Inflation Hedges

January 23, 2015

InnovationsAndRisingStockPricesInvestors’ nightmares tend to fall into two categories—portfolios relentlessly devalued by inflation, and portfolios destroyed by bear markets. With two nasty bear markets since 2000, one would expect bear markets to be the bigger worry, especially since the last double-digit inflation in the U.S. was in 1981, 33 years ago. Nevertheless, inflation fears are ever-present. The popular antidotes are commodity investments, including gold or oil, as hedges or real estate. The historical data offer a more nuanced story: Nothing works all the time, many things work some of the time and market crashes are a bigger problem.

Figures 1a and 1b show inflation rates and returns for selected asset classes over the last few decades. They present 10-year periods because inflation slowly and steadily shrinks the value of an investment portfolio and is best examined over long time frames. The tables also include two widely followed inflation measures—the Consumer Price Index (CPI) and the Producer Price Index (PPI). The latter has a much longer history but is less informative about typical consumer expenditures and incomes, although the two tell broadly similar stories. Three asset classes—commodities, housing and stocks—are possible candidates for inflation hedging and are represented in the tables. The commodity measures include the S&P GSCI—a broad-based commodity index—oil and gold. For oil and gold, the table compares the components of the S&P GSCI with the cash market. Figure 1b shows the change in the real, inflation-adjusted, prices of the asset classes. Large positive numbers mean inflation did no damage; extreme negative figures indicate losses in purchasing power. All numbers are annual rates

Commodities are thought to provide an inflation hedge because they represent real assets like metals, oil or agricultural commodities. Since investing in most commodities in cash markets, unlike stocks or bonds, involves storage costs, investing in futures contracts has obvious appeal. Positions in futures contracts are not equivalent to a position in the same commodity in the cash market, so it makes sense to consider both approaches.

 

 

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