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Inflation is four times higher than CPI, U.S. economist says

Section: Daily Dispatches

Gold's Rise Points to Inflation;
Actual Rate Much Higher
Than CPI, U.S. Economist Says

By Jonathan Chevreau
Financial Post / National Post, Toronto
Wednesday, December 13, 2006

The real annual inflation rate is closer to 8% than the 2% or 3% governments claim, a prominent U.S. economist said yesterday.

David Ranson, president of Boston-based H.C. Wainwright & Co. Economics Inc., defines inflation as a decline in the purchasing power of a national currency. He prefers that definition to flawed ones like the rising cost of living or increasing labour costs.

Official government-massaged measures such as the consumer price index (CPI) do not detect the onset of inflation as quickly as financial markets, he says. The latter indicate "current inflation is much higher than policymakers realize and is still accelerating."

A year ago, Ranson released a study that concluded the price of gold is a better predictor of inflation than oil. He reiterated that view at a briefing in Toronto yesterday hosted by Bullion Management Services Inc.

Ranson charted inflation and gold in the U.S. and six European countries between 1948 and 1999. He found rising gold prices predicted rising consumer price indexes in all those nations.

These views seems to jibe with those of the average man in the street, who feels prices are rising higher than the benign rate governments portray.

Consumers and investors experience inflation at what Ranson calls "market-clearing prices."

As we all know from daily experience, such prices can jump quickly. Some components of the CPI, such as clothing, are accurately picked up but the index is distorted by the way the United States and other countries account for housing.

Shelter makes up 37.4% of the CPI but the U.S. uses what Ranson terms a "mythical figure" based on old historical data.

Wainright's Proxy Index of Market-Clearing Consumer Prices eliminates the parts of the CPI that use historical prices. The revised index showed shelter rose 13% in 2005 and energy at 16.7%. Food and beverages rose only 2.3%, transportation 0.4% and food and beverages 2.3%, all in line with the CPI.

However, the weighted average was 8.4%, which Ranson suggests is "the true inflation rate -- 8.4% is what is happening now, which should correlate with the performance of financial markets, where we always measure what is happening now."

Since gold has risen 200% in the last five years, it is giving an ominous early warning on inflation. However, it takes time before the CPI fully reflects the trend signaled by gold. Ranson found it takes six years for the CPI to reflect even half the trend signaled by gold.

"This is a serious matter," Ranson said. "It's a very big deal if what I'm saying is correct."

This time lag also creates "the enormous gulf in opinion" between the conventional view of inflation and the minority view that inflation shows up first in the price of commodities.

"One indicator says nothing is happening at all and the other says something very big is happening."

Because inflation weakens the economy, it is bad for both stocks and bonds. Contrary to popular belief, stocks are not a good hedge against inflation, Ranson said. And since currencies became unhooked from the gold standard in the early 1970s, even cash can no longer be described as a risk-free asset class.

In addition to signaling inflation, Ranson says gold stocks or precious metals can be used to hedge portfolios against inflation. He says they do a better job than inflation-indexed government bonds.

While Ranson made no predictions as to the future direction of inflation, gold prices, or the stock market, he suggested advisers could use the rising price of precious metals as a "reliable guide" to asset allocation.

Investors holding only bonds would need an 18% gold position to completely "immunize" a portfolio against serious inflation. "Eighteen percent is the upper end in practice, unless you know for sure that inflation is here and continuous, in which case, why hold bonds at all? But we're all in ignorance so hedge our bets."

For a typical asset mix of 60% stocks to 40% bonds, as much as 30% might be needed in precious metals, Ranson told advisors. He concedes that's more than the 5% or 10% position many recommend as "insurance." But "partial protection is better than none."

In an interview, he said real estate investment trusts (REITs) are also a good inflation hedge, one he uses in his personal portfolio.

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