Inflation hedging: how to protect yourself against inflation
Since commodities are used as inputs for a wide range of industries, their prices can be taken as an indicator of expected inflation. If, for example, the demand for goods and services throughout the economy is high and firms bid on basic inputs, prices will rise.
Likewise, if shocks occur and raw material supplies are limited, their prices will also increase due to constant demand. In either case, a surge in commodity prices will likely precede a higher rate of inflation.
This price appreciation means that exposure to the commodities market can be a good hedge against inflation. For many investors, owning a real commodity like gold or oil is impossible – access through stocks in a commodity ETF may therefore be the most practical solution.
Commodity ETFs will either buy the commodity itself or buy securities such as stocks of companies related to commodities (such as mining companies or oil producers), or both. It depends on the particular fund. In addition, they can use derivatives such as futures or swaps to track the performance of a specific commodity, industry, sector or commodity index.
Other ETPs that provide exposure to commodities include Exchange Traded Notes (ETNs) and Exchange Traded Commodities (ETCs). ETNs and ETCs are debt instruments (as opposed to stocks) but can be bought and sold on an exchange like stock ETFs. Their main amounts – and therefore their prices – fluctuate according to the price of the commodity they are tracking.
Of all the commodities, gold is perhaps the most valued by seasoned investors as a safe haven. During times of high inflation, financial uncertainty, and currency devaluation, gold prices rise as demand for the precious metal increases.
For example, in mid-2020, amid fears over the continued economic impact of the coronavirus and further national lockdowns across the world, the spot price of gold hit $ 2,058.40 per troy ounce – a level never seen before.1 Additionally, the average price of gold in 2019 was $ 1,392.60, which rose to $ 1,769.64 at the end of 2020.2 This represents an annual increase of just over 27%.
While the gold market is accessed through the exchange traded products mentioned above, you may want to consider using derivatives like CFDs to speculate on its spot price, as well as the prices of futures contracts on gold. gold and gold options. As CFDs are available on stocks, holding the stock price of companies linked to gold is another way to gain exposure to the larger gold market during times of high inflation.
Learn more about trading or investing in gold
Well-diversified equity portfolios
The relationship between stocks and inflation is not straightforward, and each stock should be evaluated on its individual merits when it comes to developing a solid investment strategy. Having said that, a few guidelines can be mentioned.
In the long run, stocks reduce inflation.
The first concerns the duration of your investment. In the long run, a well-diversified equity portfolio can hedge against inflation, as companies have enough time to adjust their practices, prices and inputs to new conditions. This allows them to restore normal profit margins and real incomes (ie corrected for inflation).
In essence, once an appropriate period has been granted, businesses tend to pass the higher prices on to consumers who in turn can afford those prices as their own wages and salaries have also increased.
As shown in the chart below, inflation-adjusted returns of global equities have significantly outperformed savings accounts, UK gilts and 50/50 portfolios over a 15-year period, given the same initial investment amount.