Buy the Commodity Boom, But Ignore Money Printing: SPDR Gold Trust (ETF) (GLD)

There are many reasons to buy into the commodity boom. The world’s population is increasing and even the UN is starting to question if this growth is sustainable. With a limited amount of arable land, constraints in agricultural inputs, concerning crop yields, and a growing demand for meat there are many factors pushing commodity prices higher.

It is common to hear that the printing of money by the government will push prices even higher, but this analysis has serious problems. Investors who don’t examine history risk making choices on weak evidence and needlessly complicating their decision making process.

Why Ignore the Money Printing?

In a credit based world, banks lend money to people and business. A mortgage for the construction of a new home is a great example. In older economic theories banks are presented as being constrained by the number of reserves they have. In these models the banks cannot lend until they have enough reserves in the bank to cover the new loans. In this thinking money printing by the government increases the number of reserves in the bank and thus causes inflation when the banks make new loans.

Empirical evidence tells a different story. The chart below shows how reserves have exploded and yet U.S. inflation has remained essentially the same. Major central banking officials and the Bank of English believe that banks are not constrained by reserves. America’s adventure with quantitative easing has not produced hyperinflation or the collapse that some predicted.

US Excess Reserves of Depository Institutions data by YCharts

What about Hyperinflation?

It is common to hear predictions of hyperinflation because of runaway government printing. It is easy to get someone to listen to you when they believe that all currencies will be worthless by tomorrow morning.

A look at hyperinflation over the past hundred years shows that it is commonly associated with regime change and substantial amounts of foreign denominated debt. Post World War I Weimar Germany and Zimbabwe had massive amounts of foreign denominated debt along with regime change. Argentina faced large foreign denominated debts during their recent bout of hyperinflation.

Where to Invest

Disregarding government printing, commodities have face strong upward pressures because of a growing world and slowing yield growth. PowerShares Agriculture Fund is based on a number of staple commodities. Currently live cattle, sugar #11, and soybeans have the biggest weightings between 13.4% and 12.9% of the fund. Other staples like cocoa, coffee “C”, and corn are similar with weightings between 11.9% and 10.6%.