The Federal Reserve stated that their major reason for not raising the federal funds rate at their meeting on September 17 was the inability of the economy to reach their inflation target of 2%. Further, the Federal Reserve stated that they would remain “accommodative” for the near term until inflation reached their 2% target. Adding to the case for increasing inflationary pressures is the ongoing quantitative easing by the Japanese Central Bank, and a possible increase in quantitative easing by the European Central Bank.
The eventual effect of these quantitative easing programs across the world will be increased inflation. As a global investor you should be ready to take advantage of the changing monetary environment by knowing which asset classes benefit from increasing inflation.
Historically, the best performing asset during inflationary periods has been oil. The U.S. saw the Consumer Price Index (CPI) more than double from 41.20 in early 1972 to 86.30 by 1986. During this time, oil prices rose from $3 per barrel to $40. We should note, however, that the 1973 oil crisis occurred during this time. Moving forward in time, it seems that the strong link between oil and the CPI has lessened. Consider the oil price run-up between 1999 and 2005, when oil prices rose from $16.56 to $50.04. During this same period, the CPI only rose from 164.30 to 196.80. The data suggests that oil is still the best way to hedge against inflation, but investors should be conscious of the relationship’s decaying strength.
Rare Metals (Gold, Silver, Platinum)
Gold, silver and platinum have historically performed well during times of inflation due to their ability to transfer wealth without the use of fiat currency. Inflation in the U.S. experienced extreme volatility during the 1940s and 1970s, and gold had a mixed performance. During the 1940s, gold’s value declined, while in the 1970s its value increased substantially.
While rare metals perform well during inflationary times, research suggests these metals are best used as protection against catastrophic events and their prices might wildly fluctuate during controlled inflationary environments.
Treasury Inflation-Protected Securities (TIPS)
Treasury Inflation-Protected Securities perform exactly as their name implies. In an increasing inflationary environment, TIPS outperform the market and vice-versa. The principal value of TIPS is linked to the CPI, which is the leading metric for tracking inflation. So when the CPI increases so does the value of TIPS.
The Bottom Line
For those able to take on more risk, commodity trading and broad-based metals tend to rise with inflation and could serve as another hedge to rising rates.
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