Capitalizing on Inflation

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SAN DIEGO (ETFguide.com) - As the perpetual disagreement between the two camps - inflation and deflation continues, hints of inflation are popping up.

The Consumer Price Index (CPI-U) is the government's way of measuring inflation and while it's a far from perfect gauge, it gives us clues as to where inflationary pressures are growing the most. Over the past year, prices for oil (NYSEArca: OIL), gasoline (NYSEArca: UGA) and medical care are all sharply higher versus the broader CPI index. 

Inflation is clearly visible elsewhere. Prices for soft commodities (NYSEArca: JJS) like cocoa, coffee, sugar, corn, wheat and soybean have jumped 77 percent over the past 12-months. Likewise, cotton prices (NYSEArca: BAL) have soared 171 percent. 

Instead of trying to guess which specific commodities are headed higher because of inflation, one way to capitalize is by owning a diversified commodity fund that owns a basket of commodities. Examples of this are the iShares S&P GSCI Commodity Index Trust (NYSEArca: GSG) and the Greenhaven Continuous Commodity Index (NYSEArca: GCC). GSG is often criticized for overweighting energy commodities, whereas GCC equally weights all 17 commodity futures contracts within its basket. The best choice is a matter of preference.


Other Inflation Hedges
While Treasury Inflation Protected Securities or TIPS (NYSEArca: TIP) have traditionally been used to hedge against inflation, they may not necessarily be a good method anymore. As with all fixed income investments, they are not immune to higher interest rates and longer dated TIPS in a rising rate environment will get hit hard.

Another problem with using TIPS as an end-all and be-all inflation hedge is their credit exposure to the U.S. government, whose credit quality has deteriorated substantially and will continue to do so for the foreseeable future. If you absolutely must own TIPS, it's probably best to stick with shorter-dated securities like the PIMCO 1-5 Year U.S. TIPS Index Fund (NYSEArca: STPZ).


Should interest rates rise from here, this too will be another inflationary trend. It will increase the cost of debt linked to variable interest rates and make the cost of future borrowing more expensive.

Finally, broad arguments for or against inflation usually miss a few hidden but important details. Higher inflation, for instance, does not necessarily mean all asset classes will rise in unison. In fact, some may not. Likewise, inflation does not necessarily spell an end to deflationary forces in certain markets. ETFguide's ETF Profit Strategy Newsletter identifies which assets will benefit from these trends and which to avoid so you can capitalize.

For sure, procrastination or an apathetic approach will do little to keep your portfolio from being ravaged from inflation. By the time you scramble to protect yourself, it's already done most of its damage. That's why an attentative proactive approach is absolutely necessary. An ounce of prevention is worth more than a pound of cure.    



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , ETFs

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