In the 1930s, the U.S. government sought to boost a
flaggingeconomy by maintaining very low interest rates. Throughout
the decade, consumers benefited by obtaining low-rate mortgages --
though their savings accounts garnered insultingly low levels of
interest as well.
Sound familiar? Well, the government has been pursuing that
policy in recent years as well, as the Federal Reserve has
initiated a series of programs (formally known as quantitative
easing) that aim to keep interest rates -- andinflation -- at very
low levels.
Now concerns are growing that the steps taken to spark the
economywill have negative long-term consequences and the current
period of low inflation and interest rates will again come to an
abrupt end. What will this do to your portfolio, and what can be
done?
Bill Gross, the nation's topbond fund manager at
PacificInvestment Management Co. (PIMCO), signaled just such a
concern in anote to clients this past summer cautioning that "an
investor should continue to expect an attempted inflationary
solution in almost all developed economies over the next few years
and even decades," adding that "the cult of inflation may only have
just begun."
All this raises the question: What kinds ofinvestments should be
pursued in order to protect yourself (orhedge , as industry types
would say) against inflation? The answer is not what you would
expect. In fact, the speculative cushion some investors fall back
on may not be the answer.
Whenever the prospect of rising inflation rears its ugly head,
many investors reflexively turn to precious metals such as gold and
silver. Indeed, the move up in gold prices from $800 an ounce in
late 2008 to a recent $1,670 coincides with the more aggressive
steps taken by the Federal Reserve as "gold bugs " began to fret
about runaway prices.
But here's the problem: Gold is not really a hedge against
inflation -- it is only perceived to be. If and when inflation
starts to kick in, there's no clear-cut reason gold prices must
move higher. In fact, gold has suffered from major sell-offs in
past decades when inflation rose more slowly than had been
feared.
Still, inflation is corrosive. It eats away at thepresent value
of all assets. If you keepcash in the bank at a paltry 0.5%
interest rate but annual inflation moves up from a current 2% to
4.5%, then it's as if your banked cash is losing 4% of its value
every year.
That's why it pays to find investments that can hold their own
when inflation reappears. And finding these opportunities is
actually quite simple. You want to find any companies that have
thepricing power to adjust or the hard assets that tend to serve as
an inflation hedge.
Let's look at a few examples.
When it comes to making beer,
Anheuser-Busch InBev (
BUD
)
feels the effects of inflation. Virtually all of its costs go up,
from the raw ingredients such as barley, malt and hops to the fuel
used in delivery trucks. But beer makers simply pass on those
higher costs to customers and, as a result, have shown remarkably
steady operatingprofit margins in periods of both high and low
inflation.
Automakers have no such luxury. If they choose to raise prices,
then consumers may decide to stick with their existing vehicle a
bit longer or they may check out lower-priced products made by
foreign rivals. And thanks to a stream of government mandates
regarding safety and fuel efficiency, car making has never been
more complex or expensive. Still, car prices -- adjusted for the
content in each vehicle -- have in fact fallen in value in the past
decade on an inflation-adjustedbasis . So a period of rising
inflation may spell trouble on theprofit front for automakers. But
other investments adjust well with inflation.
You can extend this framework to virtually any industry. If
you're concerned about an imminent upturn in inflation, then focus
on companies that have proven pricing power. Providers ofconsumer
staples such as
Procter & Gamble (NYSE
: PG
)
and
Colgate-Palmolive (NYSE
: CG)
always raise prices when their costs go up.
Consider this as well: Consumers may not realize that one of the
greatest inflation hedges is already in their possession. I'm
talking about houses and condos. Sure, we saw neck-snapping plunges
in home prices over the past five years, though that was partially
a function of surging home prices in prior years. In the long haul,
home prices tend to track inflation. That's because the cost to
build a new home or repair an existing one always rises as the
costs of lumber, siding, plumbing, labor and other inputs rise.
In the early 1970s, a period of high inflation, my parents
bought a home for less than $80,000. A decade later, they sold that
same home for $225,000. They weren't savvyreal estate speculators,
just thebeneficiaries of high inflation that boosted their home's
price by a significant amount.
So there are ways to hedge against inflation. It's just a matter
of knowing where to look.
Action to Take -->
Few investors are thinking about inflation right now, but that
doesn'tmean we'll have low inflation and low interest rates for a
long time into the future. Indeed, prices may start to rise as soon
as the global economy picks up, perhaps in a year or two. At that
point, any slack in the global economy will have been eliminated,
creating bottlenecks in shipping and production -- which is often a
key precursor to higher inflation. That makes this a good time to
start reading up on the kinds of investments that will help protect
you against the corrosive effects of inflation.
This article originally appeared on InvestingAnswers.com:
High Inflation Is
Coming -- Here's How To Protect Your Wealth Now