in 3-4% range for 5 years (p1 =35%?) Stocks with pricing power and long-term duration debt bought at a reasonable price do ok with high certainty (Probability p1s = high) Oil does ok in medium term with high certainty if bought at bottom last year (p1o = high) Cash loses 16% to 22% value with high certainty over 5 years (p1cashWin= low, p1CashLoss = high; Amount of loss = 16-22%) Gold: cannot say with certainty what happens - could go down as low as what makes miners unprofitable like the bottoms it has hit in the past and gold could lose money (p1gLoss = Medium). Low certainty that Gold does well (p1gWin = low). Scenario 2. High inflation in 5-10% or higher range at some points in the next 5 years (p2= 65%?) High quality stocks with pricing power and long-term duration low debt with stock price that assumes high discount rate do ok over 5 years (p2shqrp = high certainty) but may dip and provide buying opportunities (p2shqrpCashWin = medium certainty event) High quality stocks whose price assumes low discount rate or have earnings way in the future, low quality stocks with short-term debt or high debt or without pricing power suffer badly and indexes provide great buying opportunities to buy with CASH and hold (p2sCashWin = high certainty event) Oil does well in medium term (p2oWin = high certainty) Gold: Might spike if retail investors get on the bandwagon (p2gWin = 60-70% range but not high certainty; however, amount of win could be high) To summarize, Gold: In high-inflation scenario, gold does well, but only with medium certainty, albeit high amount win. In low inflation scenario, gold could possibly lose a lot. Cash: In high-inflation scenario, cash does well also, and that too with high certainty to give opportunity to buy indexes. In low inflation scenario, loss is bound with high certainty. Thoughts on probabilities above?

Thanks @wabuffo. After BRK bought GOLD, I've been slowly warming up to the idea that having small amount of gold exposure might not be bad insurance to have as long as it is bought at a low enough price. I think one other factor we need to add above in determining price of a commodity is the speculation factor. Beyond price, I think we also need to look at what is the lowest price this commodity will trade at given its real needs, to figure out how much downside risk we are taking by buying it at a given price. Regarding stability, if products/services in the world were priced in gold, like oil was effectively priced in gold before 1970s inflation, we could have relied on gold's stability more. In today's world, if one wants to be prepared for S&P 500 bottom with very high certainty, wonder if cash might be more stable than gold.

I agree Crude is not a perfect inflation hedge also. That said if someone bought oil stocks at the bottom, those stocks could benefit from positive surprises from unexpected "bottlenecks". Also, on average, the price for crude will be determined by marginal cost of production of crude needed. So, if you could buy a producer that can produce below that cost, and buy at a time when crude was trading below that cost, it should work out ok during inflation as inflation should cause that marginal cost of production in general to go up and thus price of crude to go up. That said, I agree with you that unlike 1970s, oil and those oil stocks might not necessarily hit peak with high certainty this time when S&P 500 is hitting bottom due to inflation/interest rates.

I agree if interest rates hit 10%, REITS without 30-year mortgages will go down, and also CAP rates will track interest rates, lowering valuation of CRE.

