Inflation Hedging: How to Protect Your Portfolio

Right now, the markets are caring about one thing: inflation. And they’re starting to get a little edgy. They need inflation hedging…

Why? The U.S. Treasury is printing money and dumping it into the financial system at historically unprecedented rates, in an effort to stimulate the economy.

Chances are good that the Fed won’t know when to stop the printing presses. Continuing to print money only exacerbates the inflation problem and deepens the hole.

And it’s quite a hole.

Jessica Hoversen, Fixed Income Analyst at MF Global, had this to say Thursday on CNBC: “The ratio of U.S. budget deficit to [gross domestic product] GDP is at the highest level since World War II.”

The government thought process goes something like, “If some stimulation is good, more will be even better.” And most politicians, who are always looking ahead to the next election, won’t want to risk their futures by cutting off ANY economic aid prematurely.

It goes on and on…

The real problem though, is that all of this economic over-stimulation sets us up for inflation. It’s something every investor should guard against in his or her portfolio. And it’s why we’ve got the best four investments for you to hedge against inflation’s impact.

The Tried and True Inflation Hedge - Gold

These days, many think of gold as a great investment for its safety and growth. And solely based on the amount of direct-mail advertisements I get from gold bugs, you’d think it was the only investment worth keeping.

But in fact, it really is an effective inflation hedge against a declining U.S. Dollar and an inflationary economy. It’s why every investor should have some exposure to gold in his or her portfolio. As part of our Asset Allocation Model, we recommend 5%.

For all its benefits, there are currently two problems with the physical metal: It’s in great demand - and therefore hard to get - and purchasing it requires a stiff premium - in some cases, 10% or more - when and if you do find bullion or coins to invest in.

A much better way is to pick up a few shares of SPDR Gold Trust ETF (NYSE:GLD), which seeks to replicate the price performance of gold bullion. Shares of GLD trade at the ratio of 10 shares to one ounce of gold.

This investment trust holds the physical metal for investors in vaults: You can see what those gold vaults looks like.

HSBC Bank (HBC) serves as the custodian of the trust’s physical gold, and recently had to move it to a larger vault to accommodate growing investment.

A Stand-Alone Inflation Hedge - Inflation-Adjusted Treasuries

Our next inflation hedge is inflation-adjusted Treasuries (TIPS). These investment bonds stand alone in the investment world, as they’re the only investment guaranteed to beat inflation.

Essentially, they are Treasury bonds that hedge against inflation - the bondholder gets an interest payment twice a year, just like a standard Treasury note.

But the catch here - and it’s a good one - is that the bond principal increases each year by the amount of the consumer price index (CPI). And so does the amount paid in interest, which is exempt from state and local (but not federal) taxes.

While the bonds themselves can be purchased directly from the U.S. Government or any broker, the easiest way to participate in them is through the iShares Barclays TIPS Bond Fund (AMEX:TIP).

This fund seeks to duplicate the return of the Barclays Capital U.S. Treasury Inflation Protected (TIP) Securities Index.

And while regular Treasuries have lost 3.9% (including interest payments) this year, TIPS have returned 3.6%. That’s a full 7.6% better return than Treasuries with the same amount of safety.

Hedging Against Inflation With Energy Stocks

Our third hedge against inflation is energy stocks because energy figures into the cost of just about everything. And since oil and natural gas are priced in dollars, an inflationary cycle tends to raise the price of energy and energy-related stocks.

Of course, even without inflation, the long-term trend for energy prices is one way: up. Inflation will just add fuel to an already burning fire (pun intended).

Rather than looking at individual energy stocks, however, consider a shotgun approach in the form of an energy exchange traded fund or ETF.

One we like for its low fees and solid performance is the Vanguard Energy ETF (NYSE:VDE), which seeks to replicate the performance of the Morgan Stanley U.S. Investable Market Energy Index. It’s up over 29% since its March low.

Made up of a diverse group of large, medium and small cap companies in the energy sector it provides wide ranging coverage of the sector. In addition, it includes companies such as drillers, equipment providers, exploration, refining marketing and production and transport of oil and gas products.

As I find energy and infrastructure some of the most interesting opportunities in the markets today, investing in energy companies allows us to easily align our hottest investing ideas alongside inflation protection.

A Final Inflation-Protection Hedge - Commodities

Our final inflation-protection hedge is in commodities like wheat, cattle, fertilizer, and base metals - all usually rise during inflationary periods.

Until recently, profiting from commodities involved commodities futures trading, something that most people know little about.

