In my previous post, we discussed the recent move by the FOMC to buy $300 Billion worth of long-dated treasuries along with $750 billion worth of agency obligations. “B-52 Ben” is flooding the economy with cash and the potential for an extremely inflationary environment is building. Please use the link above to view the background theory as today’s article deals more with the practical steps necessary to survive and even thrive in this environment.
So without further introduction, here are some portfolio steps you can take to build profits in the face of a falling dollar:
Inflation Strategy #1 - Own Hard Assets
The primary issue with inflation is not necessarily that “things” become more expensive, but that dollars essentially buy less. But if dollars become less and less valuable, then the primary storage of value can no longer be currency. During historical inflationary periods, the investors who came out the other side with significant value intact were those that invested in assets that could be stored, had long-term value, and could be easily exchanged.
Now of course gold fits that category, and is actually trading sharply higher on the most recent FOMC news. Precious metals certainly have their place in fighting inflation, but until the past few years, it has been hard for individual investors to participate. One of the best tools for small investors is the Spdr Gold Trust (NYSEARCA:GLD) which is an ETF whose performance corresponds to the price of gold bullion. You can buy this ETF just like any other stock in an IRA, investment account, and even in some 401(k)s. Similarly, the iShares Silver Trust (NYSEARCA:SLV) corresponds to the price of silver.
Precious metals are not the only investments that hold their value in an inflationary environment. I also expect the price of oil, natural gas, agricultural products, and other physical goods to increase. Now remember, the objective is to find situations that store value. This particular strategy is more about keeping your wealth than sharply increasing it. I’ve been impressed with the iShares products which include the North American Natural Resource Sector (BATS:IGE) as well as the Dow Jones Basic Materials Sector (NYSEARCA:IYM). Both of these ETFs have begun trading sharply higher with our market rally and even more-so with the announcement by the FOMC.
Inflation Strategy #2 - Inflation Protected Securities
There are several “inflation protected” vehicles which are usually indexed to the CPI (Consumer Price Index) or similar measures. These investments are typically a poor place to put capital into because they offer little real return and instead only protect against inflation. But during a time when inflation is expected to skyrocket, it may be worthwhile to place a conservative portion of your net worth in such securities to preserve the purchasing power of your nest egg.
A word of caution: Unfortunately, these vehicles may not always perform as well as might be expected - even in an inflationary environment. Treasury Inflation Protected Securities (or TIPS) are issued by the US treasury and offer returns indexed to inflation. But you can see that the government has a bit of a conflict of interest. Overstating inflation figures would mean that the government would have a larger liability to holders of these vehicles. Understating inflation obviously is in their best interest.
During 2007 and 2008, the economy experienced quite a bit of inflation from an individual consumers’ perspective. After all, gasoline was more than $4.00 per gallon, and prices of many important goods were higher due to the input prices to produce them. As a father of six, I definitely saw increases at the grocery and I’m sure you experienced a tighter budget as spending capital just didn’t go as far.
But according to government statistics, inflation was held largely at bay because of the common “ex food and energy” stipulation. The rationale was to exclude these items because they were volatile and could send wrong signals to the market. But last time I checked, food and energy were important parts of every consumer’s budget. So while inflation protected securities certainly offered investors some return during that period, they did not fully keep up with the increasing cost of living. This scenario could repeat itself in the coming years so use TIPS with a bit of skepticism.
Inflation Strategy #3 - Fundamentally Sound Growth Companies
They say that necessity breeds creativity - or is it innovation? or invention? You get the point… Many of tomorrow’s most successful growth companies are in the formative stages today and are making sound business decisions based on the economic environment that is evolving. As these companies thrive in the quarters to come (by investing their capital in attractive opportunities, managing balance sheet risk, and properly capitalizing their assets) they will offer us as investors a chance to build our wealth alongside.
Essentially, cash that is not actively put to work will systematically lose its value. This is true on your personal balance sheet, as well as the balance sheets of growth companies. Now some would make the argument that debt is a great tool in an inflationary environment because the real value of that debt burden diminishes, while the real value of certain assets remains constant. However, I think debt obligations should be managed carefully because inflationary environments almost always include significant rate increases which can be extremely damaging to highly leveraged companies.
But small growth companies with creative approaches to making money will not only hold their real value in this environment, but they will create actual gains as profits compound on top of the value of real assets. At ZachStocks, we will do our best to cover these attractive opportunities as they come public, or as companies make decisions to set up for profits in future quarters. Our daily posts should help you begin your research as you build a strong investment portfolio. The ZachStocks Growth Model offers a one-stop-shop for an actively managed portfolio of these growth stocks for you to implement.
Cash is No Longer an Option
If you have held a healthy cash balance over the past 9 to 12 months, let me be the first to congratulate you. Your wise aversion to risk has likely spared you significant losses. There is certainly a time for this type of approach and the last few quarters have rewarded conservative investors.
But it appears we are on the precipice of a new environment where for better or worse, risk aversion will not be rewarded. I don’t want to see you sitting on cash that is decreasing in value in the name of safety. There’s simply nothing safe about this strategy anymore.
So in the weeks and months ahead, I would encourage readers to put capital to work in various areas that will protect them against inflation. The United States will pull through this economic crisis. We will see commerce pick up once again, and jobs will be created. But unfortunately, inflation will be just as much of a danger as the previous economic recession was. Protect yourself, and put yourself in a position to succeed. After all, we never trade “not to lose”, but instead we need to “trade to win!”