Thanks @no_free_lunch, I couldn't find any REIT that could satisfy my criteria either. The best is probably to have 30-year mortgages on directly owned real estate. I agree it doesn't have be just REITs. Any entity with assets that don't need to be replaced at higher cost, i.e. "rights", that are cash-flowing well that can track at least inflation, trading at a reasonable EV/EBITDA ratio, and has long duration debt that is not too high relative to EBITDA, should do fine over the long run. I include spectrum as such a right as well. The best I could find here was VZ. However, 10% inflation per year will still take 7 years for prices to double, while 10% interest rates will increase cost of loans & discount rate immediately, potentially creating buying opportunity. So, I think it has to be balanced approach, where if the inflation/interest rates don't go too high, you do fine, and where if inflation/interest rates go high, you do well there too. For the scenario of inflation/interest rights going high, and being ready for a buying opportunity, I've also been trying to figure out what could hit high peak in that scenario when S&P 500 is hitting bottom. So far, I think the most certain way to take advantage of that bottom would be to have extra cash ready like BRK is holding. With alternatives, I like oil stocks the most for having some probability of hitting peak during S&P 500 bottom and doing ok also for low-inflation scenario. Gold is another possibility but I don't have conviction on that to do well also in the medium term possibility of us not hitting ultra-high inflation as currently it is trading at a price that doesn't have much downturn protection - best time to buy Gold protection to hold might have been to buy GLDM/GLD/IAU when gold was hitting bottom, or buy gold producers with lowest cost (sub-1000 cost/oz) when gold was trading below $1200. TLT put options would have to be timed perfectly to work well also - not high certainty scenario to get that timing prediction perfect. Any other ideas that will be high when S&P500 will bottom in event of high inflation, but will also not go down in case of low inflation? Looks like the only way to be certain to be ready for that bottom is to have some dry powder ready like BRK?

Which REIT is shareholder oriented enough to have (1) 30-year long mortgages and (2) doesn't have the culture to print shares to buy expensive real estate? If you don't have examples of REITs that satisfy both #1 and #2, how about examples of REITs that satisfy #1? If you don't have examples of #1, what's the REIT with longest average-weighted mortgage duration you've found?

I agree oil is a much better inflation hedge. That said the only thing we can predict with above 99% certainty with these commodities is that the price in the long run will be above the marginal production cost for the amount of supply needed to meet real needs. There are still times when the commodity price falls below that price during which the producers of commodity go on sale, and that is a good time to buy. With oil, that marginal production cost ranges anywhere from $30 to $60, or maybe higher at some time, and then longer term, when consumption goes down, marginal product cost could possibly go down eventually. We had some opportunities last year when it was trading below that medium term marginal production cost price of at least $30-60. Even today, it is not too far off from that. With oil, because some ownership is consolidated, there is possibility of positive surprises. With gold, the consumption needs for jewelry, tech, and industry are so small, that they could likely easily be met with marginal production cost of below $1000. It is currently trading far higher than that. So, there is little downside protection. There is a possibility of positive surprise here if many neural nets end up getting influenced by historical gold prices and end up pushing them up during high inflation or any other surprises. The probability of such a speculation is higher than probability I'd try to give to any meme stock speculation, but it is still similar-type speculation, except that the influence on human mind is much stronger from much more historical data. That said, that influence on human mind has gone down a lot since 1970s when we had just come off the gold standard, and there were fewer options for folks to speculate on during 1970s inflation. To diversify beyond oil, anything else folks have considered other than gold, TLT put options, banks, and to some extent, companies with pricing power, to protect against high inflation/interest-rates? Ideally something that would immediately go up if inflation/interest rates spike just when S&P 500 is bottoming so that one could then sell at peak to get into S&P 500 bottom. Something that will also not go down if inflation/interest rates don't spike.

Thanks wabuffo clarifying. I see where the disconnect is. GLDM sounds like it is an ETF composed of gold miners :-). However, it is not :-). Both GLD and GLDM are backed by physical gold itself. Both are created by State Street. The difference is that GLD has been around for a long time and provides liquidity for large institutional investors. For that, State Street continues to make them pay 0.4%. Because there was demand for lower expense ratio, State Street created another physical-gold-backed ETF with 0.18% expense ratio, especially to serve the needs of smaller investors that don't need to make huge purchases/sales that need higher liquidity. There are some other differences as well. Please see: https://www.ssga.com/us/en/institutional/etfs/funds/spdr-gold-shares-gld https://www.ssga.com/us/en/institutional/etfs/funds/spdr-gold-minisharessm-trust-gldm

Thanks @wabuffo, are you saying GLDM doesn't maintain a peg? Does that make a huge difference? For long term gold exposure, GLDM seems to have lower expenses at 0.18% vs. GLD's 0.40%. Any issues you see with GLDM? Looks like with miners you get amplification of changes in gold price, i.e. (price of gold - $1000 all-in production cost/oz) * Multiple. Have you looked into marginal production cost curve of gold? I think the ideal entry point would have been when gold price was close to marginal cost of production needed to supply jewelry/industrial/tech needs. Now, it is way higher than that, and somewhat speculative, no? Yes, marginal production cost curve should move as labor prices move up, but looks like marginal cost needed to supply those needs will still be much much lower than today's prices.