But now investors can leave the fancy and complex futures trading to the experts, and reap the benefits as commodities rise.

The Pimco Commodity RealReturn Strategy Fund [MUTF: PCRDX] invests in both leveraged and unleveraged commodity-linked index notes to match the return of the commodity futures markets.

The fund also uses other fix-income instruments like treasuries and preferred stocks to increase returns and lower the volatility that is commonly associated with investments in commodities.

Well, there you have it: four great ways to protect your portfolio against the coming inflation wave. In the coming weeks and months we’ll bring you additional ideas in these areas.

Regardless of how you do it, in the current environment, investors need to keep their eyes focused on inflation. And as the global economic engine shifts into higher gears it will likely become an even more significant factor.

Comments

[LKofScotland:]

perhaps it's a little odd to say "own food" since we all have to eat but the greatest hedge against THIS type of government mandated and greed oriented inflation is actual food. In other words, start a garden and buy a few chickens and maybe a cow while your at it. Most importantly don't be alone. Farming takes help from your neighbors and preferably a wife with hard working kids, not that anyone reads the bible or acts like Christians, let alone believes in actually keeping the family intact. Still, there's always the chance that there isn't someone like you in the world. Maybe you'll get lucky.

May 31 02:27 PM

[Prudent Man...:]

On May 31 10:50 AM Baboon wrote:

> REITs are good inflation hedge since the rents go higher with the
> rising inflation.

So do taxes, interest expense and vacancies. Ever manage a real estate investment and their tenants? A major headache.

May 31 03:16 PM

[hanumanhojo:]

Also have about emerging market mutual funds and ETF's? I believe they should be on the list of inflation hedges. The MSCI Emerging Market Index has been on an absolute tear lately with the weakening of the USD. Just graph that against the USD index.

Jun 01 12:30 AM

[gold33vain:]

Over the past 4 months, SILVER has out performed GOLD almost 2 X 1

SILVER is the "working man's" GOLD.

Stock up before it breaks $20. Dubai is setting up a SILVER ETF projected to open in late June. If indeed they back it 100% with PHYSICALS, the price will react upwards as they take more off the physicals market, which is very very THIN at this point.

Jun 01 01:29 AM

[gold33vain:]

We all have insurance for our CAR, LIFE, HOUSE, HEALTH

GOLD & SILVER are the "insurance" for THE DOLLAR !

Jun 01 01:34 AM

[tonny adamms:]

I would agree with Jonathan Christopher on many counts on what he has said.Equally valid points!

Jun 01 03:27 AM

[Danny Furman:]

Like gold33vain said, you can buy old US coins for less than the value of the silver in them. I have only found worthwhile deals on eBay, I'm curious what you're getting for below melt value at coin shows? I'm new to the precious market but a firm believer. Is it huge lots selling below spot? Just Roosevelt dimes and Washington quarters? In a year, when silver is $65/oz, will uncirculated coins from 1964 or Morgan coins from 1900 with equal silver content be worth more?


Thanks in advance for any responses.

Jun 01 08:00 AM

[Fat Charlie:]

The government attitude towards printing money is probably my fault. 40 years ago while performing maintenance on our armored personnel carrier in Berlin, our squad developed the General Theory of Lubrication, "if some is good, more is better." Apparently, the concept has spread since then:(

Charlie

Jun 01 12:33 PM

[Vox Rationalis:]

"The U.S. Treasury is printing money and dumping it into the financial system at historically unprecedented rates, in an effort to stimulate the economy. Chances are good that the Fed won’t know when to stop the printing presses."

First off, which is it, Treasury or the Fed?

But more importantly, are you aware that currency in circulation, that is currency outside of the Fed and Treasury, has increased less than 10% since August? Perhaps this rate (about 15% annualized) is unprecedented. But if it is to be feared, can you explain why?

Jun 01 01:03 PM

[gold33vain:]

Market trends CHANGE. Using $500. face (375.5 oz pure) as a base:

Jan 7 FUN Show Orlando 25-35% over melt ($11.25/oz spot price)

April 30, Cinti, Central States Conv. face 90% silver coins were selling for 10-15% over melt. ($12.50/oz spot price)

May 22 at the Pittsburgh Coin Show the trading range was 2% below melt to 1% over melt. ($14.60/oz spot price)

May 29 at Long Beach Coin Expo 3% below melt to melt . ($15.75/oz spot price)

Prices were for CASH payments. Check payment were slightly higher. No credit cards at these levels.

