Many people, on this site and others, have expressed concern about the Fed’s current policy of quantitative easing as well as the prospect of trillion dollar federal budget deficits as far as the eye can see. The fear is that these policies will ultimately lead to a best case scenario of rapid inflation and a loss of value in the dollar.
Given this reality, investors would be wise to take some steps to protect themselves in the face of a dollar decline. Here are a few ideas:
Invest in gold, silver, or other commodities
It cannot be denied that commodities have been on a complete tear recently. In the last decade, gold has soared almost 300%. Foodstuff commodities have nearly doubled in the last year while just about anyone who drives a car can see what oil has done since the Clinton administration. Commodities are valued in dollars and thus tend to increase in value, or at least maintain their real value, as the value of the dollar decreases. There are multiple reasons for this, but two stand out:
- Commodities are hard assets and have intrinsic value unlike paper dollars which can be printed at will. As more fiat dollars chase the same commodities, basic economics tells us that the price of the commodities will inevitably be pushed up.
- Speculators and investors are well aware of the long-term tendency of commodities to act as a hedge against a declining dollar and so will bid up the values of publicly-traded commodities when they predict future inflation (a decline in the value of the dollar).
There are several ways for investors to invest in commodities. Some, such as gold (GLD) and silver (SLV), have ETFs that can be purchased through your broker. Gold and silver can also be purchased as physical metals. Others, such as oil, have a large futures market (although oil ETFs are also available, they suffer from some problems for long-term investors). Alternatively, you could invest in a company that makes its profits from commodities such as ExxonMobil (XOM) or BHP Billiton (BHP).
Invest in foreign currencies
Another way to protect your money from a decline in the value of the dollar is to quite literally not have it in dollars! Fortunately, today it is easier than ever before to add foreign currencies to your portfolio. Rydex’s CurrencyShares, along with a few other ETF and ETN providers, offer a selection of foreign currency products that are designed to give investors an easy way to invest in foreign currencies.
This table summarizes a few of the foreign currency ETFs and ETNs available (click to enlarge):
It is worth noting that CYB does not directly hold the currency like the CurrencyShares ETFs do. Instead, the fund’s website states that CYB “seeks to achieve total returns reflective of both money market rates in China available to foreign investors and changes in value of the Chinese Yuan relative to the US dollar.” While it does not directly hold the currency, it is still an excellent way for investors to diversify away from the US dollar and into the Chinese yuan.
Foreign stocks that pay out their dividends in a foreign currency
Foreign stocks are another excellent way for an investor to hedge against a declining dollar. They offer many of the same benefits as foreign currencies as they earn their revenues (and profits) in something other than the US dollar. Thus, even if their profits remain stable in their home currency, they will increase when measured in US dollars (assuming that the dollar declined relative to the foreign currency). Ideally, however, you want to invest in a company that is growing its profits in its domestic currency as that will deliver both growth and protection against a declining dollar. Additionally, some of these companies pay their dividends in a foreign currency. For example, Statoil (STO) pays its dividend in Norwegian kroner and RWE (OTC:RWEOY) pays its dividend in euro.
Investors would be well served to have at least one or more of the above in their portfolio for diversification as well as to protect from a decline in the value of the dollar. As the risks on most of the assets listed above also have different risk profiles than American equities, they can also help protect investors from declines in the American markets. In particular, commodities historically have a negative correlation to the S&P 500 (although this has not been the case in recent years). The above should also help you preserve all that you have worked hard for in the face of inflation.
Disclosure: While I do not directly own any of the stocks listed above, I am heavily invested in a variety of commodities stocks. Additionally, I am long several funds which may own some of the above stocks.