If 5bps valve turn could have such a big impact, could Fed turn these valves in the future also, making it hard to predict TLT/GLD/GLDM prices AND their timing?

@wabuffo, curious what makes you more comfortable about gold etfs over other ideas for inflation protection? Speaking of gold ETFs, have you considered GLDM?

Interesting how Paul Tudor Jones mentions at around 4:55 that now is not the time to be invested in financ[ial assets], but better to be in commodities. This brings another distinction that someone mentioned earlier #1. Inflation in financial assets vs. #2. Inflation in day-to-day products/services. I wonder if another way to think about this is that with the monetary supply going up and interest rates being low for so long, we have been having inflation for a long time. So far, the monetary supply was going in the hands of the rich who don't spend that much and end up saving or buying financial assets, which has been increasing the price of financial assets. Now, when we see stimulus and minimum wages go up, putting monetary supply in the hands of lower-income spenders, and we have bottlenecks happen, all of a sudden we see them compete with each other on limited products/services and we see inflation start to happen in day-to-day products/services. The danger here though is that as inflation starts to shift from financial assets to day-to-day products/services, it will result in higher interest rates/discount rates, bringing the value of financial assets lower. Another way to say it is that the value of financial assets is basically a multiple on price of day-to-day products/services. With inflation in day-to-day products/services, that multiple goes down.

Because 10% inflation in prices will take more than 7 years for prices to double. However, 10% inflation/interest rate will have an immediate impact on discount rate and also an immediate impact on cost-of-capital for some. When inflation was running red hot in 1970s, if you had invested in S&P 500 in Dec 1972, you'd have lost 46% of your investment as of Sep 1974. However, if you had prepared in advance and stayed in cash until Sep 1974, and had invested at that time, you'd have done ok. This was a time when P/Es were not high to begin with, and interest rates were not that low to begin with. This time, it will be devastating if inflation/interest rates shot up that high by any chance. That said, it is possible that Mr. Market might be irrational and not look at that impact on discount rate for some amazing companies, and not give us an opportunity like 1974. So, we have to be prepared both ways. However, I think it is likely that it will give us an opportunity for at least not-so-amazing companies. The video at https://www.youtube.com/watch?v=AcQ0UlSzohA does a better job of explaining how market's discount rate is impacted by higher inflation and higher interest rate, e.g. risk premium goes up and risk-free rate goes up. On top of that, margins go down for companies without a lot of pricing power. Also, as Buffett explained in his infamous inflation article, asset-heavy companies have to replace the assets at high-inflation cost, not leaving much for shareholders.

At the May 1, 2021 meeting, Buffett acknowledged "very substantial inflation" using the clearest language he has ever used on inflation: At the same time, BRK March 31, 2021 Balance Sheet shows Total Cash: $145.439 Billion Investment in Equity Securities: $282.097 Billion Liquid Portfolio (Cash + Equity Securities + Fixed Income Securities): $447.563 Billion Cash as percent of Liquid Portfolio: 32.5% I understand Cash position is only 16% as a percentage of total assets, including hard assets. I also understand he has said he also needs some cash for any circumstances that might be faced by BRK. I also understand Buffett has been preparing for inflation all his life by being in the right businesses with pricing power. That said, even with all the early data on the onslaught of immediate inflation that he is getting, he is choosing to have almost a third of his liquid portfolio in cash, not in gold, not much in oil, but in cash! Based on his experience in 1970s that he has recalled so many times, he is probably one of the most prepared individuals for inflation! I wonder if he is hoping for another 1974-style opportunity, and the best way he could think about preparing for that was to be in cash! What do folks think about Buffett's strategy?

