One of the biggest investment debates of our times is whether we face inflation or deflation. In other words, whether prices of goods and services will rise or fall… and how that will impact on our investments.
In the wake of the financial collapse of the past two years, it’s been deflation that has been the major worry. Everything’s been falling in price. Your house has lost value, commodity prices have plummeted and stock markets have been smashed. Interest rates have been slashed and wages in many sectors have been falling too.
Put simply, inflation means prices and interest rates are rising. As they do, the pound in your pocket loses its purchasing power. Deflation is the opposite. Prices and interest rates fall, and the purchasing power of your money rises.
The thing to be aware of is that different sorts of investment will perform in different ways, depending on whether we get inflation or deflation…
If inflation wins out, then commodities like oil, gold and silver and the companies that are involved with them should do well. That’s because inflation will chip away at the dollar and other paper currencies, raising the value of real assets such as commodities.
And while inflation should be good for commodities, it will be bad for government bonds. That’s because they respond to interest-rate risk, and interest rates rise with inflation. In fact, every one-point uptick in inflation could lead to the value of bonds falling as much as 10%.
On the other hand, if we get deflation, commodities will likely suffer, and bonds will do well. So it’s important to get this right.
Falling prices will be a short-term problem
So where do we think the economy is heading? Well, we’re not through this recession yet and prices of goods and services, and wages, could continue to fall. This will be bad for asset prices generally.
However, we think this is a short-term problem. We believe inflation will be the biggest threat. That’s because, with interest rates near zero, and with governments pumping money into the system with their quantitative easing, it’s only a matter of time before people start spending and prices start rising again.
When inflation comes back, it’s going to come back hard and we need to protect ourselves from it now. We need to make sure that our wealth grows at a faster rate than inflation.
And right now, there aren’t many good choices for investors looking to hedge against the risk of higher inflation. As we’ve said here before, it’s really down to shares. They’re the best way to beat inflation and to grow your wealth over the long term. But we can be a little more specific…
One way to beat inflation is to own the “real assets” I mentioned earlier. Things like oil, silver and gold. It’s not easy to own physical oil, although you can bet on the price of it in the futures market or through spread betting. Given the volatility of this market, though, and the added risk of using leveraged instruments, we’re not recommending that.
It’s a little easier with gold and silver, which you can quite easily take delivery of in bars and coins, for example. And, of course, you can get exposure to the oil, gold and silver markets via exchange traded funds (ETFs) as well.
Here are some investment ideas to consider
But the other way is to combine the inflation-beating qualities of these commodities with those of listed company shares. My colleague, Chris Mayer, in our Baltimore office sent us some ideas he’s looking at:
“We prefer playing the commodities market through the stock market in order to protect yourself from inflation. I like owning energy fields, gold mines, water rights, and the producers of agricultural fertilizer. After suffering a big correction in 2008, these assets are cheap right now. They'll hold their value much better than your bank deposits during inflationary times.”
The kind of stocks Chris mentions which deal in tangible goods that cannot be easily reproduced should do very well in the coming years. And as a way to beat inflation, these are the areas to start looking at.
Remember, if the stimulus that governments around the world are providing to get the economy moving is successful, the additional money that has been created should trigger inflation. When consumers and investors become more confident and start spending and investing, then expect to see inflation come roaring back.
The best way to protect yourself from inflation will be to own carefully chosen stocks and to get some exposure to real assets.
Good investing,
Frank Hemsley
For The Right Side
P.S. Keep an eye out for my colleague Theo Casey’s latest inflation-beating strategy in The Fleet Street Letter.
MARKET NOTES
Dr. Copper’s booster shot from China
BY SHIVVY ARORA
Copper has bounced back by 70% from its lows in the past four months.
The red metal, popularly known as ‘Dr. Copper’, is often considered a vital indicator of the economy’s health. It tends to move with business cycles. So, when copper prices start to level off or increase, economists start to get excited.
However, copper’s recent surge doesn’t necessarily mean business conditions are improving. This time, its price movements have been caused by other factors, which we’ll explain in a moment.
Take a look at the chart below. It shows spot prices for copper over the past six months. Its price has been increasing through the first quarter of this year, and it has climbed by more than 40% since March this year.
Copper’s recent bout of strength has come from a string of upbeat data from China, which uses much more copper that it mines domestically. The superpower recently reported record copper import levels.
Copper’s five-month high may lead investors to view it as an early indicator of economic recovery. But ‘take caution’, says Melinda Peer of Forbes magazine. “China and its state run corporations are big buyers and they like to hoard for the long-term”, she advises. Deutsche Bank analyst Joel Crane agrees. He thinks China has been taking advantage of cheap prices to stock up on the metal.
A weak dollar and China’s re-stocking of copper supplies has helped copper sustain a higher price. But it remains to be seen whether the metal can continue a rally once this demand fades.
The Daily Reckoning – Perverting the economy
BY BILL BONNER
Buenos Aires, Argentina
Tuesday, 21 April 2009
Just got back from our trip to the ranch. (About which, more below...)
As near as we can tell, the financial world conveniently remained on hold while we were gone. As of Sunday night, little had changed. Gold, stocks... economists... politicians – they’re all about where we left them. That is to say, the bear market rally on Wall Street continued. The feds continued to pervert the economy with their bailouts. Economists continued to call a spade a petunia. And politicians and commentators continued to blab and bluster about nothing.
But yesterday, the rally on Wall Street got smacked in the chops. The Dow fell 289 points. Oil dropped to $45. Investors were selling stocks – mostly financials – and turning to the dollar and gold for safety. The dollar rose to $1.29 per euro. Gold returned to $887.
The most important fact still sits like an alien spaceship on the White House lawn – so monstrous and dumbfounding that people don’t know what to make of it... so they simply ignore it. The US government is spending $13 trillion – nearly an entire year’s output – to ‘fix’ the problems caused by the worldwide financial meltdown. Of course, they can’t actually fix anything. Companies that are losing money are still going to be losing money. Investors are still going to take losses on stocks and bonds that were overpriced. Bad debts are still bad. Bad investments are still bad. A kiss is still a kiss. A smile is still a smile. Time goes by just like it always did.
But this $13 trillion of extra spending is bound to have some big effect. What?
Read on…
To read the Daily Reckoning in full, click here.
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