Though US inflation likely won’t be a problem until 2014 and beyond, it’s not too early for investors to start implementing long-term inflation hedges. But with so many possible inflation fighting investments out there, I continue to get lots of questions from clients and readers alike about the various protection strategies.
In the sixth of my ongoing series of posts dedicated to questions I receive, I’ve compiled some of these queries, along with my answers. You can check out earlier installments here.
Q: Is gold no longer an inflation hedge?
A: Gold certainly can be an inflation hedge, and it has worked in the past. Obviously, one of the reasons gold has been weak of late is that people are becoming less concerned about inflation. Now, I don’t think you want to have a huge allocation to gold unless you’re really, really concerned about inflation, and I’m not. But gold also does two other things, which make it worth having in the portfolio in small amounts:
- It’s diversifying as it behaves differently than paper assets.
- Exposure to gold is also a useful strategy to take advantage of the negative real-rate environment. Typically, gold is a beneficiary when real interest rates become negative as this lowers the opportunity cost of holding the metal.
Q: What’s your assessment of Treasury Inflation Protection Securities (TIPS)?
A: I’m not that enthusiastic about this asset class because TIPS are currently not cheap. In fact, in this environment the real return on a TIP, i.e. how much money an investor gets back after inflation – is actually negative. In other words, investors in TIPS are basically paying the government to give them back an inflation-linked principal amount at a certain date.
Q: What asset classes might investors consider if they’re worried about inflation?
A: Having inflation protection in a portfolio is incredibly important and there are cheaper ways to get that protection than TIPS. While there’s not one substitute for TIPS, there are other asset classes that do a good job of hedging against inflation that investors may want to consider. Within fixed income, floating-rate notes and bank loans that will reset as interest rates go higher are options. On the equity side, some of the natural resource companies, and particularly energy companies accessible through the iShares S&P Global Energy Sector Fund (IXC), can do a very good job of hedging against inflation. And right now, those companies offer a fairly generous yield 1 . Finally, though I advocate it be a small part of a portfolio, gold can be an effective inflation hedge over the long term.
The author is long IXC.
1. IXC Average Annual Total Returns as of 3/31/2013