BAC also had "$450 billion in terms of our ability to fund loan growth or invest" as of April 15, 2021. See https://app.tikr.com/stock/transcript?cid=19049&tid=2592914&ts=2251951&e=670919338&refCode=u8yosp#. In the past, they have said they were ok with getting 10 bps while they wait for higher interest rate environment. Also, from BAC's clients perspective, "there's a lot of cash on the sidelines. And when you think about our business and the size of our business relative to the marketplace, I think it not only tells you where investors are, which is still maintaining some caution, which is as a contrarian, that's a bullish signal, makes me feel like we're not very late stage. And I think if you kind of gross up our kind of excess deposits or uninvested funds right now, that speaks to $1 trillion of buying power that could come into the market over the months ahead when client perspectives of risk do shift more meaningfully." See https://app.tikr.com/stock/transcript?cid=19049&tid=2592914&ts=2319413&e=717689992&refCode=u8yosp. Wonder where clients will invest/spend that cash.

@wabuffo, I really like your analogies. When we look back at the 2020s decade in the future, I wonder if we might say some events caused folks to realize the currency debasement going on so quickly this time as well, e.g. Home builders realized quickly they had to pay double (?) the price for lumber because of bottlenecks caused by covid Small business owners realized quickly they had to pay almost double the wages they used to pay pre-covid Soon, restaurant customers realized quickly they were paying almost double the prices they used to pay pre-covid Soon, consumers started realizing they were were paying almost double for their favorite foods at supermarkets Soon, consumers started realizing they were paying almost double to their wireless company for their bundle of streaming packages + wireless service for their phone, watch, AR glasses, 5G laptop for work-from-anywhere lifestyle, etc. Soon, the health insurance companies started realizing they were paying almost double to drug companies and had to double the cost to their customers And then, near the end of the decade, the Chinese economy became bigger than the U.S. economy, and RMB started overtaking USD for trading, just like the American economy and USD had overtaken British economy and GBP a century ago. ... It will be interesting to see what history will say about 2020s. Lets hope U.S. stays united throughout all this.

And, why did that happen itself? Could it have been because it might have been harder to provide in increased quantities something that was "bottlenecked" or "limited in supply" to people with increased money supply, which had been happening already with increased wages?

Because money supply didn't get as much to people who will be competing to get the same bottlenecked goods & services, unlike now with the stimulus, unemployment funds and now wage increases. Similar to how before the 1973-1974 oil "bottlenecks", money supply had already started going up in terms of wage increases in the hands of people who were going to compete for that bottlenecked oil. This time we might end up calling some other oligopolies/cartels/monopolies or something that is truly limited in supply that starts the fire as the "bottlenecks".

Thanks @nafregnum for sharing. I really liked that he talked about some nuggets that folks forget at times: How to identify how big is the barrier-to-entry: Figure out what is the minimum market share you need in order to be viable now Electric car market: Now, if a market is small like the electric car market is today, you probably need to get to 20% market share to be viable In the mature global auto-market, you can be viable at 2% market share. At 20% requirement, Tesla maybe able to keep rivals out, but at 2%, nobody is going to keep anybody down, and guess where the electric car market is going. Not a chance Tesla will dominate 20 years from now because barrier-to-entry will be lower with bigger market. Cloud computing: The market is going to get really big and it is going to be harder to dominate [because percentage market share needed to enter market will go down] Checklist to keep in mind that DCF doesn't address #1. DCF doesn't make distinction between estimates of near-term cashflows and estimates of distant cashflows Near-term cashflows might be closer to being correct, but distant cash flows are more likely to be incorrect. DCF adds bad information from distant cashflows with good information from near-term cashflows Growth stocks have even more extra-ordinary emphasis on future cashflows [that are likely to be incorrect] #2. DCF has no easy way to integrate strategic insights #3. DCF is all forward looking as it is based on estimates of the future and completely ignores balance sheet Why inflation is a likely possibility: Because our economy is 70% oligopolies and local [meaning niche] monopolies

