The Answer to Inflation Woes Could Be Under This Dusty Lake

In Wednesday’s Smart Money, we took a deep dive into the inflation story of 2021 – and the three powerful forces behind it:

Coin stock with red arrow representing inflation.

Source: Anton Watman/Shutterstock.com

  • A massive, new QE campaign
  • Off-the-charts government spending
  • Major supply-chain constraints that are causing commodity prices to soar

On Wednesday, I used Northern California’s dusty Folsom Lake to demonstrate the decade-long drought that inflation was in before the post-pandemic recovery.

I said that I’d show you how this parched lake is part of the reason why we’re seeing inflationary prices… and how, at least metaphorically, it also points out how we can protect ourselves – and potentially even profit – from the ravages of inflation.

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As I noted on Wednesday, the agricultural complex has joined in the larger commodity rally.

The price of corn has doubled, as has the price of soybeans. During the last 60 days alone, agricultural commodities, as represented by the Bloomberg Agricultural Sub-Index, have rocketed 17%.

Which brings us back to Folsom Lake: the formerly picturesque lake northeast of Sacramento that is becoming a dust bowl.

“Instead of being flush with newly melted snow,” The Sacramento Bee reported earlier this week, “Folsom Lake is the driest it’s been in springtime since the epic drought of 1977. Water levels are so low that temporary pumps probably will be installed to help move water out of the stricken reservoir.”

Meanwhile, along the Oregon-California border, the federal government’s Klamath Project has run dry. Every year since 1907, the project has fed water from Oregon’s Upper Klamath Lake into nearby California farming communities.

But not this year.

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Severe water restrictions like these are not merely a serious economic threat to farming operations; they are also a contributor to rising food prices. Without adequate water supplies, many farmers simply refrain from farming. And that’s not a good thing in a state like California, which grows nearly half the country’s fruits, vegetables, and nuts.

Almost all agriculture is thirsty, of course, but California agriculture is especially thirsty. Growing a single almond requires more than one gallon of water, while growing a single avocado requires 60 gallons! Obviously, a major drought is not helpful.

For many California farmers, the drought is simply too much to handle. Even the farmers who manage to endure the drought conditions must contend with a battery of long-term, water-related costs, like investing in water efficiency equipment, pollution abatement, and water recycling systems.

These expenses are also inflationary. When you add it all up, you get a $10 jar of almonds and a $3 tomato.

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“A crop rally in the U.S. is making essential food commodities dramatically more expensive, and the costs could soon spill over onto grocery store shelves,” Bloomberg reports. “Wheat, corn and soybeans, the backbone of much of the world’s diet, are all surging to highs not seen since 2013… The rally is stirring food inflation fears, because staple crops heavily influence consumer prices for everything from bread and pizza dough to meat and even soda.”

The inflationary signals from other parts of the commodity complex are not any less ominous.

Over in industrial metals, most sector insiders anticipate large and growing supply deficits of key metals.

According to estimates from CRU Group, soaring copper demand from the electric vehicle and energy storage industries will cause the annual supply deficit of that metal to hit 4.7 million tonnes by 2030, unless the copper industry invests at least $100 billion between now and then.

In the meantime, high-cost metals will continue flowing into global supply chains, driving prices higher for numerous products, including “new age” EVs like a Tesla Model S.

For all of Tesla Inc. (TSLA)’s innovative prowess and creativity, the company cannot escape mundane issues like rising input costs.

Elon Musk admitted as much recently when he said that Tesla would be hiking its prices for the fifth time this year, “due to major supply-chain price pressure industrywide… Raw materials especially.”

The price of a Model 3 Standard Range Plus, Tesla’s cheapest vehicle, has jumped from $37,000 back in February to $40,000 today.

Surprisingly, that steep 8% price hike may not be enough to compensate for rising input costs. The prices of the main metals that make up a battery-electric vehicle (BEV) are soaring. The chart below tells the tale. It shows “back of the envelope” estimates of the raw metal costs of a Model S.

These cost increases may not seem like a big deal for a car that retails for $80,000. But bear in mind that Tesla effectively netted just $1,442 per vehicle last year… and that net profit included regulatory credits equal to $3,160 per vehicle.

Rising metals prices could squeeze Tesla’s margins enough to wipe away the profit completely.

Clearly, inflation isn’t good for much. It squeezes profit margins and undercuts the value of our savings. But inflation can be a “friend” to hard assets like real estate, commodities, and precious metals. In fact, inflation and gold have been “BFFs” for centuries. And they probably remain close friends today, even in this modern cryptocurrency-enabled age.

Which returns our story once again to the dehydrated Folsom Lake.

The New Gold Rush

As its waters dried up, its lakebed exposed the timeworn antidote to inflation: gold.

The lake’s receding shoreline revealed the old California Gold Rush towns of Salmon Falls and Mormon Island – 170-year-old settlements that were once home to about 2,500 Gold Rush settlers. Remnants of their way of life are now visible… as are occasional glimpses of the gold they sought.

Elsewhere in California, water levels are falling to such low levels that several long-sunken ghost towns are rising from the shallows. As they do, modern-day prospectors are gaining fresh access to placer gold deposits that had been inaccessible for decades.

Some of these modern-day “panners” are still pulling gold nuggets and flakes from the state’s historic Gold Rush waterways… and that gold still possesses value, just like it did in 1849.

Until proven otherwise, therefore, I’m betting gold will continue to offer a store of value for decades to come and am trusting it to provide at least partial protection from any serious bout of inflation.

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Yes, I know, the ancient monetary metal is “so yesterday” and seems utterly irrelevant in a world dominated by cryptocurrency marvels.

Many are the new-era apologists who scorn the yellow metal as a monetary has-been that is too cumbersome and, well, too physical to provide a store of value in a digital world.

But I suspect the “barbarous relic” still possesses some relevance in the modern era… perhaps even a relevance that is inversely correlated to cryptocurrencies!

That said, most of us don’t want to huddle over California streams for hours to acquire gold. We’d rather shop for it on Wall Street.

Many folks buy the SPDR Gold Trust ETF (GLD), as their one-stop gold play. I wouldn’t argue with that approach, but in my Fry’s Investment Report letter, I have recommended a balanced allocation to gold and silver that includes exposure to both physical metal and select mining company stocks.

All three of these stocks have produced meaningful gains for my subscribers. But because the current inflation trend is gaining momentum, and because I expect gold to respond favorably to that trend, I am also expecting all three of these gold-related stocks to move even higher still.

Click here to learn more about these trades as an Investment Report member.

Regards,

Eric Fry

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NOTE: On the date of publication, Eric Fry did not own either directly or indirectly any positions in the securities mentioned in this

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