How to Select Assets for Inflation

by: Anthony Davian

by Barbarian Capital

So let's chat about inflation, and investing for inflation (this blog is not investment advice).

If you listen to the eggheads, there are many ways to define "inflation." The more academic one is the increase in overall money supply (inclusive of credit). On the other hand, the esteemed Garage Logic University School of Economics defines inflation as the increase in the overall price levels, much like Yogi Berra's famous "a nickel ain't worth a dime anymore." There are quite a few shenanigans in the headline CPI number which I am not going to discuss here (substitutions and adjustments) so I personally keep track of my own inflation in different expense baskets. I recommend that you do that too: housing, food, transportation, utilities, sales tax, education, and others. You should track items that do not change across the years, such as a gallon of milk, gallon of gas, a NYC subway ride, price per kWh, tuition credit cost at the local school, men's haircut, whatever. Healthcare costs are a little trickier because it is difficult to assign values to coverage and deductible changes, but it is still a good idea to keep track of it. You can do it once a year, or twice a year, and compare your basket to the "official" CPI. I can almost guarantee you that you would be surprised.

So let's do a rundown of the more popular ways historically (or currently) for protection of your purchasing power. I will try to give a balanced view on each as there is no silver bullets (pun intended). Also please note that I am discussing a "manageable" inflation level (that is, no complete societal breakdown).

Gold: on the positive side, widely recognized as money. Durable material. No industrial (jewelry) demand above certain prices. On the flipside, it can be the ultimate "greater fool" trade. Once there is a belief that inflation will be controlled, the stampede for the exits will be ugly. Additionally, gold provides no current income. Having GLD is actually costing you (you read the prospectus like a good boy, right?).

Silver and Platinum: not dissimilar to gold but also have legitimate industrial uses that play a role in supply/demand.

TIPS: if the government determines the CPI to which its interest expense is indexed, what do you think are the incentives?

Foreign Bonds/Foreign TIPS: similar story here. No country will let its currency appreciate too much versus the other currencies.

Stocks: one has to be very, very careful. Some of the things to consider here are: discretionary vs. staples (and Coke is NOT a staple; neither are iTunes); capital structure (interest rates are rising in an inflationary environment so look at the debt maturities for refinancing risks, fixed vs. floating, and property-level/non-recourse); pricing power (lots of factors here); "hard" assets/general asset quality. Also pay attention to the commodity cycles: farm and energy will likely outperform base metals/other materials.

REITs: while "real estate" has been a good play traditionally (especially if they can pay debts in "old" dollars and charge rent in "new" dollars), pay attention to the refi risks. Some REITs (office, industrial) are heavily linked to the overall economy as well. Also beware of mortgage REITs with debt duration mismatch (if you pay floating and short but receive fixed and long during a rapid rise in rates, you're in a tough shape once the rates move up).

Residential RE: has been one of the trades of the century for people who bought in the early 1970s on fixed rate. My caution here is that too many people take the availability of mortgages for granted. The 30-year, fixed-rate is something rare globally and it will be very expensive/not available at high rates, so once your house is less leverageable than before, it loses "real" value. See what happened to RE prices in emerging markets once mortgages (a new product) appeared in the late '90s/early 00's: they shot up not based on productivity but based on people being able to pull forward 15-20-30 years of future income. This can reverse just as quickly.

Productive Land: again think whether current prices are influenced by leverage and productivity that cannot be sustained if fertilizer prices are too high. I think one of the safer plays.

Timberland: also a "classic", one can even choose the harvest timing over years. The issues there are (1) unlike prior inflation episodes since Gutenberg invented the press, pulp demand is in a secular downtrend, (2) new housing may not be coming back for years and (3) again, what happens if you try to exit when buyers have no access to credit.

Food, personal care, tobacco, alcohol, medical supplies, ammo, heating oil/wood/coal, useful stuff: good bets; works for bartering, too

Livestock: my bet is on poultry. Easy upkeep, small space needs, eggs without a "bull" unlike milk, and best feed-to-weight gain ratio. Goats and donkeys live long and are easy to keep though milking the latter is not recommended by farm experts. Farm ponds with carp are also good feed-to-weight investments.

1st Class Stamps: have been reflecting inflation well but (1) email has displaced mail and (2) the services will likely change (e.g. less delivery days) so the real "value" will be less.

Children: the timeless retirement plan. Cash-flow neutral by year 20-25. Some economies of scale and quantity discounts.

Disclosure: None