Thanks @aws, that's exactly what I ended up doing once. I ended up selling the options in the same tax year to balance the short-term gain. Waiting to sell the options next year was gonna make me pay the tax on short-term gain the year I bought the options. However, you're right that buying options with expiration in next year gives me the option to decide. If there is a big gain in options, I could then take the gain next year, while paying the taxes on the original short-term gains this year. You could potentially extend the strategy to move the big gain in options to being a long-term gain, but with speculative gains, might not be able to predict well. Another reason I was thinking the trade might still make sense is that I'd be effectively trading (1) one short-term gain in 2021 from selling a stock for (2) another potential short-term gain in 2021 from a speculative option-based position. Because #2 is speculative & volatile, #2 will likely result in either zero or multiple times of short-term gains from #1. If it is zero, I save on taxes (which is a benefit that other investors in that speculative option might not get). If it is multiple of #1, I end up paying an even bigger tax bill, but still end up making a multiple of #1. Overall, looks like we agree that if one uses short-term capital gains to fund speculative options that they either sell within the same year or let expire within the same year, their effective cost is less than those who are not using short-term capital gains to fund them.

Thanks @Castanza. What do folks think about partnering with IRS to make such speculative bets, e.g. use short-term capital gains to fund put options expiring within the tax-year, reducing the effective cost of Put options compared to other folks? If it pans out, great. If it doesn't, you save on taxes - of course you still lose the money but you would have paid a big percentage of that money to IRS anyway. Anything I'm missing?

If you are going to hold a broad-index for the very-long-term, maybe you're right over the very-long-term as S&P 500 ended up reaching its non-inflation-adjusted 1972 high in 1980 and again in 1982. However, when adjusting for inflation, 1968 high took 25 years to recover in 1993. Please see https://www.macrotrends.net/2324/sp-500-historical-chart-data. The reason I said long-term is because 10% price increase every year will take more than 7 years for prices to double. However, 10% interest rate will have an immediate impact on discount rate and also an immediate impact on cost-of-capital for some. Someone neck-deep in debt at 5X EBITDA at 3% interest rates having to now renew debt at 10+% interest rates will have a hard time even if they were able to increase prices by 10%. This video does a better job at explaining how market's discount rate is impacted by higher inflation and higher interest rate, e.g. risk premium goes up and risk-free rate goes up. On top of that, margins go down for companies without a lot of pricing power. Please see https://www.youtube.com/watch?v=AcQ0UlSzohA. Also, as Buffett explained in his infamous inflation article, asset-heavy companies have to replace the assets at high-inflation cost, not leaving much for shareholders. That said, it is possible that Mr. Market might be irrational and not look at that impact on discount rate for some amazing companies, and not give us an opportunity like 1974. So, we have to be prepared both ways. However, I think it is likely that it will give us an opportunity for at least not-so-amazing companies.

Thanks@DeepSouth for sharing. I do believe the probability of that event is higher than what market is believing it to be, but don't think the probability is 100% within the next few years. Any particular multi-year-long cheap OTM interest rate options you'd look at? The issue with options and futures positions is that it is very hard to predict the timing with high certainty. Mr. Market can be irrational longer than anyone expects. I'm looking for stocks that do reasonably ok with both (1) low inflation & low interest rates, and especially (2) high inflation and high interest rates. If I stick to only #1 as market is doing mostly, finding stocks can be easy. If I stick to only #2, that gets a little harder. Now, if I want to satisfy both #1 and #2, that gets even harder :-).

@Gregmal, what are you thinking is still cheap for putting in new money (not from perspective of holding)?

Thanks @wabuffo for starting this discussion. Now, if capital gains are ~50%, and you wanted to avoid paying taxes, and just wanted to sit on what you bought, are you ok with holding 4500 Equal-Weight forever, or would you rather hold S&P 500 Tot. Return forever?