As you can see, as the price of silver escalated, the % droped. Larger quantities 1/2 to 1% less. Smaller quantities 1-3% higher.

Once the price has settled down and silver trades in a price range ...say $17.00... for 30-45 days, spreads will INCREASE as demand will go up as selling into the market will slows down creating more demand than supply.

Let's suppose silver climbs to $25./oz by December. Demand will will be greater than supplies and the spreads will increase to 10-15% maybe higher.

Prices for 1, 5, 10 &100oz bars/ingots are slightly higher than coin silver at this time.

NOW is the cheapest you will see spreads for the next few years!

Jun 01 02:12 PM

[gold33vain:]

For you gold buyers.

K Rands are now selling for $30. over melt...$25. over in quantity.

Jun 01 02:13 PM

[RiskReturnO...:]

DBA is good way to hedge for inflation. Volume is running at 2x-3x typical volume, price momentum is very strong, and the big money is finally noticing this as an alternative to hedging using GLD (gold), TBT (short US treasuries), and Oil (USO). Looks like someone is accumulating a lot of shares, perhaps hoping to capture some upside until the low 30's.

Jun 01 05:56 PM

[Baboon:]

What it has anything to do with the inflation? Managing a business is always a headache.


On May 31 03:16 PM Prudent Man CFA wrote:

>

Jun 01 06:51 PM

[Whippet:]

Thank you- great anecdotal data!
Curious- do you get soaked for state sales tax at these shows? Paying a 6% "commission" here in PA is obscene. Also- anyone know of dealers in the great state of Delaware?

On Jun 01 02:12 PM gold33vain wrote:

> Market trends CHANGE. Using $500. face (375.5 oz pure) as a base:
>
>
> Jan 7 FUN Show Orlando 25-35% over melt ($11.25/oz spot price)<br/>
>
> April 30, Cinti, Central States Conv. face 90% silver coins were
> selling for 10-15% over melt. ($12.50/oz spot price)
>
> May 22 at the Pittsburgh Coin Show the trading range was 2% below
> melt to 1% over melt. ($14.60/oz spot price)
>
> May 29 at Long Beach Coin Expo 3% below melt to melt . ($15.75/oz
> spot price)
>
> Prices were for CASH payments. Check payment were slightly higher.
> No credit cards at these levels.
>
> As you can see, as the price of silver escalated, the % droped.
> Larger quantities 1/2 to 1% less. Smaller quantities 1-3% higher.
>
>
> Once the price has settled down and silver trades in a price range
> ...say $17.00... for 30-45 days, spreads will INCREASE as demand
> will go up as selling into the market will slows down creating more
> demand than supply.
>
> Let's suppose silver climbs to $25./oz by December. Demand will
> will be greater than supplies and the spreads will increase to 10-15%
> maybe higher.
>
> Prices for 1, 5, 10 &amp;100oz bars/ingots are slightly higher than
> coin silver at this time.
>
> NOW is the cheapest you will see spreads for the next few years!

Jun 02 11:12 AM

[diogeron:]

All of this talk about inflation is premature, to be kind. There is no evidence whatsoever in the fundamentals that inflation is heating up. It may happen some day, but that day is certainly not here. A lot of the inflation talk is fueled by politics, criticism of the stimulus spending that didn't seem to bother some of the same people when the deficits were being created because of tax cuts for the wealthy.

Jun 02 11:13 AM

[gold33vain:]

PA has no sales tax on purchases of coins or bullion.

TX and other states have no sales tax on purchases over $1000.

Before going to a coin show, phone a dealer in that state to find out about sales tax laws.

Jun 02 11:44 AM

[gold33vain:]

First State Coin Dover 302-734-7776

Ask for RAY

Jun 02 11:47 AM

[Whippet:]

Excellent- thank you much!!


On Jun 02 11:47 AM gold33vain wrote:

> First State Coin Dover 302-734-7776
>
> Ask for RAY

Jun 02 12:35 PM

[Farmland In...:]

Another excellent inflation hedge - direct farmland investments. Jim Rogers is a big advocate of agriculture and farmland investments for two key reason - unimpaired fundamentals in the ag space (think “food, feed, fuel”) and returns that have a high positive correlation to inflation. Rogers is on the board of two farmland funds:

Agcapita (focusing on Canada)

Agrifirma (focusing on Brazil)

Jun 07 05:10 PM

[Stockpickin...:]

wow, thanks gold33vain, I am going to look into that!

Jun 27 02:12 PM